Industry experts have welcomed the regulator's updated guidance on liability-driven investment (LDI), although concerns over the level of detail and the need for future evolution have emerged.

The Pensions Regulator (TPR) and the Financial Conduct Authority (FCA) yesterday (24 April) shared updated LDI guidance designed to increase the resilience of LDI funds following market volatility in autumn 2022.

Pensions and Lifetime Savings Association (PLSA) deputy director policy, Joe Dabrowski, highlighted the guidance as a "helpful resource" for pension schemes looking to make use of LDI strategies.

“LDI has worked well for many schemes and employers over two decades and has helped defined benefit pensions, in the round, now being much better funded against their liabilities," he continued.

"Nonetheless, it is prudent of TPR to publish guidance on how to manage the potential risks, which were exposed by the unprecedented volatility episode that followed the mini-Budget last autumn.

“The industry has adapted well following those events and schemes using LDI are generally holding additional collateral buffers at the levels suggested in the guidance already."

However, Dabrowski also emphasised the need for the guidance to be a "living document" that is updated as the market changes and evolves.

“We note that a ‘standing level’ of 250 bps collateral buffer has been recommended – it is important however that any level of collateral holding should be evidence-based and reflect prudent market risks for the strategy, rather than scenarios, which could be too soft or excessively cautious and come at cost to performance," he added.

“We would like to see further detail on this analysis from regulators on how they will continue to assess systemic risks into the future.”

Adding to this, Isio investment advisory, Tim Barlow, said that whilst the regulator's guidance is welcomed, more guidance is still needed on what constitutes “periods of stress” where schemes can operate LDI hedges below the minimum resilience level of 250 bps.

"This would help trustees plan better and avoid reckless prudence in the amount of collateral set aside to support LDI hedges," he added.

Industry experts have suggested that the FCA's guidance included more news, with XPS Pensions highlighting a "clear theme of greater accountability" through-out the decision-making chain in relation to LDI.

XPS Pensions Group chief investment officer, Simeon Willis, stated: “A higher bar is being set. It’s clear that a siloed approach from investment manager or investment adviser, narrowly focused on their own role alone, is insufficient to meet expectations.

"Everyone involved in the decision chain should be demonstrating that they are considering the suitability of the investment for the end investor and the resilience of that investor’s overall arrangements.

"This means LDI managers will need to be asking questions about what a client is trying to achieve by investing in the LDI fund, so it can satisfy itself and evidence that the fund is the best approach all round.”

Adding to this, Barlow highlighted the FCA's encouragement for asset managers to better understand their clients’ liquidity waterfalls, and to ensure operationally clients are able to deliver collateral to their LDI vehicles within five days or sooner, as particularly pleasing.

"This is likely to lead to more schemes consolidating their LDI and collateral assets with a single manager, which in our view is ultimately a simpler, better and more cost-effective solution than many schemes currently have," he continued.

"We are also pleased to see that the FCA expects manager to have established a crisis response protocol which explicitly covers resourcing.

"The resourcing issues many LDI managers experienced during the crisis exacerbated the problem as it meant schemes were often required to make decisions with little or no information. Improvements here are critical to help schemes navigate the next crisis, whatever that may be."

Cardano managing director, Sinead Leahy, Managing Director at Cardano, agreed that it is important that trustees and sponsors effectively run a ‘healthcheck’ on their mandate.

However, she stressed that "you can't have your cake and eat it", pointing out that the focus should not just be on collateral management and governance but also look at the operational side of the overall LDI mandate – how is the process managed, monitored and acted upon.

"A review of operational resilience and governance is essential together with the need to revisit journey plans, desired endgame options based on the current funding position, hedging and leverage positions, and updating growth asset outlooks," she stated.

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