Appearing before the Industry and Regulators Committee on November 22, L&G chair Sir John Kingman and chief executive Sir Nigel Wilson told members of the House of Lords that it could not have foreseen the market consequences of the September “mini” Budget and had not factored such a scenario into its stress-testing.
L&G’s representatives also backed calls for the regulation of investment consultants, after Financial Conduct Authority chief executive Nikhil Rathi expressed the same view before the committee on November 16.
Kingman and Wilson were interrogated on schemes’ abilities to respond to the liquidity crisis, which was triggered by a sharp rise in gilt yields following the “mini” Budget. Collateral calls poured in for schemes, and the Bank of England launched a 13-day, £13.9bn bond-buying intervention in a bid to stabilise prices, having previously announced a gilt-selling package on September 22.
Wrongly, nobody anticipated that the British government would choose to create such extraordinary instability in its own sovereign debt marketSir John Kingman, L&GKingman told the committee that “the ability of pension funds to post wider forms of collateral in conditions of liquidity stress” will need examining, adding that “it would have greatly eased the situation we’ve just been through”.
They were also asked why L&G’s stress-testing had not foreseen autumn’s market turbulence.
“Wrongly, nobody anticipated that the British government would choose to create such extraordinary instability in its own sovereign debt market,” Kingman replied.
L&G did not stress-test for ‘mini’ Budget outcome
Markets have since stabilised and inquiries have begun into schemes’ handling of October’s turmoil.
Rathi appeared before the Industry and Regulators Committee alongside the Pensions Regulator’s chief executive, Charles Counsell.
The Work and Pensions Committee will also hear from industry bodies and experts, including the Pensions and Lifetime Savings Association, on November 23.
L&G is one of the main liability-driven investment providers for UK schemes, alongside BlackRock, Insight, Schroders and Columbia Threadneedle.
The group’s representatives defended pension schemes’ use of LDI, citing research that suggests such investment has created £150bn in value for funds. The concept of LDI was created in 2001.
Kingman and Wilson were asked whether L&G would change how it managed leverage in LDI funds.
L&G’s chair said the most important lesson from the crisis would involve understanding how extreme a scenario LDI vehicles should be insulated from. “The present situation is that LDI vehicles are extremely well-insulated,” he said.
“There will then be a judgment made about where […] you want to put yourself on a spectrum between where we used to be [and] where we currently are.”
“I think it’s extraordinarily unlikely that anyone would advocate going back simply to where we were,” Kingman continued, adding that increases to protection would drive up costs for schemes and their sponsors.
Wilson accepted that there had been “conflicting messages” between the BoE’s gilt-selling programme and a “huge unfunded component” in the subsequent “mini” Budget.
“I think the size of the movements surprised us, and the thinness of the market,” he said.
“Trying to sell very modest amounts, particularly into the index-linked market, was causing further large intraday movements in pricing that have never been seen before in the history of the gilts market,” he added, arguing that no analysts had predicted this scenario.
“We’d never stress-tested for that. There has never been a question that the stress-testing that we’ve had in the past has been inappropriate,” Wilson continued.
After pointing out that nobody had envisaged that the government would create the circumstances which led to the turmoil, Kingman said there is “nothing wrong with the process of stress-testing”, adding “a scenario occurred that no-one tested against”.
‘Trustees are very well-informed’
Investment consultants do not fall within the FCA’s remit, despite previous advice from the Competition and Markets Authority calling on the Treasury for consultants to come under the scope of the FCA.
On November 7, Rathi and FCA 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.
Rathi reiterated this message on his November 15 appearance at the Industry and Regulators Committee and called for the regulation of investment consultants. He also suggested “gaps in competence” for some investors.
Appearing alongside Rathi, Counsell suggested a lack of awareness among some trustees over LDI, particularly at small schemes, and expressed concerns over the standard of their governance.
Kingman said that it would be L&G’s preference for investment consultants to be regulated, caveating that this view was not connected to the LDI crisis.
“I don’t believe that were the consultants regulated, this episode would have been avoided,” he said.
Wilson claimed that trustees are “very well-informed” and “ask very good questions” in response to a query over their understanding of LDI.
TPR and the FCA have been criticised in some quarters over their responses to the crisis.
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 informed MPs that it had contacted the BoE and other regulators before the launch of the central bank’s gilt-buying programme, in order to clarify what actions they could take in response to the gilt market turbulence.
TPR and FCA flag governance and competence concerns over LDI
The Pensions Regulator and the Financial Conduct Authority have raised questions over the governance of small schemes and the competence of some investors, in response to questions from a parliamentary committee over the use of liability-driven investments by pension schemes.
L&G said that it had met with regulators on a regular basis, with a handful of meetings involving representation of the BoE, the FCA and the Prudential Regulation Authority.
“It was clear that during the course of those discussions that they were thinking about whether there was an intervention required from the BoE,” Wilson said.
“We were just explaining that the gilt market was a lot more fragile than we’d ever seen before, and relatively small amounts of volumes were causing very large price movements.”
Alex Janiaud is deputy editor at FTAdviser's sister publication Pensions Expert
