News & analysis


Brexit frontloading drives fall in hedging activity in the second quarter – investment banking survey


Interest rate and inflation hedging among UK pension schemes has fallen amid an increase in market volatility ahead of the Brexit deadline. Total interest rate hedging activity fell by 13% in the second quarter to £23.3bn while inflation hedging dropped by 14% to £19.4bn, according to a poll of investment bank trading desks conducted by BMO Global Asset Management. Rosa Fenwick, LDI portfolio manager at BMO, predicts that hedging activity could fall even further, as 10 year treasury yields dropped to record low levels in August. “Activity levels are likely sup- pressed due to pension schemes ‘frontloading’ planned hedging programmes prior to ‘Brexit date No.1’ at the end of the first quarter,” she added.


Yields on 10-year UK gilts fell below levels of two-year gilt yields, mirroring the inversion of the US yield curve earlier that month and investors expect rates to drop further as the Brexit rate approaches.


The slowdown of LDI ties into a broader trend of UK hedging activity slowing down, which Hymans Robertson predicted last year. The consultancy estimated that as of 2017, notional interest rate and inflation hedging already exceeded 75% of private sector defined benefit (DB) assets, which meant that the market had almost reached its peak. The decline in LDI coinciding with unabated buy-out activity is set to influence relative asset values. LDI accounts heading towards buy-out tend to hold gilts while the provider tends to switch out of gilts and into credit and inflation swaps. Consequently, there has been growing demand for SONIA-based (Ster- ling Overnight Interbank Average Rate) swaps, BMO says.


Bank of England governor Carney challenges dollar dominance


With the end of his stint as governor at the Bank of Eng- land in sight, Mark Carney used his annual Jackson Hole speech to attack the dominance of the dollar, warn- ing that it could lead to a global liquidity trap. Pulling no punches, Carney warned of a “destabilising asymmetry in the global financial system” and argued that the dominance of the dollar should be replaced by a multipolar currency system.


While the US economy accounts for only 15% of global trade, the dollar continues to hold a hegemonic position as global reserve currency. Carney warned that the defensive accumulation of the dollar by emerging economies fed into a “global savings glut” and a reduction of global cross border flows, with emerging market economies being disproportionally hit by the tightening of US monetary policy. He warned that defensive accumulation of dollar assets- by emerging economies had pushed down the global equilibrium interest rate, reducing central banks’ ability to respond to demand shocks and increasing the risk of a global liquidity trap.


These risks could be addressed by “changing the game” of the international monetary financial system by estab- lishing a more multipolar currency order. In the absence of the Renminbi becoming a second reserve currency, Carney advocated the establishment of a global electronic currency which could act as new hegemonic medium of exchange through a network of central bank digital currencies. Carney’s proposals were welcomed by Oli Rehn, mem- ber of the ECB’s governing council, who described it as “an idea worth pondering”.


Strikes loom as plunging gilt yields tear hole in USS’ funding level


The sharp fall in gilt yields has doubled university workers’ scheme USS’ funding deficit, fuelling renewed tensions between the scheme’s management and members. In a letter to Universities UK chief execu- tive Alistair Jarvis, USS chief executive Bill Galvin revealed that the funding hole for the scheme had almost doubled to £6.6bn, and that scheme member contributions would have to increase significantly to cover that gap. From October, scheme contributions are


set to rise to 9.6% from 8.8%, and to 11% as of 2021. Key drivers behind the funding shortfall were the fall in gilt levels and “volatility in financial markets” with adversities on equity markets combined with the uncer- tainty about future gilt yields leading to a more cautious investment outlook. The increase is set to spark another wave of strike action, after last years’ pensions dis- pute caused strikes among 64 universities across the UK. The Union demands a


8 | portfolio institutional | September 2019 | issue 86


maxmimum member’s contribution of 8% and is now gearing up for further strike actions with ballots due to close on the 30 October.


USS’ executives are already under pressure as the The Pensions Regulator (TPR) has expressed “grave concerns” over changes to the current valuation standards. Mike Birch, director of supervision at TPR, warned that planned contribution schedule included a 22% chance that total contribu- tion levels could increase above £40%.


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48