Asset managers offering LDI strategies to pension funds must ensure their clients can deliver collateral within five days, Britain’s financial services watchdog said as part of a series of reforms following the market mayhem caused by September’s mini-budget.
(Bloomberg) — Asset managers offering LDI strategies to pension funds must ensure their clients can deliver collateral within five days, Britain’s financial services watchdog said as part of a series of reforms following the market mayhem caused by September’s mini-budget.
The Financial Conduct Authority said in a statement Monday that it saw significant deficiencies in the risk management of so-called liability-driven investment strategies, whose meltdown threatened financial stability last year. They included areas such as stress testing and scenario planning as well as communications and client services.
The regulator said that it now expects all firm to manage their products and services in a way that does not create risks to the orderly functioning or the stability of UK financial markets.
“Especially where leverage is a feature, we expect firms to consider whether there are circumstances in which the product or service they offer may present such a threat,” it said in the report.
The UK’s pensions regulator also published its own guidance.
The Pensions Regulator “expects trustees to only invest in leveraged LDI arrangements which have put in place an appropriately sized buffer,” it said in the statement. “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.”
Former Prime Minister Liz Truss’s announcement of unfunded tax cuts in September 2022 triggered a selloff of gilts that caught pension funds by surprise, leading to billions in liquid assets being sold at quick notice to meet margin calls. The Bank of England had to step in to prevent a meltdown and UK lawmakers have urged the government and regulators to change pension fund rules as a result.
Asset managers, including BlackRock Inc., Schroders Plc and Legal & General Investment Management were caught in the chaos as they offer LDI strategies to pension fund clients.
In a series of recommendations, the regulator said that LDI managers’ systems were not set up to allow them to react with the necessary speed during the crisis and that they should take steps to change their operations in a way that would enable clients to deliver collateral to their LDI vehicles within five days.
Asset managers should also review the design of product operations, including features such as recapitalization processes and buffer triggers and carry out stress tests that take into account multiple scenarios. LDI managers should also keep buffers in place if they can’t meet the five-day target for collateral.
Parliamentary Hearings
It comes after a series of parliamentary hearings, during which lawmakers interviewed key participants of the LDI drama, including the outgoing chief executive officer of Legal & General Nigel Wilson and the head of pensions’ regulator Charles Counsell, who is also stepping down in March.
The committee said that some pension scheme trustees were not aware of the potential implications of their LDI strategies and were dependent on advice from investment consultants, who are currently unregulated.
“We expect LDI Managers to complete and embed as a matter of urgency all necessary improvements to their operating practices to address the deficiencies identified,” the FCA said in the report. “We will be working with firms to assess their progress in addressing vulnerabilities.”
–With assistance from Greg Ritchie.
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