Pensions experts have told MPs they are ‘absolutely shocked’ by the level of ‘hidden’ borrowing in UK pension schemes, which nearly spilled some funds during the bond market crisis in September and strained trustees cash-strapped to sell up to £500bn of assets. .
Speaking to politicians on the Work and Pensions Committee on Wednesday, academics and pensions experts laid bare the risks that certain types of liability-oriented investments, or LDIs, posed for retirement savings.
Defined-benefit pension funds, which guarantee a fixed pension at retirement regardless of investment performance, were found wanting during the bond crisis. They appeared to have relied heavily on LDI hedging deals, which involved holding government bonds as collateral. When the value of government bonds fell dramatically after the disastrous Liz Truss-Kwazi Kwarteng mini-budget, pension plan administrators were forced to quickly sell their holdings to raise funds. This further depressed the value of the bonds, causing a “catastrophic loop”.
Within days, the Bank of England had to step in with a £65bn emergency bond purchase program to prevent a large number of LDI funds from failing.
John Ralfe, an independent consultant and pensions expert who previously managed the Boots pension scheme, expressed concern about the extent of leverage – in effect borrowing – used by pension schemes in the as part of their LDI strategies.
UK rules prohibit pension schemes from borrowing money to fund investments, but experts such as Ralfe and Henry Tapper, executive chairman of Agewage, have said LDI hedging arrangements are the same as borrowing .
“Pension funds shouldn’t be borrowing money, and in my mind leverage is borrowing,” Tapper told MPs. “There is a difference between matching your assets and liabilities, which is hedging, and leveraged LDI, which is pure speculation.
“What has absolutely shocked me about what we’ve seen over the past few weeks is… the hidden leverage,” he explained, referring to borrowing levels that would otherwise did not appear on company pension plans or balance sheets.
“I don’t think it’s widely known. If you look at all the information produced by the pension regulator and the pension protection fund … there is nothing,” Ralfe said. “If you look at individual company accounts, there’s nothing there. So it was hidden. »
Iain Clacher, a professor at the University of Leeds business school, also blamed leveraged LDI programs for the bond market meltdown.
“If you only look at the active side, based on the calculations that myself and Con [Keating] have done, we estimate that around £500 billion is probably missing somewhere. And it’s not a waste of paper. It’s a real loss because pension funds were selling assets to meet collateral calls,” Clacher said.
And while the pensions regulator admitted to encouraging the use of hedging strategies, including LDI, experts told MPs on Wednesday that watchdogs had failed to keep up with the systemic risks associated with their widespread use.
The pensions regulator launched an investigation into the use of LDI after the Bank of England drew attention to the schemes in its Financial Stability Report in 2018. However, experts said the regulator does not had not properly understood the systemic risks created.
“The most important thing is that there is not a single numerical estimate of risk in this [pension regulator] report,” said Con Keating, head of research at the Brighton Rock Group.
About 60% of pension schemes would use the LTD, according to the Regulator of pensions.
Keating added that the regulator was aware of the risks before the market collapsed in September and claimed the crisis was ‘entirely predictable’, contradicting claims by watchdogs including the Financial Conduct Authority, which also appeared before parliamentary committees in recent weeks.
However, Jonathan Camfield, a partner at Lane, Clark & Peacock, defended the use of LDI and told MPs that leverage was an important part of ensuring company pension schemes can pay pensions. retirees.
He said that while leverage created systemic risk and LDI required “better management going forward, these strategies were an ‘effective’ way to protect against interest rate fluctuations and the inflation.
“LDI will have been a success for diets that have been in LDI [in the] halfway,” he said.
The pension regulator declined to comment.