It’s leverage wot dunnit!

Hidden borrowing, hidden losses and a hidden group of victims from the LDI crisis – that’s what came out of yesterday’s remarkable evidence sessions held in committee room 16 of the House of Commons.

Hidden borrowing.

The legal argument about whether repos are a means for pension schemes to borrow seems open and shut.

The only people who do not think that the use of Repo in LDI contracts isn’t borrowing are in the Pension Regulator and those who hide behind the regulator for legitimacy.

The use of Swaps to magic leverage in government bonds is argued not  technically borrowing as the borrowing happens within the swap. This is casuistry, the kind of legal argument that is punctured by common sense.

LDI was a means of borrowing gilts which turned from a tactical to a strategic strategy once pension schemes realised that quantitative easing was here to stay. The MPs who congregated to listen to Iain Clacher, John Ralfe and Con Keating will hear the same thing from Baroness Sharon Bowles and no amount of bluster from L&G and others about the benefits of LDI in the roaring twenties will hide the fact that when LDI blew up , it nearly took the Government’s means of long-term financing with it.

That LDI is borrowing is no longer hidden, that borrowing is illegal in pension schemes is no longer hidden and that the losses sustained this year as a result of the super saturation of gilts in DB pension strategies is no longer in doubt. John Ralfe superbly distinguished between the proper matching of liabilities and investments and the operation of LDI contracts – with spurious matching depending on illegal borrowing. Con Keating provided technical arguments to support him.

Hidden losses

For over a decade, we have been hearing that pension deficits , based on discounting liabilities at gilts + rates, were real. What was hidden was that most of the 2020s,pension schemes had the assets to meet liabilities on a best estimate basis. Now we find that £500bn has been wiped off the value of our occupational pension schemes as a result of the inexorable fall in gilts prices, resulting from interest rate rises and most recently, a loss of confidence in the UK Government to repay its debt.

The estimate of Clacher and Keating that total losses from falls in fixed interest securities held in our DB pension plans this year is £500bn, it is thought that up to £300bn of this has been in the past two months – attributable to the mini- budget. But the meeting heard that margin calls were being made much earlier in the year and that the industry was being warned of the risks associated with rising rates for the last 7 years. If there is any doubt that Clacher and Keating were not giving warning of the LDI crisis, then input either name in this blog’s search facility.

Attempts by others to camouflage these real losses in our assets are based on the same illusory metrics that allowed the Pension Regulator and their agents to demand money from UK corporates to fund imaginary deficits in the last decade. These illusory metrics now tell TPR that schemes are home and hosed on their race to buy-out. Sadly there is precious little by way of assets , for insurers to take on, a point made by Nigel Wilson yesterday when he refused to promise price falls for buy-out – arguing that the assets weren’t there on which he could make precious profits.

Bogus  deficits and now hidden losses, this is the pernicious impact of the wrong means of accounting for pension scheme solvency. It lies at the heart of the problem and Con Keating and Iain Clacher made this absolutely clear yesterday morning.

Hidden victims

The reason John Cunliffe of the Bank of England gave for the Bank’s buy-back facility was not to save the big pension schemes such as BT. It was to stop the collapse of LDI pooled funds which were in danger of defaulting on collateral calls because they could not get a price on the gilts they were selling to satisfy the bankers. These pooled funds weren’t owned by BT or the large schemes that form the core of the PLSA’s membership. The pooled funds own assets on behalf of the small schemes with assets of less than £250m whose positions are managed as protected cells of the pooled arrangement.

The victims of the near collapse of these pooled funds are small pension schemes who have found that their gilts have been sold at knock down prices to the market and then the Bank . Many of these schemes have lost most of their assets and also lost the capacity to borrow going forward (it’s called losing the hedge). As Con Keating put it, they have been locked out of their fund.

Because of lack of information (which will eventually appear when they publish their accounts) we don’t know who these victims are, what they’ve lost and what is worse – neither did they. The first many small schemes heard of their predicament was once the black swan had flown.

I was at a meeting of small schemes and their advisers yesterday afternoon. It was clear that nobody is talking about them as they are not newsworthy. It is also clear from comments made in the second session of yesterday’s evidence giving, that the trade bodies are in denial that these victims exist. Small schemes are the hidden victims of this crisis, they have no voice and there is no-one who wants to  turn over the stone to see the mess that lies beneath.

The other hidden victims of LDI are the retirement savers who are not being bailed out but will find that their employers cannot afford better contributions to their workplace pensions because the money in their DB schemes has been depleted (see yesterday’s blog).

My contribution to yesterday’s proceedings was to point out that many of the casualties of the LDI fiasco, are still buried under the rubble of collapsed pooled funds.

Time for a more honest approach

I was proud to sit alongside John Ralfe, Con Keating and Iain Clacher yesterday. They carried the argument with strength and rigour. I hope that their disinterested evidence has resonated with the MPs present and that the powerful messages from our session were not diluted by what followed.

It’s leverage wot dunnit!

All four of us said the same thing to the Work and Pensions Committee, the level of leverage in LDI going forward should be zero.

Pretending that we can carry on with hidden borrowing , disguising real losses with fake accounting and ignoring the real victims of the LDI fiasco, is no longer an option.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to It’s leverage wot dunnit!

  1. Jnamdoc says:

    Good session, and thank you all for making a representation – not an easy thing to do, and certainly not on such a nuanced issue. We can admire JR remaining absolute on his convictions, always has been, although concern about not allowing different views to hold the space or last word. He also IMO doesn’t take into account the bigger picture. TPR similarly take a scheme-by-scheme approach to this. What is a fact is that the amount of actual pensions to be paid has not changed at all because of the LDI crisis. Crucially, what has changed is that around £500,000,000,000 more (and that’s discounted NPV) of those pensions fall to be paid for from gilts and bonds – so effectively a lot more has transferred to Govt to pay. And, we as a nation have £500,000,000,000 less of equities / returns / growth assets with which to pay those pension and support the economy. This is the important point Professor Clacher was trying to make. As a nation we are worse off, significantly, and it will get worse if we carry on this myopic approach.

    On the point made about the “PPF being like a (house) insurer, and therefore it is reasonable for the insurer to impose conditions on the insurance” – that analogy may have benefitted from being extended, by considering the conditions being imposed? Of course, the proponents of LDI would consider them akin to getting double locks on your doors and windows and fitting fire alarms (say), while the ‘naysayers’ on the other side of the argument consider it akin to storing 4-star fuel in your loft – not really a problem until it goes wrong. Helpfully BoE were able to act as fireman at the end of September!

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