British Regulators Issue LDI Guidance So ‘Necessary Lessons Are Learned’

The UK’s Financial Conduct Authority and The Pensions Regulator have published guidance for asset managers and pension funds intended to help funds manage risk when using leveraged liability-driven investments.

The guidance comes in response to the September 2022 bond market meltdown, when U.K. financial assets saw severe re-pricing, particularly of long-dated government debt. The spike in yields triggered collateral calls and forced gilt sales that led to market dysfunction for firms with LDI strategies.

The FCA has since been working with other regulators, both in the U.K. and abroad, and has engaged directly with firms involved in managing LDI portfolios to develop and maintain increased resilience to minimize any future volatility.

“We have been closely monitoring asset managers using LDI strategies as they make improvements and the sector is now much more resilient to potential risks, but there is more to be done,” Sarah Pritchard, the FCA’s executive director of markets, said in a release.

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The FCA’s guidance, which follows recommendations from the Bank of England’s Financial Policy Committee, focuses on risk management and operational arrangements for LDI managers. It sets out what the FCA expects in terms of risk management, stress testing, and client communications, “so that the necessary lessons are learned from last September’s extreme events,” Pritchard said.

TPR is reminding trustees that they are responsible for how the assets in their plan are invested, and its guidance stresses the importance of having the right governance and controls in place to reduce risks, and to react quickly to extreme events.

According to TPR, it expects trustees to only invest in leveraged LDI arrangements that have an appropriately sized buffer in place. This must include an operational buffer specific to the LDI arrangement to manage day-to-day changes, in addition to the 250 basis points minimum to provide resilience in times of market stress.

The regulator is also urging trustees to make sure there are processes in place to monitor the resilience of LDI arrangements, taking into account TPR guidance on monitoring pension plan investments.

“The unprecedented market volatility seen last September clearly demonstrated there is the need for stronger buffers, more stringent governance and operational processes and more oversight by trustees,” Louise Davey, TPR’s interim director of regulatory policy, analysis and advice, said in a release. “Trustees must understand the risks they carry in their investment strategy, and only use leveraged LDI if appropriate. Our guidance provides practical steps to ensure they achieve this vital balance, and we expect trustees to use it.”