The government and Pensions Regulator should consider restricting the use of liability-driven investments until governance improvements have been implemented. They should also collect data on LDI and put the new defined benefit funding regime on ice, while investment consultants should be brought under the Financial Conduct Authority’s remit, MPs have recommended in a new report on the LDI crisis of last year. 

 

The report published on Friday is the result of an inquiry into defined benefit schemes with LDI by the Work and Pensions Committee that started last October. It contains wide-ranging recommendations on improving regulation and oversight, not least of trustees and their investment consultants. 

 

The Department for Work and Pensions should “work with TPR as a priority to improve the regulation of trustees and standards of governance, as it has said it intends to do. Given the time it will take to consult on, legislate for, and implement measures to improve governance, DWP should consider whether the use of LDI could be restricted, for example, based on a test related to a trustee board’s ability to understand and manage the risks involved,” the report reads, noting that the DWP needs to first respond to its 2018 consultation on DB consolidation by the end of October. 

 

MPs also want the regulation of investment consultants to pension funds, first proposed by the Competition and Markets Authority five years ago, to be brought under the FCA’s rule.  

 

“We heard, including from the FCA itself, that in some cases investment consultants were giving standardised advice, rather than thinking through what was best for the individual pension fund,” the committee says in the report. 

 

It adds: “Given the complexity of the decisions trustees are required to make, this is a concern. The government should bring forward plans for investment consultants to be brought within the FCA’s regulatory perimeter before the end of this parliament.” 

 

 

The revamp of the DB funding regime has raised widespread concerns over herding of schemes into certain assets like long-dated gilts and bonds, as the draft regulations include prescription that schemes should have broad cash flow matching in place. 

 

MPs therefore want the DWP and TPR to “halt their existing plans for a new funding regime, at least until it has produced a full impact assessment for the proposals, including the impact on financial stability and on open DB schemes”.  

 

The crisis of last autumn threatened to spill over into other parts of the financial system that could have caused a severe crash had the Bank of England not stepped in as a gilts buyer of last resort. The bank has since announced that it will conduct its first ever system-wide exploratory exercise to better understand leverage, liquidity mismatches and interconnectivity in the system. 

 

 

    

Controversially, MPs state that “DB pension scheme investments must not be allowed to jeopardise the UK economy again”.  

 

Many in the pensions industry might take issue with this statement, given that it was the ‘Mini-Budget’ announcements by the former government that impacted the UK’s credit rating outlook and spooked global markets. The crisis and ensuing political tussle arguably created further uncertainty for businesses. 

 

 

Other recommendations in the report are that the DWP should report back to the committee by the end of January 2024 on how it proposes to take forward the Financial Policy Committee’s recommendation that TPR should have a remit to take account of financial stability considerations, and how the government plans to ensure that TPR has the capacity and capability to deliver on this. 

 

TPR’s capability appears to be in question also in relation to new requirements the regulator itself introduced on the level of collateral buffers for LDI investments. MPs say they support regulators specifying minimum levels of resilience for the LDI arrangements in which pension schemes might invest and to ensure these are maintained. However, they believe that “TPR does not have the data to check whether its guidance is being followed.” 

 

DWP and TPR are therefore being asked to report back to the committee by the end of October on how they plan to monitor whether LDI resilience is being maintained.  

 

They should also set out a timeline for TPR’s commitment to become a more digitally enabled and data-led organisation, with plans to resource it, MPs note. By October, the committee wants the department and regulator to report how they intend to make sure they can collect better data on LDI and analyse this, working with other regulators. 

 

In the context of data collection, reporting is set to become a bigger part in future, as MPs say TPR should require trustees to report certain data on their use of LDI and should develop a strategy for engaging with schemes based on the results more closely. 

 

 

Two of the experts – Con Keating from the Brighton Rock Group and Professor Iain Clacher from Leeds University – in their written evidence questioned the widely held belief that DB schemes are in much better shape now because of how interest rates and yields improving funding levels. 

 

The committee also says: “We are concerned that some schemes had their funding levels negatively affected as a result of the events of September 2022.” It cites Pension Protection Fund figures about aggregate scheme assets being £400bn lower at the end of 2022 than at the beginning.  

 

“It is important that we understand what the impact was and what led to these results so that the system can work better in the future. DWP should work with TPR and the PPF to produce, by the end of 2023, a detailed account of the impact on pension schemes of the LDI episode,” the committee recommends. 

 

This should detail how the value of assets and liabilities changed, showing the results disaggregated by whether the fund used LDI and, if so, whether in a pooled, segregated or bespoke arrangement. It should also include analysis of the factors which contributed to scheme funding improving or deteriorating, including the role played by LDI strategies. 

 

 

Professional trustees are seeing an opportunity in the suggestion that DB schemes’ governance requirements should be tightened, perhaps even with a mandatory professional trustee on each board. Nevertheless, the Association of Professional Pension Trustees warned against rushed policy actions in the wake of the LDI episode. 

  

Harus Rai, who chairs the APPT, said: “The APPT supports the idea of formally increasing the standards of trusteeship for DB pension schemes, but we have to stress that what may appear to be simple steps, like ‘more consolidation’, require very careful thought and policy actions to accommodate the diverse range of UK schemes. A rushed response to this and other areas of the report could easily create new but different financial risks to members’ benefits.” 

 

On pausing the introduction of a new DB funding regime, he said uncertainty must be avoided: "Whilst the APPT understands the committee’s rationale in reaching this conclusion, it suggests that it would be helpful if clarity could be provided in the near future so as to inform the approach taken by trustees and sponsors to scheme funding.” 

 

Other professional trustees are also keen to see governance requirements raised. David Fogarty, a director at Dalriada Trustees, said his firm fully supports the recommendation by MPs that the government should consider restricting the use of LDI until new governance measures have been legislated for and implemented. 

  

“Complex investments such as LDI cannot be allowed to be nodded through on the back of narrow advice,” said Fogarty. 

 

Many of the industry reactions to the report acknowledge that lessons had to be learnt, but some highlighted that schemes were now in better health, and that their investment approach had been driven by regulation and many years of quantitative easing. 

 

The Pensions and Lifetime Savings Association said it supports the committee’s recommendations to manage the potential risks arising from schemes’ use of LDI. However, deputy director of policy Joe Dabrowski said LDI has helped DB pensions overall to becoming much better funded against their liabilities and that the industry has “adapted well” following last year’s events. 

  

“Nonetheless, the proposal for regular reporting to the regulator by pension schemes on their use of LDI is entirely appropriate, and the committee also agrees with our recommendation to regulate investment consultants,” he added. 

  

“We especially welcome the committee’s consideration of open DB schemes in the incoming funding regime. We have previously called for more flexibility for open DB schemes in the funding code to allow them to invest in higher returning assets.” 

 

The issue of open DB schemes is being looked at in more detail as part of the committee’s ongoing separate inquiry into DB schemes. 

 

Others did not mince their words. The select committee's findings of significant weakness in the ability of pension schemes to manage risk seems “completely at odds with the rude health that most UK private schemes find themselves in”, the Association of Consulting Actuaries argued. 

 

ACA treasurer Stewart Hastie said: “LDI helped trustees and their advisers to improve funding levels and member benefit security in the face of decades of low gilt yields and the Bank’s 12-year [quantitative easing] programme.” 

  

He acknowledged that lessons around managing liquidity risk are being learnt, however, with industry adopting higher collateral buffers and improving governance. 

  

“We look forward to engaging further on some of the recommendations of the Committee and working with the DWP and regulators in how we can continue to improve resilience of the UK pension system. One area will be around tweaking DWP’s draft regulations for the new funding regime to ensure there is sufficient flexibility and avoid a one-size fits all approach to UK pension scheme investment. However, we don’t think a significant delay is necessary given industry has already been waiting for several years for the new funding regime,” Hastie added. 

 

Mike Smedley, a partner at consulting firm Isio, agreed lessons have already been learnt and said it was “unfair to blame trustees for risking economic stability. Trustee boards have followed government instructions to prioritise the security of members’ benefits and used LDI to achieve that with huge success.” 

 

What is your view – should LDI use be restricted until new governance requirements are in place? And should the new DB regime be put on ice?