Steven Taylor, chair of the Association of Consulting Actuaries, has called on the pension fund industry to renew their focus on systemic risks as liability-driven investments (LDI) evolve.
Speaking at an industry event yesterday, he said: “There seems little doubt that as a risk management tool, LDI has been very effective over the past decade and that, without it, the stresses on DB [defined benefit] funding levels, scheme sponsors, and potentially on member outcomes during that period could have been severe.”
He noted, however, that recent events have also been a “timely reminder that risk management steps must be continually assessed to make sure they stay fit for purpose”.
“In that light, I was pleased to see this week’s statement by TPR [The Pensions Regulator] and other regulators. This aligns well with our calls for increased collateral levels and, importantly, with measures that have already evolved naturally over recent weeks,” he added.
DB schemes are among the government’s largest creditors, he said, adding that it is no surprise that their combined behaviours can have system-wide effects, especially if prompted by unexpectedly bold policy changes.
“As schemes continue to mature, these challenges will need to be managed, but in doing so it will be vital to avoid knee-jerk reactions that could introduce new risks to the system,” Taylor continued.
According to LCP partner Jonathan Camfield, however, schemes will find this difficult to do in practice unless and until regulators collect detailed systematic data on how LDI arrangements are being used by schemes.
In this week’s letter from the Central Bank of Ireland, investment managers that run LDI funds were told that in working out appropriate capital buffers for LDI arrangements, they should take account not only of normal market fluctuations which would affect individual schemes, but also of the potential for “[…] second-round effects of actions taken by other market participants on the individual funds, for instance the market impact of asset disposals triggered by rising yields”.
However, as UK regulators have admitted, there is currently little system-wide information on the use by individual schemes of LDI strategies, nor of the level of capital ‘buffer’ built into such arrangements, LCP claimed. This makes it very hard for schemes to assess the extent of any potential ‘second round’ effects of using leveraged LDI, the firm added.
LCP is, therefore, calling on UK regulators to work together to fill this ‘information gap’, if these new regulatory instructions are to work effectively.
The firm is suggesting a three-pronged approach:
- TPR should use its existing information gathering powers, including, but not restricted to, annual scheme returns, to gather detailed data across the whole DB universe of patterns of use of LDI strategies – both pooled and segregated arrangements. This should not be a one-off exercise but should be a process of constant monitoring.
- The Financial Conduct Authority (FCA) should also gather real-time data on what is happening to LDI funds, also including both pooled and segregated funds.
- This data should be supplied to regulators, such as the FCA and the Bank of England, which have responsibility for ‘systemic’ risk; through them this data should be made appropriately available to pension schemes so that their assessment of any ‘systemic’ risk of adopting a leveraged LDI strategy can be made on an informed basis.
LCP’s Camfield, who has recently given evidence to two parliamentary committees looking into LDI issues, said: “Recent statements by regulators are welcome in setting out a clear framework for future decisions about the role of leveraged LDI in the strategy of individual pension schemes. We also agree that schemes now need to think about collective or ‘systemic’ risk. But we are concerned that they currently simply do not have the necessary information.”
He added: “Regulators with responsibility for systemic issues, such as the FCA and Bank of England, should work with The Pensions Regulator to collect, analyse, publish – and keep updated – detailed data on the use of leveraged LDI by all pension schemes. The FCA should also be gathering and appropriately sharing real-time information on what is happening in the LDI market. Without such information, schemes and individual managers can’t realistically assess the system-wide risks they may be exposed to.”
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