RegulationNov 16 2022

TPR and FCA flag governance and competence concerns over LDI

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TPR and FCA flag governance and competence concerns over LDI
Pexels/Ravi Kant

Defined benefit pension funds scrambled for liquidity in the aftermath of September’s “mini” Budget, which pledged extensive unfunded tax cuts and precipitated a deterioration in markets. Around 60 per cent of schemes in the UK have invested in LDI, according to TPR.

Gilt yields spiked and collateral calls poured in for schemes. The Bank of England launched a 13-day, £13.9bn bond-buying intervention in a bid to stabilise prices.

Markets have stabilised and inquiries have begun into schemes’ handling of October’s turmoil. The Work and Pensions Committee will hear from industry bodies and experts, including the Pensions and Lifetime Savings Association, on November 23.

Not all parts of the system performed as we would have wanted them to.Nikhil Rathi, FCA

On November 7, FCA chief executive Nikhil Rathi and interim chair Richard Lloyd appeared before the Treasury Committee to discuss its recent work. At the hearing, Lloyd highlighted a “gap in regulation” concerning investment consultants. Investment consultants are not regulated by the FCA.

In the same month, Sarah Breeden, the BoE’s executive director for financial stability strategy and risk, called on regulators to review how leverage is managed.

Speaking at a meeting of the Industry and Regulators Committee on November 15, Rathi reiterated this message and called for the regulation of investment consultants. Rathi also suggested “gaps in competence” for some investors.

Appearing alongside him, TPR chief executive Charles Counsell suggested a lack of awareness among some trustees over LDI, particularly at small schemes, and expressed concerns over the standard of their governance.

FCA reiterates call for regulation of investment consultants

There have been previous calls for investment consultants to fall within the FCA’s remit. In 2019, the Competition and Markets Authority advised the Treasury to extend the FCA’s regulatory perimeter to cover services provided by investment consultants.  

In his November Treasury Committee appearance, Lloyd declined to agree whether the regulation of investment consultants would have “solved the problem” of October’s volatility, particularly given the unexpected nature of its trigger.

Rathi emphasised to the Industry and Regulators Committee that government bond markets are currently less liquid than before, and also pointed to the “extraordinary” speed and scale of the turbulence that unfolded.

“Not all parts of the system performed as we would have wanted them to,” Rathi admitted.

“There were clearly gaps in capability and competence in some of the investors. There were clearly gaps in the investment consultants. We do believe they should be regulated, which they’re not at the moment.

The governance of smaller schemes is not as strong as the governance of larger schemes.Charles Counsell, TPR

“Some of the custodians were struggling through manual processing with the majority of the volume of transactions they were having to deal with,” he added.

Committee member Lord Burns asked the panel whether advisers “have not really quite served the purpose that was hoped from them”.

Rathi reiterated his call for investment consultants to be brought “into the regulatory perimeter”, a stance that the FCA has held since 2018.

“The perimeter is a matter for government and parliament,” he said.

“We don’t believe that pension funds have necessarily had the ability to compare performance [and] qualities of disclosures,” he continued, along with their ability to assess fees. 

“There has been this nagging concern about conflicts of interests within the investment consultancy model. To what extent are they using their privileged position with pension schemes potentially to steer them towards other services that they may provide?” 

“We therefore thought that the regulatory umbrella would be valuable.”

‘Trustee awareness varies’

During the market volatility, TPR issued guidance urging schemes to “review their liquidity, liability hedging and governance processes, suggesting that managers of their LDIs could be granted power of attorney over some assets to quicken trading”.

The watchdog also told MPs that it had reached out to the BoE and other regulators before the launch of the central bank’s gilt-buying programme, to clarify what actions they could take in response to the gilt market turbulence.

“In terms of the degree to which trustees were aware of what they were investing in, I think it does vary,” Counsell told the Industry and Regulators Committee.

“Broadly, we have a lot of extremely good trustees who will have been very aware and will have known exactly the right questions to be asking of the LDI fund,” he continued.

Counsell pointed to the broad nature of the pension scheme landscape, which he noted consists of “a number of very large schemes” and “a very big number of rather small schemes”.

“I think the degree to which the trustees of those small schemes were fully aware of what they were in is a good question,” he said.

“There is a broader question […] about the overall governance,” of small schemes, he continued, “and that is something that’s been giving us concern for, frankly, many years”.

Counsell told the committee that TPR has been pushing for the consolidation of smaller schemes, with the watchdog harbouring concerns over “the degree to which the smaller schemes are sufficiently well run”.

“We’ve got quite a lot of evidence that demonstrates that they are less likely to be well run than larger schemes,” he said.

“It is not to say that there aren’t some small schemes that are well run […] but on balance, it is true that the governance of smaller schemes is not as strong as the governance of larger schemes.”

Counsell told the Industry and Regulators Committee that TPR would need to look at the speed of decision-making in pension schemes, something he said is “partly wrapped up” in issues surrounding scheme governance.

New DB funding rules could ‘increase systemic risks’

As part of the Work and Pensions Committee’s own call for evidence, respondents have been asked whether TPR has “taken the right approach to regulating the use of LDI and had the right monitoring arrangements”.

In its submission – dated November 15 – the Association of Consulting Actuaries argued that “LDI has overall significantly benefited DB pension schemes” and “remains fit for purpose”. It predicted changes to the operation of LDI, such as standard minimum levels of collateral.

While TPR has come under fire from some quarters of the pensions industry, the ACA said that the watchdog “has historically taken an appropriate and proportionate [approach] to regulating the use of LDI and investment in general for individual schemes”.

“However, systemic risk is a separate point, including whether the cumulative effects of hedging activities from individual schemes were being sufficiently closely monitored by wider regulators,” it continued.

The ACA stated its concerns regarding government proposals over the funding of DB schemes, which would see them needing to be funded in such a way that they are in a state of “low dependency” on their sponsoring employer by the time they are significantly mature.

The industry body warned that a typical way for schemes to meet this proposal would be the “greater use of LDI approaches”.

“This standardisation therefore has potential unintended consequences, such as increasing systemic risks in future by encouraging all DB schemes to invest in very similar ways,” it said.

The ACA also cautioned that the proposals were “insufficiently flexible” and introduce an “industry-standard approach”.

“We believe the opportunity should now be taken to reflect on these dynamics, to ensure that investment decisions do not contribute to an increase in systemic risks when viewed across the whole industry,” it added.

Alex Janiaud is the deputy editor of Pensions Expert, FTAdviser's sister publication