The sponsoring employers of defined benefit pension schemes look set to be called on for advances of contributions or additional funding, as schemes seek to preserve their liability hedging and lock in their improved funding levels.
A number of schemes have been forced to meet collateral calls on liability-driven investment strategies following a surge in gilt yields. LDI funds use leverage in order to achieve desired hedge ratios and can demand collateral from schemes when gilt yields rise.
Some schemes have had to sell down assets, including gilts, in order to generate the cash they need to fulfil these collateral calls. Schemes do not have to pay the money, in which case their hedge ratio would be reduced.
The Pension Protection Fund told the Financial Times that it received calls to provide £1.6bn in cash to satisfy collateral calls. It has since been repaid around £1bn as gilt yields have fallen.
If sponsors can afford to accelerate contributions, then that’s to be welcomed
Pavan Bhardwaj, Ross Trustees
The lifeboat fund subsequently told Pensions Expert that it had no intention of reviewing its use of LDI in response to the recent market turmoil.
Some schemes, such as the Nationwide Pension Scheme, make limited use of LDI with tight limits on the amount of collateral they can be called on to provide.
“We were always conscious you could have this sort of risk,” Nationwide scheme trustee Mark Hedges told Pensions Expert on September 28, the same day that the Bank of England announced a gilt-purchasing programme in response to falling gilt prices.
Others, however, are debating whether to approach their sponsoring employers for funds as they seek to retain their LDI strategies.
“We haven’t formally made the request but it’s actively being discussed,” said Pavan Bhardwaj, trustee director at Ross Trustees.
A window to lock in improved funding levels
DB funding levels have improved throughout the year, with healthy levels supported by the recent rise in gilt yields, which move inversely with scheme liabilities.
UK DB pension schemes have become more than 106 per cent funded on a long-term target basis following the market’s volatile reaction to the government’s September “mini” Budget, according to XPS Pensions Group.
Funding surpluses would usually rule out the need for employer contributions. Schemes that are in deficit, meanwhile, will normally have a schedule of contribution payments from their employer.
However, some schemes appear set to request contributions from their sponsors in order to protect their hedge ratios and, ultimately, secure their healthy funding positions.
“It’s certainly on the table. It makes sense for a lot of schemes who will have seen a real improvement in their funding positions but don’t have the liquidity available to lock that in,” Bhardwaj said.
Should an employer decline to meet this request, the scheme may then be left to reduce its hedge ratio, he suggested.
With a decline in yields, “you kick back the improvement in the funding level, and then some”, he continued.
“If sponsors can afford to accelerate contributions, then that’s to be welcomed.”
Teneo client development director Simon Kew, meanwhile, has “seen cases of sponsors being asked to either provide cash for short-term liquidity, or to prevent the (potentially costly) process of unwinding existing positions”.
MPs question TPR role in LDI market turmoil
The Work and Pensions Committee has questioned the Pensions Regulator’s role in the market turmoil that led to the Bank of England’s intervention, asking if the watchdog should have “taken stronger action” earlier and what actions it was taking to monitor risks.
Zedra managing director Richard Butcher has already put the idea of bringing forward contributions and retaining the hedge ratio to a scheme sponsor.
“Having taken a few other actions”, Butcher had established that its scheme has enough cash to see it through an increase in gilt yields of 1.5 per cent.
He said: “We’re not going to them begging. We’re just going to them and saying, ‘this is prudent planning, sensible planning. To optimise the value of all the assets, we’d rather retain the hedging ratio. We don’t want to sell stuff at a distressed rate, so do you want to bring forward contributions?’”
