TPR’s announcement was broadly a reiteration and elaboration on the previous guidance issued in November 2022, with a notable development being the reference to the minimum 250bps market stress buffer which must have scope to be replenished within 5 days, plus an operational buffer which is sufficient to cover day to day volatility. An operational buffer of 100 basis point was mentioned but the level for any particular investor was to be set to an “appropriate” level.
The FCA contained more news, with a clear theme of greater accountability through-out the decision making chain in relation to LDI and other similar investments. LDI managers will be expected to satisfy themselves that the choice of investment is suitable for the investor in the context of their intended outcomes and wider arrangements.
The FCA explicitly mentions considering the benefit of segregated versus pooled funds, recognising how the operational flexibility of segregated funds was advantageous during last year’s crisis.
LDI managers will need to obtain detailed up to date information about a scheme’s wider arrangements, which would typically involve more information than would be readily available in the scheme’s Statement of Investment Principles.
It’s not clear at this stage how any new responsibilities on LDI managers will be monitored or enforced. A natural implication is that there will be some level of increase in client servicing. If this went as far as the LDI manager having a duty of care on the end investor, this could also increase risk for the LDI manager. These factors may result in higher fees charged to pension schemes to compensate the manager.
Simeon Willis, Chief Investment Officer at XPS Pension Group commented: “A theme running through the FCA announcement was one of all participants sharing greater responsibility for LDI arrangements being appropriate to achieve the end investor’s intended outcome. A higher bar is being set. It’s clear that a siloed approach from investment manager or investment adviser, narrowly focused on their own role alone, is insufficient to meet expectations.
Everyone involved in the decision chain should be demonstrating that they are considering the suitability of the investment for the end investor and the resilience of that investor’s overall arrangements. This means LDI managers will need to be asking questions about what a client is trying to achieve by investing in the LDI fund, so it can satisfy itself and evidence that the fund is the best approach all round.”
These more outcome focused developments mirror the messages that have emanated from discussions around the responsibilities of regulators themselves. For example, the Bank of England’s recommendation last month that TPR is set an additional objective around financial stability. This overlapping approach has been proposed as a means to ensure key matters of systemic importance don’t slip through the cracks, which is surely no bad thing.”
Sinead Leahy, Managing Director at Cardano, said: “LDI has served as an invaluable tool for pension schemes for the last 20 years, resulting in many schemes being in stronger funding positions and with lower dependencies on their sponsoring company.
Overall, the system and use of LDI is not broken and what we saw at the end of last year was an extreme event that was not foreseen by the market. However, there have definitely been winners and losers. And so, it is important that trustees and sponsors effectively run a ‘healthcheck’ on their mandate.
“TPR guidance regarding collateral buffers will mean that some pension schemes will need to review their returns objectives and level of hedging, as it won’t be possible to continue hedging to the same degree and target high returns and meet the new collateral guidance. Choices will need to be made. Unfortunately, you can’t have your cake and eat it. As both the FCA and TPR guidance say, the focus should not just be on collateral management and governance but also look at the operational side of the overall LDI mandate – how is the process managed, monitored and acted upon. A review of operational resilience and governance is essential together with the need to revisit journey plans, desired endgame options based on the current funding position, hedging and leverage positions, and updating growth asset outlooks.”
|
