Gilt market volatility fallout to have 'wide-ranging' impact on UK assets

Regulatory reforms following the liquidity issues faced by defined benefit (DB) pension schemes amid the market volatility in autumn 2022 could have a wide-ranging impact on UK assets, according to a report from Bloomberg Intelligence.

The report explained that while the Bank of England (BofE) made a profit from the market intervention, the fallout from the volatility will take longer to settle, with some of the regulatory reforms proposed expected to have wider implications.

It highlighted comments made by the BofE, which recommended that The Pensions Regulator (TPR), in co-ordination with the Financial Conduct Authority (FCA) and overseas regulators, takes regulatory action to ensure liability-driven investment (LDI) funds remain resilient.

In particular, the BofE's Financial Policy Committee (FPC) suggested that the regulators should set out appropriate steady-state minimum levels of resilience for LDI funds, including on operational and governance processes.

However, Bloomberg Intelligence warned that such changes will affect how LDI investment funds operate and may change the capacity of DB pension plans to invest in less-liquid growth strategies.

In particular, it explained that the regulatory pressure to reduce leverage within DB benefit pension plans and increase liquidity buffers won't just affect gilt holdings as funds rebalance, as investments using alternative growth strategies, and particularly those in less liquid assets like real estate, private equity and private debt, may also come under review.

However, the report also highlighted some opportunities that emerged from the market volatility, pointing out that the proposed regulatory reforms, "ironically", come as higher interest rates have improved funding positions.

Indeed, the report acknowledged that the funding position of many DB schemes improved amid the rise in gilt yields, as the discounted value of their liabilities fell, with a record year expected in the bulk annuity market in 2023 as a result.

More broadly, the report also showed that pension funds' search for greater liquidity has affected real estate funds, with some firms restricting redemptions from institutional real estate funds after struggling to meet demand from investors seeking to withdraw money.

However, the report pointed out that whilst the pension-fund sales presented challenges, they also presented an opportunity, stating that Apollo Global "snapped up" $1.1bn of assets from UK pension funds amid the market volatility in September.

According to the report, Apollo Global co-president, Scott Kleinman, said on an earnings call that Apollo's Athene unit accounted for about a third of the collateralized loan obligations sold by pension funds as they sought to raise cash to meet collateral calls.

Bloomberg Intelligence senior industry analyst (insurance), Charles Graham, commented: “September's dramatic events in the gilts market and the BofE's forced intervention were always going to have consequences, with LDI funds, DB pension plans and their trustees and advisers facing a regulatory crackdown.

“Leverage, liquidity buffers and the size of exposure to illiquid assets are in the spotlight. Solutions that served pensions well during the long period of falling interest rates are being reassessed.

"UK investment-markets consequences could be widespread given the £1.8trn size of DB pension-fund assets.

“Yet the review comes as higher interest rates have significantly improved pension plans' funding positions, making it easier for some to transact buy-in or buyout deals with insurers such as Aviva, Phoenix or Legal and General.”

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