Learn from bond market turmoil, UK watchdogs tell LDI funds

By Huw Jones and Carolyn Cohn

LONDON (Reuters) -Asset managers and pension fund trustees should apply lessons from how recent turmoil in UK bond markets left liability-driven investment (LDI) funds struggling to meet collateral calls, Britain's markets and pensions watchdogs said on Wednesday.

The Bank of England had to intervene in bond markets in September as LDI funds, used by pension funds to ensure they have cashflows to cover future payouts, had difficulty in meeting higher collateral calls as bond prices tumbled.

Although managed from London, many of the LDI funds are listed in Dublin and Luxembourg, and regulators are now jointly focusing on ensuring the funds hold enough cash to cover any future spikes in collateral.

"The FCA will maintain a supervisory focus to ensure vulnerabilities identified during the period are addressed," the Financial Conduct Authority said in a statement.

"We are reviewing lessons learned and engaging with firms on their operational contingency planning, and intend to publish a further statement on good practice towards the end of Q1."

Lessons include the speed at which LDI funds are able to rebuild buffers or rebalance funds, client and stakeholder engagement, and reliance on third parties, the FCA said.

LDI funds had been stress-tested in the past, but the speed and scale of moves in UK bond markets were unprecedented.

"As in this event, participants should also consider the risk profile and systemic dynamics of events that could conceptually occur beyond this," the FCA said.

Britain's Pensions Regulator told pension fund trustees - who decide on using LDI funds - to maintain an "appropriate level of resilience" and improve their scheme's operational governance.

It and the FCA welcomed statements from the Central Bank of Ireland and Luxembourg's CSSF regulator on Wednesday on bolstering resilience in LDI funds.

In a letter to managers of LDI funds, the CSSF said the recent build-up of buffers to cope with a 300 to 400 basis point move in UK bond yields should be maintained, with a reduction not appropriate at this juncture.

Funds should provide the regulator with a detailed analysis to justify any move to reduce the buffer and provide a step-by-step plan on how current buffer levels could be regained if market volatility returned, the CSSF said.

The Central Bank of Ireland said it had already told LDI funds last week that they must maintain their new, higher levels of liquidity buffers.

(Reporting by Huw Jones and Carolyn Cohn; Editing by Jon Boyle and Bernadette Baum)