By Naomi Rovnick
LONDON (Reuters) – British lawmakers urged the government and pensions watchdog on Friday to restrict pension schemes’ use of derivatives products that last year exacerbated turmoil in bond markets after former Prime Minister Liz Truss’ “mini-budget”.
So-called liability driven investments (LDIs), a hedging strategy used by thousands of schemes to ensure their assets generate enough cash to meet liabilities, almost blew up the UK pension industry in September when Truss announced unfunded tax cuts that sent government bond yields soaring.
The Bank of England was forced to intervene and regulators have since told LDI managers to require that schemes post more collateral and cut leverage to lower the risk of it happening again.
Releasing the findings of its report into the crisis, Work and Pensions Committee Chair Stephen Timms accused The Pensions Regulator (TPR) of being “blindsided” by LDI given experts had identified the dangers five years earlier.
The government should consider restricting the use of LDIs to scheme trustees who have the “ability to understand and manage the risks involved,” it said.
TPR should also ensure that schemes using LDIs, at one point a $1.6 trillion market and a money-spinner for asset managers and pension consultants, maintain “minimum levels of resilience,” the committee said.
A spokesperson for TPR said it had taken decisive action to learn lessons from last year.
“Pension trustees are acting on our latest guidance on using leveraged liability-driven investments which clearly sets out our expectations,” the spokesperson said.
Henry Tapper, founder of pensions market analysis group AgeWage and who provided evidence to the committee, said the pension establishment had downplayed the risks of rising rates before, during and after the crisis
“And so long as we have the herding of vulnerable trustees by blinkered consultants, we may well have another blow-up,” he said, calling non-expert trustees use of complex financial products equivalent to them being armed “with a gun without a fireams license”.
Some analysts estimate schemes lost billions of pounds in the LDI debacle. The Committee said a detailed account of the financial impact was still required to know how much of a 400 billion pound drop in the value of scheme assets in 2022 was caused by LDI.
Supporters of LDI say the strategy has helped schemes close funding deficits and used appropriately it can continue to play a role in managing risk.
A BoE policymaker this week said that recent jumps in bond yields had tested the resilience of LDI funds, but that they appeared more resilient today thanks to bigger buffers.
(Reporting by Naomi Rovnick; Editing by Tommy Reggiori Wilkes and Conor Humphries)
