The Bank of England (BofE) has welcomed progress in improving the level of resilience in liability-driven investment (LDI) funds, while its Systemic Risk Survey has revealed improved confidence in the stability of the UK financial system.

The BofE's Financial Policy Committee (FPC) previously outlined its key recommendations following issues with LDI funds in autumn 2022, suggesting that The Pensions Regulator (TPR) should take action “as soon as possible” to mitigate financial stability risks by specifying the minimum levels of resilience for LDI funds.

The FPC's latest Financial Policy Summary and Record provided an update its work to improve operational resilience, again highlighting the LDI stress in September 2022 as a key example of a period of financial instability during which operational issues amplified the initial financial stress.

The report explained that, during this episode of market volatility, the replenishment of LDI funds’ liquidity buffers was hindered by firms’ operational arrangements, and in some cases by the governance processes at pension schemes, exacerbating liquidity issues and the need to sell assets in stressed conditions.

In addition, the FPC said that some custody banks that provide services to these funds struggled to keep pace with the volume and complexity of requests, with the operational complexities of making and receiving large volumes of collateral calls during periods of significant market volatility amplifying market stress.

However, the FPC said that it “welcomed progress made against its November 2022 and March 2023 recommendations” since then, specifically highlighting TPR’s guidance on the use of leveraged LDI strategies.

“There had been continued progress in the implementation of the resilience standard the FPC recommended for LDI funds, and several steps had been taken by authorities to ensure that it would be met on an ongoing basis,” the report stated.

“The FPC observed that this resilience standard was continuing to function well, with funds maintaining higher levels of resilience compared with prior to the LDI episode in September 2022.

"Areas for improvement that FPC had identified in its October 2023 record, including slow recapitalisation periods by some LDI managers, were being addressed via collaboration between domestic and international authorities."

In particular, the FPC welcomed recent consultations by the Central Bank of Ireland (CBI) and Luxembourg’s Commission de Surveillance du Secteur Financier (CSSF) on macroprudential measures for sterling LDI funds, suggesting that, if put into effect, these measures would complement existing guidance by UK authorities to maintain the resilience of the LDI sector.

The FPC also welcomed TPR’s efforts to enhance its data collection and capabilities and ongoing collaboration between UK authorities on LDI data monitoring, arguing that addressing data gaps and embedding the more regular use of data analytics is "essential" to building a deeper understanding of vulnerabilities and resilience in the LDI sector as well as market-based finance more broadly.

The report also provided an update on the BofE's plans to tackle systemic risks in market-based finance by developing a new facility to allow it to lend to insurance companies and pension funds (ICPFs), including newly-resilient LDI funds.

The report stated: "The FPC welcomed ongoing work to strengthen the Bank’s toolkit to intervene where liquidity-related dysfunction in core sterling markets threatened financial stability.

The report stated: "In system-wide stress scenarios where non-banking financial institution (NBIFs) were seeking temporary liquidity, it was preferable, where possible, to backstop market functioning by lending directly to NBFIs against high quality collateral, rather than with asset purchases. This presented less risk to public funds and less moral hazard.

"The FPC noted that the first step in this process would be to design a facility that will enable the Bank to lend to eligible pension funds, insurance companies and LDI funds against UK gilts in times of system-wide stress."

It also suggested that, over time, the BofE will consider how this tool might be broadened to include a wider range of NBIFs as counterparties.

TPR welcomed the Bank's latest report, with chief executive, Nausicaa Delfas, stating: “We welcome the FPC’s recent announcement recognising the progress TPR has made in response to its recommendations on making the leveraged LDI market more resilient to gilt market shocks.

“TPR will continue to work with the Bank of England and other regulatory partners to ensure any risks to financial stability in the pensions sector are reduced”.

The BofE also published the key results from its Systemic Risk Survey, which includes views from pension schemes, UK banks and building societies, large foreign banks, asset managers, hedge funds, insurers, and large non-financial companies.

This showed that survey respondents remain confident in the stability of the UK financial system, reporting a similar level of confidence to 2023 H2.

The perceived probability of a high-impact event affecting the UK financial system in both the short term and medium term had also fallen further.

Geopolitical risk and cyber attack remained the most frequently cited risks among participants, with 85 per cent of respondents citing geopolitical risk as one of the top five risks they thought would have the greatest impact on the UK financial system, while 70 per cent identified a cyber attack as one of their top five concerns.

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