Regulators demand LDI strategy ‘buffers’ to shore up funds following mini budget market meltdown
Regulators are pressing managers of debt-fuelled liability driven investment (LDI) strategies to boost their access to quick cash and review the make up of their clients after the market was plunged into crisis by Liz Truss’s disastrous mini-budget last year.
Liability driven investment (LDI) strategies were at the heart of the turmoil that rocked the UK’s financial markets last Autumn in the wake of Truss and Kwasi Kwarteng’s tax-cutting plans.
The plans, which were unveiled in September’s mini budget, fuelled a wild surge in the price of UK government debt and triggered hefty collateral calls for asset managers, leading to a fire-sale of gilts and the-near collapse of some funds deploying LDI strategies.
The Financial Conduct Authority and The Pension Regulator are now looking to shore up the market from future turmoil and laid out a host of recommendations for LDI managers today, including diversifying exposure to certain types of assets and the spread of a firm’s clients.
Sarah Pritchard, executive director, markets at the FCA said in a statement today: “We have been clear that asset managers must take the necessary steps so that their LDI portfolios are resilient to future market volatility.”
“Since September last year, we have been closely monitoring asset managers using LDI strategies as they make improvements and the sector is now much more resilient to potential risks, but there is more to be done.”
FCA and TPR outline LDI measures
Among a host of new risk management protocols laid out today, the FCA said it now expects funds to review the “composition of clients’ liquidity waterfalls”, asset and exposure concentrations and the extent of leverage at “fund, mandate, client, or firm-level.”
The watchdog also warned that firms’ systems were not set up to “allow them to react with the speed that was needed” when crisis hit last year, and recommended they push through operational changes to react with speed in future.
“We expect managers to [r]eview the design of product operations, including features such as recapitalisation processes and buffer triggers to enhance their effectiveness even in stress scenarios,” the FCA said in its recommendations.
Firms have also been urged to make changes to ensure they can provide cash to their LDI vehicles “within five days or sooner”.
In a separate statement today, the Pensions Regulator issued new guidance for pension schemes and said they are expected to “only invest in leveraged LDI arrangements which have put in place an appropriately sized buffer”.
“This must include an operational buffer specific to the LDI arrangement to manage day-to-day changes, in addition to the 250 basis points minimum to provide resilience in times of market stress,” the Pensions regulator said.
The measures today mark another step to try and shore up the market after volatility sparked fears of a major financial crisis and prompted the Bank of England to step in with an emergency bond-buying programme.
Threadneedle Street allso recently backed calls for LDI funds to hold stronger cash buffers to prevent similar shocks in future
The crisis has sparked calls for a rethink of the regulatory oversight of schemes from lawmakers.
The House of Lords’ industry and regulators committee said earlier this year that regulators had been “too slow” to recognise risks, and recommended to City minister Andrew Griffith that the Bank of England should play a role in regulating the sector.