We’re now asking some big questions about DB funding.

One of the big  questions behind the LDI debate is at what point so much of the Occupational Pension Schemes are now backed by Government Bonds (gilts) that the Government pays them.

This argument is regularly made by JNAMDOC on this blog;  for instance

TPR has exercised its very considerable powers to coerce schemes into denuding themselves of growth assets in favour of govt debt, and the evidence of that has played out in the investment outcomes of those schemes since 2004 with the wholesale transition away from growth assets into gilts. Did anyone realise that an unelected and by all accounts accountable quango had the capacity to in effect steer the investment direction of c£3,000,000,000,000 of private pension scheme savings – that presents more fire-power than what is available to most nation states. Has that £3trn store of our nation’s wealth been well deployed.

One of the reasons that pension schemes have loaded up with Government Debt, is that Pension Schemes have been allowed to use the Repo market to borrow more gilts and hedge inflation and interest rate risk.

So what is the Repo or Repurchase agreement?

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations. – Investopedia

Repos are widely used by pension schemes to increase their flexibility. They can generate additional cash to allow a scheme to target its growth objectives or meet near-term cash payments, while still ensuring liabilities are hedged.

Is this legitimate?

There’s an interesting comment on linked in , which suggests that it is.

I’ve listened to the recording, which was fascinating. On the issue of legality of leverage, David Fairs noted that the government at the time (’05) exempted the repo market. That is not an error, because for the central bank repos are an essential element of the non-bank finance system. In the US, repo collateral is shielded from creditors in bankruptcy since 1984. Prohibiting repos for pension funds is problematic because so much of the gov’t borrowing relies on that (and LDI in a broader sense). There was a good podcast where repos are discussed at 33:32 https://www.bloomberg.com/news/articles/2022-11-07/transcript-josh-younger-on-the-origin-story-of-the-shadow-banking-system

That link needs a Bloomberg account but you can listen to the podcast on itunes (which I did). What’s actually being said on the market,  is that Repo was invented by the American Treasury and central bank and became the way that the State created a debt market (going back to 1953). At some point in the development of Repo, the market took over and Repo became the plumbing that the Fed uses to manage market stability.

That’s why the protections Roman talks of came about and that’s why Repo became fundamental to the shadow banking system. I can understand why David Fairs takes the position he does, he doesn’t make the rules, he enforces them. However the people who write the regulations have worked for him and in the absence of counter-arguments , the draft rules we are about to see, won’t be substantially different.

But challenge is coming , from Keating, Clacher, JNAMDOC, Bowles and I suspect from others within Government who have yet to show their hands.

These people are challenging why we  talk of gilts being “risk-free”. They argue that such talk is why LDI threatened the financial stability of the gilts market and why the BOE had to intervene.

The Repo market is a form of money-substitute that looks like deposit funding but a little bit more funky. It’s not money. but it’s backed on both sides by Government so it’s treated like money. Not dissimilar (but not quite the same as) “crypto currency”.

“The Treasury market is as volatile as the world itself”

  • is the message of the Podcast and it’s one that everyone involved with pensions needs to remember. Having Government debt underwrite our pensions runs risks – and these risks were exposed by the leverage in the pension funding system. Paradoxically, the Regulator, whose job it is to manage risk, legitimises it by allowing the Pension System to depend on the functioning of the Repo market and shadow banking.

But to JNAMDOC’s point, the reason that Pension Funds were , in the past, less dependent on gilts , was more fundamental. In the 1960sthrough to the end of the millenium, Alistair Ross-Goobey had championed the investment of pension schemes in real “productive” assets and set about proving pensions could use growth assets through his management of Hermes as the investment vehicle for BT and Royal Mail. Ross-Goobey was highly influential in the Treasury and he would undoubtedly sided with JNAMDOC in his complaint that we are not properly deploying our pension assets by  handing our money to the Government to fund its debt.

That view of the world became subordinate to LDI when the valuation of future liabilities became linked to the gilt rate – rather than the best estimates of long-term returns , assumed by Ross-Goobey and others.

So there are two questions at stake here

  1. Does our pension system rely too heavily on Government debt (rather than productive assets)?
  2. Does the way pension schemes get hold of that debt rely too heavily on shadow banking which (as LDI showed) carries its own risks?

I am quite sure that there will be people who pick holes in this blog from both sides , but I think I characterise the fundamental issue which are at stake here. These are the big fundamental questions that need to be answered by DWP and TPR before they enact their DB funding regulations and finalise their DB funding code.

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 We’re now asking some big questions about DB funding.

  1. con keating says:

    Roman is correct in describing the importance of repo to the banking and financial system more broadly. However the debate here is about borrowing which is prohibited for pension funds for the simple reason that it makes them more risky. TPR has tried to claim that Repo is a derivative when it patently is not. The reason for this is the exemption extended to derivatives use. Repo is not secured borrowing (and the Financial Collateral regulations were written to ensure that) but that does not mean it is not borrowing. There is absolutely no doubt that economically they are. It appears that TPR is not interested in applying the purposive interpretations of black letter law we expect of our governing institutions but will pursue its own agenda of casuistry.

  2. Jnamdoc says:

    Thank you for the namecheck. My sense, and certainly the evidence when considered in the aggregate, is that we have materially transitioned the ultimate onus for the payment of second pillar pension away from the broader economy (ie from dividends and returns from businesses) more narrowly to the State (via gilts), and this has probably occurred more by accident and stealth, than by deliberate design. The reason for this is down to the authority the TPR exercises from its skewed mandate to protect the Insurer (the PPF), and the uniform scheme by scheme approach of the TPR. As they acknowledged at the WPC yesterday, TPR just did not and do not consider, or have the capacity to consider, the whole system effect. And nor should they – the sheer enormous scale of DB pension provision and related investments means it would be akin to seeking to managing an entire economy under a central premise or supply side perspective. As such, we do not have an integrated pension system the considers the greater good of the economy and what should be a symbiotic relationship. A worry aspect of this, even if we can see and understand the problem, is the almost uniform acceptance from the Regulatory and consultancy side of this statist approach, but again that is not surprising given they are sewn from the same actuarial cloth, lacking diversity and challenge and suffering (as critically identified under the 2004 Morris Review) from a strong tendency for group think. Regulation and fear of conflict has squeezed out the creative and alternative thinkers from the industry and from Trustees board, which (pre-2004) were once full of such talent. Its just a view.

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