Bank of England releases detail on index-linked gilt purchases as LDI woes continue

Dan Barnes

The Bank of England (BoE) has said it continues to monitor developments in financial markets very closely in light of the significant asset repricing of recent weeks.

It has also been working with the UK authorities to “address risks to the resilience of Liability Driven Investment (LDI) funds arising from volatility in the long-dated government bond (gilt) market.”

On 28 September, the BoE announced it would make temporary and targeted purchases of gilts to help restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses. It plans to end these operations and cease all gilt purchases on Friday 14 October.

On 10 October, the BoE announced additional measures to support market functioning and an orderly end to its gilt purchase scheme. These included the launch of a Temporary Expanded Collateral Repo Facility (TECRF) through which banks would be able to help to ease liquidity pressures facing their client LDI funds through liquidity insurance operations, and the expansion of the scale of its remaining gilt purchase auctions.

The purpose of these operations is to enable LDI funds to address risks to their resilience from volatility in the long-dated gilt market. LDI funds have made substantial progress in doing so over the past week. However, the beginning of this week has seen a further significant repricing of UK government debt, particularly index-linked gilts. Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability.

Therefore the Bank has announced on 11 October that it will widen the scope of its daily gilt purchase operations also to include purchases of index-linked gilts. This enhancement to our operations will be in effect from 11 October 2022 until 14 October 2022 alongside the Bank’s existing daily conventional gilt purchase auctions.

The Bank is inviting market participants to offer to sell index-linked gilts in competitive reverse-auctions. Initially the size of each auction will be up to £5 billion. This will be kept under review each day in light of prevailing market conditions.

Reflecting the specific dynamics in the market for index-linked gilts, the Bank will set a minimum yield that will be applied to its temporary purchase operations for these index-linked gilts.

Initially, the Bank will not allocate any offers for index-linked gilts at real yields below the levels observed, as quoted by Tradeweb, at close of business on 10 October 2022.

In addition, the Bank is studying patterns of demand and intends to use reserve pricing in order to ensure the backstop nature of the scheme is delivered. In its auctions for index-linked gilts, the Bank would be likely to accept most offers above market mid-yields at the close of the auction, subject to competition within the auction and to the minimum yields described above. As confirmed in the 3 October 2022 Market Notice, the ‘reserve spread’ will be reviewed ahead of each auction to ensure consistency with the backstop nature of the scheme. In doing so, the Bank takes into account a wide range of information on prevailing market conditions and the pattern of demand in its auctions. More information on the Bank’s reserve pricing approach is available on the Bank’s website.

Timing and frequency of operations 

Auctions to purchase index-linked gilts will be conducted daily from 11 October 2022 to 14 October 2022, between 2.15pm and 2.45pm.

Auctions to purchase long dated conventional gilts will be conducted daily from 11 October 2022 to 14 October 2022, between 3.15pm and 3.45pm.

The auction schedule will be kept under review, and details of each auction will be confirmed by the Bank on its wire services pages at 9am. 

Eligible instruments in index-linked gilt purchases

The Bank will purchase index-linked gilts with a residual maturity of three years and above in the secondary market.  Index-linked gilts with an 8-month indexation lag will be excluded.

Eligible instruments will be subject to further exclusion criteria. In particular, the Bank will not offer to purchase index-linked gilts newly issued by the UK Debt Management Office (DMO) within one week of their issue; and will not offer to purchase index-linked gilts which the DMO has announced it will re-open, including via a mini-tender, during the one week before and after re-opening. 

In addition, the Bank does not intend to purchase index-linked gilts where it holds more than 70% of the free-float, i.e. the total amount in issue minus government holdings. 

Instrument eligibility will be kept under review. 

Auction parameters for index-linked gilt purchases

Auctions will be held using the Bank’s electronic tendering system, Btender. The Bank reserves the right, at its sole discretion, to restrict the number and/or the timing of offers submitted by counterparties who do not have access to Btender.

Counterparties must input the nominal sterling amount in millions for each specific index-linked gilt they wish to sell and the clean price they wish to offer.

The number of decimal places allowed for the price is currently 3. Offers are submitted by counterparties using a clean price.

The minimum offer amount and increment are currently set at £5 million and £1 million respectively.

The Bank will not restrict the maximum total value of index-linked gilts for purchase from a single counterparty in each auction.

The Bank reserves the right, at its sole discretion, to reject offers, in whole or in part, including in light of other offers received; and reserves the right, at its sole discretion, to set a minimum offer yield.

Offers will be allocated in descending yield order, based on the attractiveness of offers for different stocks relative to market yields, subject to the conditions mentioned above. Offers that are accepted at the lowest yield may be scaled down on a pro rata basis and will be rounded down to the nearest allocation increment, currently set at £0.1 million. 

Offers are accepted in full or in part at the counterparty’s offer price. The amount of each accepted offer in total proceeds will be paid to the counterparty.

These additional operations will act as a further backstop to restore orderly market conditions by temporarily absorbing selling of index-linked gilts in excess of market intermediation capacity. As with the conventional gilt purchase operations, these additional index-linked gilt purchases will be time-limited and fully indemnified by HM Treasury. The Bank has also consulted with the Debt Management Office.

As announced on 10 October, the Bank stands ready to purchase up to £10bn of gilts each day, of which up to £5bn will be allocated to long-dated conventional gilts and up to £5bn to index-linked gilts. The pricing of this additional operation will reflect its nature as a backstop and that this is not a monetary policy instrument. The total size of these auctions will be kept under review. All purchases will be unwound in a smooth and orderly fashion once risks to market functioning are judged to have subsided.

The Bank will temporarily pause its CBPS sales operations this week. Confirmation of these restarting will be included as part of the Bank’s regular operational announcements.