The Pensions Regulator has published a guidance statement setting out its recommended actions for trustees of DB schemes that use liability-driven investment (LDI) in light of the recent gilt market volatility. The Regulator expects trustees with investments in segregated leveraged LDI mandates and/or single client LDI funds to:

  • Maintain a specified level of liquidity buffer to withstand a fast and significant rise in gilt yields.
  • Review and, where necessary, improve their scheme’s operational governance.

The Regulator is continuing to monitor this area and to discuss it with a range of external stakeholders. It plans to issue a further update in its 2023 annual funding statement and will issue further statements and investment guidance as necessary.

Background

The statement follows the Regulator’s October statement setting out the actions that the Regulator expected trustees to consider taking before the end of the Bank of England’s gilt purchase scheme and in the near-term as the market volatility continued (for more information on that statement, please see our legal update). It also follows statements by the Central Bank of Ireland and Luxembourg’s Commission de Surveillance du Secteur Financier (the NCAs) setting out the levels of resilience and reduced risk profile that the NCAs expect LDI pooled funds denominated in GB pounds to maintain.

The Regulator’s expectations

Liquidity buffer

In light of the recent market volatility and future uncertainty as well as the current geo-political landscape, the Regulator expects trustees with investments in segregated leveraged LDI mandates and single client LDI funds to maintain the same level of liquidity buffer as that specified for pooled LDI funds in the NCA statements. Where trustees cannot, or do not wish to, maintain that level of liquidity, they should consider their level of hedging with their advisers to ensure that the scheme has the right balance of funding, hedging and liquidity. Trustees departing from the specified liquidity buffer should:

  • Demonstrate the buffer that the scheme has in place.
  • Complete a risk assessment of how the scheme will respond to stressed market events so as to maintain its resilience.
  • Detail a step-by-step plan for increasing the scheme’s resilience in the event of market volatility returning.
  • Document and regularly review these arrangements.

Operational governance

Trustees should review their governance processes and consider what practical steps they can implement to ensure that they can respond quickly in response to stresses in the market. The Regulator recommends a range of practical steps that trustees should take, including:

  • Stressing non-leveraged LDI asset allocation and leveraged LDI pooled fund/segregated mandate allocations using a yield shock as set out in the NCA statements.
  • Producing documented arrangements around required collateral amounts and how collateral/margin calls would be met and reviewing those arrangements regularly.

The Regulator also recommends that trustees continue to have detailed discussions with LDI managers on liquidity for pooled and segregated arrangements.

Employer loans

Where trustees choose to take a loan from the employer to ensure liquidity, the arrangement should be clearly documented and regularly reviewed. The trustees should also take legal advice on the arrangement to ensure it is available when needed. Any such loan facilities may only be used on a short-term basis and for liquidity purposes. For more information on the issues trustees should consider in relation to employer loans, please see our recent legal update.

Comment

Trustees of DB schemes which have investments in segregated leveraged LDI mandates and/or single client LDI funds should review the statement and consider what changes they may need to make to their investment and governance arrangements in light of the statement. Trustees should take advice from their investment consultants and, where relevant, their legal advisers in this respect.

For more information, please speak to your usual Mayer Brown contact, Andrew Block or Duncan Watson.