Key points:
- Legal and General shares are up 3.8% this morning
- This is on the back of an announcement about the gilts market and pensions funds
- LGEN is an advisor here, not a market participant with balance sheet risk
Legal and General Group (LON: LGEN) shares are up 3.8% this morning on the back of a trading announcement. The essential message is that the market turmoil of the past few days hasn't caused any problems for L&G. This despite LGEN being the major player in the specific part of the market that went haywire before the Bank of England intervention. This, perhaps, should not be all that much of a surprise given that the L&G share price didn't decline as if it was going to have significant problems from that market turmoil.
It's worth reminding ourselves what actually happened here. Because of Gordon Brown's insistence two decades back UK defined benefit pensions funds have to hold a lot of gilts. These give appalling returns – creating that captive market of buyers being the reason for the prices and also the policy – and so those gilts generally get used as collateral against loans. Which are then reinvested in higher yielding corporate debt. It would tend to be simpler for the pensions funds just to buy the corporates but there we are.
But using something with a changeable price as collateral has problems – like what happens when the price slumps? There are massive calls for cash collateral. If those aren't met then the underlying – the gilts – will be sold at distress prices. Which feeds the doom loop all over again just down another notch. The answer is BoE intervention, the market has stabilised.
But, and here's the connection with Legal and General, who is the major player in the market? That's LGEN.
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However, as L&G points out today that's not quite the whole story. Some outside estimates say the business is worth perhaps £80 million a year to LGEN. However:
“LGIM acts as an agent between our LDI clients and market counterparties and therefore has no balance sheet exposure.” The meaning of this is that sure, maybe the tactic might be used less in the future but the effects of past work can't cause losses. L&G collects fees here, not takes risks. Therefore market turmoil could affect future fees, but market moves don't then lose money.
Of course, L&G also runs insurance funds and they too could be caught up in the same sort of turmoil. As LGEN points out their capital ratio is such that they've not had any forced sales, they've been able to ride this turmoil just fine, thanks for asking.
In fact, things are better than that. As with many other financials, rising interest rates improve operating margins. So, L&G reiterates its insistence that this year will see revenue growth and capital generation. Far from the market turmoil causing problems, the more general background environment is going to be good for the group.
The really important part of this announcement is the reminder to the market that L&G is not a principal in these gilts and collateral call markets. It's an advisor, carrying no balance sheet risk.
