The Bank of England says $1 trillion could have been erased from UK pension funds' investments if it hadn't stepped in following budget turmoil

• The BoE's emergency bond buying stopped $1 trillion from being lost in pension funds' investments.
• It's top governor said liability-driven investment strategies could have been left with deep losses.

The Bank of England said $1 trillion in UK pension funds' investments could've been lost if it didn't intervene with its emergency bond purchasing program last week in the wake of turmoil stemming from the government's budget plans.

In a letter to the Treasury Select Committee viewed by Insider, deputy governor for financial stability Jon Cunliffe said concerns over liability-driven investment strategies popular with UK pension funds is what drove the central bank to take action.

"Had the Bank not intervened on Wednesday 28 September, a large number of pooled LDI funds would have been left with negative net asset value and would have faced shortfalls in the collateral posted to banking counterparties. [Defined benefit] pension fund investments in those pooled LDI funds would be worth zero," Cunliffe said.

Liability-driven investment strategies typically buy long-dated bonds and employ leverage in a bid to boost their returns so they can more confidently meet their future obligations. But with sudden jerks in the UK gilt market, that leverage comes with the risk of getting a margin call.

According to Cunliffe, there's over £1 trillion ($1.1 trillion) invested in liability-driven investment strategies among the country's pensions.

UK gilt yields recently soared, with the 30-year gilt yield climbing as high as 5.09%, it's highest level since 2002, triggered by UK Prime Minister Liz Truss' tax cut program to stimulate economic growth. That spurred the Bank of England to buy $72 billion in long-dated UK bonds to prevent a financial catastrophe and ease investor worries that lower taxes and more government spending will worsen inflation, which is already close to four-decade highs.

On Thursday, the 30-year gilt yield was up about 13 basis points, trading at 4.34%.

"If the LDI funds defaulted, the large quantity of gilts held as collateral by the banks that had lent to these funds would then potentially be sold on the market. This would amplify the stresses on the financial system and further impair the gilt market, which would in turn have forced other institutions to sell assets to raise liquidity and add to self-reinforcing falls in asset prices," Cunliffe said.

In other words, soaring gilt yields, accompanied by falling prices, means lenders could demand that bondholders post more collateral, forcing them to sell assets to meet the margin calls and subsequently adding further pressure on prices.