European regulators have urged pension plans and the LDI funds they use to consider “system-wide” risks of their approach rather than just the risks to their individual scheme, but according to LCP, unless regulators gather comprehensive, systematic data on how LDI arrangements are being used by schemes, schemes will find it challenging to implement this in practice.
Investment managers who manage LDI funds were informed this week in a letter from the Central Bank of Ireland that when determining the proper capital buffers for LDI arrangements, they should consider the possibility of “.. 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”.
But there is currently little system-wide data on the use of LDI techniques by specific schemes or the amount of capital “buffer” included in such arrangements. Due to this, it is extremely difficult for schemes to determine the scope of any possible “second round” impacts of employing leveraged LDI.
LCP is urging UK regulators to cooperate in order to close this “information gap” if these new regulatory guidelines are to be successful. The firm proposes that The Pensions Regulator (TPR) should use its existing information-gathering powers, including, but not limited to, annual scheme returns, to gather detailed data across the entire DB universe of patterns of use of LDI strategies – both pooled and segregated arrangements. This should not be a one-off exercise, but rather a process of constant monitoring.
The FCA should also collect real-time information about LDI funds, including both pooled and segregated funds, to better understand their operations. LCP suggests that this information should be given to regulators, like the FCA and the Bank of England, who are in charge of “systemic” risk. Through them, this information should be made appropriately available to pension plans so that they can assess any “systemic” risk associated with using a leveraged LDI strategy.
LCP partner Jonathan Camfield says: “Recent statements by regulators are welcome in setting out a clear framework for future decisions about the role of leveraged LDI in the strategy of individual pension schemes. We also agree that schemes now need to think about collective or ‘systemic’ risk. But we are concerned that they currently simply do not have the necessary information.
“Regulators with responsibility for systemic issues, such as the FCA and Bank of England, should work with The Pensions Regulator to collect, analyse, publish – and keep updated – detailed data on the use of leveraged LDI by all pension schemes. The FCA should also be gathering and appropriately sharing real-time information on what is happening in the LDI market. Without such information, schemes and individual managers can’t realistically assess the system-wide risks they may be exposed to”.
