Work and Pensions Committee publishes LDI report

The cross-party Work and Pensions Committee (WPC) has today published its report on "Defined benefit pensions with Liability Driven Investments" (LDI).

The WPC opened an inquiry last year in light of economic turbulence that followed the September 2022 ‘mini-Budget’, when unprecedented sharp rises in gilt yields resulted in LDI funds held by pension schemes being forced to sell gilts into an illiquid market where additional collateral could not be posted quickly enough. This led to further upward pressure on yields and ultimately to intervention by the Bank of England to protect financial stability. The inquiry took both oral and written evidence from across the pensions and investment industries.

The report’s main themes are the need for more systematic, regular and comprehensive collection of data on LDI and the need to improve governance throughout the investment chain. The report concludes that “The September 2022 episode demonstrated the potential for the investment strategies used by DB schemes to give rise to systemic risks. While action has been taken to address some of the weaknesses which were exposed in this episode, there is still more work to be done.”

The WPC makes a number of recommendations, some relating to how regulators should collaborate, but with the key ones having the potential to affect pension schemes more directly:

• The Pensions Regulator (TPR) should require trustees to report certain data on their use of LDI, following TPR’s acknowledgement that the information currently being collected on LDI was “not sufficiently detailed” for it to assess whether its guidance is being followed by pension schemes that weren’t otherwise under some form of specific supervision.
• The DWP should respond to its 2018 consultation on defined benefit (DB) consolidation and then work with TPR as a priority to improve the regulation of trustees and standards of governance.
• Prior to implementing measures to improve governance, DWP should consider whether the use of LDI could be restricted, for example, based on a test related to a trustee boards’ ability to understand and manage the risks involved.
• The Government should bring forward plans for investment consultants to be brought within the Financial Conduct Authority’s (FCA) regulatory perimeter before the end of this Parliament.
• TPR should work with the FCA to review whether the guidance the FCA issued to LDI funds in April has been implemented effectively and is providing trustees with a simple mechanism for monitoring LDI.
• Both DWP and TPR should consult on whether governance would be improved by introducing disclosure requirements on pension schemes relating the use of LDI through the annual report or investment statement. This might include specifying the maximum leverage allowed within the LDI funds; the type of LDI that can be used; compliance with minimum resilience levels; and data on growth and matching asset allocations.
• DWP and TPR should halt their plans for a new funding regime (previously expected to come into effect from April 2024), at least until a full impact assessment has been produced, covering the impact on financial stability and on open DB schemes. This stems from concerns that the current proposals are not sufficient to allow open schemes to thrive and will result in greater ‘herding’ in investment decisions.

The report also supports the recommendations from the Bank of England’s Financial Policy Committee that TPR should be given a remit to take account of financial stability and that TPR should specify minimum levels of resilience for the LDI arrangements in which pension schemes may invest and work with other regulators to ensure these are maintained.

Contact

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Graham McLean

Head of Scheme Funding

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