The liability-driven investment crisis shook the pensions world last year. The huge spike in gilt yields following the mini-Budget led to defined benefit schemes facing large collateral calls in a short period of time, with some experiencing huge losses during the turmoil.

Some schemes suffered from having to meet the requirement for assets to be sold at undesirable prices, while others were locked out of trading on their LDI funds. Actions were taken that would not have been under normal circumstances, and there is a direct and measurable loss from things not going as expected.

There is increasing talk of pension funds instructing lawyers to make claims against their LDI managers or investment consultants. The Financial Times reports that in the London Solicitors Litigation Association’s annual study, which questions lawyers about upcoming trends, many expect litigation over LDI strategies.

Claims are emerging against managers of some pool funds because of the fire sales that schemes were forced into, according to Chris Edwards-Earl, senior associate of law firm Stephenson Harwood. 

Schemes that are seeking compensation are in the £20m-£1bn range and will mostly be in pooled funds, he adds. 

The Bank of England has said only 15% of LDI funds were pooled funds, which is where the bulk of issues arose, and the circa 175 pooled LDI funds represent about 1,800 pension funds.

Anna Rogers, senior partner of ARC Pensions Law, says some DB schemes will certainly be looking at whether they can extract money from asset managers by threatening legal action.  

But investment claims are hard to get off the ground, and there is unlikely to be a huge wave of LDI claims. 

Edwards-Earl predicts there will be three or four big claims but thinks these will all settle out of court because nobody will want to be the first one to say that this is the standard one will expect of the LDI manager.

There is also the possibility of collective claims where a large asset manager has a lot of clients in its pooled funds that suffered losses due to its actions. Small schemes which have assets available to them may well go for a class action, and that could be interesting, says Edwards-Earl.

It will be challenging for schemes that had losses to go down the claims route, and recovering any meaningful compensation will not be easy.

To claim successfully, several things must be proven: that there was a breach of contract or breach of a duty of care, a loss was suffered, and the breach caused the loss. The legal issues can be complex.

 

Rogers says: “One example of a clear breach of contract is where trustees suffered a loss because they gave a complete instruction in accordance with the contract, but the manager didn’t act on it. Many schemes were not able to do that because they couldn’t get information. They’ll have to prove what they would have done in response to the information, as well as prove that they suffered a loss as a result.” 

 

The manager’s response might be that it could only do what was reasonable. 

 

“It could argue that the scheme should have done scenario planning for extreme events and should have understood the risks,” says Rogers.

 

She is aware of some contracts stating that schemes are required to post their collateral within a period of up to 10 days but with no minimum period – and in some cases during the turmoil, it was as little as 20 minutes.  

 

“It shows the value of a legal review. Even with pooled funds, they may be non-negotiable, but it’s still worth scrutinising the terms and conditions prior to signing them to build the best governance around it," Rogers says. 

 

 

Schemes might want to raise conflicts of interest between one group of clients and another. In a pooled fund, the manager usually has duties to the fund, not to each individual investor. 

 

“The interests of different investors may be in conflict but if the manager had power to do what it did to protect the fund’s solvency, it will be hard for investors to complain that the consequences were unfair to them,” says Rogers.  

 

There will be an argument about who is responsible, but she doubts that it will be an open and shut case that it is the asset manager’s responsibility.  

 

She thinks the asset manager is likely to point things back at the trustees and investment consultants and say: "'You didn't understand it, and did [your consultant] give you adequate advice about the sensitivity of the structures that we've put in place in extreme market movements?’”  

 

So, sometimes it will come down to investment consultants who were in the middle of it all. 

“Their liaising role does always come down to be quite an important part of these investment cases,” says Edwards-Earl.

But, in practice, Rogers points out that trustees have often agreed relatively low liability caps with investment consultants, which make it less commercially viable to make claims against them.

 

 

Interestingly, other kinds of LDI-related claims have come up in the background, where a scheme has been affected by being in the wrong place at the wrong time. 

Edwards-Earl says for example, a scheme might have been doing a standard project where there was a latent error, which was made much more significant due to the leveraging position being completely out from what it should have been. 

“And the question is, was that foreseeable? That’s a claim where a normal kind of error has now become significantly larger as a result of [the LDI crisis].”

It is clear several different types of LDI claims could arise, but it will be a murky journey for those schemes who seek compensation for their losses.