Industry experts have welcomed the Work and Pensions Committee's (WPC) report on defined benefit (DB) pensions with liability-driven investments (LDI), backing a number of the committee's recommendations.

The WPC's report, shared today (23 June), outlined a number of recommendations on a range of issues surrounding the LDI episode, including the upcoming DB Funding Code, consolidation, and the regulation of investment consultants.

LCP partner, Steve Hodder, praised the committee for not being “drawn into some of the more hysterical commentary from last year”, particularly in relation to suggestions that the concept of leverage itself is inappropriate, instead providing a “fair summary of the logic behind schemes using LDI”.

“Leverage, used sensibly, is a cornerstone of our economy: company balance sheets, individual home ownership and financial risk management,” he continued.

“The fault lines that emerged last year were due to political events catalysing systemic volatility that was far more severe than reasonable market participants thought possible.

“We are glad the committee has focussed on systemic issues rather than the “blame game” that individual investors did not consider their impact on the multi-trillion gilt market."

This was echoed by Association of Consulting Actuaries (ACA) spokesman and treasurer, Stewart Hastie who noted that LDI with appropriate levels of leverage has been, and continues to be, an “important and successful risk management tool for UK pensions”.

He stated: “There were a small minority of schemes that didn’t fare so well last Autumn although many will have started from a better position because of the use of LDI in the years before this.

“Nevertheless, lessons around managing liquidity risk have and will continue to be learned with the industry moving quickly to adopt higher liquidity buffers and improve governance processes.”

Isio partner, Mike Smedley, also noted that lessons have been learned about "how quickly gilts can hit the rocks when markets lose trust in government", with much stronger liquidity and contingency plans now in place across the pensions industry.

“But it’s unfair to blame trustees for risking economic stability," he added. "Trustee boards have followed government instructions to prioritise the security of members’ benefits and used LDI to achieve that with huge success."

The Pensions and Lifetime Savings Association (PLSA) also welcomed the WPC's report, with deputy director, policy, Joe Dabrowski, stating that the industry has adapted well following the autumn volatility, with schemes using LDI generally holding collateral buffers at higher levels.

Despite this, Dabrowski agreed that the proposal for regular reporting to the regulator by pension schemes on their use of LDI is “entirely appropriate”, alongside the recommendation to regulate investment consultants.

Calls to ‘halt’ DB Funding Code

In addition to this, Dabrowski said the PLSA “especially” welcomed the WPC’s consideration of open DB schemes in the incoming funding regime, having previously called flexibility for open DB schemes in the funding code to allow them to invest in higher returning assets.

This was echoed by the Institute and Faculty of Actuaries (IFoA) president, Matt Saker, who suggested that there is an “important read-across” to the current discussion on scheme funding rules for DB pensions, in particular to ensure that the proposed funding rules are amended to allow genuinely open schemes to be exempt from some of the requirements introduced by the proposed new funding and investment regulations.

“In addition, it is important that both the Department for Work and Pensions (DWP) and The Pensions Regulator (TPR) work together to ensure consistency between the regulations and the funding code,” he stated.

“With the funding code delayed until 2024, there is now an opportunity to look again at the proposals with the Committee’s recommendations in mind. We are happy to engage in discussions with DWP and TPR on this issue.”

Hodder also welcomed the calls to reconsider the new DB funding regime, arguing that “a better use of time would be to focus on incentivising behaviours for better investing these £ 1trn+ assets for the benefit of the wider UK economy whilst appropriately safeguarding members’ benefits”.

However, Association for Professional Pension Trustees (APPT) chair, Harus Rai, said that while the association understood the committee’s rationale in this recommendation, it would be helpful if clarity could be provided in the near future so as to inform the approach taken by trustees and sponsors to scheme funding.

This was echoed by Hastie, who said that significant delay is not necessary given industry has already been waiting for several years for the new funding regime.

Improving trustee knowledge

The report also considered the importance of ensuring trustee boards have sufficient knowledge and skills in place, calling on the DWP to work with TPR “as a priority” to improve the regulation of trustees and standards of governance.

In addition to this, the committee also suggested that, given the time it will take to consult on, legislate for, and implement measures to improve governance, DWP should consider whether the use of LDI could be restricted, for example, based on a test related to a trustee board’s ability to understand and manage the risks involved.

Dalriada Trustees professional trustee, David Fogarty, confirmed that the firm was “fully supportive” of this suggestion, emphasising that trustee boards need to have sufficient skills and competence to scope what advice is required, to challenge the advice when given, and to ensure the appropriate level of controls are in place to monitor risks.

“Complex investments such as LDI cannot be allowed to be nodded through on the back of narrow advice,” he stated. “We look forward to supporting the further development of trusteeship to achieve this elevation across the sector.

“We also look forward to working with TPR, the DWP and other organisations such as the Financial Conduct Authority (FCA) to ensure the lessons learned are put to use."

Rai also agreed with the recommendation that trustees have high levels of knowledge, understanding and experience to manage complex areas such as the use of LDI, also supporting the idea of formally increasing the standards of trusteeship for DB pension schemes.

Adding to this, however, Rai clarified that what may appear to be simple steps, like ‘more consolidation’ require very careful thought and policy actions to accommodate the diverse range of UK schemes.

“A rushed response to this and other areas of the report could easily create new but different financial risks to members’ benefits.” he stated.

Hodder also highlighted the recommendation to further consider DB consolidation as “interesting”, given the events of last year highlighted how a concentration of actions can cause market issues.

“For example, based on our experience, consolidating schemes into fiduciary management did not result in better outcomes,” he added.

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