The Pensions Regulator (TPR) has issued guidance for the UK market on liability-driven investment (LDI) resilience.

The guidance – Maintaining liability-driven investment resilience – follows statements made today by the Central Bank of Ireland and the Commission de Surveillance du Secteur Financier (CSSF), known collectively as National Competent Authorities (NCAs), about the resilience of LDI funds.

TPR is also calling on pension fund trustees investing in leveraged LDI to improve their schemes’ operational governance.

TPR chief executive office Charles Counsell said: “LDI funds are regulated in the country their provider is based and in most cases, these are EEA countries. We are very pleased therefore to see these joint statements from regulators in Ireland and Luxembourg setting clear expectations for the resilience of LDI portfolios.”

Counsell, who just last month told delegates at the Pensions and Lifetime Savings Association (PLSA) annual conference 2022 in Liverpool that defined benefit pension funds were “not at risk of collapse”, is urging trustees to read the TPR statement and “consider how they can meet the steps it outlines to ensure their scheme buffer is sufficient to cover a swift and substantial increase in yields at the level set by the NCAs.”

The turbulence in longer-dated UK government debt in late September exposed shortcomings in the resilience of LDI funds, as well as in the operational processes of the funds and of pension schemes investing in them.

Charles Counsell

Charles Counsell, TPR

In particular, the ability to raise liquidity in a timely manner was an issue for several schemes. This created risks for pension schemes of losing the effectiveness of their hedge during a period of high volatility. It also created the potential for wider impacts on the orderly functioning of the economy.

Counsell said: “We continue to work closely with other regulators to ensure we learn from the challenges we have seen in recent weeks.”

Higher levels of buffers

The guidance effectively re-affirms the need to maintain the higher levels of buffers against yield rises that have been put in place since the start of October 2022 – a higher level of buffer than has been typical in the past, said consultsancy LCP.

“The yield rise level buffers discussed are in line with what we have seen the main LDI investment managers adopt and implement since early October, this means that the vast majority of schemes are unlikely to need to make immediate changes to investment strategies in order to fit with the new expectations,” the firm said in a statement.

However, with the new regulatory expectations confirmed, schemes can now plan their future investment strategies with more confidence, it added.

Compared to before, in some cases, this will lead to reduced protection against movements in interest rates and/or reduced expectations for future investment returns, LCP said.

In turn, in such cases, this will put more risk or cost onto the sponsoring employers, the firm noted, adding that a blanket limit on leverage is not necessarily good news for all schemes.

Dan Mikulskis. partner in LCP’s Investment team, said: “We are pleased to see this joined up guidance from regulators on their expectations for the buffers that should be used to support LDI going forwards. This central steer should help materially reduce systemic risk, and enable schemes to focus on now developing a longer term investment strategy that works for them.”

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