Regulators failed to anticipate the threats borrowing from pension schemes posed to the stability of Britain’s financial system, according to a parliamentary report into the turmoil in gilt markets after Liz Truss’ disastrous “mini” budget last September .
Pension plans suffered multi-billion pound losses when they were forced to sell assets to ensure that complex derivatives-linked strategies – known as liability driven investments (LDIs) – were liquidated when gilt yields surged. did not come because investors rejected the economic strategy of the then Prime Minister.
In its findings published on Tuesday, the House of Lords industry and regulatory committee called on the government to review the need for retirement income promises in company annual accounts as it pushed pension schemes into LDI strategies that relied on borrowed money .
Lord said, “We are calling on regulators to introduce greater control and oversight over the use of borrowing in LDI strategies and for the government to assess whether UK accounting standards are appropriate for long-term investment strategies , which is expected of pension plans,” Lord said. Clive Hollick, chairman of the committee.
Truss said on Monday that neither he nor his chancellor, Kwesi Kwarteng, had been informed about the pensions “tinderbox” ahead of the mini-budget. He told The Spectator, “We did not consider the issue urgent and it is a difficult position as PM and Chancellor.”
Some Tory MPs have privately described the truce as “illusory” as the former prime minister tries to defend his 49-day record in Downing Street. He was forced to step down in the wake of his controversial debt-funded £45 billion tax-cut plans.
The committee’s report marks the conclusion of the first of three parliamentary inquiries into the pension scheme crisis last year, which forced the Bank of England to intervene with a £65 billion gilt-buying programme.
Around £1.4tn was invested in LDI strategies, which were used by around 60 per cent of the UK’s 5,131 defined benefit pension plans, representing around 10 million members.
In a letter to ministers, a House of Lords committee called for the pensions regulator to be given a statutory duty to consider the effects of the pensions sector on the wider financial system. It also recommended new powers for the Bank of England’s financial policy committee to direct regulators to take action if risks are not addressed.
The pensions regulator said it has noted the recommendations of the committee and is already “taking action to learn lessons and resolve a number of issues raised”.
The report also recommended regulation of advice provided by investment advisors to pension schemes, an idea mooted earlier by Nikhil Rathi, chief executive officer of the Financial Conduct Authority, financial watchdog.
The Lords committee also questioned the legal status of LDI strategies, pointing out that UK law prohibits the use of borrowing by pension schemes to boost returns.
Using derivatives allows pension plans to buy exposure to up to £7 in gilt for every £1 invested in the most leveraged LDI strategies. Lord Hollick said that tighter control and supervision of LDI strategies was needed, with a “much tighter limit” on permitted leverage.
Two other inquiries into the pension fund crisis have heard calls for a complete ban on the use of leverage in LDI strategies by MPs.
In evidence to an inquiry by the House of Commons Work and Pensions Select Committee last week, Sarah Breeden, the Bank of England’s executive director for financial stability, said leverage was “not inherently a bad thing” and could be “a good thing”. Could be if it was managed well.
The central bank will next month outline a plan to boost the flexibility of the LDI sector, which will include guidance on appropriate leverage limits for these funds.