UK downgrade could impact LDI strategies, consultancy warns
UK – The recent downgrade of the UK's credit rating could impact collateral arrangements agreed by some of the country's pension funds, but will otherwise have little effect, Redington has said.
The consultancy's head of manager research Pete Drewienkiewicz said the impact of Moody's long-expected decision on Friday to downgrade the sovereign one notch to Aa1 would be "fairly limited" and noted that the country was still left with the longest average maturity profile – higher than both neighbouring France and the US at 15 years.
However, he warned that the downgrade could impact liability-driven investment (LDI) strategies put in place by some of the country's pension funds due to collateral requirements agreed with banks.
"We have seen some banks insert 'AAA-only' clauses into Credit Support Annexes (CSAs), meaning that Friday's move would have rendered Gilts ineligible to be posted as collateral against derivative trade mark-to-markets," Drewienkiewicz said.
Tom McCartan, associate within the manager research division, said the consultancy would "strongly recommend" against signing any such restrictive CSAs, as it would render the majority of assets a UK fund could use as collateral useless.
"Where there is no ratings restrictions on collateral, banks usually look for the compromise of stepped increases in haircuts," he told IPE.
"This means that if the UK does get downgraded further, you agree to increase the haircut, over-collateralising your mark to market position."
Asked whether the downgrade would otherwise impact investment strategies – specifically if any fund deeds would force trustees to reconsider their Gilt holdings – Aon Hewitt's Paul McGlone dismissed the notion out of hand.
"Most trustee rules are drafted sufficiently widely to enable an investment in a very wide range of assets," he said, noting that a number of deeds would date back as far as the 1950s and would likely only require trustees to invest in "marketable instruments".
"It certainly won't go as far as saying what makes them investment grade and what doesn't," he said.
"My gut feeling is that it really doesn't matter from a pension fund perspective."
He added that his "gut feeling" was that the downgrade would not matter greatly.
"We've seen Gilt prices and yields continue to move around – and every time Gilt yields twitch, it has implications for pensions," he said.
"Other than that, I don't anticipate the twitching is going to be substantially more than we've seen in recent months and years."