Pension schemes can’t realistically assess systemic risks unless regulators collect industry-wide information on use of LDI

Pension schemes, and the LDI funds which they use, have been challenged this week by European regulators to take account of ‘system-wide’ risks of their strategy, rather than just the risks to their own scheme. However, according to LCP partner Jonathan Camfield, schemes will find this difficult to do in practice unless and until regulators collect detailed systematic data on how LDI arrangements are being used by schemes.

Pension schemes, and the LDI funds which they use, have been challenged this week by European regulators to take account of ‘system-wide’ risks of their strategy, rather than just the risks to their own scheme. However, according to LCP partner Jonathan Camfield, schemes will find this difficult to do in practice unless and until regulators collect detailed systematic data on how LDI arrangements are being used by schemes.

In this week’s letter from the Central Bank of Ireland, investment managers who run LDI funds were told that in working out appropriate capital buffers for LDI arrangements, they should take account not only of normal market fluctuations which would affect individual schemes, but also of the potential for

“..second- round effects of actions taken by other market participants on the individual funds, for instance the market impact of asset disposals triggered by rising yields”.

However, as UK regulators have admitted, there is currently little system-wide information on the use by individual schemes of LDI strategies, nor of the level of capital ‘buffer’ built into such arrangements. This makes it very hard for schemes to assess the extent of any potential ‘second round’ effects of using leveraged LDI.

LCP are therefore calling on UK regulators to work together to fill this ‘information gap’, if these new regulatory instructions are to work effectively. The firm suggests a three-pronged approach:

• The Pensions Regulator (TPR) should use its existing information gathering powers, including, but not restricted to, annual scheme returns, to gather detailed data across the whole DB universe of patterns of use of LDI strategies – both pooled and segregated arrangements; this should not be a one-off exercise but should be a process of constant monitoring;
• The FCA should also gather real-time data on what is happening to LDI funds, also including both pooled and segregated funds;
• This data should be supplied to regulators, such as the FCA and the Bank of England, which have responsibility for ‘systemic’ risk; through them this data should be made appropriately available to pension schemes so that their assessment of any ‘systemic’ risk of adopting a leveraged LDI strategy can be made on an informed basis.

LCP Partner, Jonathan Camfield, who has recently given evidence to two Parliamentary Committees looking into LDI issues, said:

“Recent statements by regulators are welcome in setting out a clear framework for future decisions about the role of leveraged LDI in the strategy of individual pension schemes. We also agree that schemes now need to think about collective or ‘systemic’ risk. But we are concerned that they currently simply do not have the necessary information. Regulators with responsibility for systemic issues, such as the FCA and Bank of England, should work with The Pensions Regulator to collect, analyse, publish - and keep updated - detailed data on the use of leveraged LDI by all pension schemes. The FCA should also be gathering and appropriately sharing real-time information on what is happening in the LDI market. Without such information, schemes and individual managers can’t realistically assess the system-wide risks they may be exposed to”.

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Notes to editors:

1. This week’s letter from European regulators can be found at: Industry Letter - Liability Driven Invetments Funds (centralbank.ie)
2. A more detailed article on the role of systemic risk has been published by Jonathan Camfield and can be found at: The role of financial regulators in managing systemic LDI risk | Lane Clark & Peacock LLP (lcp.uk.com)