While trustees are complying with explicit collateral guidelines surrounding liability-driven investments (LDI), several areas deserve greater focus by trustees in the future, The Pensions Regulator (TPR) has said.

The regulator's market oversight report, which looked at how well pension schemes are prepared for LDI risk, showed that the LDI sector has made significant steps to improve resilience following the gilt crisis in 2022.

TPR said that regulatory intervention, strengthened governance and enhanced risk management practices have all improved the sector’s ability to withstand market shocks, with particular progress seen in compliance with interest rate buffers, improved recapitalisation processes, and increased focus on liquidity.

"The key focus has been to increase exposure to matching assets away from growth assets and reduce leverage within LDI mandates," it stated.

"Within return-seeking assets, trustees have been re-considering their exposure to less liquid assets, as they prioritise liquidity and resilience."

The regulator also noted that both the size and duration of LDI exposures have reduced materially since the end of 2021, which means that daily volatility in leveraged LDI assets is more than 50 per cent lower now than it was at the end of 2021. 

According to TPR, the rise in long-term interest rates had a "profound" impact on the LDI market, with a fall in the size of the LDI market from about £1.5trn at the end of 2021 to about £0.7trn at 31 March 2025.

The duration of LDI exposure has also fallen significantly from about 20 years to 13 years, driven by the passage of time and the impact of significantly higher real interest rates. 

However, TPR clarified that while there will be a cohort of schemes that have significant reserves within their LDI mandate, enabling them to ride out any foreseeable increase in gilt yields, there are a number of areas that deserve greater focus by trustees in the future, including diversification of collateral assets and resilience testing. 

Indeed, TPR said that trustees need to be more aware of the concentration risks associated with the assets earmarked for sale during stress events.

It explained that there is a risk that pension schemes attempt to sell similar types of assets at the same time, which results in valuations for collateral assets falling and also the inability to find buyers.

TPR suggested that trustees could mitigate this by considering diversifying collateral assets, reducing liquidity bottlenecks in specific markets, or by developing greater flexibility in liquidity frameworks, in order to allow for a dynamic approach to meet cash calls where prevailing market conditions may mean that a change of approach is desirable.

TPR also said that improvements are needed on resilience training, suggesting that, in order to further strengthen resilience, schemes should develop and test processes to restore depleted buffers within five days. 

In addition to this, TPR encouraged trustees to carry out periodic stress tests to evaluate LDI strategy robustness and the ability to replenish interest rate buffers within five days, and be more aware of the concentration risks associated with assets earmarked for sale during stress events. 

It also urged trustees to consider whether a diversified pool of collateral assets is desirable and if a more flexible approach to generating cash may be more prudent in extreme scenarios.

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