UK gilt market crisis leads regulators to dig deeper

Bank of England working paper underlines the importance of getting regulatory reporting right

The Bank of England’s recently released working paper ‘An anatomy of the 2022 gilt market crisis’ reminds us why regulatory reporting is so crucial to the healthy operation of the financial markets.

The paper, published in March, is a subject for further debate rather than a policy document. Nevertheless, the production of a 95-page document has clearly been prompted by a very keen interest.

A quick recap – what happened last year?

The Bank of England intervened on three separate occasions during September and October 2022 in order to maintain financial stability and prevent pension funds collapsing, following the Kwarteng/Truss ministerial statement, ‘The Growth Plan’ of 23 September 2022.

The paper’s author identified such extreme concentration in the liability driven investment (LDI) pension insurance industry that just 3 firms were accountable for 70% of UK gilts they were forced to sell to primary dealers in the eye of the storm.

Rapidly rising interest rates and inflation expectations at this time played havoc with the balance of assets and liabilities at these funds, particularly as real yields plummeted to new extreme negative levels.

The demands of future pensioners necessitate real, rather than nominal returns, i.e. pension funds need to be able to lock in a certain level of future spending power for their members, irrespective of the future path of inflation. When you discount future liabilities with ever more negative real yields, those liabilities grow alarmingly.

The LDI pension insurance industry faced the double whammy of significant bond market losses being compounded by margin calls on repo, inflation swap and OIS swap positions, meaning that they had to sell yet more gilts in order to cover these margin calls. Subsequently, the gilt market entered into something of a downward spiral, that it took BoE intervention to bring to a close. 

What does this mean for regulatory reporting?

On the first page of this working paper, the author places a quote prominently at the top of the page:

“It was not quite a Lehman moment. But it got close.”

(ref: Sep 2022, senior London-based banker).

One of the outcomes of the last financial crisis was the additional regulatory reporting obligations that were placed on firms to ensure that both prudential and conduct regulators had sufficient transparency of derivative markets, securities financing markets and greater transparency of securities markets.

This was achieved through the regulatory reporting regimes introduced post-crisis – EMIR, SFTR/MMSR/SMMD (financing & money markets) and a significant broadening of the MiFID transaction reporting requirements via MiFID II.

These obligations allow regulators to quantify and respond effectively to the macro-systemic risks around solvency, market stability and concentration risks.  The Bank of England has been able to use this data; MiFIR RTS 22 transaction reporting (UK government bond, inflation linked and conventional ‘gilt’ markets), EMIR reporting (inflation & OIS swaps, UK gilt futures) and Sterling Money Market Daily (SMMD) reporting (UK gilt repo market) to produce this.

Clearly, if the bank’s efforts were thwarted by low quality data stemming from firms’ transaction reports, the firms’ CEO and compliance officers would be the first to hear about it in no uncertain terms! Any reporting errors could lead to costly audits or investigations and potentially substantial fines and reputational damage. Firms need to ensure they have robust controls and procedures in place, including how accurately they report under these regimes.

• Read the full working paper on the Bank of England’s website
  
• If you have concerns about the quality of your transaction reporting under any of the regimes referenced in this blog or for a conversation with Jonathan Lee. Please contact us.