LDI: BoE recommends 250bps ‘steady state’ buffers
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The Bank of England’s Financial Policy Committee has recommended the Pensions Regulator “take action as soon as possible” on liability-driven investing strategies by specifying the minimum levels of resilience for the funds and mandates in which pension scheme trustees can invest. It recommends a minimum 250 basis points yield buffer in LDI.
On Wednesday, the FPC said that to support the implementation of appropriate long-term minimum levels of resilience in LDI, it has recommended that “TPR take action as soon as possible to mitigate financial stability risks by specifying the minimum levels of resilience for the LDI funds and LDI mandates in which pension scheme trustees may invest”.
In a new recommendation paper, it argued that as part of an appropriate steady-state minimum level of resilience, LDI funds should be resilient, at a minimum, to yield swings of around 250 basis points, much higher than before the gilts crisis. Typically, LDI programmes were tested to be able to withstand a 100bps swing in yields. On 28 September last year, in one day, gilt yields moved 127bps.
The 250bps recommendation comes after European regulators and TPR said in late November that a 300-400bps buffer level was required. In November, Nikhil Rathi, chief executive the Financial Conduct Authority, said some funds holding this level of buffer were worried about the drag from holding large amounts of cash in a high inflation environment.
The FPC said it had welcomed the November guidance about 300-400bps and noted that so far, LDI funds had largely maintained these levels of resilience.
“However, this requirement was explicitly temporary, and the level of resilience might erode over time in the absence of a clear long-term approach,” it added.
The recommendations by the Financial Policy Committee published on Wednesday also include that:
- LDI funds should be able to withstand “severe but plausible” stresses in the gilt market, which should account for historic volatility and the potential for forced sales to amplify market stress and disrupt gilt market functioning;
- LDI funds should be able to meet margin and collateral calls without engaging in asset sales that could trigger feedback loops and so add to market stress;
- pension schemes might need to improve their operational processes to provide collateral to their LDI funds more swiftly when needed; and
- LDI funds should take into account the nature of their exposures, including on duration, leverage, and concentration of holdings, and the liquidity, duration, and convexity of collateral, in modelling their resilience to yield moves.
The Bank’s FPC asked the Pensions Regulator to report back on how it intends to implement the recommendations.
TPR chief executive Charles Counsell said: “We note the recommendations from the Bank of England’s Financial Policy Committee on LDI. The Committee has clearly set out its expectations relating to the minimum level of resilience it wants trustees and fund managers to adhere to when using LDI, and I am pleased this builds on the guidance that we, and the National Competent Authorities, put in place in November.”
He said updated guidance will be available in April, taking into consideration the FPC’s recommendations. TPR previously announced an update to its LDI guidance would be contained in the Annual Funding Statement due out next month.
“In the meantime, I urge schemes to continue to follow our existing guidance, which is designed to ensure trustees achieve and maintain an appropriate level of resilience in leveraged LDI funds across pooled and segregated arrangements to withstand a fast and significant rise in bond yields, and improve operational governance of pension schemes.”
DB pension funds with LDI programmes came under pressure during the gilt market turmoil that followed the former government’s Mini-Budget. A vicious cycle driving down gilts prices developed as schemes were forced to post collateral at great speed to maintain their hedges, with the spiral only stopped by the Bank of England stepping in as a buyer of gilts.
TPR had to take considerable heat from politicians over the episode, appearing before Commons and Lords committees.
