U.K. government focuses on data, regulation in wake of LDI liquidity crunch

The need for the regulation of investment consultants, a push for greater and more timely pension fund data, and careful consideration of the impacts of increased collateral buffers are some of the key takeaways from the U.K. liquidity crisis last year.

Representatives for the U.K. Treasury and Department for Work and Pensions answered questions from the Work and Pensions Committee and Industry and Regulators Committee on Wednesday regarding pension funds with liability-driven investments — the latest in a series of hearings before parliamentary committees related to the gilt markets liquidity crunch in September and October following the then-government's announcement of unfunded tax cuts.

Over a matter of days, gilt yields rose by 165 basis points, triggering a downward spiral in prices and huge and multiple collateral calls for pension funds using LDI programs to hedge liabilities. Some pension funds — those using pooled LDI funds in particular — were forced to sell assets to meet those calls.

Asked whether investment consultants should be brought within the Financial Conduct Authority's regulatory perimeter given their role in advising on investment strategy, Andrew Griffith, economic secretary to the Treasury, said the regulation of investment consultants "is the direction of travel." Mr. Griffith said he wants to know whether there were "deficiencies in the investment advisers" in relation to the LDI-related crisis.

"That is not what I've heard so far — I've heard about issues about governance, about transparency, about reporting, about the speed of response in a situation that was somewhat exceptional. No one has actually said, brought forward examples, where they say the investment advisers, who are all members of institutes of actuaries and regulated at a professional level, were not giving diligent and professional advice."

The unprecedented situation last year resulted in regulatory recommendations that pension funds increase their collateral buffers to be able to absorb a change in gilt yields of 300 basis points to 400 basis points, from about 100 basis points.

Laura Trott, minister for pensions, said at the same hearing that, based on previous data, regulators thought that level of buffer was adequate. The situation last fall has proven that to be incorrect, and "we as government understand and support that we need to increase collateral buffers," she said.

However, Ms. Trott highlighted that it is important to understand that increasing collateral buffers "is not without consequence. When you increase collateral buffers, it increases costs to employers and reduces investment in other areas of the economy. But I think it is the right thing to do," she said.

Regarding pension fund data, Ms. Trott said: "We don't have the systemic collection of data at the moment that I think we need to have." The Pensions Regulator, which oversees U.K. retirement plans, needs to have sufficient data and information on when collateral buffers are breached, for example, she said.

Ms. Trott said the government knows "that some schemes last year lost out," although on aggregate, funding positions have improved due to increased interest rates. She also reiterated evidence at a separate hearing by the Pension Protection Fund — the lifeboat fund for the defined benefit plans of insolvent U.K. companies — stating that no plans had notified it of risk of falling into the PPF due to the events of last fall.

However, Ms. Trott added that many U.K. defined contribution plans "lost an awful lot of money that day… We don't really (have a sense) of the exact numbers" in terms of the impact of gilt yield moves on DC assets.

Asked whether LDI was an appropriate instrument for DB funds, and whether plans were still making use of the strategy given the move to higher collateral buffers for such programs, Ms. Trott said LDI is still being used. The Bank of England, she said, will be reporting in the near future on whether an increased level of collateral buffer should be maintained going forward.

"We still think (that LDI is) a useful tool in the armory of pension schemes, but we need to make sure they are regulated effectively," Ms. Trott said. However, she added that "governance around pooled funds is definitely something we need to look at," since that was "one of the key problems at the time of the crisis last year." During the liquidity crunch, some pooled LDI funds had major issues in locating and posting sufficient levels of collateral, due in part to the structure of such arrangements whereby many — often smaller — pension funds are invested through the same program.