LDI crisis – as the Bank of England’s temporary intervention programme ends, what should trustees be doing?

On 12 January, the Bank of England announced that it had completed its sale of £19.3bn of index-linked and long-dated UK government bonds purchased last autumn in an effort to prevent a "self-reinforcing spiral", after gilt yields soared following the previous Chancellor's September fiscal statement. Andrew Bailey’s confirmation at the Treasury Committee meeting on 16 January that the Bank of England’s estimated £3.8bn profit from the sale will be passed on to HM Treasury, was met with laughter.

Those pension schemes who had to sell assets at discounted prices to meet urgent calls for collateral or who weren’t given the option to post collateral and consequently saw their hedge reduced, are unlikely to be laughing. Now that the Bank of England’s temporary intervention has ended, what should those DB trustees with an LDI strategy be doing?

• First, if you haven’t done so already, trustees should confirm what has happened to their scheme’s funding level since October.  Remember that liabilities will have reduced as well as assets in many cases (though not necessarily at the same rate).  Has your scheme’s funding position remained broadly similar, improved or deteriorated?
  
  
• Speak to your investment consultant and LDI manager about any changes that may need to be made to your LDI strategy. Focus in particular on liquidity buffers and the agreed degree of leveraging. Is extra collateral needed to ensure greater collateral headroom? What assets will the LDI manager accept as collateral in future – there may be an increased reluctance to accept illiquid assets. Can the trustees rebuild their portfolios to ensure they have assets available to meet future collateral calls? If not, can they agree a contingent loan arrangement with the scheme’s sponsoring employer now so that emergency funds can be accessed for collateral purposes in the event of a future market shock? If these are not options, seek advice from your investment consultant and scheme actuary as to whether the scheme should have lower hedging protection or target lower investment returns and what this will mean for the scheme’s long term funding plan.
  
  
• Review the decision making processes in place for your trustee board. Have you delegated decision-making and execution of decisions to an investment sub-committee? Is that delegation documented and are investment advisers aware of and do they follow the agreed process and lines of communication to ensure that the correct trustees make the required decisions at the right time? Is there an effective process in place to execute trustee decisions quickly or is a power of attorney needed?
  
  
• Collate the documentation relating to your LDI strategy. If you don’t have copies, ask your investment adviser. The contract terms relating to these strategies are often contained in a variety of different documents including the Statement of Investment Principles, investment management agreement, investment prospectus and other side letters. We have seen situations where the investment adviser has been unable to provide copies of all the different terms that govern the LDI strategy.
  
  
• Once you have located the contract documentation, is the drafting sufficiently clear regarding areas such as ongoing management obligations, timescales for executing instructions, whether the agreed hedge level is permitted to drift, when deleveraging may occur in a pooled LDI fund, is the deleveraging fair to all investors in a pooled fund, what are the liability exclusions and, if there is a liability cap, is it fair and proportionate?
  
  
• If you are unsure as to the terms of the contract or how the arrangement works in practice, ask your investment adviser or LDI manager to explain it to you. When listening to their explanation, ask yourself if you would feel comfortable explaining how it works to a scheme member. This is a clear example of a situation where having a diverse trustee board comprised of member-nominated and employer-appointed trustees alongside a professional trustee can serve the best interests of members. We have seen a number of cases where trustee boards with MNTs have ultimately refused to enter into investment contracts that advisers weren’t able to clearly explain to them. I wonder if an unexpected outcome of the various ongoing LDI enquiries will be a silencing of the call for the full professionalisation of the trustee board. I am sure the Association of Member Nominated Trustees would welcome such an outcome.

If you would like further advice on any of these points, please do contact our Pensions Team.

Q283 Chair: We will come back to liability during investing when Dame Angela returns. However, on the profits that you have made on the gilts that you bought during that intervention, what are your plans for those? .... Andrew Bailey: They all go to the Treasury. [Laughter.]

https://committees.parliament.uk/oralevidence/12520/pdf/