“More still needs to be done to address significant weaknesses in the ability of defined benefit pension schemes to manage risk, MPs say today, in a report that warns that their investments must never again be allowed to jeopardise the stability of the UK economy as they did during the events of September last year.”
That’s the message of the the Work and Pensions Committee’s Report on DB pension schemes with liability driven investments (LDI) The report outlines a ‘missed opportunity’ to improve resilience. After the Bank of England spotted the potential risks of LDI use in 2018, the Pensions Regulator conducted a survey but neglected to look at small pension funds, which were the cause of September’s instability because of the nature of their arrangements.
TPR encouraged LDI to be used by trustees “not up to the job”.
The report concluded that there was also no system put in place to collect data on how LDI was used. It was not known that leverage grew, giving rise to systemic risk.
The Committee concluded that the weaknesses meant that LDI funds lacked the resilience to cope with the sharp rises in gilt yields, initially triggered by the ‘mini-Budget’ last year, leading to the Bank of England being forced to intervene to protect financial stability.
Setting out some key areas of change for the Government and TPR, the Committee questions why TPR encouraged schemes to use complex financial products involving LDI and relied on trustees to act as the first line of defence, despite its long-standing concerns that some of them were not up to the job, and its awareness that it did not have sight of what individual schemes were doing.
Calls for LDI to be restricted till governance is sorted out
The Committee called for more systemic collection of data and for regulators to work together to analyse it to spot emerging risks.
It called on DWP to consider whether the use of LDIs should be restricted while the process of improving standards of scheme governance takes place.
Timms speaks his mind
Stephen Timms MP, Chair of the Work and Pensions Committee, said:
“The turbulence around last year’s ‘mini-Budget’ exposed a lax approach to regulation.
Despite the dangers of the use of LDI being identified five years ago, there was a lack of focus from TPR and inadequate data. The use of leverage by DB pension funds grew, giving rise to systemic risk in a way that was not visible to regulators until crisis hit in September last year.
“Although the speed and scale of the rise in gilt yields was unprecedented, the consequences for DB pension funds should have been foreseen and TPR should not have been blindsided.
Gaps in regulation and the system for managing systemic risks must now be addressed to ensure that DB pension scheme investments never again threaten the stability of the UK economy.”
Key recommendations:
TPR to specify minimum levels of resilience to LDI risks
• DWP and TPR should explain how they intend to deliver on the Bank of England’s Financial Policy Committee recommendations that TPR should specify the minimum levels of resilience for LDI arrangements in which pension schemes invest and work with other regulators, to ensure that LDI funds maintain the resilience that has been built up
TPR to get LDI updates from trustees
• TPR should consider requiring trustees to report regularly on their use of LDI and develop a strategy for engaging more closely with schemes based on the results
DWP to publish response to 2018 consolidation response
• DWP should publish its response to the consultation on DB consolidation by the end of
October and work with TPR to improve the regulation of trustees and standards of
governance. (the DWP has attempted to publish this response three times and been prevented from doing so by another department).
L plates for trustees till they past LDI risks test.
• Given the time it will take to consult on, legislate for, and implement measures to improve governance, DWP should consider whether the use of LDI could be restricted, for example, based on a test related to a trustee board’s ability to understand and manage the risks involved
Investment consultants should be directly regulated by FCA
• The Government should bring forward plans for investment consultants to be brought within the FCA’s regulatory perimeter
DB funding code should be put on hold
• In light of the FPC’s recommendation for TPR to take account of financial stability, DWP and TPR should halt their existing plans for a new funding regime, at least until they have
produced a full impact assessment for the proposals, including the impact on financial
stability and on open DB schemes.