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Northern Trust, a large US custody bank, was overwhelmed by a slew of margin calls during the UK government bond market turmoil, hampering the ability of pension funds to raise cash, according to several people involved in the trades.
Processing hold-ups forced Northern Trust to redeploy staff from its US headquarters to help with the workload, according to two people with knowledge of the bank’s operations. Northern Trust acts as a depository for two of the biggest liability-driven investment managers caught up by the gilt sell-off, Legal & General Investment Management and Insight Investment.
UK pension funds were faced with sudden and escalating demands for cash following a steep sell-off in gilts after chancellor Kwasi Kwarteng’s ill-fated “mini” Budget on September 23.
This forced the schemes and their LDI managers, who use derivatives to help pension schemes manage risks stemming from long-term liabilities, into a rush for cash to meet margin calls, leading to further selling of gilts.
The Bank of England responded with a series of market interventions, including a gilt-buying programme that it has insisted publicly will end on Friday.
While the lack of liquidity in pension fund investment portfolios was the principal reason for the market volatility, these problems were intensified by processing backlogs at some of the custody banks that administer the assets.
“Aside from the liquidity risk issue, there was a huge human resources processing component,” said a senior banker involved in the trades, adding that Northern Trust’s manual processing was a key blockage in the system.
“They have diverted a lot of US resources to the UK over the past two weeks to deal with what is going to come next. That’s the sort of pre-work you would be seeing in this space. It makes sense.”
Another banking executive said: “Northern Trust are one of the biggest custodians in this market. They were overwhelmed with trade volumes, particularly for margin calls.”
Though often overlooked, custody banks provide a vital administrative function for investment funds, safekeeping their assets, settling trades, keeping records and exchanging currencies. Acting as depositories for funds, the banks are responsible for protecting investors’ interests, providing security for assets and liquidity.
Among the biggest global players are US banks BNY Mellon, State Street, JPMorgan and Citigroup.
An executive at a rival custody bank said Northern Trust used more manual processing than other players in the market, which predominantly use automated processing.
Another competitor said Northern Trust’s role as depository for two of the largest LDI managers created a concentration of stress on its operations.
Northern Trust, which is headquartered in Chicago, declined to comment.
The bank is being investigated by the UK’s Financial Conduct Authority as part of its two-year probe into the failings of former star fund manager Neil Woodford’s investment business.
Northern Trust was depository for the £3.7bn Woodford Equity Income fund, which closed in 2019 after Woodford got caught in a liquidity crisis of his own making, sparking the biggest UK investment scandal for a decade.
The FCA has been assessing whether Northern Trust did enough to keep in check the fund’s authorised corporate director, Link, which itself faces a fine of up to £306mn for its role in the fund’s collapse.
Additional reporting by Joshua Franklin in New York
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