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Sean's avatar

Hi Lads. Some interesting facts I read this morning:

- during Liz Truss’s eight minute press conference on Friday, the 10 year swap rates moved 20bps. That’s over 2.5bps per minute!

- in the last two weeks, the UK had more than 30bps interest rate swings in one day, and USD to GBP FX rates moving more than 2.5% in a single day.

Extraordinary.

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Sean's avatar

Hi Lads. Thanks for the latest podcast

The pension industry discussion is boring to most but interesting to me. I found this article really good:

https://www.ft.com/content/6ca2ff89-e59b-4529-8448-4c09b27af480

The “search for yield” has been a huge pension issue. If all pensions were backed with “risk-free” government bonds, our pension pots wouldn’t be getting us very far at all. This is generally solved by taking on some risk, and that risk is credit and liquidity risk. Without it, we’d all be complaining.

For life insurers, there is massive business in buying out these old DB schemes. That may accelerate in the wake of the LDI crisis.

But life insurers are also tasked with this search for yield. An insurer is only competitive in this market if they’re backing these liabilities with highly illiquid assets, and there’s a bit of a race to the bottom on this. This approach is fine in theory if you can match the asset and liability payments exactly. In the EU and the UK, there is strong regulation around demonstrating you’ve done this.

But it is very hard to perfectly match the specifics of your liabilities with illiquids alone. By their nature they are infrequently traded, and the insurers have a very specific liability profile to match. So that’s where the derivatives are supposed to come in. Swap out risk free for durations you don’t want and buy into the durations you need. That’s how it’s supposed to work. But this derivative positions come with margin accounts and collateral that needs rebalancing with liquid assets.

A big challenge with markets moving so extreme so quickly. It is worth noting that insurers are technically supposed to be capitalised against 1-in-200 year events over a 12 month time horizon. But the interest rate rises since the beginning of the year are in the ballpark of that type of stress. We are witnessing a very extreme event this year.

All too often, those portfolios of illiquid assets are making their way offshore to countries like Bermuda, where reinsurers can take greater credit for those higher yields than is allowed by EU or UK regulators or have poorer liability matching rules. Yet their regulatory regimes are technically “equivalent” - go figure! This is a massive risk. In effect, there is a trend for all our pension money to end up offshore where regulations (or enforcement of them) are more relaxed, with more risks being taken with the money than our domestic regulators would allow. What could possibly go wrong with that?

By the way, for experienced financial professionals a job with the regulator would require a pay cut of around 50% in my opinion. But you often finish by 4pm on a Friday.

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