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LDI crisis shows need for investment fund 'death plans' - UK regulator

FILE PHOTO: FCA signage seen at their head offices in London

By Huw Jones

LONDON (Reuters) -The near meltdown in Britain's pension sector after government bond yields rocketed in September showed how investment funds need 'death plans' like banks, the UK Financial Conduct Authority said on Tuesday.

Liability-driven investment (LDI) funds, which help pension funds meet future payouts, struggled to meet collateral calls totalling billions of pounds on their holdings of gilts in September, forcing the Bank of England to step in to buy the bonds.

FCA Chief Executive Nikhil Rathi said banks are required to have a 'resolution regime' detailing how they can fail in an orderly way, known popularly as death plans.

"That work needs to be done in the non-bank space, not just in pension funds. How do we cope with failures?" Rathi told the House of Lord's industry and regulators committee.

The banks that provided leverage to LDI funds would have faced potential losses worth billions of pounds without intervention to stabilise the market, Rathi said.

It was not obvious that some types of funds had the "financial acumen" to understand what would happen to LDI funds in a crisis given the role of derivatives in LDI, Rathi said.

Investment consultants who advised the pension funds on using LDI also need regulating, he added.

Custodian banks who were part of the LDI chain also struggled to cope with the volume of activity during September and need to be looked at, raising further questions about LDI, Rathi said.

"There is a question - and some managers are doing some soul searching now - as to whether that is a product they think is going to be available in the way it has been historically, going into the future," Rathi said.

Following weekly checks on now far higher LDI cash buffers, leverage has been cut materially as the watchdog scans the wider funds sector for hidden leverage.

Leverage caps and higher buffers were on the table, but like many non-banks, LDI funds are listed outside Britain in Luxembourg and Dublin so global action was needed to make regulation effective.

"That is hard going," Rathi said, adding Britain would take its own steps domestically where it can.


The Pensions Regulator (TPR) oversees UK pension schemes, while the FCA regulates the asset managers in London who operate LDI funds.

TPR Chief Executive Charles Counsell was content that pension schemes were using LDI funds given the need to hedge moves in interest rates, but said the TPR had also encouraged pension schemes to assess the risks as well.

The speed and magnitude of the huge increase in UK bond yields was beyond feasible plausibility for LDI, Counsell said, adding that the TPR and FCA may make a joint statement to funds on how much cash they should hold in a stronger buffer.

LDI has been an "incredibly useful tool" for two decades to help pension funds plug funding gaps, but they will have to provide more data to regulators in future, the watchdog said.

There was also the question regarding the extent to which trustees of smaller pension schemes understood risks from LDI, coupled with a "concern" about their governance generally, in particular the need for faster decision-making, Counsell said.

"We would like to move to the point where all schemes have a professional trustee on their trustee board. At the moment that is not practical," Counsell said.

(Reporting by Huw Jones, Editing by Iain Withers, Bernadette Baum and Susan Fenton)