How LDI “evolved” from being a short-term tactic into a long-term strategy
The Work and Pensions Committee’s Oral evidence sessions have proved the most accessible and wide-ranging of the various inquiries into what happened when LDI blew up in September and October.
Tomorrow, Weds. 14th, the WPC meet again
This is likely to be followed by the pensions and national press, not least because it can be viewed from the comfort of your own desktop or phone. Follow this link
This is likely to be an awkward meeting for the Pensions Regulator and FCA who have so far – not come out of this well. However, there has been time for both to regroup and position themselves going forward as the protector of member’s interests and indeed the PPF.
Why are the PPF giving evidence?
I am very pleased that the PPF will be giving evidence as Evan Guppy spoke very well of how he has managed its exposure to LDI over the past few years at the Pension PlayPen. If you weren’t at the coffee morning, here is the recording.
The PPF’s use of LDI , as explained by Evan Guppy, interested me in three ways
- PPF did not use LDI funds but made their own arrangements, it claims this helped in dealing with operational issues which came to a head at the end of September
- PPF operated a much larger buffer than most LDI funds (anticipating “stress” much higher than the testing of the regulators)
- PPF actively managed leverage before the crash and to some extent reduced exposure to the crisis
Their evidence will be of great interest. TPR has a duty to protect the PPF from being swamped with insolvent pension schemes , unsupported by sponsors. Did leveraged LDI used by the corporately sponsored DB plans protect the PPF or has it caused more harm than good?
Why did the PPF operate LDI differently from most corporate schemes and are there lessons to be learned from its version of LDI management?
Challenges to TPR
The challenges to LDI laid down by John Ralfe, Con Keating and Iain Clacher have been addressed by the WPC , further information sought and letters been exchanged. You can catch up on the latest debate over the “£500bn that’s gone missing” here.
Recently, we’ve had written evidence from a small firm whose DB pension scheme didn’t use leveraged LDI. You can read the employer’s complaint that they were bullied by TPR, here.
The argument made by Baroness Sharon Bowles in the House of Lords and at a recent SG conference is that the use of LDI arose from the adoption of marked to market valuations of liabilities using the risk-free rate. This made non-leveraged LDI enormously expensive and created a market for secondary banking to provide what amounted to borrowing through the use of swaps and Repos.
TPR are accused of encouraging LDI to a point that it was used by 60% of Schemes, Keating and Clacher argue that the over-exposure to liability matching instruments has led to £500bn of pension fund money going missing and the Bank of England and others have accused DB pension schemes of “poor risk management” which according to its Governor, put the gilts market at risk.
Challenges to FCA
My contribution to the debate has been to highlight the impact of non-leveraged LDI to corporate activity (a fundamental criticism of the liability valuation process) and the lack of information relating to the impact of the crisis on the hedges of smaller DB schemes in pooled funds.
These may seem small beer , but they are very material to the management of sponsoring employers , to staff not in the DB scheme and to the impact their investments had on the long dated and index-linked gilts markets.
These pooled funds are regulated by the FCA and like many retail products which have caused problems (offshore bonds) they are registered in offshore jurisdictions (Luxemburg and Ireland).
The loss of control created by the FCA relying on other regulators to provide oversight on what the risks and controls within pooled funds must be a matter of regret to today’s FCA. I am told that offshore funds were originally needed to manage each employer in a protected cell, this might be possible today in the UK but wasn’t fifteen years ago. Should these funds have been repatriated – it’s one of the many “in hindsight” questions that we’ll not get an answer to.
But what we need an answer to is what happens to a trustee’s holding when the collateral buffer increases to above 2% and maybe to 3 or 4%. What does this mean to the overall investment strategy of the scheme and will it require more money to be pumped in by the sponsor?
Is the future of leveraged LDI viable? Is it only manageable the way the PPF does things or can it still work where liability hedging is reduced and collateral increased? What will the FCA allow as collateral in future and how do the issues in institutional markets with regards liquidity, and fund jurisdiction, compare with the retail markets?
Democracy in action
It should be an interesting session, I hope that many of these questions will be address (if not answered). This is the proper democratic process at work and I hope that when I have a chance of watching tomorrow’s event on “catch-up” , I will be able to better understand the Regulator’s position.
Thanks to the WPC for this.
Hello Henry,
WPC: Enquiry
As a ‘punter’ I was interested in the video of both your’s and Messrs Clacher, Keating, and Ralfe’s evidence to the above.
Given that assessment from a video does not include the ‘feeling’ in the room because the viewer can only see what the Director wants them to see. Thus, the following point stayed somewhat mute. Dr Keating emphasised three times the problem as he and the other two saw it. That the ‘hidden’ LDI investments was where the truth of the LDI losses lay. It came across to me that he had to say it a third time because the WPC had made no ackowledgement of his claim. Indeed, in their questions afterwards, the WPC questions seemed to have been framed from your previous written evidence (to the WPC). It seemed to me that Dr Keating’s aside at the end i.e. it was the first time that he and John Ralfe had ever spoken in full agreement, to me indicated the gravity of the above.
In fairness to the WPC Members, they, like others from outside the financial world, might not fully appreciate what billions or trillions of anything means. What I would be faced in understanding ‘£500bn’ is how many pensioners that figure would support and for how long. It’s only since David Cameron and George Osbourne were in power that ‘billions’ entered into news reports and conversations.
Kind regards,
Tim Simpson
I think they get it now Tim