Lessons will be learned from the shock to pension funds which happened during recent market volatility, according to the boss of a regulator.
Charles Counsell, chief executive of the Pensions Regulator (TPR), said the speed at which bond yields increased over a short time period was beyond what had been thought “reasonably plausible”.
Earlier this autumn, the Bank of England had to step in to soothe market chaos following the mini-budget, amid fears for some defined benefit (DB) pension funds.
Liability-driven investment strategies, or LDIs, are used as a tool to manage risk and ensure that pensions are paid when due. The strategies use collateral, such as government bonds, known as gilts, to raise cash. But funds can be left exposed to sudden market movements – as was seen following the mini-budget.
Mr Counsell told the House of Lords Industry and Regulators Committee: “What we had collectively looked for is the degree to which pension schemes and indeed LDI funds would be able to withstand a shock, being able to withstand increases in bond yields.
Now we need to look to see what lessons need to be learned and what we need to change as a consequence of that
Charles Counsell, the Pensions Regulator
“Typically, that meant testing it to something like 100 basis points.
“What happened was an increase in bond yields much greater than that.
“It was about 150 basis points in less than three days and that was an extraordinary shock and much broader than anything that we had expected, beyond what we thought was reasonably plausible.”
Asked why only a small level of increase had been anticipated, he said: “It is the speed of rise that sits at the heart of this… bond yields had been going up through the year and we were clearly aware of that…
“But it’s not the fact that they are going up that caused the liquidity problems that sat within the funds, it was the speed at which they went up over a very short period of time.
“And it was that that was the real difference between what we had seen in the lead up to it and what actually happened.”
Mr Counsell added: “Clearly it happened, I mean there’s no getting away from the fact it happened, and now we need to look to see what lessons need to be learned and what we need to change as a consequence of that.”
He said that immediate work needs to focus on “the degree to whether there is sufficient collateral in the system to be able to support shocks such as this”.
On reflection, we didn’t have as much data on this as perhaps we would like to have… this is clearly an area where we will be having a real focus
Charles Counsell, the Pensions Regulator
This could mean having a stronger buffer in the event of very sharp bond yield movements, the committee heard.
Mr Counsell added: “On reflection, we didn’t have as much data on this as perhaps we would like to have… this is clearly an area where we will be having a real focus.”
He told the committee that LDIs have been “a useful vehicle” for pension schemes.
“The ability of a scheme to hedge is really important,” he said.
Nikhil Rathi, chief executive of the Financial Conduct Authority (FCA), told the hearing that work needs to be done among non-banks, including pension funds, around detailed planning for what would happen in a situation where they failed.
He said: “In the banking sector, we have a stress test, but then we have a resolution regime.
“So we require detailed planning for, if you blow through the stress test, how would the system cope and how would you fail.
“That work needs to be done in the non-bank space, not just pension funds but I think across the non-bank arena.”
