On the go: The Financial Conduct Authority has urged managers of liability-driven investment funds to learn the lessons of the autumn liquidity crisis, claiming that liquidity buffers represent only part of the solution to future volatility.
On November 30, the Central Bank of Ireland and Luxembourg’s Commission de Surveillance du Secteur Financier – known together as the national competent authorities – noted an improvement in the resilience of sterling-denominated LDI funds across Europe, with an average yield buffer of around 300 to 400 basis points having been secured.
This buffer refers to the level of yield adjustment on long-term gilts that an LDI fund is insulated from, or may absorb, before its capital reserves are depleted. LDI funds trading in the UK are based exclusively in the Republic of Ireland and Luxembourg.
The NCAs called on LDI funds to maintain their current levels of resilience, a demand that was echoed by the Pensions Regulator.
The appeals from the regulators follow an autumn liquidity crisis, during which UK defined benefit pension schemes faced collateral calls from LDI managers after the government’s doomed September “mini” Budget precipitated a spike in gilt yields.
The FCA welcomed the NCAs’ statements and said that it expects asset managers “to take any necessary or appropriate action following these communications, and that they operate their products and services in a way that will not create risks to market integrity or financial stability”.
“Measures such as liquidity buffers are a necessary but only partial solution as there can always be events or conditions that exceed them,” it continued.
“Managers of LDI funds should learn lessons from these events to understand and reduce the consequences in tail events.
“These include operational lessons, the speed with which they are able to rebuild buffers or rebalance funds, client and stakeholder engagement, and reliance on third parties.”
The FCA said that it would publish a further statement on “good practice” towards the end of the first quarter of 2023.
Schemes’ use of LDI has prompted inquiries from several parliamentary committees.
On November 23, the Work and Pensions Committee was told by Brighton Rock Group head of research Con Keating that during the transposition of the Institutions for Occupational Retirement Provision II directive into UK law, limits on derivative investment conceived by European law had been amended.
The UK transposition omitted the word “investment”, Keating told MPs, and added a second line that would permit derivative investment.
“No English court, to our reckoning, would support that transposition. The use of derivatives to hedge liabilities is also almost certainly illegal,” Keating said.
The select committee’s chair, Stephen Timms, has subsequently written to pensions minister Laura Trott to clarify whether the government took external legal advice on this process, also seeking its reasoning for the amendments and an outline of the transposition process.
