The UK Gilt and LDI Crisis

UK defined-benefit pension funds owe retirees payments decades into the future, and to hedge that long-dated liability, many use liability-driven investment (LDI): they hold long-term government bonds (gilts) whose value rises and falls with the same interest-rate moves as their liabilities — see Liability-Driven Investment. To match a very long liability without tying up the fund's entire portfolio in gilts, many LDI managers used leverage: hold a smaller pool of gilts and derivatives that behaves, for hedging purposes, like a much larger one — see LDI Hedge Ratios and Leveraged Gilt Strategies. That leverage worked exactly as intended for years, until gilt yields moved further and faster than any recent scenario had modeled.

What happened

Date, 2022	Event
23 Sep	UK government announces large unfunded tax cuts ("mini-budget") without independent fiscal forecasts
23-27 Sep	Gilt yields spike; 30-year gilt yield rises over 1 percentage point in days, an extreme move for that market
27-28 Sep	LDI funds face collateral calls on their leveraged gilt positions; some forced to sell gilts to raise cash
28 Sep	Bank of England announces emergency, temporary purchases of long-dated gilts "to restore orderly market conditions"
28 Sep - 14 Oct	BoE buys gilts under the program; yields stabilize; the government reverses most of the tax measures

The mechanism

Leverage in LDI works through collateral: a leveraged gilt derivative position requires posting collateral, and if gilt prices fall (yields rise), the position loses value and the fund must post more collateral, usually within days. Pension funds mostly don't hold large cash buffers, so meeting a collateral call meant selling something fast, and the fastest asset to sell was gilts — the same asset whose price was already falling.

That created a feedback loop: falling gilt prices triggered collateral calls, forced gilt sales to meet those calls pushed gilt prices down further, which triggered more collateral calls. It is the same fire-sale spiral that appears in Margin Calls and Forced Liquidation generally, but here the asset being liquidated was the same asset the wider LDI industry was structurally short of. The Bank of England intervened not because the government's fiscal plans were the central bank's concern, but because a dysfunctional gilt market threatened financial stability broadly — pension funds are large, systemically important holders of gilts, and a further leg down risked more forced selling regardless of the tax policy's own merits. The 30-year gilt yield move over roughly a week was larger than most LDI risk models had ever stress-tested for; some funds' leverage had been calibrated to moves that had historically taken months, not days.

The lesson

A hedge and a liquidity risk are not the same thing, and a position can be a perfectly correct hedge on the liability side while still creating a forced-selling risk on the funding side if it's leveraged. The speed of the shock mattered as much as its size: a 1-percentage-point yield move over a year would have been manageable; over three days it broke collateral buffers across the industry, because those buffers were calibrated on how fast yields had moved historically, not on how fast they theoretically could. This is a leveraged, mechanical version of the correlated-shock problem behind The 2022 Rates Shock and the 60/40 Drawdown, where the same year's rate moves broke a different set of assumptions elsewhere in the market. For the regulatory response, see The 2022 UK Gilt LDI Crisis.