The UK’s Work and Pensions Select Committee is conducting a short inquiry on the “lessons to be learned” from the recent market turmoil that saw increases in yields on long-dated Gilts in late September and early October, which meant defined benefit (DB) schemes using liability-driven investment (LDI) strategies to deal with the rapid increase in collateral required to support the LDI trades.
This led to the Bank of England’s (BoE) announcement on 28 September under its financial stability remit of the temporary purchase of long-dated Gilts until 14 October.
The Committee’s inquiry will look into the latest events focusing on the impact of the recent volatility in Gilt yields on DB schemes with LDI strategies and their regulation and governance.
The Committee is looking to receive written evidence from those with expertise, experience or an interest in DB pensions with LDI strategies. It is particularly interested to receive evidence on the following:
- The impact on DB schemes of the rise in gilt yields in late September and early October;
- The impact on pension savers, whether in DB or defined contribution pension arrangements;
- Given its responsibility for regulating workplace pensions, whether The Pensions Regulator has taken the right approach to regulating the use of LDI and had the right monitoring arrangements;
- Whether DB schemes had adequate governance arrangements in place. For example, did trustees sufficiently understand the risks involved?
- Whether LDI is still essentially ‘fit for purpose’ for use by DB schemes. Are changes needed?
- Does the experience suggest other policy or governance changes needed, for example to DB funding rules?
The deadline for submissions is Tuesday 15 November 2022.
The Committee intends to follow work in this area with a further inquiry in the new year looking at DB schemes more widely. A separate call for evidence for that inquiry will be made in due course. Issues are likely to include DB scheme funding requirements and arrangements to protect pension benefits when a scheme is wound up.
Peter Goves, fixed income research analyst at MFS Investment Management, noted that the abandonment of former prime minister’s Liz Truss’ economic programme has been welcomed by the markets.
Yields remain high – not least due to the impact of higher economic and political uncertainty – but have rallied given the installation of a new chancellor, Goves said. “The return of fiscal rectitude and appointment of Rishi Sunak as prime minister is also cementing the rally and erosion of some risk premium,” he added.
What’s next for the Gilt market
Drivers of Gilts are complex and multifaceted at present, Goves said, explaining that the politics – which is associated negative credit rating outlooks from Moody’s/S&P – unleashed a wave of volatility owing to uncertainty regarding the UK’s fiscal outlook.
This has now changed with the new chancellor and the resignation of Truss.
In addition, the BoE remains in hiking mode due to the high inflationary backdrop – but again, some pricing has been pared back owing the abandonment of unfunded tax cuts, Goves said.
“Liquidity considerations are also playing their part. All in all, we can expect some erosion of risk premia in the long-end and some paring back of aggressive BoE hikes, but the BoE is still hiking nonetheless, and inflation is uncomfortably high. As such, gilt yields look set to remain relatively high for the foreseeable future,” he said.
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