On 24 April 2023, the Pensions Regulator (‘tPR’) and Financial Conduct Authority (‘FCA’) both published updated guidance setting out their expectations around the future management of LDI. Whilst this does not represent a regulatory change at this stage, it does provide a clear set of expectations that trustees, their advisers and LDI managers can now have certainty in working towards.
tPR and FCA guidance
The tPR guidance builds on previous statements by providing further detail on the steps that they feel trustees should take when investing in LDI. The key issues to consider are summarised as:
- where LDI fits within a scheme’s investment strategy,
- the setting, operating and maintenance of a collateral buffer,
- testing the resilience of LDI allocations,
- the importance of good governance, and
- monitoring LDI
In addition, tPR has accepted the Bank of England’s recommendation that they specify the minimum levels of resilience for leveraged LDI strategies. The guidance states that trustees should only invest in leveraged LDI that includes an appropriate ‘operational buffer’ which is sufficient to cover day to day market volatility, in addition to a 2.5% minimum ‘market stress buffer’ to provide resilience in times of market stress. This minimum level should be replenishable within 5 days, or else a higher stress buffer is recommended.
The main talking point of the FCA guidance is the trailing of the introduction of new responsibilities for LDI managers. Whilst precise details have not been provided at this stage, they outline their expectation that managers will be expected to satisfy themselves that the choice of LDI is suitable for the investor given their objectives and wider portfolio. To do this, managers will be expected to obtain detailed and up-to-date information about a Scheme’s wider portfolio to ensure that the LDI investment and wider portfolio are complementary and that risks are clearly understood.
The FCA also recommends that LDI Consultants help investors to establish the approach to LDI that best suits their needs, specifically in relation to whether the additional flexibility of segregated or ‘pooled fund of one’ arrangements outweigh the additional costs when compared to investing through pooled funds.
Quantum Advisory’s view
Quantum Advisory welcomes the FCA and tPR’s guidance, it is a valuable resource for pension schemes to help them manage risks associated with their investment strategies. Ultimately, by following the guidelines set, pension schemes are likely to be better positioned to achieve long-term investment objectives and safeguard their members’ retirement benefits.
However, it is clear that the costs associated with investing in leveraged LDI, (in terms of both net returns but also trustee governance) are increasing. This comes at a time when many schemes are more strongly funded and are coming to rely less on leverage as a means of achieving their risk management objectives.
Our view is that schemes should be reviewing their LDI arrangements to ensure both that they are robust in light of the new guidance, but also that their current arrangements remain the most appropriate way of meeting their objectives.