British liability-driven investment (LDI) funds in Ireland and Luxembourg will need to be able to resist a rise in GBP yields of at least 300 basis points, under new restrictions from EU financial markets regulator, the European Securities and Markets Authority (ESMA).

The requirement was part of the ESMA's advice to the Central Bank of Ireland (CBI) and the Commission de Surveillance du Secteur Financier (CSSF) on investment restrictions for GBP Liability-Driven Investment (LDI) funds to ensure their resilience.

This comes after the CBI and the CCSF previously notified ESMA of their intention to impose an investment restriction on Alternative Investment Fund Managers (AIFMs) established in Ireland and Luxembourg and managing GBP-denominated AIFs pursuing a LDI funding strategy.

These funds are typically set up by defined benefits (DB) pension schemes that provide guaranteed returns to future pensioners.

Under the requirements, which came into effect yesterday (29 April 2024), GBP LDI funds will need to maintain a yield buffer of at least 300 points.

GBP LDI funds established on or after this date must comply with the measure immediately while existing GBP LDI funds have a three-month transitional period to comply. The measure is not limited in duration.

ESMA also encouraged both regulators to monitor the evolution of the GBP LDI funds and to assess the necessity to recalibrate the yield buffer, after its analysis found that the conditions for taking actions under the AIFM Directive have been met and the measures proposed by the CBI and the CSSF are justified and should contribute to improving the resilience EU GBP LDI.

The ESMA also encouraged other competent authorities of AIFMs managing such funds to adopt similar measures.

British LDI funds in Ireland and Luxembourg were thrown into the spotlight in 2022, after the mini-Budget triggered "unprecedented volatility" in gilt markets, triggering liquidity issues for some DB schemes.

UK regulators have undertaken work since to address the issues that emerged during this time, with The Pensions Regulator and Financial Conduct Authority (FCA) sharing guidance designed to increase the resilience of LDI funds, which required trustees to only invest in LDI arrangements that have an appropriately sized buffer.

This was also in line with recommendations from the Bank of England's Financial Policy Committee, which suggested that the size of the yield shock to which LDI funds should be resilient should be, at a minimum, around 250 basis points.

Commenting on the new requirements, OpenGamma margin expert, Jo Burnham,said: “The issue is that, in the wake of a situation like the UK gilt crisis a few years back, it can take two to three days for pension fund to liquidate their assets to meet their margin obligations.

"This is why EU pension funds exposed to UK gilts need to have a far greater understanding of the capital that the need to have to meet the cash flow requirements to identify liquidity challenges during the trading day.

"This is the only way they can start liquidating their assets much sooner in the event of another unwelcome fiscal policy rocking debt markets.”

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