Do they mean us? – Washington Post takes aim at TPR over LDI


Below are extracts of an article published in the Wall Street Journal which gives the American perspective on our LDI crisis. Since the UK Pension Regulator seems to be in denial that their has and is a crisis resulting from LDI, I am quoting it extensively – indeed exclusively. It is important that we do not allow pension regulation to be judged by its own scorecard, an external correlative is welcome – and helpful.

U.K. Regulator Pushed Pensions to Load Up on LDIs

The rush into the derivatives-based investment strategies concentrated risks in the
market, sparking a Bank of England bond-market rescue

By Caitlin Ostroff;   Following , Jean Eaglesham Follow and Chelsey Dulaney 
Oct. 4, 2022 2:41 pm ET

The derivatives-based investment strategy that tipped the U.K.’s pension sector into crisis
started with good intentions: Help companies fulfill promises they made to employees to pay a steady income through retirement.

Behind the push into that strategy, say pension trustees and their advisers, was the Pensions Regulator, the U.K.’s powerful watchdog, charged with safeguarding the savings of millions of private-sector workers. The regulator steered private pension funds to adopt liability-driven investments, known as LDIs, linked to returns on U.K. government bonds, according to pension trustees and consultants.

The rush into the strategies concentrated risks in the market. It was, analysts say, the financial equivalent of a crowded room during a fire alarm. When government-bond yields surged, everyone rushed for the exits. The resulting mayhem made the situation even worse and prompted a Bank of England rescue of the bond market.

“The regulator thought that LDI was a virtually zero risk strategy and encouraged schemes to adopt it,”

said Robin Ellison, a consultant with the law firm Pinsent Masons and trustee of a number of pension plans. The Pensions Regulator challenged funds that refused to use
derivatives or used them sparingly, according to the pension trustees and consultants.

In conversations with trustees, the regulator would tell funds they needed to lower their risk to big swings in the markets by increasing exposure to U.K. government bonds, known as gilts.

Gilts are considered safe…not because yields on them were low in the slow growth years after the financial crisis, holding more of them exacerbated the shortfalls pension
plans forecasted to pay retirees far in the future.

A solution was to own LDIs instead. They invest in interest-rate swaps and other derivatives that are tied to gilts. But because they typically use leverage, they free up the pension fund’s balance sheet to invest in other higher-yielding investments such as stocks, private equity or real estate.

The increased use of LDIs enabled pensions to increase what they call in the industry hedge ratios, or the degree to which a pension fund is protected against market swings.

“There’s been a promotion of higher hedge ratios being a good thing or a necessary thing regardless of the extent to which leverage was employed to get there,”

said David Fogarty, a professional trustee at Dalriada Trustees, which helps run pension plans.

“The regulator pushing everybody in that direction has been a contributory factor here.”

Because the regulator has strong enforcement powers, including the ability to ban trustees and to undertake criminal prosecutions, trustees felt pressure to follow the guidance, according to the pension trustees and consultants.

The Pensions Regulator saw the strategy as a way of helping pensions manage their assets
better, reducing the risk that pension plans would have to be bailed out by a public fund meant to be a backstop for failed employer schemes, the pension trustees and consultants said.

A spokesman for the Pensions Regulator said it

“does not drive particular investment strategies,” but requires plans to consider the risks they are carrying. LDI has been effective for managing downside risk”

It added that the regulator has consistently reminded plans

“to have contingency plans in place particularly given the likelihood of interest rate rises.”

British lawmakers intend to probe the regulator’s role in overseeing the pensions that have been caught up in the crisis. A Parliamentary panel, the work and pensions select committee, will be writing to the Pensions Regulator this week, according to a spokesman.

One sign that the Pensions Regulator was a force behind LDIs: U.K. local government pension plans, which are governed by a separate regulator, rarely used the derivatives strategies, according to Christopher Sier, chief executive of pensions research firm ClearGlass Analytics.

His survey of more than 600 defined-benefit private plans found that two-thirds of them used LDIs.

LDIs grew in popularity quickly. Pensions and others had invested £1.6 trillion ($1.8 trillion) in LDIs by 2021, up from £400 billion in 2011, data from trade group the Investment Association show.

There were warning signs that some plans using LDIs were dangerously exposed to sharp rises in interest rates, like those that precipitated last week’s crisis. The Pensions Regulator conducted a survey in 2019 that showed many pension plans gearing up, with leverage levels of up to seven times.

Some pension funds were wary about using derivatives in place of plain-vanilla government bonds. The Pensions Regulator and fund managers running LDIs reassured pension funds that the risks were low, the pension trustees and consultants said. The underlying government bonds tied to LDI derivatives didn’t move much day-to-day and were unlikely to trigger demands for increased collateral to back the investments.

“A lot of these underlying investments were seen as absolutely AAA, gold-standard investments that don’t fluctuate, that don’t suffer from volatility,”

said Bill Manahan, who advises pensions at Validus Risk Management.

“Ten years ago, the British economy was seen as rock solid. Gilts were of the highest order, therefore utilizing leverage in relation to these wasn’t seen as so much of a risk.”

Responding to a question from a pension plan regarding the risks of LDI strategies, the
regulator said in a 2020 email, reviewed by The Wall Street Journal:

”Our guidance to pension schemes is written on the basis that our regulatory colleagues at the Bank of England will be successful in their remit of maintaining monetary and financial stability.”

A Bank of England spokesman said the central bank is

“not the regulator of pension funds or liability-driven investments.”

Trustees and pension advisers said in addition to the Pensions Regulator, the financial industry also pushed LDI as a way to solve pension plans’ inflation- and rate-related risks, without highlighting the additional risks that the strategy incurred.

“There’s a question over the way LDI was sold to trustees by investment advisers and whether the trustees were told what could go wrong,”

said Stephen Pugh, an adviser to the pension plan for Adnams PLC, a U.K. brewery.

Jennifer Churchill, who served as a trustee adviser for the U.K.’s local government pension
scheme from 2010 to 2014, said she was required to do compulsory trainings hosted by the fund industry.

After basic guidance on stocks and markets, there

“would always be this big push for liability driven investment: how this is a great way to reduce your risks,”

she said.

“There would be people in suits telling you, ‘this is the most responsible decision you can take on behalf of your employees and residents.’”

Ms. Churchill, who is now a senior lecturer in economics at the University of the West of
England Bristol, added that the plan she advised decided LDI was too risky.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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2 Responses to Do they mean us? – Washington Post takes aim at TPR over LDI

  1. John Mather says:

    Article in the FT today on this, see below. Interesting comment string below the article including this one

    Unfunded government schemes are “not sustainable” according to the last pensions minister. If they are to survive then the private schemes have to exist even if they are in the intensive care ward.

    Of some concern must be the dwindling number of schemes that support the PFS with a levy. That support is rather like drilling holes in the bottom of a sinking boat to let the water out.

  2. Tim Simpson says:

    Hello Henry,
    2008 doesn’t seem all that long ago to me when we had a disaster due to heavy investment into similar debt liabilities. Surprising that the City sees LDI as something different. The financial Press draw attention to Lord Wolfson (of the long-running successful ‘Next’ chain) apparently contacting the BoE in 2017 to stress his concern. The BoE then issued a similar critical stability Report but, apparently, nothing further was heard from either they, the FCA or the Pensions Regulator. Yet again it begs the question, do they only look backward, or do the Government insist they only look forward to protect the market?
    In the light of your earlier blogs this week, what confidence is there that this Government will be concerned since, so far, they have only spoken of growth…!
    Kind regards,
    Tim Simpson

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