The guidance effectively re-affirms the need to maintain the higher levels of buffers against yield rises that have been put in place since the start of October 2022 – a higher level of buffer than has been typical in the past.
The yield rise level buffers discussed are in line with what we have seen the main LDI investment managers adopt and implement since early October, this means that the vast majority of schemes are unlikely to need to make immediate changes to investment strategies in order to fit with the new expectations.
However, with the new regulatory expectations confirmed, schemes can now plan their future investment strategies with more confidence. Compared to before, in some cases, this will lead to reduced protection against movements in interest rates and/or reduced expectations for future investment returns. In turn, in such cases, this will put more risk or cost onto the sponsoring employers. So a blanket limit on leverage is not necessarily good news for all schemes.
Given the outplay of systemic risk at the end of September and during October, we are of the view that a regulatory line in the sand in this area is helpful, to avoid a creeping up of leverage levels over time as managers compete. The level of buffer chosen by the regulators is sensible in our view, and expressed in a way that doesn’t give us any immediate concerns about unintended consequences.
In LCP’s view LDI needs better systemic oversight by regulators to help avoid a repeat of the market stress seen after the government’s mini-budget on 23 September. It is a positive development to see TPR working together with other regulators on this announcement.
TPR’s guidance also focuses on the operational processes schemes should have in place around levered LDI and the stress testing and contingency planning they should undertake. We welcome that and believe this is at least as important as the level of leverage itself. We continue to work hard with our clients, as we have done for most of the year, on making their operational processes around LDI as resilient as possible.
Inquiries into LDI are ongoing, from the Work and Pensions Commons Select Committee and the Industry and Regulators Lords Select Committee. Further recommendations, guidance and regulations in this area in the coming months cannot therefore be ruled out.
As a result of the same financial conditions that led to liquidity challenges relating to LDI, many schemes are better funded than they have ever been before and many – perhaps one in five or more – are now fully funded on a buyout basis and therefore have the funds to be able to pass their risk to an insurance company, improving protection for members. LCP are therefore projecting continuing strong demand for pension buyouts in the next few years.
Dan Mikulskis. Partner in LCP’s Investment team, commented “We are pleased to see this joined up guidance from regulators on their expectations for the buffers that should be used to support LDI going forwards. This central steer should help materially reduce systemic risk, and enable schemes to focus on now developing a longer term investment strategy that works for them.”
|
