Illustration shows pound banknotes
Pound banknotes are seen in this illustration taken March 1, 2022. Reuters

Britain's financial regulators will work together to tighten rules for pension funds which use derivatives to insure themselves against big moves in bond markets, drawing on lessons from past crises, the Bank of England said on Wednesday.

The BoE said it would work with the Financial Conduct Authority and The Pensions Regulator to "ensure strengthened standards are put in place" on the use of liability-driven investment (LDI) strategies.

The FCA regulates asset managers who sell and run LDI strategies, while TPR regulates pension funds. The BoE oversees banks, some of which are part of the LDI chain.

LDI funds have come under severe stress since prices of British government bonds tumbled from the end of September following news of the government's 45 billion pound ($49.7 billion) package of unfunded tax cuts.

LDI is a popular product sold by asset managers to pension funds, using derivatives to help them match assets with liabilities so there is no risk of a shortfall in money to pay pensioners.

Pension funds struggled to come up with higher collateral calls to back the derivatives used in the strategy, forcing the BoE to intervene in the gilts market.

The BoE has given the pensions sector until Friday to come up with billions of pounds in liquidity to meet any future big increases in gilt yields after central bank support ends on that day.

FCA CEO Nikhil Rathi said lessons would be learned.

"What's really important right now is that everybody involved in this situation, the pension funds, the managers, the bank counterparties, really focus on the work they need to do in coming days to ensure there is resilience in the system," Rathi told reporters.

The BoE's Financial Policy Committee said on Wednesday in its quarterly update that vulnerabilities exposed by the "gilt market dysfunction" shared characteristics with other parts of the non-bank financial system already identified during the global financial crisis over a decade ago, and more recently.

In a 'dash for cash' in March 2020, when economies went into lockdowns to fight COVID-19, money market funds (MMF) struggled to meet redemption calls from investors.

The FPC signalled that policies already being drawn up and introduced for MMFs and other parts of the non-bank sector such as real estate funds could be applied to LDI strategies, including higher liquidity buffers.

Given many LDI funds are listed in Dublin or Luxembourg, the European Union would also need to make reforms to implement such requirements.

The BoE said it welcomed moves at a global level by the G20's Financial Stability Board, which is due to report on fresh regulation for non-banks later this year.

($1 = 0.9047 pounds)