Some UK pension schemes are being forced to try and meet large (and immediate) margin calls, of up to £100 million, on the interest rate derivatives and asset swaps they hold as part of their liability driven investment (LDI) strategies. This follows the recent sharp falls in the value of gilts and sterling which have seen mark-to-market valuations on derivatives and leveraged repurchase (repo) positions move significantly against some schemes. Some schemes are also being asked to post additional collateral against foreign exchange derivatives used to hedge US dollar assets due to the decline in sterling.

10-year UK government bond yields have increased significantly in the past few days. This, combined with a large drop in the sterling/US dollar FX rate, exposes relevant schemes to market risk as the values of these positions have moved against them.

Pension schemes may be required to provide additional collateral in very short order to avoid the risk of hedges being unwound and losses crystallised.

Schemes require access to liquid assets to meet the margin calls and some may call on their scheme's sponsor for short-term funding support. Trustees in this position will need to:

  • ensure they have the power under their scheme's trust deed and rules to enter into any such loan agreement
  • be mindful of any restrictions which prevent such support, including legislative and regulatory limitations and any restrictions contained in their scheme's rules, and
  • consider how any such support payments will be treated from a tax perspective.

Schemes which cannot access sufficient liquidity face the risk of closing out positions and (ultimately) default termination.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.