That discussion was played out in front of parliament’s Treasury Committee on Monday and that same meeting – part of an inquiry into Financial Stability reports, can be watched here.
The second part of the meeting was spent rehearsing “what happened next” after the Bank of England closed its support for long dated and index linked gilts. It turns out the Bank bought £19bn worth of these, mainly from pension schemes and resold them into the market for £3.8bn more, pocketing the Treasury a tidy profit.
There are some, my friend Bob Compton among them , who see this as profiteering at the expense of pension schemes, others will see this as a windfall that arose out Bailey’s bail-out for LDI managers who otherwise would have lost a lot more in their fire-sale.
Nobody seems to be congratulating the Bank of England, which I think is harsh. It took a lot of stick from pension schemes and the PLSA for not extending the purchasing period beyond October 14th but it proved itself right to limit its support, the public purse has other priorities.
In an otherwise excellent article in Pension Age, this headline is a little misleading. The Bank did indeed tell the committee it saw £23bn of gilts sold over the LDI crisis period but that was not everything that was sold. Pooled LDI funds had to call on whatever assets they could once collateral calls were triggered and it’s unlikely that gilts were the only things sold. The FT has reported a surge of private market assets being purchased by hedge funds and undoubtedly margins were paid by the more liquid growth assets prior to the illiquids.
Andrew Bailey told Angela Eagle at the meeting that it was hard to know the losses incurred by the “fire-sale” because of the complexity of pension fund accounting. I suspect that the losses will emerge eventually but the fire-sale certainly sold down more than £23bn.
Andrew Bailey and his team’s comments about LDI were focussed on the sources of the problem
- Too much leverage
- Concentration of risk
- Pooled fund structures
Although only 15% of LDI liabilities were covered by leveraged pooled funds, that caused the problem- not the 85% of LDI in larger segregated funds.
Bailey’s criticism of pooled funds was with their “limited liability” structure , where each participant had a ring-fenced hedge which had to be defended individually. So the 15% of liabilities meant thousands of schemes spread across hundreds of funds. Some pooled fund manages (especially Insight) maintained hedges for trustees better than others. The fall out will go on for some time – we are still dealing with the BSPS fall out six years on.
The obscure 15%
“I think we must hold our hand up at this point and say that, by looking at the 85 per cent, the 15 per cent remained relatively obscure, and the fact that this legal structure was sort of buried in there was also somewhat obscure,”
Wherever I looked during the crisis, I saw evidence of large schemes managing their collateral waterfalls and coping, But I know , from years working with platforms as a consultant that small schemes were told they could have the advantages of those in segregated funds, through pooled LDI funds.
There was nothing clandestine about this. The funds were domiciled in Ireland because they needed to create what were effected protected cells (something that couldn’t be done 15-20 years ago with UK regulated pooled funds). But the funds were being marketed by household names and formed an essential part of investment consultant’s toolkits.
This may be obscure to the Bank of England and for the reason that Bailey went on to explain
“The non-bank sector is a huge landscape, particularly globally, but we have a lot of parts of it in this country, so the challenge we have on our hands—obviously, we need the assistance from the micro-regulators—is how we get both the breadth and the depth of the coverage here. It is a pretty big challenge in that respect.”
However , small DB pension funds are not so obscure as to be ignored by the investment consultants or the insurers or the platforms or indeed the organisations creating the banking instruments – all of which went untested.
For “micro-regulators” – read TPR and the FCA who clearly did not support the PRA and BOE as they might have done. The stress testing was not conducted on the “15%” but on the “85%”, ironically -even though testing was conducted to a maximum spike of 100bps in gilt yields, the 85% proved resilient to the 240bps spike that happened (though at what cost we won’t perhaps ever know). But because the 15% were “obscure”, the likes of L&G, BlackRock, Schroders, Columbia Threadneedle and Insight (and others running pooled funds) were never tested. Looking back that looks like not having a fire-drill in a newspaper warehouse.
And to anyone used to the problems of having two “micro- regulators” operating in the same space with different skill-sets, cultures and priorities, it is obvious that the FCA regulating the LDI pooled funds and tPR regulating the trustees and advisers, didn’t work.
Large DB schemes survived the LDI crisis but at what cost? We may never know says the BOE – accounting’s too complex.
Small DB schemes were too obscure to be stress- tested and ended up nearly burning down the paper warehouse.
Micro-regulators were stress-testing the large schemes when the problems with small schemes were left to the offshore arms of UK based insurers.
We don’t know what we don’t know but we know that the non-bank sector is huge and very active in this country. The challenge is that the next blow up will almost certainly come from “obscurity”.
As the Transparency Taskforce keep saying.
“Transparency is the best disinfectant”