FCA admits being unprepared for ‘mini’ Budget’s threat to pensions

FCA admits being unprepared for ‘mini’ Budget’s threat to pensions

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The UK’s financial regulator admitted that it wasn’t prepared for the threat to pension funds from a sharp rise in yields following Liz Truss’s “mini” Budget. He said the issue was not “right at the forefront of his attention”.

Nikhil Rathi, chief of the Financial Conduct Authority, made the admission during a hearing of the House of Lords’ industry and regulators committee, which was examining how turmoil in the bond market led the Bank of England to pledge an emergency intervention worth up to PS65bn.

The central bank was forced to intervene after the bungled “mini” Budget on September 23 sent UK bond yields soaring, with the 30-year gilt surging from 3.7 per cent to a peak of 5.1 per cent. The spike triggered cash calls on thousands pension funds that used hedging contracts or liability-driven investment strategies (LDIs), which can be sensitive to changes in bond prices. This led to plans to quickly sell liquid assets, including gilts. This increased yield pressure. Rathi gave evidence to the committee. He stated that banks that were counterparties to LDI contracts could have suffered losses of tens to billions of pounds if there was a collapse in gilt demand.

Asked why the FCA had not been more alert to this systemic risk, Rathi said: “I don’t think that the particular scenario of a 250 basis point move in a space of five days in index-linked gilts, which has just never happened at any major [time] in our history, that particular risk wasn’t tested for.”

He added: “This didn’t come up, ultimately, as right at the top of the radar. There were many other [risks]. . . Where we were focusing our energy. Clearly, that’s something for us to think about.”

Pressed on its record of supervising schemes, Charles Counsell, chief executive of The Pensions Regulator, told the committee that “on reflection, we didn’t have as much data” on the use of LDI strategies, leverage and collateral, as “perhaps we would like to have”.

“This area is clearly where we will be having an actual, a real focus,” said he.

Rathi said the FCA was now considering stronger safeguards — including leverage caps and higher capital buffers — on LDI strategies, which have been used by up to 60 per cent of the UK’s 5,200 defined-benefit pension plans to mitigate interest rate and inflation risks. He said that it was appropriate for the FCA to now consider whether there should be stronger safeguards against leverage. He also stated that cross-border agreements and implementation would be most effective, as most LDI funds used in UK pension plans are offshore. The FCA stated that it is now receiving information from LDI managers on a “fairly intensive and frequent” basis. Counsell was asked by the committee if LDI strategies still played a role in pension strategies. He said that “the hedges serve a function” and that removing the ability to hedge would not be without cost.

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