The UK’s pensions minister told parliamentarians this morning that despite the pension fund investment losses and systemic near-disaster of the liability-driven investment (LDI) crisis last September, LDI had been a successful tool that was still useful for defined benefit (DB) pension schemes.

Laura Trott, UK minister for pensions, and Andrew Griffith, economic secretary to the treasury, gave evidence to the House of Commons Work and Pensions Committee and the House of Lords Industry and Regulators Committee at their joint parliamentary session this morning, as part of the country’s continuing probe into the LDI incident.

Trott said that while there had been a number of problems with the use of LDI by DB schemes, “I do think it was successful in that aim of improving scheme funding performance.”

She added: “It still remains the case that LDI has a useful place in the overall options available to pension schemes.”

On the question which has arisen during the LDI investigation of whether UK law had been mis-transposed or misinterpreted to allow borrowing by pension funds – such as through leveraged LDI – which were basically illegal, Trott said: “My letter to the committee dated 9 of December was clear that we basically don’t agree that the use of leverage or borrowing in the context of LDI is illegal.

“The response to the consultation made at the time in 2005 specifically said that adjustments to the EU legislation were made to allow schemes to use derivatives and repo arrangements to manage risk,” she said.

This had been the clear intent of the UK legislation, she added.

Committee member Nigel Mills, MP, asked Trott and Griffith whether – with hindsight – this was still the right position, and whether it was desirable for pension schemes to use “effectively supercharged, leveraged instruments that are really quite complicated and risky”.

Trott replied: “Broadly, my opinion is they have had their place, however the events of last year showed there were a number of deficiencies in the way they were managed and governed.”

The failings had particularly been around the collateral that LDI users had been asked to hold, as well as around data and the overall resilience of the financial system, she said.

“Those are areas where we absolutely need to make some changes going forward, but the LDIs have played a useful role over the past couple of decades,” she said.

In particular, Trott said she agreed that The Pensions Regulator (TPR) needed more data on pension schemes’ activities. “That is something we need to bring forward,” she said.

Giving his evidence, Griffith agreed said lessons to be learned from the LDI crisis included data, disclosure, governance “and making sure – I think its a fairly uncontentious principle – that trustees and those responsible are fully apprised of the risks they take with whatever instruments they use.”

Referring to 2018 work done by TPR which included consideration of the risks of LDI, Trott said that at that time, the regulator had decided that collateral buffers of 100 basis points were reasonable.

That decision had been understandable, she said, given the maximum movement in the Gilts market that had been seen in the previous 20 years.

However, in the crisis last September, Gilts had moved by an unprecedented 165 basis points over five days, she said.


Laura Trott UK pensions minister

“It’s true to say TPR were aware of the risk, but they thought the collateral buffer was adequate”

Laura Trott, UK minister for pensions

“It’s true to say TPR were aware of the risk, but they thought the collateral buffer was adequate,” said Trott, and added that this had “obviously been proved to be incorrect”.

“We as government understand and support that we now need to increase collateral buffers,” she said, but added that it was important too, to understand that such a change was not without consequences.

“When you increase collateral buffers, it increases costs to employers and it reduces investment in other parts of the economy,” said Trott.

Griffith noted that the Bank of England’s Financial Policy Committee (FPC) had taken an interim view that 300-400 basis points was the right buffer.

“Some would advocate the tolerance for holding leveraged insurance is zero. That isn’t our view […] we’re seeking to get a balance in the system and obviously particularly keen to see on a steady state basis what the FPC advise the right level of these instruments is,” he said.

Clearly, he added in response to a question from the panel, the reciprocal of a higher buffer was that those instruments would be less attractive.

One member of the parliamentary committee raised a point made previously in UK hearings on the LDI crisis, namely that investment consultants were not currently regulated for pension fund investment strategies.

Asked whether investment consultants should now be brought within the Financial Conduct Authority’s regulatory perimeter in this regard, Griffith said: “That is the direction of travel, so that is our policy.”

Trott and Griffith have today submitted a written response to February’s letter from Lord Hollick, chair of the House of Lords’ Industry and Regulators Committee, which is to be made public next week.

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