The LDI crisis

What is LDI?

Liability-driven investments (LDI) are a hedging product offered by investment banks to defined benefit (DB) pension schemes which uses a range of assets, such as derivatives and gilts (ie government-issued bonds), to construct a portfolio which is designed to move in a similar way to a DB scheme’s liabilities (including as a result of changes in interest rates and inflation) so as to minimise the risk of a funding shortfall and maintain good scheme liquidity levels.

Like other derivative products, LDIs may give rise to ‘margin calls’. The act of buying ‘on margin’ is where an investor, (eg a pension scheme) buys an asset (eg a derivative) but only pays a deposit (also known as the ‘initial margin’). This normally represents a few percent of the value of the contract. As the value of the contract changes (eg if the value of the underlying asset tracked by a derivative falls), additional payments may be requested (known as ‘variation margin' or ‘collateral’).

The LDI crisis

The government’s mini-budget of 23 September 2022 caused sharp price falls in the financial markets