Britain’s Financial Conduct Authority has admitted it was unprepared for the threat posed to pension funds by a sharp rise in bond yields following Liz Truss’s “mini” budget, saying the issue had not been “right at the top of the radar”. .
Nikhil Rathi, the head of the Financial Conduct Authority, made the admission at a hearing of the House of Lords Industry and Regulatory Committee, which was looking into how turmoil in the bond market prompted the Bank of England to promise emergency intervention worth up to £. 65 billion.
The central bank was forced to intervene after the September 23 “mini” budget widened Britain’s bond yield on September 23, with the 30-year note rising from a peak of 3.7 percent to 5.1 percent.
The increase triggered cash calls to thousands of pension funds that used hedging contracts, or liability-driven investment (LDI) strategies, which are sensitive to changes in bond prices. This forced plans to quickly sell liquid assets, including gold, putting more upward pressure on yields.
Giving evidence to the committee, Rathi said that at the height of the bond market storm, banks that were counterparties to the LDI deals faced potential losses of tens of billions of pounds if demand for gold collapsed.
Asked why the FCA had not been more alert to this systemic risk, Rathi said: “I don’t think that particular scenario of a 250 basis point move over five days in index-linked gilts, which has just never happened in any majority [time] in our history there was no testing for that risk.”
He added: “It didn’t come up, in the end, as top of the radar.” There were many others[risks]. . . where we were actually focusing our energy. It’s clearly something for us to think about.”
Charles Counsell, chief executive of The Pensions Regulator, which pushed for its regulatory framework, told the committee that “on reflection we don’t have as much data” on the use of LDI strategies, leverage and collateral, as “we might like to have”.
“It’s definitely an area where we’re going to have a real, real focus,” he said.
Rathi said the FCA was now considering stronger safeguards – including leverage caps and higher capital requirements – on LDI schemes, which have been used by up to 60 per cent of the UK’s 5,200 defined benefit pension plans to reduce interest rate and inflation risks.
“I think it’s right for us now to think about whether there should be more protection against leverage,” he said, adding that intervention would be “most effective” if there was agreement and implementation between countries, given most LDI funds used. of British pension funds are domiciled abroad.
The FCA added that it was now receiving information from LDI managers on a “fairly intensive and frequent” basis.
Asked by the committee whether LDI plans still had a role to play in pension plans, Counsell said “the hedge serves a purpose” and that removing the option to hedge would be “not without a cost.”