FCA highlights 'gap in regulation' following gilt market turbulence

The Financial Conduct Authority (FCA) has said that there are a number of lessons for the regulatory community to learn from the recent issues around liability driven investment (LDI), highlighting a particular “gap in regulation” around investment consultants.

In an evidence hearing for the Treasury Select Committee, FCA interim chair, Richard Lloyd, and chief executive, Nikhil Rathi, were asked about the recent liquidity issues around LDI, and whether further regulatory focus was needed in future.

Responding to the committee, Lloyd pointed out that the FCA had previously highlighted the risks in LDI, "and also that there was a gap in regulation, which is investment consultants, who were advising pension trustees".

Also reflecting on whether the regulation of investment consultants would have made a difference, Rathi explained that "part of the challenge in some of these stress situations is that sometimes there are operational challenges in managing the situation".

"We need to see stronger resilience and stronger reverse stress testing so people think about how they would work in a world where the system could be broken, and how they would plan and manage their resilience in those situations," he continued.

"To that extent, if investment consultants were more actively regulated, there would be a greater focus on those issues from those parties, and they obviously play a role in advising pension funds and trustees."

More broadly, Rathi suggested that there are "a number of lessons for the regulatory community collectively to think about and reflect on".

"There is a pattern when we have seen disruptions during market turbulence of leverage not being managed well enough, causing those disruptions," he stated. "Going forward, we want to see—and we will be working on this—stronger data reporting on leverage and liquidity management."

Rathi said that this data reporting could be to the FCA, The Pensions Regulator, or "any of us who have a focus on some part of the system", to make sure that the data needed is being collected, and that there are proper data sharing arrangements in place.

Rathi declined to agree with the idea that if pension fund consultants were regulated by the FCA the recent issues would not have happened, clarifying that there are "many different dimensions".

"What I would say is that there were challenges related to the resilience of the management of the situation by managers and pension funds," he continued.

"Perhaps if their advisers had been more sensitised to dealing with such levels of stress, then some of that risk may have been managed a bit more effectively. I wouldn’t go so far as saying that that, in and of itself, would have prevented such a situation."

Indeed, Rathi argued that "it is difficult to say with hindsight what particular measure may have prevented that situation, as it was wholly exceptional", stressing that the movements of 30-year gilt yields earlier this year were "unprecedented".

International efforts may also be needed to prevent further issues in future, as Lloyd noted that some of the assets in this situation were being managed and supervised outside the UK, with FCA having to work "very closely" with regulators in Europe.

"I think there is a lesson there for us about needing to ensure that when there is a crisis of that type—we did our best, and we are still doing our best. Not the whole of the situation is in our hands in terms of regulatory oversight," Lloyd explained.

"There are asset managers based in other parts of Europe, for example, where we are reliant on the regulator in that country to give us the data to be able to respond.

"There are some quite big lessons there about how we co-operate and work together with regulators internationally, and in the UK between the regulators that have different parts of the system within their remit."

This was echoed by Rathi, who emphasised that "these are interconnected markets, and if there is stress in one market around the world, it can play back into our system".

He continued: "There are certain things on which we can take steps. Certainly in terms of our collection of data and oversight and reporting, we can take steps, but, as Richard alluded to, many of these funds—in fact, the overwhelming majority—are located outside the UK.

"Many of the managers are located outside the UK. This requires cross-jurisdictional co-operation, and therefore the important endorsement of the G20 leaders and Finance Ministers, which we hope to progress in the coming days, is important, as is each jurisdiction moving forward expeditiously to bring these rules into place."

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