The Pensions Regulator believes defined benefit schemes had “sensible waterfall measures in place” to face the collateral calls prompted by rising gilt yields and has advised struggling trustees to speak to their advisers.
Speaking at a XPS Pensions Group webinar on October 3, TPR investment consultant Neil Bull noted that the watchdog has “been highlighting to schemes the need to have a liquidity plan, particularly in the light of rising interest rates”.
“The vast majority of schemes had good collateral [and] sensible waterfall measures in place,” he said.
The Bank of England announced on September 28 a £65bn bond-buying programme in an attempt to stabilise markets, after falling government bond prices prompted collateral calls for pension funds.
We would encourage schemes to continue to talk to their advisers about this, to get help and understanding on those issues like collateral, which might be less familiar to some schemes
Neil Bull, TPR
Government bond prices collapsed and yields rocketed after the government’s “mini” Budget on September 23, which pledged extensive tax cuts for businesses and high earners.
Before chancellor Kwasi Kwarteng’s Budget announcement, UK 10-year gilt yields sat at just under 3.4 per cent. They have since risen to almost 4.6 per cent, dropping briefly below 4 per cent following the BoE’s announcement.
Liability-driven investment is a risk management tool used to protect schemes from adverse movements in interest rates and ensuring that funding levels do not deteriorate when these rates fall.
Pension schemes will have plans in place so that if interest rates rise, they are required to post collateral, and typically conduct a stress test against a 1 per cent rise in long-term gilt yields.
While schemes have generally coped with the additional capital calls required, an increase of gilt yields to 4 per cent went beyond the contingency plans that most schemes had in place, creating stress within the financial system and dictating the need for the BoE’s intervention.
Bull believes the markets are working as designed and dismissed claims of mass defaults in the pensions industry.
He said: “There have been reports of pension schemes becoming insolvent — no pension schemes have gone bust, nobody has lost their pensions.
“Was it a challenging period of liquidity? Yes, it absolutely was. But the system coped.”
Majority of schemes coped with collateral calls
A poll of the 700 attendees of the XPS webinar showed that almost 38 per cent of schemes were able to source assets at short notice to top up their hedge when faced with collateral calls, while 25 per cent did not need to top up their hedge.
Only 3.6 per cent of schemes saw their hedge reduced due to not being able to source assets, while 5.3 per cent suffered a reduction in hedging due to suspension of trading by their fund manager.
XPS Pensions Group head of investment Ben Gold classified the results as “pretty positive”.
“Not surprisingly, we have nearly 30 per cent that don’t know what their position is at the moment, and that’s probably going to be an area of focus for lots of schemes in the coming days,” he said.
Bull added: “What’s happened in the recent week was a sharp movement which caused schemes to move their attention — rightly so — towards liquidity. We do talk about that in our guidance.
“We would encourage schemes to continue to talk to their advisers about this, to get help and understanding on those issues like collateral, which might be less familiar to some schemes. The advisers are a good place to start those discussions.”
All eyes on the regulator
With some market commentators calling for LDI to be banned from DB schemes’ investment strategies, TPR is being called on to clarify the current situation in the industry.
As first reported by the Financial Times, the Work and Pensions Committee is going to write to the regulator “about issues raised by the BoE intervention”.
So far, the watchdog has said: “We are monitoring the situation in the financial markets closely to assess the impact on DB pension scheme funding. We welcome steps announced by the BoE to restore orderly conditions through temporary purchases of long-dated UK government bonds.
Bank of England buys gilts to protect pension funds
The Bank of England has commenced a round of government bond purchases in an attempt to stabilise markets, after falling government bond prices prompted collateral calls for pension funds.
“We again call on trustees of DB schemes and their advisers to continue to review the resilience and liquidity of their investments, risk management and funding arrangements, and plan accordingly to protect the interest of scheme members.”
However, Pensions Expert understands that TPR has been called for the first time to join the emergency talks with Treasury officials and City regulators, including the BoE and the Financial Conduct Authority, as first reported by the Guardian.
These meetings, organised under the Authorities’ Response Framework — which was established in response to the 2008 financial crisis — are designed to examine measures to respond to the current financial crisis and determine next steps.
