Home truths – a year on from the LDI Crisis

Katie Martin writes on the anniversary of the Kwarteng mini-budget of its lasting impact. A budget designed to create growth in the British economy has done quite the opposite

Even now, bankers and investors say the whole episode is holding back the flow of money in the UK towards illiquid assets, as funds are nervous about holding paper they cannot sell in a hurry.

You could argue that the main reason corporate DB pension plans aren’t investing in growth assets is because insurers don’t want them after buy-out. But this is substantively the same problem. The urge to de-risk pensions is so prevalent that the thought of running a pension scheme “on” is considered a radical “new” strategy.

Most of the debate on why a pension scheme should be invested at all (rather than locked down in matching assets) is couched in terms of “extraction” of surplus. There is a feeling that a pension scheme might be an alternative source of finance for companies, a sentiment not felt since the end of the last century. But there is little appetite (as yet) for this.

Instead, “de-risking” remains pension’s mantra.

  • Running a pension scheme without recourse to the sponsor’s cash,
  • Managing a pension scheme so that it can be bought out by an insurer.

These are as much the mantras of the regulators , advisers and fiduciaries today as they were a year ago.

What the explosion of LDI did was remove any choice for schemes about the direction in which they were heading.  For most schemes using leveraged LDI, most  liquid assets were sold to meet liabilities. Many had to go further , securing lines of credit from banks of liquidating illiquid assets in firesales, typically at hefty discounts. Equities – UK equities included- were immediate casualties.

What Katie Martin’s banking contacts are observing is not the unwillingness of trustees to buy back into growth markets, but their incapacity. They are still in thrall to LDI programs and while these may now accept some “dirty collateral” (corporate bonds), they certainly won’t accept “illiquids”.  Pension schemes do not have the capacity to invest in anything much as they have no money to purchase with.

Clacher and Keating’s estimates that pension schemes were cleaned out of over £600bn last year now turns out to be correct. The latest ONS survey reports that the total net assets of DB schemes were £1,244 billion up from a revised £1,225 billion (previously £1,230 billion) in December 2022. This brings the total net losses of schemes since December 2021 to £577 billion and the gross loss to £626 billion.

What money that remains in DB schemes that used leveraged LDI is in the illiquids that couldn’t be sold.

The cause of the failure – not  LDI – but the mentality behind it

Katie Martin concludes her article

“The LDI crisis highlighted that after the 2008 financial crisis, the agenda was to reduce counterparty risk through margining,”

one former policymaker said. That makes sense. Bank failures are bad.

“But that had this knock-on effect of transforming counterparty risk to liquidity risk,you get these dashes for cash.” 

Authorities are increasingly taking note, ramping up the warnings on the financial stability vulnerabilities nestling outside the banking system. Reform of the financial system after the global financial crisis was the right thing to do.

But it has taken a decade and a half to really figure out what the long-term trade-off is. The UK’s gift to the world one year ago was to give a technicolour example of what authorities around the world must strive to avoid in future.

Of course there is another view of pension funds – one that the “pensions” regulator is “increasingly taking note of”.

That view is that the fund behind a pension is there to pay pensions, not to make insurers profitable or feed the margins of banks. The huge tax breaks offered to pension schemes are based on a view that they will invest in the long-term assets of the nation and in the equity of the companies that fund the schemes.

It is also based on the belief that over time, the welfare of the country depends not just on tax-payer funded pensions and benefits, but on pensions paid by companies to their former staff.

These fundamentals of pensions seem all but forgotten, even by those entrusted to enforce the rules.

LDI amplified a deeper flaw in the nation’s pension strategy.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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