The Central Bank of Ireland (CBI) has released a statement on ensuring the resilience of liability-driven investment (LDI) funds denominated in Great British pounds (GBP).

The National Competent Authorities (NCAs), the CBI, the Commission de Surveillance du Secteur Financier and the European Securities and Markets Authority, engaged with managers of GBP LDI funds throughout the period of recent volatility in yields associated with UK gilts, which gave rise to a “concerning” cycle of collateral calls and forced sales, the CBI’s letter stated.

Following this engagement, the resilience of GBP LDI funds across Europe improved to an average yield buffer of 300-400 basis points.

Amid the current market outlook, the NCAs said they expected the levels of resilience and reduced risk profile of GBP LDI funds to be maintained, and that they do not consider any reduction in the resilience at individual sub-fund level to be appropriate at this time.

If it is deemed necessary to advertently reduce an individual GBP LDI fund’s resilience below the levels that were achieved following the volatility in the UK gilt market, the CBI stated that relevant parties should: “Inform in advance the NCA supervising the investment fund manager and, in case of cross-border setups, the NCA in the country where the LDI Funds are domiciled, of the proposal to advertently reduce an individual GBP LDI Fund’s resilience and of the level.”

It also told relevant parties to complete several actions prior to making any reductions, with such documents to be made available to the relevant NCA upon request.

The CBI directed that relevant parties must: Undertake and document a detailed analysis justifying the need to reduce the GBP LDI Fund’s current resilience; complete and document a risk assessment with relevant modelling of how the proposed reduction in the GBP LDI Fund’s resilience will not impact the orderly functioning of the GBP LDI Fund in the current and in stressed environments; and detail and document a step-by-step plan for returning the GBP LDI Fund to current levels of resilience in the event of increased market volatility, noting any assumptions that the framework is based on.

“The GBP LDI Fund must ensure that clear policies and procedures are established to increase resilience in the event of further volatility in the market,” it added.

If there is an inadvertent decrease of GBP LDI fund resilience due to a changing market environment, the NCAs expect the GBP LDI fund to have procedures in place to recapitalise and/or de-risk their portfolios by reducing their exposures in a timely manner.

“This should include accounting for the second-round effects of actions taken by other market participants on the individual funds, for instance the market impact of asset disposals triggered by rising yields” the letter continued.

“For LDI funds in other currencies, the above-mentioned notification system does not apply for the time being.

“However, the NCAs expect that the LDI managers maintain for these LDI funds an appropriate level of resilience at an individual sub-fund level in order to be able to absorb possible market shocks. Again, this should include accounting for the second-round effects of actions taken by other market participants on the individual funds.”

As reported by our sister publication, Pensions Age, The Pensions Regulator (TPR) in the UK also issued guidance on LDI, encouraging scheme trustees who use LDI to maintain an "appropriate level of resilience" in leveraged arrangements to better withstand a fast and significant rise in bond yields.

Responding to the NCAs’ statement, TPR acknowledged the expectation of maintaining a specific level of liquidity buffer along with the reduced risk profile, given the recent higher level of market volatility and future uncertainty, and the current geo-political landscape.

Building on the NCA guidance, TPR suggested that, where statements from the NCAs refer to pooled funds, it believes the same level of resilience should be maintained for segregated leveraged LDI mandates and single-client funds, as they face the same market risks and operational challenges.

More broadly, TPR stated that, if a scheme is not able to hold sufficient liquidity, or is unwilling to commit to that level of liquidity, they should consider their level of hedging with their advisers to ensure they have the right balance of funding, hedging and liquidity.

TPR’s guidance outlined a number of steps trustees should take if they choose to depart from the liquidity buffer set out by the NCAs, including working with advisers to demonstrate the buffer the scheme has in place, completing a risk assessment of how the scheme will respond to stressed market events.

The regulator also encouraged trustees to review their governance processes and consider the challenges that arose for their pension scheme during the volatility in September and October 2022, and then consider what practical steps in terms of their arrangements they can implement as a result of lessons learned.

The guidance also included a number of practical steps that trustees should take to ensure they are able to react quickly in response to stress in the market, such as calculating the required collateral amounts, and the type of assets, specifying the dates when these collateral/margin calls need to be made, and ensuring governance is robust.

The regulator clarified that the guidance aims to address immediate requirements on liquidity, with TPR clarifying that it remains "alive to the constantly changing market conditions and the implications for the future".

In light of this, TPR is continuing discussions with a number of external stakeholders, with plans to issue a further update in its Annual Funding Statement in April 2023, and in further statements and investment guidance as necessary.

TPR chief executive, Charles Counsell, stated: “LDI funds are regulated in the country their provider is based and in most cases, these are EEA countries. We are very pleased therefore to see these joint statements from regulators in Ireland and Luxembourg setting clear expectations for the resilience of LDI portfolios."

"Accordingly, we have now issued a guidance statement for trustees and advisers confirming our expectations for the use of LDI funds. I urge trustees to read the statement and consider how they can meet the steps it outlines to ensure their scheme buffer is sufficient to cover a swift and substantial increase in yields at the level set by the NCAs.

"We continue to work closely with other regulators to ensure we learn from the challenges we have seen in recent weeks."

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