How Britain’s Bond Market Almost Toppled

○ Pension funds use derivatives to reduce risk—but the strategy backfired when interest rates spiked

- Pat Regnier

Mike Johnson, a partner in the pension and risk consulting firm Hyman Robertson LLP, was on the phone with a client on Sept. 23, casually looking at the price of British government bonds—known as gilts—on his computer screen, when a sharp, sudden decline in prices made him sit up. The move came as the UK’s new government was announcing an unorthodox plan to borrow vast sums of money to reduce taxes. Johnson immediately understood that the shock could set off a sustained wave of selling as investors—including his client—scrambled to meet calls for more collateral. He and his client drafted an email to the Bank of England warning of a gilt market meltdown.

At a time when Britain’s economic outlook was already grim, the government’s plan spooked markets, tanked the pound, and unleashed a chaotic 48 hours that forced the BOE to spend billions buying bonds. After several days of public outcry, the government decided to cancel one of its most controversial tax cuts.

The turmoil revealed something that many had failed to realize: The government bond market was far more fragile than it had appeared.