TPR issues LDI guidance urging trustees to build 'appropriate' resilience

The Pensions Regulator (TPR) has issued guidance on liability-driven investment (LDI), encouraging scheme trustees who use LDI to maintain an "appropriate level of resilience" in leveraged arrangements to better withstand a fast and significant rise in bond yields.

The guidance was published in response to the statements on the resilience of LDI funds made by the Central Bank of Ireland (CBI) and Luxembourg's Commission de Surveillance du Secteur Financier (CSSF), known together as National Competent Authorities (NCAs).

The NCAs statement confirmed that both the CBI and CSSF engaged “proactively” with the managers of LDI Funds during the recent gilt market volatility, noting that the resilience of GBP LDI Funds across Europe has subsequently improved, with an average yield buffer in the region of 300-400 basis points being built up.

“Given the current market outlook, the NCAs expect that levels of resilience and the reduced risk profile of GBP LDI Funds are now maintained, and do not consider that any reduction in the resilience at individual sub-fund level is appropriate at this juncture,” it stated.

However, the NCA’s statement outlined the appropriate steps should firms find it necessary to advertently reduce an individual GBP LDI Fund’s resilience below the levels that were achieved in the period following the dislocation in the UK gilt market.

In addition to this, the NCAs confirmed that they will expect GBP LDI funds to have procedures in place to recapitalise and/or de-risk their portfolios by reducing their exposures following exceptional market circumstances in a timely manner.

According to the statement, this should include accounting for the 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.

Although the NCAs expectations and notification system will not apply to LDI Funds in other currencies for the time being, the statement confirmed that the LDI managers are nonetheless expected to maintain for these LDI Funds an appropriate level of resilience at an individual sub-fund level in order to be able to absorb market shocks.

Responding to the NCAs statement, TPR acknowledged the expectation of maintaining a specific level of liquidity buffer along with the reduced risk profile, given the recent higher level of market volatility and future uncertainty, and the current geo-political landscape.

Building on the NCA guidance, TPR suggested that, where statements from the NCAs refer to pooled funds, it believes the same level of resilience should be maintained for segregated leveraged LDI mandates and single-client funds, as they face the same market risks and operational challenges.

More broadly, TPR stated that, if a scheme is not able to hold sufficient liquidity, or is unwilling to commit to that level of liquidity, they should consider their level of hedging with their advisers to ensure they have the right balance of funding, hedging and liquidity.

TPR’s guidance outlined a number of steps trustees should take if they choose to depart from the liquidity buffer set out by the NCAs, including working with advisers to demonstrate the buffer the scheme has in place, completing a risk assessment of how the scheme will respond to stressed market events.

The regulator also encouraged trustees to review their governance processes and consider the challenges that arose for their pension scheme during the volatility in September and October 2022, and then consider what practical steps in terms of their arrangements they can implement as a result of lessons learned.

The guidance also included a number of practical steps that trustees should take to ensure they are able to react quickly in response to stress in the market, such as calculating the required collateral amounts, and the type of assets, specifying the dates when these collateral/margin calls need to be made, and ensuring governance is robust.

The regulator clarified that the guidance aims to address immediate requirements on liquidity, with TPR clarifying that it remains "alive to the constantly changing market conditions and the implications for the future".

In light of this, TPR is continuing discussions with a number of external stakeholders, with plans to issue a further update in its Annual Funding Statement in April 2023, and in further statements and investment guidance as necessary.

TPR chief executive, Charles Counsell stated: “LDI funds are regulated in the country their provider is based and in most cases, these are EEA countries. We are very pleased therefore to see these joint statements from regulators in Ireland and Luxembourg setting clear expectations for the resilience of LDI portfolios."

"Accordingly, we have now issued a guidance statement for trustees and advisers confirming our expectations for the use of LDI funds. I urge trustees to read the statement and consider how they can meet the steps it outlines to ensure their scheme buffer is sufficient to cover a swift and substantial increase in yields at the level set by the NCAs."

"We continue to work closely with other regulators to ensure we learn from the challenges we have seen in recent weeks."

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