MPs have called on regulators and politicians to address how defined benefit (DB) schemes manage liability driven investments risk.
The Work and Pensions Select Committee has published its report that makes a number of recommendations to encourage better leadership.
The study stems from a sharp rise in gilt yields initially triggered by last September’s mini-Budget that forced the Bank of England to intervene in the market.
The market turmoil in gilts exposed shortcomings in liability driven investment (LDI) that has been used by DB schemes for 20 years.
LDI aims to help trustees at DB schemes manage volatility in their funding levels by investing in assets that move in the same direction as their liabilities.
If both assets and liabilities can be reconciled in an orderly manner there is no problem but if they cannot there is.
It has been found that poor accounting standards and leveraged LDI strategies made DB schemes vulnerable to a sharp rise in interest rates.
It forced pension funds to sell assets, often at significant losses, in order to meet the liquidity calls required by the fall in leveraged LDI values.
The committee’s report today (23 June) questions why the Pensions Regulator (TPR) encouraged schemes to use complex financial products involving LDI.
And also why it relied on trustees to act as the first line of defence, despite its long-standing concerns that some of them were not up to the job.
And TPR’s awareness that it did not have sight of what individual schemes were doing.
Key recommendations include DWP and TPR should explain how they intend to deliver on the Bank of England’s Financial Policy Committee suggestions.
The idea is TPR should specify the minimum levels of resilience for LDI arrangements in which pension schemes invest and work with other regulators, to ensure that LDI funds maintain the resilience that has been built up.
Also TPR should consider requiring trustees to report regularly on their use of LDI and develop a strategy for engaging more closely with schemes based on the results.
Work and Pensions Select Committee chair and MP Stephen Timms said: “The turbulence around last year’s ‘mini-Budget’ exposed a lax approach to regulation. Despite the dangers of the use of LDI being identified five years ago, there was a lack of focus from TPR and inadequate data. The use of leverage by DB pension funds grew, giving rise to systemic risk in a way that was not visible to regulators until crisis hit in September last year.
Although the speed and scale of the rise in gilt yields was unprecedented, the consequences for DB pension funds should have been foreseen and TPR should not have been blindsided. Gaps in regulation and the system for managing systemic risks must now be addressed to ensure that DB pension scheme investments never again threaten the stability of the UK economy.”
