Managers using LDI debacle to ‘grab assets’ from schemes

Toby Nangle, who previously worked at Columbia Threadneedle and Baring Asset Management, and is now an independent economic and financial markets commentator, told the Work and Pensions Committee that those managers “that are able to do LDI will have a greater claim on the pension assets more generally”.

Giving evidence in parliament on February 1, he said: “I have heard of a number of instances where schemes have been asked for 500, 600 or 700 basis point buffer, and this has been understood as an asset grab by the asset managers to say, ‘we just want to have more of your assets, and we will charge fees on more of your assets and this is the prudential thing to do’.”

After the September market turmoil, which led to Bank of England intervention through a £65bn bond-buying programme, the Pensions Regulator published guidance for schemes on November 30 setting out the expectation that liquidity buffers be maintained across pooled and leveraged LDI mandates.

I have heard of a number of instances where schemes have been asked for 500, 600 or 700 basis point buffer, and this has been understood as an asset grab by the asset managers

Toby Nangle, commentator

Sterling-denominated LDI funds across Europe are expected to secure an average yield buffer of around 300bp to 400bp, according to the Central Bank of Ireland and Luxembourg’s Commission de Surveillance du Secteur Financier.

This buffer refers to the level of yield adjustment on long-term gilts from which an LDI fund is insulated, or may absorb, before its capital reserves are depleted. LDI funds trading in the UK are based exclusively in the Republic of Ireland and Luxembourg.

Nangle explained that the move from asset managers could result in “potentially greater concentration among individual asset managers of assets under the banner of ‘it is all to reduce systemic risk’, but I think schemes are starting to push back on that because it is seen as an asset grab”.

Different buffers for different schemes

He noted, however, that distinct schemes should be allowed to hold different buffers in their LDI strategies. “Large schemes, which had a couple hundred basis points buffer, pretty much didn’t have a problem,” he said.

“They had strong levels of governance, delegated authority; they had arrangements in place whereby this was a real test, but they came out unblenched.”

Before the so-called “mini” Budget on September 23, which saw falling government bond prices prompt a series of collateral calls from DB schemes, 48 per cent of schemes had capital buffers below 200bp to 249bp, according to the Pensions and Lifetime Savings Association’s submission to the Work and Pensions Committee inquiry.

Just one in five schemes had buffers of more than 300bp. In early October, more than half said they planned to increase their collateral buffer to more than 300bp by October 14, while a 10th intended to make their buffer 250bp.

Nangle added: “It seems reasonable to me to have an arrangement whereby schemes could have their governance recognised and their arrangements in place that they should perhaps [be allowed] to have a lower buffer than other schemes, which might have more primitive arrangements in place.

“Some kind of discrimination between schemes seems entirely rational.”

BoE to set leverage standards

During its inquiry, the committee has been told that leveraged LDI was the main cause of this crisis, with some calling for this feature to be banned.

It is common for schemes to introduce leverage into their LDI portfolios to free up capital to invest in growth assets, and in the case of an interest rates rise — where liabilities and asset values fall — this leverage will increase.

As a result, the LDI fund manager will require additional capital to reduce the leverage to the original level.

Sarah Breeden, executive director for financial stability strategy and risk at the Bank of England and member of the Financial Policy Committee, does not believe leverage “should be banned outright”.

She told the MPs that the FPC is “discussing and deliberating on what the appropriate steady state response” to the episode should be, and a report should be published in the second half of March.

“Leverage has a role to play in the economy in general [...] but it does need to be well managed,” Breeden said.

“We will set out the resilience outcomes that we want to see and if there are some schemes, perhaps because they are so small they are unable to meet those standards, then it is a reasonable question to ask whether an LDI is appropriate for them.”

She added that the BoE interest is “on the financial stability consequences of that leverage, so what we will be doing is describing the outcomes we think are needed in terms of financial operational resilience and understanding in order to reduce risk to financial stability”.

“TPR and the fund regulators might have additional requirements reflecting their views on these issues,” she added.