Iain Clacher & Con Keating

“1000 and 1 days in the life of a Thanksgiving Turkey”

Having read the Pensions Regulator’s response to the questions posed by the parliamentary Work & Pensions Select Committee and their new guidance “Managing investment and liquidity risk in the current economic climate”, we find ourselves arriving at the same conclusion as Mr Justice Warren on some other Pensions Regulator guidance.

“In all the circumstances of the present case, I feel able to attach only the slightest weight to the views of tPR.”

Mr Justice Warren[i]

It appears that we are far from alone. In a recent Chartered Institute for Securities and Investments (CISI) webinar on the gilt market crisis, among their most popular ever with 359 attendants registered, we polled the following question:

“When questioned about their involvement with liability driven investment, the Wall Street Journal reports: “A spokesman for the Pensions Regulator said it “…does not drive particular investment strategies,”.

Do you agree or disagree with this statement?

71% of respondents disagreed and 11% agreed.

Patrick Bloomfield, of Hymans Robertson and Chair of the Association of Consulting Actuaries, sought to bring some clarity to the situation in question-and-answer format in a recent posting on LinkedIn.

“WHY HAVE SO MANY DB SCHEMES USED LEVERAGE (LDI) TO INVEST IN GILTS?

Regulators have been pushing schemes to reduce risk and improve funding quickly, stimulated by scandals like BHS and Carillion. Leverage enabled de-risking and earning returns simultaneously. Without leverage it would either take longer or need bigger contributions to hit regulatory targets.”

Referring to the endogenous feed-back loop of LDI:

“IS THAT WHAT WE MEAN BY SYSTEMIC RISK?

Yes. Regulation led to DB assets being concentrated in gilts-based assets. This had big risk buffers, but the loss of control of monetary policy (inflation & interest rates) and fiscal policy (tax cuts and national debt) was so huge that that it burnt through the buffers and so rapid that schemes couldn’t react quickly enough. We got to the brink of spiralling out of control.”

We disagree with the interpretation here. The declines in gilt prices in response to the mini budget which triggered the meltdown were relatively mild. Table 1 below shows the price movements of conventional and index linked gilts for the period from 22^nd to 28^th September.

Table 1: Daily price changes (Close-Close) 22 – 28 September

It is clear that declines of 5.5% over two days overwhelmed some “big risk buffers” and triggered the LDI spiral. Our contention would be not that we were “…on the brink of spiralling out of control…” but rather, we were already well into that process by the 26^th. Without the Bank of England intervention, there is no telling where this spiral may have stopped or the damage that this would have wreaked.

It appears that the Pensions Regulator would like us to consider it to be the victim of the assault on the gilt market, not its perpetrator.

We are informed that liability driven investment (LDI) had been a very successful strategy and this leaves the impression that it should continue largely unchanged. This mixture has proved explosive, TPR’s solution would be to remove a fissile material and leave something that is merely highly flammable in its place.

As for the prior success, this is true of all but the most abject of speculative strategies. Turkeys live a very satisfied life until Thanksgiving .  To repeat the well known quote and chart from The Black Swan: The Impact of the Highly Improbable by N N Taleb:

“Something has worked in the past, until — well, it unexpectedly no longer does, and what we have learned from the past turns out to be at best irrelevant or false, at worst viciously misleading.”

Indirect answers to direct questions

TPR also fails to answer explicit questions posed, such as:

“Did TPR ask the Bank of England (BoE) to intervene?”

Its response is:

“As the gilt market instability developed, we established regular contact with the Bank of England and other regulators about what action could be taken to mitigate risks from rapid changes in the gilt market. Fundamentally, it was the Bank’s decision to intervene in the way it did.”

In common with much else in these documents, it is necessary to interpret these Delphic mutterings.

So, that will be a “No” then, will it?

In many other blogs[ii], we have challenged the legality of schemes using repo to borrow and the use of derivatives to hedge liabilities; these TPR documents fail even to recognise, let alone respond to those challenges. The circumlocutions, in language and logic, needed to achieve that are almost impressive. TPR’s response draws heavily on the Bank of England’s response to Treasury Committee; its own data are woefully inadequate and even mutually inconsistent.

By way of ending, given their centrality in LDI strategies and the crisis, we were astonished by the complete non-appearance of the words ‘repo’ and ‘derivative’ in the 6,200 words of those documents. The Bank of England showed no such reticence. It therefore begs the question, why TPR did not?

These  documents are worthy of Fawlty Towers: “Don’t Mention the War”, and bring to mind the theme of Dad’s Army: “Who do you think you are kidding, …”?

[i] From PNPF Trust v Taylor [2010] EWHC 1573 (Ch) judgment of Warren J delivered on 28th June, 2010.

[ii] See: https://henrytapper.com/2022/03/28/keating-and-clacher-debunk-ldi/

https://henrytapper.com/2022/09/29/anatomy-of-a-crisis/

https://henrytapper.com/2022/10/03/tprs-role-in-the-current-crisis-keating-and-clacher/

https://henrytapper.com/2022/10/11/holding-to-account-analysis-and-resolution-of-a-crisis-keating-and-clacher/