LDI recommendations 'not a surprise'; devil will be in the detail

Industry organisations have suggested that the Bank of England's (BofE) recommendations on liability-driven investment (LDI) won't have a major impact on LDI funds, although experts acknowledged that the "devil's going to be in the detail".

The BofE's Financial Policy Committee (FPC) yesterday (30 March) said that The Pensions Regulator (TPR) should take action “as soon as possible” to mitigate financial stability risks by specifying the minimum levels of resilience for LDI funds, recommending a minimum level of resilience of around 250 basis points.

XPS Pensions Group chief investment officer, Simeon Willis, noted that further developments in relation to LDI were expected, stating that the FPC's announcement "doesn’t come as a surprise".

"The minimum level of resilience is lower than most pension schemes have been working to and as such this shouldn’t cause any issues for schemes whose funds were already in alignment with guidance," she continued.

"What we now know is that the regulator will be specifying what is acceptable, rather than simply letting schemes and their underlying fund managers decide that for themselves. This reflects the systemic risk that pension scheme represent to the wider gilts market.”

This was echoed by Pensions and Lifetime Savings Association (PLSA) deputy director of policy, Joe Dabrowski, who revealed that more than half of the DB funds surveyed by the PLSA were holding more than 250bps additional collateral in the wake of the mini-Budget and have since strengthened their positions further given uncertainty about the future.

He continued: “Since the unprecedented speed in gilt repricing following the mini-Budget last autumn, there has been much commentary about how pension schemes should manage the risk of potential volatility in future.

“One of the most effective ways schemes can manage this risk is by holding additional collateral, although this does come at the cost of potentially reducing some investment in growth assets.

“It is therefore important that recommended levels of collateral reflect the current stage of the interest rate cycle.

“The PLSA looks forward to seeing the regulator’s update of their stress testing, and underpinning analysis to see their assessment of systemic risks."

LCP head of investment, Zuhair Mohammed, also suggested that the recommendations "will not materially impact the way LDI mandates are run", noting that the recommended minimum 250bps of capital buffer for LDI mandates is less than the “temporary” 300-400bps adopted after the gilt crises.

He also emphasised that these are "recommendations at this stage", warning that the devil will be in the detail, with TPR expected to respond with more detailed guidance.

However, the FPC also recommended that TPR’s remit be expanded to include an objective around wider financial stability and for this to be equally weighted with its other objectives.

Whilst the minimum resilience levels are not currently expected have a major impact on those schemes already aligned with TPR's guidance, Willis suggested that a change in remit could lead to a "very significant change to TPR’s approach in relation to a number of aspects reaching well beyond LDI".

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