We saw the LDI crisis coming – we called it. Lis Truss had not been warned because none of her people were listening.
If regulators had seen the Sep22 pensions crisis coming – and Truss had been warned – she would have cancelled the mini-Budget.
But no one did see it coming, so it suited a great many people to blame Truss for the whole debacle.https://t.co/qtyzzVP9aZ
— Fraser Nelson (@FraserNelson) September 16, 2023
The pension big-wigs are quite happy for Fraser’s assessment to become the received wisdom. I’m not and nor are those who did see the LDI crisis coming
Key in LDI to the search engine on this blog for the many excellent articles throughout 2021 and 2022 warning of the risks of over-concentrating pension strategies on gilts and borrowing to do so using Repos and Derivatives.
Click the links at the bottom of this blog and you will see my first broadside was in 2012, this blog also contains an excellent comment from Robin Rowles
For the next ten years, the blog has continued to argue that LDI is based on the wrong assumptions. It has gathered many followers in that time including some concerned consultants.
In June 2021 by blog featured Raj Mody of PWC who told us
“Pension schemes have been “shoehorned” into valuing liabilities against gilts, creating a “herd mentality” that does not reflect scheme funding accurately”, said PwC on a blog which also contained a stern warning from Con Keating on the impact of regulation on the operation of pension schemes.
In March of 2022, Con Keating and Iain Clacher posted an article debunking LDI
Risk and DB Pension Scheme Funding
It is often claimed that these leveraged LDI strategies reduce the risk of the scheme. This runs counter to elementary financial theory where leverage increases, and in some instances is purposefully used to increase, risk and return.
It concluded with a broadside at the Regulator’s failings to properly understand the risks pension schemes were taking
“The mood music was emphatically always to hedge and to fund more and more. The tone of their engagement teams was not the avuncular Dixon of Dock Green, rather more Commander Kenneth Drury’s: “Pay up or we’ll fit you up.” TPR would, of course, deny it if challenged.”
On Tuesday 21st June, Pension PlayPen ran an LDI special asking “what can possibly go wrong – sadly we only got 100 people on the call and neither Liz or Kwasi attended
Warnings at large
It wasn’t just this blog, it was – much more influentially – the FT
— Toby Nangle (@toby_n) September 17, 2023
Toby’s article , dated July 2022, was close to the edge of the precipice
Three weeks earlier, Chris Flood had posted a warning from consultants Mercer headline
UK pension schemes confronted by growing liquidity strains
Those , honest enough to accept they missed the warnings, included the PPF which admitted it could and should have lowered its exposure to LDI prior to the events of last September.
This blog continues to chronicle the changing narrative of the pensions industry to explain why they didn’t see this coming.
As early as mid October 2022, Keating and Clacher were commenting on the “reframing of the LDI narrative to suit those potentially exposed”
Con Keating and Iain Clacher now estimate that Corporate DB pension plans lost over half a trillion pounds from their asset base in 2022, most of it as a result of the sell-down of assets to meet the collateral calls needed to keep LDI hedges in place
Saying so hasn’t done them much good, nor me. Raj Mody and PWC, Toby Nangle, Chris Flood and Chris Giles had all been sending out warnings but no-one got any thanks for doing so, they deserve recognition that they put their reputations on the line and had them tarnished – despite being right
The public face of the pensions industry is the sunny face of schemes that have found themselves with healthy surpluses despite the losses.
What is not being said is that those surpluses could have been many hundreds of billions pound bigger if the hedges had been lifted at the end of 2021.
It did not take a crystal ball to work out that inflation was on its way. The energy crisis, food inflation and the pressure on the central banks to start unwinding quantitative easing meant that predicting interest rate rises in 2022 was an easy game. Smart money fixed mortgages and pre-purchased commodities at 2021 prices. Smart money did not take hedges off LDI.
There was a very strong coercive pressure on trustees from Regulators and from LDI providers to do nothing. The feeling was that to call the Emperor’s new clothes was to risk a run on liquidity which could cause a systemic risk.
So everyone remained seated and hoped that the storm would blow over. Stress tests had been down and they told pension scheme trustees, providers and regulators that even if the big bad wolf huffed and puffed, he couldn’t blow the house down. Unfortunately they underestimated the big-bad-wolf’s lung capacity.
The narrative has moved on
We are at now at state 2 of the denial of the LDI catastrophy. Stage 1 was what we saw at the PLSA annual conference last year where everyone pretended that nothing was going on.
Stage 2 is to say that no one could have seen Liz Truss coming. It is true that the Kwasi mini-budget wasn’t anticipated and probably couldn’t have been. It was monumental foolishness, but you can’t rule out monumental foolishness from a Government that gave us Boris Johnson. We voted in monumental foolishness.
We now move beyond blaming Liz Truss and do as Fraser Nelson does, see the blame passing to regulators and by extension pension advisers. Except that this argument doesn’t work unless there is a body of opinion warning regulators, advisers and trustees of what was to come (and for their influence to have permeated Downing Street).
Fraser Nelson ends his article with a postscript.
I say that “no one saw it coming” but is a big generalisation. If anyone was pointing to the size of the LDI bomb at the time, please let me know in comments and I’ll update this blog.
The final stage of the narrative will be to accept that Nelson Fraser is substantively right. We just need to change “no one saw LDI coming” to, “no one wanted to listen“. We need a change of mindset – as the new CEO at TPR is calling for.