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© 2023 International Monetary Fund
WP/23/210
IMF Working Paper
European Department
Putting Out the NBFire:
Lessons from the UK’s Liability-Driven Investment (LDI) Crisis
Prepared by Ruo Chen and Esti Kemp1
Authorized for distribution by S Ali Abbas
September 2023
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
ABSTRACT: Liability Driven Investment (LDI) funds were at the center of the severe stress that emerged in the UK gilt market in the aftermath of the September 2022 UK “mini-budget”. The episode, which came on the heels of the “Dash for Cash” and “Archegos” stress episodes in the previous two years, highlights underlying vulnerabilities in the large and diverse non-bank financial institution (NBFI) sector. This paper seeks a deeper understanding of the factors that amplified the gilt market turmoil which ultimately led the Bank of England (BoE) to undertake temporary gilt purchases on financial stability grounds in late September/early October 2022 to restore orderly market conditions and enable LDI funds to build their capital positions. With the gilt market stress and the BoE’s purchases now fully unwound, this paper identifies the key reasons for the success of the BoE’s intervention. Then, drawing also on findings of the 2022 UK Financial Sector Assessment Program (FSAP), the paper discusses key gaps and policy issues related to the monitoring of financial stability risks in the broader NBFI sector for both individual jurisdictions and international standard-setting bodies.
RECOMMENDED CITATION: Ruo Chen and Esti Kemp, “Putting Out the NBFire: Lessons from the UK’s Liability-Driven Investment (LDI) Crisis,” IMF Working Papers 2023/210 (Washington: International Monetary Fund).
| JEL Classification Numbers: | E43, E44, G18, G23 |
| Keywords: | Defined benefit pension funds; liability driven investment; NBFIs; Bank of England financial stability intervention; liquidity management; central bank liquidity backstops; NBFI surveillance; financial stability |
| Author’s E-Mail Address: | rchen@imf.org, ekemp@imf.org |
| JEL Classification Numbers: | E43, E44, G18, G23 |
| Keywords: | Defined benefit pension funds; liability driven investment; NBFIs; Bank of England financial stability intervention; liquidity management; central bank liquidity backstops; NBFI surveillance; financial stability |
| Author’s E-Mail Address: | rchen@imf.org, ekemp@imf.org |
Title Page
WORKING PAPERS
Putting Out the NBFire:
Lessons from the UK’s Liability-Driven Investment (LDI) Crisis
Prepared by Ruo Chen and Esti Kemp
Contents
GLOSSARY
1. INTRODUCTION
2. THE LEAD-UP TO THE LDI CRISIS
3. THE LDI CRISIS AND THE BANK OF ENGLAND’S FINANCIAL STABILITY INTERVENTION
3.A The Unfolding of the LDI Crisis
3.B The Bank of England’s Financial Stability Intervention
4. KEY TAKEAWAYS
4.A Regulatory and Information Gaps
4.B NBFIs’ Liquidity Management and Oversight of Leverage
4.C Central Bank Liquidity Backstops fot Systemic NBFIs
4.D Overall Surveillance of the NBFI Sector
5. CONCLUDING POINTS
REFERENCES
Glossary
| AIFMD | Alternative Investment Fund Manager Directive |
| BCBS | Basel Committee on Banking Supervision |
| BoE | Bank of England |
| CCP | Central counterparties |
| CRE | Commercial real estate |
| DB | Defined benefits |
| DC | Defined contribution |
| ETF | Exchange-traded fund |
| ESRB | European Systemic Risk Board |
| FCA | Financial Conduct Authority |
| FSAP | Financial sector assessment program |
| FSB | Financial Stability Board |
| LDI | Liability driven investment |
| LME | London Metal Exchange |
| LMT | Liquidity management tool |
| MMF | Money market fund |
| MPC | Monetary policy committee |
| NBFI | Non-bank financial institution |
| OBR | Office for Budget Responsibility |
| OTC | Over the counter |
| PRA | Prudential Regulation Authority |
| SME | Small and medium-sized enterprise |
| SWES | system-wide exploratory scenario |
| TECRF | Temporary expanded collateral repo facility |
| TPR | The Pension Regulator |
The authors would like to thank Ali Abbas and Laura Pappi for their suggestions and support for this paper. They are grateful for useful comments from the Bank of England, the Financial Conduct Authority, HM Treasury, the Pension Regulator, and major market players.