The inquiry into LDI moves apace as L&G’s summoned to parliament

Days after their skewering of the CEOs of the FCA and TPR over the regulator’s role in the recent LDI debacle, the House of Lords Industry and Regulators Committee will hold a session with the Chief Executive and Chair of Legal & General , on the use of liability-driven investment strategies by defined benefit pension schemes following their role in recent market turbulence.

This is no ordinary delegation from Britain’s top LDI fund manager.

Nor is the tone of the likely questions anything but blunt

L&G’s policy team is headed by former Prime Ministerial adviser John Godfrey and it’s clear that he’s briefed his CEO and Chair that this meeting is of national importance. I am pleased that the insurer is taking this matter seriously, LDI had the potential to cause systemic harm to the Government’s capacity to borrow through the gilts market.

Unlike many in the pensions industry who continue to regard the Bank of England’s £13.5bn bail out of LDI funds having to offload gilts as collateral for their derivative positions, Nigel Wilson and John Kingman will know full well that their insurer was an unwitting agent of this near calamity.

The alternative narrative

Tomorrow (Wednesday), I will be appearing at a similar session , this time run by the Work and Pensions Committee, chaired by Stephen Timms and featuring a group of MPs whose normal “pension” business is considering the management of auto-enrolment, pension freedoms and people’s engagement with their retirement financing.

Their call for evidence is here. Here are their areas of interest

– The impact on DB schemes of the rise in gilt yields in late September and early October;

– The impact on pension savers, whether in DB or defined contribution pension arrangements;

– Given its responsibility for regulating workplace pensions, whether the Pensions Regulator has taken the right approach to regulating the use of LDI and had the right monitoring arrangements;

– Whether DB schemes had adequate governance arrangements in place. For example, did trustees sufficiently understand the risks involved?

– Whether LDI is still essentially ‘fit for purpose’ for use by DB schemes. Are changes needed?

– Does the experience suggest other policy or governance changes needed, for example to DB funding rules?

Meanwhile , the Treasury Select Committee continues to ruminate on the session conducted under then Chair – Mel Stride – now boss at the DWP, involving a senior team from the Bank of England.

Taken together, these inquiries suggest that what happened in the schemes we look after is a matter of national importance and that , far from being forgotten, Government is determined to get to the bottom of what has happened and learn lessons.

Change is happening.

Earlier this week, L&G reported that it would take a £10m hit in its profitability from not being able to manage money within its LDI portfolios at the high margin previously attained. It’s not clear whether the £10m refers to the money going , or the margin, or both.

The FTSE 100 insurer said the “sharp and extreme increase in gilt yields” in the wake of the fiscal statement had materially increased the collateral required.

“This caused liquidity problems for some LDI clients who had assets available but could not access them in time to provide cash collateral,”

it added. L&G said the

“extreme volatility . . . has highlighted the need for technical changes to ensure the smooth functioning of both LDI and the government’s financing of its debts”,

with clients increasing and diversifying their collateral, as well as holding additional scheme assets with their LDI provider.

L&G go on to say that they were not holding the risk and that there would be no balance sheet impairment. Indeed, the LDI providers are no more than intermediaries between the banks and their clients and though they determine how the rules of the product work, they are not responsible either for things going wrong or the consequences of things going wrong. Don’t shoot the messenger!

And yet…

If not the providers -the consultants, if not the consultants -the regulators, if not the regulators – the markets and if not any of these -Government and its mini-budget.

At the heart of the problem was the need of employers to fund defined benefit schemes based on an accounting standard that created the need for LDI. As John Cunliffe and his team told the Treasury Select Committee, investment banks needed new markets through the banking crisis and beyond.

Pension Schemes were a market in need of the finance that could be offered them through swaps and the repo market. The fund managers such as LGIM, BlackRock and Insight had access to the pension schemes and became the banks agents, consultants such as Redington advised the trustees and trustees took decisions often based on trust rather than an understanding of the products and the risks they presented.

All of which can be justified because it worked well, until it didn’t.

The good that come out of this.

There are very few people who are able to speak freely about these matters. Con Keating and Iain Clacher are two , John Ralfe is speaking freely in his way and so am I. We all find ourselves on one panel which I suspect will be saying very different things to the panel that follows it.

It is high time that these matters were properly debated. Those who have been following this blog over the past 13 years will know that I have been preoccupied with the funding of DB, not just because DB needs to be properly funded but because getting that funding wrong means that there is no spare cash for the vast majority of private sector employees who are not accruing a defined benefit but get a defined contribution into their pension.

It is too little observed that every penny extracted from employers to meet funding calls from the DB scheme is money not spent funding the DC plan that replaced it.

The good that can come of all this, is that we return to some kind of sanity where the DB schemes either fold into the insurer’s buy-out plans or run on without the borrowing. In the long run, we will find a way to fund DC plans to give people the dignity in retirement that those in DB plans are or will be getting. In the short run, we need to dismantle the scaffolding that has kept DB plans in place. LDI was only meant to bide schemes over but it became an investment strategy in its own right, that strategy has blown up with remarkable consequences. Let’s hope that those consequences lead to good.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in pensions and tagged , , . Bookmark the permalink.

6 Responses to The inquiry into LDI moves apace as L&G’s summoned to parliament

  1. John Mather says:

    Has anyone quantified the sum of the margin calls and the reduction of the balance sheet in the early days of October to the 13th of October 2022?

    • henry tapper says:

      One estimate presented to me yesterday for YTD is £500bn. Around half is thought to be over that period. I have heard lower estimates of around £150-170bn for the period you mention. The fact that there is so little accurate data is telling.

  2. Jnamdoc says:

    As the IFS has noted, we are entering into an era of sustained higher taxation. As a nation we have therefore lost fiscal autonomy – whether from the left or right, we will have to follow more or less the same fiscal policies over the next decade or so (at least). Furthermore, that loss of fiscal autonomy even decides what PM and chancellor we are allowed to keep. This is not the “fault” of the markets (remembering “the market” includes those other pensioners, domestically and globally who have leant us the money), it’s the consequence of a continual issuance of gilts, and the forcing of schemes (which despite its denials, is what TPR has engendered) to hold gilts and bonds artificially lowering the price of issuance for government. LDI was an accelerator of that failed model, and forced may schemes to offload the actual return seeking assets we all need to drive growth and pay the pensions.

    I had a genuine LOL moment when reading the line above “Pension Schemes were a market in need of the finance…” – no! Regulators and bankers / investment managers created a regime to require schemes to switch out of equities into gilts and LDI, where the banks alone could make risk-free (“high margin”) returns for acting as an intermediatory. They saw a huge pot of DB wealth, and they wanted a share.

    In the long run (or potentially even the short to medium term) the working young will not stand for an era of higher taxes lasting “two decades” with little prospects to develop or buy a home, and either they will legislate away the expensive pensions, or they’ll emigrate, or they will overthrow the system.

    So LDI should not be talked away as a ‘technical thing’ for funding pension schemes, and those who challenge it referred to as naysayers. It’s much more than that – because of the scale of the DB (and DC funds) its influence will be a fundamental driver that will for decades to come shape the nature of our economy, and our politics.

  3. henry tapper says:

    My comment about pension funds needing the finance should be taken in context. Appeasing the regulator and the sponsor meant taking short cuts. The finance from LDI was only needed to get stakeholders off their backs!

    • Jnamdoc says:

      Yes understood. But language matters – the schemes didn’t need finance, Finance needed the schemes. I’ve long been a fan of your old FASB index. DB pension schemes were not underfunded, but for an industry that feeds off the 1% (per annum, of course, which is a lot over the 70-year life of a pension!) that was not convenient….

  4. Bob Compton says:

    The Treasury select committee, the UK Parliamentary committee, and the Work & Pensions committee, should be interviewing Jnamdoc, for an unbiased view on how we got here, and no doubt on thoughts of where to next. With so many generating fees and profits from the implementaion of leveraged LDI strategies there are too many careers at stake to facilitate the major changes that are needed.

Leave a Reply