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Bank of England calls for pension crackdown after mini-Budget blow-up

FILE PHOTO: British Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng visit a construction site for a medical innovation campus, on day three of the Conservative Party annual conference at the International Convention Centre in Birmingham, Britain October 4, 2022. Stefan Rousseau/Pool via REUTERS/File Photo - Stefan Rousseau/Pool via REUTERS

Pension funds holding the kind of toxic products that blew up in the wake of Liz Truss’ mini-Budget should face tougher rules to prevent another market crisis, the Bank of England has said.

Funds using liability driven investments (LDIs) should be subject to new stress tests to stop a repeat of the gilt yields crisis that followed the September mini-Budget, the Bank said.

The Bank’s Financial Policy Committee (FPC) has told The Pensions Regulator to urgently introduce stress testing for LDI funds to ensure they can manage a 2.5 percentage point increase in gilt yields.

Funds must also be made to hold more cash to ensure they have enough to manage daily market moves.

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Scrutiny of the pension sector comes as banks continue to recover from shocks in the global market, triggered by rising interest rates.

Lenders have been hit by the collapse of Silicon Valley Bank in the US and the emergency buyout of Credit Suisse, which have triggered fears about the wider health of the industry.

The FPC said it was wary of “indirect spillovers” from issues with international banks and warned the crisis could make it more expensive for banks to raise cash and fund themselves.

Officials said “the economic and market environment was highly uncertain” and warned about the risk of “wider contagion from the developments in the banking sector globally”.

Higher borrowing costs, following the Bank’s eleven consecutive rate rises, are putting strain on households and businesses that has not yet been fully felt, the Bank said.

Threadneedle Street's decision to sell billions of pounds worth of Government bonds into the market will also have an impact.

However, the FPC said falling energy prices and an improved outlook for unemployment mean fewer households will struggle with debt than the committee forecast in December. But the committee warned that homeowners are being stretched by a combination of high living costs and higher mortgage payments.

The FPC report said: “Heightened geopolitical risks increase the likelihood of financial vulnerabilities crystallising.”

The Bank also called for tougher rules for money market funds to ensure they are less vulnerable to rushes of withdrawals.

This is the first time the FPC has called for minimum standards for investments in LDIs.

The LDI stress test suggested by Andrew Bailey and his colleagues would have ensured pension funds could have withstood the market moves in the wake of last September’s mini-Budget.

LDI funds were plunged into crisis after a 1.6 percentage point increase in gilt yields.

While the FPC identified LDI investments as a vulnerable point in the UK financial system, it said British banks were well-equipped to withstand greater market turmoil.

Banks are far better capitalised than before the 2008 financial crisis and have large amounts of cash on hand. Unlike in the US, where only the largest banks are stress tested, all UK banks have been under close scrutiny.

The FPC said: “The UK banking system therefore has the capacity to support the economy in a period of higher interest rates even if economic conditions are worse than expected.”

Charles Counsell, chief executive of The Pensions Regulator, said: “We will be issuing updated guidance on LDI in April, taking into consideration the FPC’s recommendations.

“In the meantime, I urge schemes to continue to follow our existing guidance, which is designed to ensure trustees achieve and maintain an appropriate level of resilience in leveraged LDI funds.”