The UK LDI Crisis, 2022

Pension funds hedged their risk correctly and still nearly failed — because being right at maturity does not pay a margin call on Wednesday.

What happened

  • Background — UK defined-benefit pension schemes owe payments decades out. To hedge the interest-rate risk of those liabilities they use leveraged gilt and swap positions, freeing capital for return-seeking assets. This is liability-driven investment, and it is sound in principle.
  • 23 September 2022 — the UK government announces large unfunded tax cuts. Gilt yields jump sharply; long-dated yields rise by around a hundred basis points within days.
  • Immediately — the hedges lose mark-to-market value and generate same-day variation margin calls. Funds sell gilts to raise the cash.
  • 26–28 September — that selling pushes yields higher, which triggers larger margin calls, which forces more selling. A textbook spiral.
  • 28 September — the Bank of England begins temporary long-dated gilt purchases explicitly for financial-stability reasons, ending the operation in mid-October.

The mechanism

Leverage compresses the distance between a market move and a forced exit. The hedge was correct; the liquidity to carry it was not there.
WipeoutMargin call3× leveredUnleveredUnderlying price moveEquity value
  • Variation margin is a liquidity demand, not a valuation. A position can be profitable at maturity and still require cash today (see margin & collateral).
  • The only sellable asset was the hedge's own underlying. Pension portfolios held gilts and illiquid private assets; raising cash quickly meant selling gilts — the very thing whose price was falling.
  • Everyone faced the same call at the same time, because the strategy was industry-standard. Crowding turned individually rational selling into a market-wide event.
  • No step was a mistake in isolation. Every action was contractually correct, which is what makes this a plumbing failure rather than a scandal.

What it teaches

  • Model the liquidity of your hedge, not just its correctness. The question is "can I fund the path?", not only "am I right at the end?"
  • Collateral waterfalls need pre-agreed, genuinely liquid buffers — sized for a move several times larger than the historical norm.
  • Leverage inside a "conservative" strategy is still leverage. The label describes the intention; the margin agreement describes the risk.
  • Central banks now treat market plumbing as a stability mandate — an intervention aimed at a spiral, not at the level of rates.