Liquidity problems in the United Kingdom

A shortage of cash has caused English pension funds to run into difficulties, as they tend to fully hedge their interest rate risks. Could this happen to your pension fund?

What’s going on?
English pension funds usually hedge the full interest rate risk on their pension commitments with interest rate derivatives (mostly interest swaps). Collateral for these contracts is exchanged on a daily basis in the form of cash. 

Interest rates in the United Kingdom rose sharply in recent weeks. That was because the British prime minister, Liz Truss, was unable to sufficiently substantiate plans for tax cuts and economic support packages. She has now stepped down.

Interest rate hikes mean interest derivatives and bonds lose market value for pension funds. More collateral is needed to place these contracts with counterparties/ brokers. English pension funds were forced to generate cash by selling mostly long-term British sovereign bonds (gilts), which had in the meantime lost value. The sell-off led to a downward spiral of their value. 

The Bank of England has intervened by purchasing government bonds to restore stability on the bonds markets. The bond-buying programme was successful – interest rates have come down again and English pension funds are less challenged by cash deficits. 

Could this happen in the Netherlands?
Yes it could, but it isn't very likely. Dutch pension funds hedge their interest rate exposure too, but not fully like they do in the UK. Moreover, Dutch pension funds make less use of interest rate derivatives, so there is less daily exchange of collateral. Dutch pension funds such as NN CDC Pensioenfonds hedge their interest rate exposure mostly with European sovereign bonds, for instance those issued by the Netherlands and Germany. These are easier to sell than gilts, as the European bonds market is much larger than the British market. Dutch pension funds are major players on the European bonds market, but not as large as the British pension funds are in the United Kingdom.

What has your pension fund done?
NN CDC Pensioenfonds has been taking into account the worldwide rise of interest rates since last year, also because of the sharp rise of inflation. Since its incorporation, the pension fund has been hedging its interest rate exposure mostly with bonds. It uses interest rate swaps to a limited extent: in the past months the number of interest rate swaps was reduced from 7 to 3 (around 2% of the matching portfolio). The need for cash is small and has come down further as a result. 

Good news
Your pension fund has more than enough cash and enough easily disposable investments to meet its liquidity needs.  In other words, the pension fund does not have a shortage of cash.  The good news is also that the funding ratio has gone up this year due to rising interest rates. That's good for your pension accrual and the indexation of your pension. Read this article about our positive outlook.