More still needs to be done to address significant weaknesses in
the ability of defined benefit pension schemes to manage risk,
MPs say today, in a report that warns that their investments must
never again be allowed to jeopardise the stability of the UK
economy as they did during the events of September last year.
The Work and Pensions Committee’s Report on DB pension
schemes with liability driven investments
(LDI) outlines a ‘missed opportunity’ to improve
resilience. After the Bank of England spotted the potential risks
of LDI use in 2018, The Pensions Regulator conducted a survey but
neglected to look at small pension funds, which were the cause of
September’s instability because of the nature of their
arrangements. There was also no system put in place to collect
data on how LDI was used. It was not known that leverage
grew, giving rise to systemic risk.
The Committee concludes that the weaknesses meant that LDI funds
lacked the resilience to cope with the sharp rises in gilt
yields, initially triggered by the ‘mini-Budget’ last year,
leading to the Bank of England being forced to intervene to
protect financial stability.
Setting out some key areas of change for the Government and TPR,
the Committee questions why TPR encouraged schemes to use complex
financial products involving LDI and relied on trustees to act as
the first line of defence, despite its long-standing concerns
that some of them were not up to the job, and its awareness that
it did not have sight of what individual schemes were doing.
The Committee calls for more systemic collection of data and for
regulators to work together to analyse it to spot emerging risks.
DWP should also consider whether the use of LDIs should be
restricted while the process of improving standards of scheme
governance takes place.
Rt Hon Sir MP, Chair of the Work and
Pensions Committee, said:
“The turbulence around last year’s ‘mini-Budget’ exposed a
lax approach to regulation. Despite the dangers of the use of LDI
being identified five years ago, there was a lack of focus from
TPR and inadequate data. The use of leverage by DB pension
funds grew, giving rise to systemic risk in a way that was not
visible to regulators until crisis hit in September last
year.
“Although the speed and scale of the rise in gilt yields was
unprecedented, the consequences for DB pension funds should have
been foreseen and TPR should not have been blindsided. Gaps in
regulation and the system for managing systemic risks must now be
addressed to ensure that DB pension scheme investments never
again threaten the stability of the UK
economy.”
Key recommendations, include:
- DWP and TPR should explain how they intend to deliver on the
Bank of England’s Financial Policy Committee recommendations that
TPR should specify the minimum levels of resilience for LDI
arrangements in which pension schemes invest and work with other
regulators, to ensure that LDI funds maintain the resilience that
has been built up (para 124).
- TPR should consider requiring trustees to report regularly on
their use of LDI and develop a strategy for engaging more closely
with schemes based on the results (para 81).
- DWP should publish its response to the consultation on DB
consolidation by the end of October and work with TPR to improve
the regulation of trustees and standards of governance (para 99).
- Given the time it will take to consult on, legislate for, and
implement measures to improve governance, DWP should consider
whether the use of LDI could be restricted, for example, based on
a test related to a trustee board’s ability to understand and
manage the risks involved (para 99).
- The Government should bring forward plans for investment
consultants to be brought within the FCA’s regulatory perimeter
(para 105).
- In light of the FPC’s recommendation for TPR to take account
of financial stability, DWP and TPR should halt their existing
plans for a new funding regime, at least until they have produced
a full impact assessment for the proposals, including the impact
on financial stability and on open DB schemes (para 149).
