Learn from bond market turmoil, UK watchdogs tell LDI funds

LONDON, Nov 30 (Reuters) – Asset managers and pension fund trustees should learn that recent turmoil in the UK bond market has left liability-driven investment (LDI) funds struggling to meet collateral requirements, Britain’s markets and pensions watchdog said on Wednesday. Lessons.

The Bank of England had to intervene in bond markets in September as pension funds using LDI funds to ensure they had the cash flow to cover future payouts struggled to meet higher collateral requirements as bond prices plummeted.

Although managed in London, many LDI funds are listed in Dublin and Luxembourg, and regulators are now collectively focusing on ensuring the funds hold enough cash to cover any future surge in collateral.

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“The FCA will maintain a supervisory focus to ensure that vulnerabilities identified during this period are addressed,” the FCA said in a statement.

“We are reviewing lessons learned and engaging with the company on its operational contingency plans and intend to issue a further statement on good practice by the end of the first quarter.”

The FCA said lessons included the speed at which LDI funds were able to rebuild buffers or rebalance funding, client and stakeholder engagement and reliance on third parties.

LDI funds have been stress tested in the past, but the speed and scale of the UK bond market volatility is unprecedented.

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“As with this exercise, participants should also consider the risk profile and system dynamics of a conceptually possible event,” the FCA said.

The UK pensions regulator has told pension fund trustees who decide to use LDI funds to maintain an “appropriate level of flexibility” and improve the operational governance of their schemes.

It and the FCA welcomed Wednesday’s announcement by the Central Bank of Ireland and Luxembourg’s CSSF regulator to increase the resilience of LDI funds.

In a letter to LDI fund managers, the CSSF said that buffers built up recently to deal with 300 to 400 basis point swings in UK bond yields should be maintained and that reductions would not be appropriate at this juncture.

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The CSSF said funds should provide regulators with a detailed analysis to justify any move to reduce buffers and a step-by-step plan for how to restore current buffer levels should market volatility return.

The Central Bank of Ireland said it had told LDI funds last week that they must maintain new, higher levels of liquidity buffers.

Reporting by Huw Jones and Carolyn Cohn; Editing by Jon Boyle and Bernadette Baum

Our Standards: The Thomson Reuters Trust Principles.

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