Pensions trustees should prepare for potential further market turmoil following Autumn budget

08 November 2022

Recent pensions market turmoil around LDI (Liability Driven Investment) gilt yields highlighted an urgent need for training and education for trustees and employers around managing risks in volatile market conditions. As the UK heads towards the Autumn budget, RSM UK is warning that further political and economic uncertainty has the potential to disrupt the pensions market further, and recommends trustees and sponsoring employers take steps now to protect pension funds. 

Tom Pugh , economist, RSM UK said: ‘With a £50bn fiscal hole to fill, it’s going to be a challenge for the government to keep public sector workers such as nurses happy on the pay and pensions front. Depending on what’s announced, the potential for a backlash, and possibly strike action, could be high. If a backbench rebellion is triggered, the markets are unlikely to react well to this, potentially causing further pensions disruption. Issues around liquidity are also ongoing, although the recent reduction in gilt yields is likely to have helped.’

Scheme lawyers are currently updating credit support documentation so that pension schemes can post other liquid assets other than cash as collateral in future. Currently, many of the legal documents between pension schemes and hedge providers state that collateral must be in the form of cash only. As pension schemes only hold a certain amount of cash, versus a large book of investments, abnormally high collateral requirements during periods of market stress force pensions schemes to sell financial assets in a weak market to raise cash.

Nav Sarai, senior pensions manager at RSM UK said: ‘Part of the issue is that LDI funds are holding onto the capital calls they received following the mini-Budget crisis and not paying these back to pension schemes, even though the markets are currently calmer. This leads to the LDI funds effectively de-leveraging themselves to avoid any similar problems occurring. Schemes that had their liquidity sucked out of them are still having to disinvest from elsewhere to replace that liquidity in order to conduct business as normal. This means the overall investment position is still having to be adjusted by trustees to address the problems caused by the crisis.’

The Pensions Regulator has now published a guidance statement on its website for Trustees and their advisors. This sets out the main points to consider in managing investment and liquidity risks in unpredictable market conditions, which includes reviewing any liquidity waterfall and topping up collateral buffers. 

RSM warns trustees should also be mindful of the increased risk of scams during market volatility, as the high volume of investment transactions currently taking place make pension scheme investments a potential target for fraud.

The Work and Pensions Committee has now launched an inquiry into defined benefit pension schemes with LDIs in response to recent events. Interested parties have until November 15 to respond. 

Nav Sarai, senior pensions manager, RSM UK concludes: ‘We anticipate this inquiry will lead to increased regulatory requirements from The Pensions Regulator, and possibly supervision of LDI investments from the FCA. Schemes may also be required to adhere to stricter rules around permitted leverage and requirements to hold higher levels of collateral. We may also see obligatory stress testing on leveraged LDI investments. The Pension Regulator may also require trustees to formally report this information as part of ongoing monitoring to avoid the liquidity issues seen in recent weeks.’