FCA sets tough tests for LDI pensions after mayhem

The UK’s Financial Conduct Authority (FCA) has demanded that asset managers offering so-called liability-driven investment (LDI) strategies to pension funds must ensure their clients can deliver collateral within five days.

The FCA said it has published a series of recommendations for asset managers designed to increase resilience of LDI funds following the market mayhem caused by last September’s mini-budget.

The Pensions Regulator (TPR) also issued new guidance setting out further practical steps trustees should take to manage risks when using LDI.

Last September’s near meltdown in the sector, when yields on UK government bonds rocketed, left LDI funds scrambling to find extra collateral.

The UK central bank had to intervene to buy UK government bonds, helping to bring down yields and relieve pressure on LDI funds.

“Following the recommendations set out recently by the Bank of England’s Financial Policy committee, the FCA has set out guidance around risk management and operational arrangements for LDI managers so that they can address risks to market integrity and financial stability,” said the FCA.

Sarah Pritchard, Executive Director, Markets at the FCA, said: “We have been clear that asset managers must take the necessary steps so that their LDI portfolios are resilient to future market volatility.

“Since September last year, we have been closely monitoring asset managers using LDI strategies as they make improvements and the sector is now much more resilient to potential risks, but there is more to be done.

“This guidance sets out what we expect in terms of risk management, stress testing and client communication, so that the necessary lessons are learned from last September’s extreme events.

“Many of these lessons will be relevant to firms beyond the LDI sector.”

The FCA said it has been working closely with its regulatory partners in the UK and internationally.

“The FCA has also been engaging directly with firms involved in the management of LDI portfolios to develop and maintain increased resilience to deal with possible future volatility,” said the FCA.

The Pensions Regulator said its guidance is the latest support TPR is giving trustees “to be resilient in times of challenge.”

It said trustees are ultimately responsible for how the assets in their schemes are invested.

“The guidance stresses the importance of having the right governance and controls in place to reduce risks to their scheme, and to be able to react to events quickly,” said TPR.

“TPR expects trustees to only invest in leveraged LDI arrangements which have put in place an appropriately sized buffer.

“This must include an operational buffer specific to the LDI arrangement to manage day-to-day changes, in addition to the 250 basis points minimum to provide resilience in times of market stress.”

Lou Davey, TPR’s interim Director of Regulatory Policy, Analysis and Advice, said: “Many schemes use LDI as a tool to mitigate volatility risks and we continue to monitor the use of this type of investment.

“The unprecedented market volatility seen last September clearly demonstrated there is the need for stronger buffers, more stringent governance and operational processes and more oversight by trustees.

“Trustees must understand the risks they carry in their investment strategy, and only use leveraged LDI if appropriate.

“Our guidance provides practical steps to ensure they achieve this vital balance, and we expect trustees to use it.”