The FCA’s appeal, which was published on December 8 by the Work and Pensions Committee among the latest contributions to its inquiry into the autumn LDI crisis, follows calls from regulators to maintain improved liquidity buffers.
Sterling-denominated LDI funds across Europe have now secured an average yield buffer of around 300bp to 400bp, according to the Central Bank of Ireland and Luxembourg’s Commission de Surveillance du Secteur Financier. 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.
Before the September “mini” Budget, which was followed by a spike in gilt yields and ensuing collateral calls for schemes, 48 per cent of schemes had capital buffers below 200bp to 249bp, according to the Pensions and Lifetime Savings Association. Just one in five schemes had buffers of more than 300bp.
The scheme may need more support from BT in future valuations than previously anticipated
Earlier in December, LDI managers told the Work and Pensions Committee of the need to impose minimum standards in order to create a level playing field in a world of increased buffers, in recognition of the additional costs brought by this added resilience.
The committee heard that some schemes would need to revise their investment approaches and rely more heavily on sponsor contributions.
Liquidity buffers come at a cost
With defined benefit schemes holding approximately 90 per cent of long-dated, index-linked gilts, according to FCA estimates, the watchdog believes that recapitalisation calls for the period from September 30 to October 21 amounted to at least £64.5bn. Over the same period, it estimates that there were sales of at least £39bn in conventional and index-linked gilts.
The FCA told the Work and Pensions Committee that it had held daily calls with LDI managers during the turmoil.
It has already endorsed the message of the Central Bank of Ireland and the Commission de Surveillance du Secteur Financier – known together as the national competent authorities – which have demanded that LDI funds maintain their newfound resilience. The Pensions Regulator has also echoed this call.
“We acknowledge the importance of calibrating liquidity buffers appropriately,” the FCA’s written submission said.
“Accepting that these come at a cost to pension schemes, and that in any event extreme events may always occur that exceed a given level, we call attention to the importance of managers stress-testing the operational consequences and their needs in these tail events,” it continued.
The FCA’s chief executive, Nikhil Rathi, will appear before the Work and Pensions Committee on December 14 to answer MPs’ questions on DB schemes’ use of LDI.
Pension Protection Fund CEO Oliver Morley and TPR CEO Charles Counsell will also appear before the committee in a separate session that day.
BT scheme may need more sponsor support
There are concerns elsewhere surrounding the trade-off between maintaining this resilience and securing investment returns.
In its own submission to the committee’s inquiry, the managers of the BT Pension Scheme said that it had increased its collateral buffer, but that reduced returns may require more support from its sponsor.
“This will position the scheme to better weather any further volatility in the gilt market, but will also reduce the expected returns from our assets,” it said.
“However, the scheme does need to achieve a certain level of investment return to achieve its 2034 funding targets, and if expected returns fall below this level then the scheme may need more support from BT in future valuations than previously anticipated.”
Schemes tapped sponsoring companies for additional cash contributions during the turbulence, with rising gilt yields leading to improved funding levels. Schemes and employers saw an opportunity to lock in these funding levels by maintaining their hedging ratios.
Bigger LDI collateral buffers will increase sponsor reliance, MPs told
The Work and Pensions Committee has been reminded of the trade-off between bigger collateral buffers and investment returns, with one chief executive warning that buffers of 400 basis points would force some schemes to “pare back their growth ambitions” and increase their reliance on sponsor contributions.
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On December 8, packaging group DS Smith disclosed in its half-year report that it had made funding support of up to £100mn to its main UK DB scheme.
“This took the form initially of a cash advance in anticipation of potential margin calls and latterly a liquidity facility,” the group said.
“The cash advance was fully repaid within days of being made and, as at October 31 2022, the liquidity facility remained in place but was undrawn.”