Can someone explain in laymans terms what is happening with the BOE/pension funds on Friday?

I asked earlier in thread,and no one answered: can LT not raise the money by hoiking a massive windfall tax at the energy companies?

cutting spending/raising taxes and interest rates will just stop all us plebs spending even more, making the recession bite deeper. This economic landscape wasn’t set by the populace overspending, it’s caused by energy prices rocketing, with energy companies’ profits also rocketing.

is this me being simple, I’m genuinely lost as to why this isn’t being done, so there must be a flaw in the idea?

I've not read all the thread yet but a big thank you to @Bookclub99 and @StatisticallyChallenged for such helpful posts so far. You rock !

www.resolveenergy.co.uk/blog/article/energy-companies-to-invest-windfall-profit

"Due to the high profits these energy companies have been earning over the past year many politicians, especially in the Labour party believe these companies should be subjected to a windfall tax. With Liz Truss announcing domestic and commercial energy support, the Labour leader believes these energy companies should be the ones to pay for this given their extra profits. However, Truss has insisted this will not be the case.

"Energy companies such as SSE have agreed with the new PM as they state they are investing at a record level into new energy infrastructure. If these companies were taxed, then it may slow down or stop the production of new energy plans that are going to help with energy security in the UK. Therefore given the importance of decarbonization and renewable energy in security for the UK many see a windfall tax as counter-intuitive for these companies."

That's what it says... probably has some truth to it.

And big thanks to other helpful posters like @Fenella123 who helped me understand why pension funds are in trouble.
And I'm liking "whoa Nellie"as a technical BoE term.


Pension funds have borrowed money and used Government bonds (aka gilts, basically chunks of debt) as security.
But, the bonds date from when interest rates were low. Interest rates and inflation are higher now, so buyers will pay less, now, for a bond that only pays (say) 1% interest.

The companies that lent the pension funds money have a bit in their agreement that says, "if the bonds you're using for security drop in value below such and such a price, you have to pay us money to make up for the fact that the 'security' is worth a lot less". Maybe the loan even gets called in in its entirety.

So where are the pension funds going to get that extra money from?

By selling some of the bonds they own...and so the prices of those bonds drop a bit more (the bond buyers know they NEED to sell, so will pay as little as they can).
So the remaining bonds they own drop a bit more in value and ooooohhhh look a nasty downward spiral right!there!

Bank of England goes, "whoa Nellie let's not see the Teachers' Pension Fund" (or whatevs) go bust" and starts buying bonds, which means the prices of those bonds go up, which puts a brake on that downward spiral.

When Labour were calling on this the second time I wondered why not and heard a spokesperson who covered key points

He was from here oeuk.org.uk/new-windfall-tax-proposals-risk-untold-damage-to-national-energy-security-warns-offshore-energies-uk/

Which is industry body aiming for sustainability

In essence I think an energy windfall tax just isn't that simple and could have lots of undesired consequences - further price increases as companies pass the impact of the tax on to consumers, reduction in investment, corporate restructuring to push profits offshore, etc.

Right now we need to be encouraging UK based energy production to try and increase our energy security, not discouraging it.

I haven't read the full details but if that article is correct and Labour have proposed retrospectively applying the tax that's generally not going to go down well with other industries either. If you were trying to decide where to invest to grow your business and there was a choice between countries and one of them had a record of retrospectively applying windfall taxes that might well sway you to go elsewhere.

They didn't put an energy tax on the industry, despite the ceo of both Shell and BP saying they should because they are cunts who would rather starve the poor and make the rich richer.

As a human being who is desperate to keep a roof over your head and food on the table, you will do anything. This includes working longer hours, accepting poorer working conditions and lower living standards.

Alongside the mortgage rates going up and fuel cost rises, they are introducing free ports and free zones where the rules (on things like employment rights, health and safety, building regs, minimum wage) can be ignored.

Instead of using Brexit to drive standards up, the government is using it to drive standards down. Failing to introduce an oil tax helps their aim on this.

LDI in itself is a perfectly sensible approach. The problem is that you've got a large number of schemes all heavily exposed to price movements in the same small group of assets (because they're the only options which really provide the required matching) and in many cases taking a leveraged position in these because they're in deficit. That's created a massive systematic risk in that a market shock (the mini budget, mostly) has had such a bit impact across a number of schemes.

This is a mistake that keeps being made in different guises but isn't necessarily the fault of any specific individual

I didn't say investment advisors / managers should be sued. Nor do I think all pension funds are in a huge mess (although some clearly are). I understand, too, the aims of LDI and know how and why it is used to manage risk. However, clearly, some LDI strategies were using too much leverage. Otherwise they wouldn't be scrambling to meet margin calls and dumping all sorts of assets on the market - not just Gilts and linkers, but corporate bonds, CLOs and shares. Nor would the BoE have had to intervene to prevent a disorderly unwind. I know the so-called mini budget was crazy and caused interest rate rises to happen much faster than expected (over several days/weeks versus months/years), but portfolios should be stress tested and managed conservatively so they can weather extreme conditions. So, while I agree the circumstances are crazy, LDI managers and pension fund trustees are somewhat culpable, as they should have been more alive to the risks posed by rising rates and leverage.

I think it's interesting that Oxford, Cambridge and Imperial were alive to these risks and wrote a letter to the USS expressing their concerns about an increase in the allocation to LDI earlier this year: www.staff.admin.cam.ac.uk/system/files/download/galvin_bill_-uss-_21_february_202296apg_final_investment_letter.pdf

Basically, no one is without fault. With the benefit of hindsight, the BoE should have moved earlier and been more hawkish in its attempt to tackle inflation. The LDI managers should have managed their portfolios more conservatively in a rising interest rate environment. However, the current government is undoubtedly most at fault for launching a bizarre and extremely ill-advised inflationary fiscal stimulus package against a stagflation backdrop.

I agree with @StatisticallyChallenged that what happened with LDI isn't the fault of one individual. There was systemic risk there. Some LDI managers could have been more alive to that risk and stress tested their portfolios more rigorously given the potential volatility of the assets (especially very long dated assets) and amounts of leverage involved.

"Energy companies such as SSE have agreed with the new PM as they state they are investing at a record level into new energy infrastructure. If these companies were taxed, then it may slow down or stop the production of new energy plans that are going to help with energy security in the UK. Therefore given the importance of decarbonization and renewable energy in security for the UK many see a windfall tax as counter-intuitive for these companies"

That's what it says... probably has some truth to it

Two things:
the rest of europe is introducing WFT's yet these very same countries/companies are investing in Green projects.

So without Putins war (subsequent v high profits) none of this pre announced investment would have occurred?

Really??

Industry body tied in with energy companies argues against wind fall taxes... who'd have thought!!!???

Companies invest in these sorts of schemes for a good return in the long term, not because they have made a lot of money in a specific time period, which end as quickly as it arose.

I think the regulators probably need to take a long hard look in the mirror, again. I've got lots of knowledge about the modelling side of things but my regulatory knowledge is more on the insurance side so I don't have the same view of the internal workings for pensions. But on the insurance side the regulators are all over the inner workings of stress testing models.

It kind of looks, to me, like a chronic underestimation of the volatility of interest rates especially in the tails of the distributions. I think that for most modelling the sort of movement we have seen would actually have been quite an extreme stress test because it has happened so quickly.

Looking back at modelling from 6 months ago is interesting.

Looks like the tax rate may change back to 20p. Good imo apparently it’s the most expensive part of the mini budget - bar the energy help not sure

Very interesting. Reminds me of a movie Margin Call I think where they realise the models show stress

I think pensions investment has always been less driven to/by excess than banking and obviously that move took characters and ran with them, and took complexities and simplified them way down. But there's definitely some parallels with that (and with the financial crisis).

My gut feel is that I don't think the contagion is as bad this time around; interest rate derivatives are (IMO) much simpler products and the underlying assets have a good fundamental value whereas when the housing bubble popped some of the ABS were fundamentally worthless. I don't think there is any real expectation that the UK will default, it's just that rising rates make our old, lower interest debt worth less than it was and that is an important difference. The various asset back securities which lay at the heart of the financial crisis were in many cases shit-rolled-in-AAA-glitter. There's also not the same opacity with repos/other interest rate derivatives, and we've got ring fencing in place now.

That's not to say that overall we don't have a massive economic mess on our hands - just comparing LDI to the ABS mess. We didn't learn enough, but I think we did learn something

For reasons I don't entirely understand, I am quietly comforted by the last few posts. I'm not an accountant or actuary or an investment professional, but I worked in a related field and generally think I have a decent grasp on the basics. So someone saying we have a massive economic mess, but we think we know how it should unwind, if politicians are sensible, is good. But I also know that I am just hitting pension age, my mortgage is paid off and I have a DC who has yet to face all these issues.

@XingMing stuff goes up and down, it's good to take a long-term view and balance allowing for these events with not being too spooked.
Having emerged from a negative equity disaster aged 30 with £0 and starting from there, I still managed to retire mid-50s. Some luck there, obviously!, BUT if I hadn't been spooked by the Maxwell pension scandal into opting out of a DB pension for 5 years I'd be significantly better off in retirement. Oh well too late now!

The only question now is: how long has Truss got?

I give her to the middle of next week. If you're a Tory MP you're likely to lose your job at the next General Election unless Liz goes. The MPs will strong arm her into falling on her sword, I think, and then have Rishi crowned as leader with no other contenders (to avoid a leadership race). That's the best chance they have at winning a GE and keeping their jobs. Everyone loves Rishi. He rode to the rescue with the furlough scheme and gave everyone free restaurant meals during Covid!

Yes I am very smug right now. I was only out by a day on the Truss resignation and right about how it would come about. The only question now is whether I'm also right about Rishi... see you back here in a week's time to find out. 🙂

Nice Book

Next up - Rishi or Boris?

or other

Will they crown Rishi, or be reluctant to waste a decent candidate when the polls are so dire...

If Boris throws his hat in the ring, they might have him back and save Rishi for the next round. Who knows?

But please can you give us a heads up on any big bets you're placing @Bookclub99 ?

@StatisticallyChallenged @MarshaBradyo

From Rishi's point of view, he's got a very decent shot at PM now at the age of 42. If he doesn't go for it, it's unlikely to be an option for him again, or certainly not for many years (potentially a decade or longer if we end up with a two-term Labour government). I can't see him turning down the opportunity, especially as there is a chance (albeit a very small one) that he becomes a Tory legend a la Thatcher if he unites the Tory Party, restores its credibility and wins the next GE.

From the Tory MPs' point of view, Rishi is one of the most popular Tory politicians from the general public's perspective, despite his connection with BoJo, plus the latest polling says he is also now the Tory Party members' preferred leader. I mean, Rishi is the guy behind the extremely popular furlough scheme and "eat out to help out" initiative. Not only that, he slagged off Truss's plan for the economy and has been vindicated in the most spectacular fashion. Basically, if you're a Tory MP, Rishi is your best shot at keeping your job in the next GE. Tory MPs don't give a shit about preserving their best candidates for the future when the Tory Party is in less of popularity slump. They want to protect their jobs in the here and now. They'll want to crown the very best candidate they have. And that's not Penny Mordaunt or BoJo.

Given Rishi likely wants the job and Tory MPs likely want to give it to him, he is SURELY the most logical replacement for Truss. I might be missing something, but I can't see a better option. So, I'm expecting a Rishi coronation next week.

@XingMing On big bets, I think the time to place those has probably passed. The markets must already be pricing in dishy Rishi as our next PM, which must be good for Gilts and Sterling. The time to buy Gilts was when the pension funds were in the eye of the storm. I never place big bets anyway, although I couldn't resist a little nibble at the 2052 and 2061 Gilts last Friday🙂... so far so good, but who the hell knows what's going to happen from here. I never trust my predictions for the future. I would have told you there was no chance of Brexit or Trump, for example! 😂

I think Rishi gets it by a mile, simply by looking the most suitable, and whisper, the least likely to frighten the markets. Face it, the Tories have a track record for not choosing the best candidates for PM... how did they not pick Ken Clarke has always puzzled me (europe is the answer). He was Chancellor in the mid 90s after Black Wednesday and rebuilt the economy a brick at a time, and handed it over in time for Blair and Brown to preside over a brief but glorious public spend, and even then, they let it out of control, mostly via costly public financing initiatives for much-needed improvement to public services. American style municipal financing long term infrastructure bonds would have been a much bettter option, for both the public and investors.