The Bank of England (BoE) is now calling for further regulation around liability-driven investment (LDI) funds both within the UK and internationally to make sure the vehicles – widely-used by defined benefit (DB) pension funds – remain resilient to the higher level of interest rates.
In a letter to Jeremy Hunt, the UK’s chancellor of the exchequer, or finance minister, Andrew Bailey, the country’s central bank governor, said action was needed in coordination with regulators in other countries as well as from the UK’s own financial watchdog, in the wake of September’s LDI crisis.
Bailey said in the letter, dated yesterday, that in his role as chair of the Financial Policy Committee (FPC), he was responding to recommendations set out in Hunt’s letter of 17 November 2022, as well as to recommendations made by the current UK prime minister, Rishi Sunak, when he was still chancellor of the exchequer back in April.
The FPC is an official BoE committee formed to focus on potential macro-economic and financial threats to long-term growth prospects.
Illustrating how the FPC worked to reduce vulnerabilities in market-based finance that could affect financial stability, Bailey wrote that back in September, the committee had recommended action in response to the stability threat from strains in the UK government bond market – and had welcomed the central bank’s intervention “to restore market functioning and provide time for Liability Driven Investment (LDI) funds to build their resilience”.
“Given the identified shortcomings in previous levels of resilience, and the challenging macroeconomic outlook, the FPC has now recommended that regulatory action be taken, as an interim measure, by The Pensions Regulator (TPR), in coordination with the FCA [Financial Conduct Authority] and overseas regulators, to ensure LDI funds remain resilient to the higher level of interest rates that they can now withstand and defined benefit pension scheme trustees and advisers ensure these levels are met in their LDI arrangements,” the BoE governor said.
In the FPC’s response to the Treasury’s “remit and recommendations for the financial policy committee” attached to the letter, the committee said that in relation to LDI funds, there was “a clear need for urgent and robust measures to fill regulatory and supervisory gaps to reduce risks to UK financial stability, and to improve governance and investor understanding”.
It was important, the panel said, that those funds maintained financial and operational resilience to withstand “severe but plausible” market moves such as those seen recently.
“This should include robust risk management of any liquidity relied upon outside LDI funds, including money market funds,” the committee said, adding that it had welcomed, ”as a first step”, the recent guidance on this from the TPR.
It also welcomed recent statements by the FCA and overseas regulators on the resilience of LDI funds, according to the response.
Following the coordinated action by TPR, the FCA and foreign regulators it was advising, the committee said regulators should then set out “appropriate steady-state minimum levels of resilience for LDI funds, including in relation to operational and governance processes and risks associated with different fund structures and market concentration”.
Further steps would also need to be taken to ensure regulatory and supervisory gaps were filled, in order to bolster the sector’s resilience, the FPC said.
“The Bank will continue to work closely with domestic and international regulators so that LDI vulnerabilities are monitored and tackled,” it said.
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