Liability-driven investment
An approach that takes the liability rather than a market index as its benchmark; run through derivatives, it creates a permanent liquidity need.
After the UK fiscal announcement of September 23, 2022, gilt yields spiked, and pension schemes running LDI had to sell assets to meet collateral calls. On September 28, the Bank of England launched a temporary purchase program to break the spiral. Liability-driven investment measures the portfolio against the liabilities rather than an index: a pension scheme or life insurer wants its assets to move with its debts when rates move. Getting that sensitivity from physical bonds would tie up almost the whole portfolio, hence interest rate and inflation swaps and repo, which deliver the required duration while committing only a fraction of the capital. That efficiency is paid for in collateral. A sharp rise in rates improves the scheme's economic position, since the value of the liabilities falls, and in the same move creates an immediate cash need. The structure holds on substance and breaks on liquidity, which a funding ratio does not show. Since 2022, supervisors have measured hedging and resilience to a collateral shock separately.
In September 2022, the sharp rise in UK government bond yields after the September 23 fiscal announcement forced pension schemes using these strategies to sell assets to meet collateral calls. The Bank of England intervened on September 28, 2022, with a temporary purchase program to break the spiral.
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