To liquidity and beyond: new funding strategies for UK pensions and insurance

Prompted by policy shifts and macro events, pension funds and insurance firms are seeking alternative solutions around funding and liquidity, say Lloyds Bank’s Anthony Vaughan, head of financial institutions solutions sales, and Ian Shaw, managing director, head of flow rates, financial institutions solutions and funding markets sales 

The UK pensions industry is navigating a new and complex landscape. Quantitative tightening, alongside changes to central bank emergency facilities, is starting to impact central bank money, while markets are pricing in further bank rate cuts, opening up the potential for schemes to distribute any surplus or move to buyout.  This has resulted in a continued slow grind that is higher in traditional repo funding levels (see figure 1).

At the same time, several recent macro events have led insurance companies and pension funds to prioritise liquidity risk. There is an increased focus on improving funding and diversifying liquidity sources, as many funds recognise they were too dependent on conventional and index-linked gilts. 

A broad range of solutions

While this backdrop poses challenges, it also creates opportunities. Many funds are looking afresh at alternative solutions around funding and liquidity, including structured repo transactions, and broadening the eligible collateral under their credit support annexes (CSAs) to create synthetic liquidity facilities. These approaches can cover day-to-day liquidity management, as well as managing the challenges associated with moving to buyout, a growing annuity fund or implementing asset strategies. These include:

• Corporate bond CSAs: Being able to post GBP and USD investment-grade (IG) bonds as collateral instead of cash or gilts significantly expands the pool of eligible assets. Transactions on corporate bond CSAs can be combined with equal and opposite transactions on other CSAs to create market-contingent liquidity facilities, tailored to kick in precisely when required.
• Committed repo facilities (government or corporate bond securities): These facilities ensure guaranteed access to the repo market on pre-agreed terms, using either gilts or IG corporate bonds.
• Gilt repo with corporate bond variation margin (VM): Instead of using cash or government bonds as collateral to cover daily market value changes in a derivative position, financial institutions can use corporate bonds as VM as part of a strategy to optimise collateral.
• Repo transactions with CSA-style collateral eligibility: Unlike a typical repo under the Global Master Repurchase Agreement (GMRA), CSA-style collateral offers greater flexibility in managing and substituting collateral, accommodating a broader range of assets and enabling active adjustments to market conditions.
• Long-dated gilt forwards to lock in elevated forward yields: Clients can lock into higher forward rates without paying cash up front, gaining rate exposure immediately while settling the gilt in up to 10 years.
• Corporate bond total return swaps (TRSs) to manage credit risk during exclusivity periods: When insurance companies buy in or buy out of pension schemes, they face exposure to credit spreads in the period between signing an agreement and the deal’s completion. Corporate bond TRSs allow them to manage that credit risk on an unfunded basis.
• Illiquid financing: Illiquid assets such as private credit can be used as collateral to facilitate funding.

Choosing the right partner

The range of options available in today’s rapidly evolving environment can sometimes seem overwhelming, but support is available.

“We offer a comprehensive solutions-orientated platform that crafts bespoke strategies to meet clients’ specific objectives while accommodating their individual constraints,” says Rob Hale, head of financial markets at Lloyds. “Our strength and scale in the flow rates and funding markets provide valuable insights into broader underlying themes that enable us to offer more complex solutions to our clients.”

As a long-standing counterparty in repo transactions for financial institutions, and as a leading gilt-edged market-maker and hedging counterparty in conventional and inflation-linked gilts and derivatives, Lloyds has a wealth of expertise and experience in pricing risk, which it puts to use in developing tailored solutions to individual client challenges. The bank looks to manage the market, liquidity and funding risks it assumes from insurance and pension fund clients by offsetting them against its significant corporate client business and its own lending activities. Crucially, all the teams work together closely to ensure clients receive the best solutions.

Lloyds has partnered with some of the UK’s top companies, delivering solutions that draw on the bank’s wide-ranging strengths and commitment to innovation. Examples include recent collaborations with insurance companies to fund their gilt and corporate bond holdings via repo for multiple years; analysing a client’s collateral positions in stressed environments and facilitating the use of corporate bonds as collateral for margin posting; and serving as the sole derivatives counterparty in a number of multibillion-pound bulk annuity transactions.

Lloyds stands ready to assist both new and existing clients in creating more diversified and sophisticated liquidity and funding solutions for schemes either in run-on or having moved to buyout. As liabilities continue to shift from pension funds to insurance companies, and funding costs rise further as funding schemes wind down, taking a proactive approach to identifying opportunities while conditions remain favourable is a prudent long-term strategy. Lloyds is also spearheading discussions with clients around innovations such as distributed ledger technology, which, for example, could facilitate the use of tokenised money-market funds as collateral.

While all reasonable care has been taken to ensure that the information in this article is accurate, no liability is accepted by Lloyds Bank for any loss or damage caused to any person relying on any statement or omission in this article. This article is produced for information only and should not be relied on as offering advice for any set of circumstances and specific advice should always be sought in each situation.

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