With the dust settling on the gilt market meltdown and long-dated gilt yields settling down as low as 3.3%, the process of counting the costs and assigning the blame for the near meltdown has begun.
In the midst of the 2008 credit crunch, Queen Elizabeth met with a team of economists at the London School of Economics and asked them a very basic question. “If these things [securitized debt] were so large, how come everyone missed them?” A similar question is now being asked in the House of Lords and the Work and Pensions Select Committee, as schemes, sponsors and consultants face the unpleasant task of assessing the damage of the LDI meltdown.
A black swan event?
Among the first to be grilled by politicians were Sir John Kingman, and Sir Nigel Wilson, chair and CEO at Legal & General, who faced questions from the House of Lords industry and regulators committee. Speaking as the CEO of one of the biggest providers of LDI strategies in the UK, alongside BlackRock and Insight Investment, Wilson was keen to minimise the role of his firm in the September market meltdown.
He described the crisis as a “black swan event” that was very much driven by the mini budget. He also stressed that only 2% of Legal & General’s operating profit is derived from LDI strategies: “This is not a massive money-making machine, this is a risk management business that is quite small from a profit point of view but very important from a strategic point of view for our clients” he stressed.
Wilson also emphasised that consultants played a key part in marketing LDI strategies. “99.7 percent of our interaction with the corporate sponsor is through consultants and we believe we are risk minimising by giving really good advice to trustees” he added.
Being quizzed on the legality of the use of leverage in LDI strategies, Kingman stressed that it was Legal & General’s understanding that their products were “within the law.”
Wilson did acknowledge that the group had failed to envisage the scope of the crisis in its stress testing scenarios. This point was also made by the regulator, represented by Nikhil Rathi, chief executive of the Financial Conduct Authority, who acknowledged in a House of Lords hearing that the risks “had not been on top of his radar”. Charles Counsell, chief executive at TPR stressed that the regulator did not direct trustees where to invest.
But this view was challenged by Con Keating, head of research at Brighton Rock Group. Speaking in a separate Work and Pensions Committee hearing, he described the LDI market as an endogenous risk spiral and that the crisis should have been expected. The issue has also been covered by portfolio institutional prior to the crisis.
Counting the costs
But while the finger pointing remains ongoing, for trustees perhaps the more pertinent question is that of financial damage. And on this front, the picture is highly uneven, but the trail appears to lead to leverage. Schemes with higher degrees of leverage appear to have booked more significant losses while some schemes have employed LDI strategies without leverage and weathered the crisis fairly well.
One example is the BT Pension Scheme, which reported a £11bn loss, reducing its assets from £47bn to £36bn, buried away on page 72 of its annual reports and accounts. This comes after the value of BTPS’ assets had already fallen from £57bn last year. BTPS CEO Morten Nilsson acknowledged the challenge, but stressed: “Our hedges have performed as expected, and whilst the value of the Scheme’s assets has fallen over this period, there has been no worsening in our estimated funding position.”
Another example is the Royal Mail Pension Scheme, which revealed last month that it had to bring forward contributions from its parent company IDS to deal with liquidity problems as a result of the LDI crisis.
For pensions consultant John Ralfe, a key concern was that the extent of leverage employed is often not disclosed transparently. “The thing that has absolutely shocked me over the past few weeks is hidden leverage. Can you see what is going on in the British Telecom Pension Scheme and therefore the company if you look at the BT company reports and accounts? The answer is no. If you look at the Pension Scheme Reports and Accounts then the answer is partially,” he said, speaking at a Work and Pensions Committee hearing on LDI.
Learning the lesson
While the blame game on LDI is unfolding, it remains to be seen which parties will acknowledge the lessons to be learned from the crisis.
With leverage receiving growing regulatory scrutiny, Rachael Healey, partner at international law firm RPC warns that trustees should also keep their eyes and ears open. “Trustees are ultimately responsible for the scheme’s investment decisions. If they fail to review the investment position of a scheme or revisit their deficit reduction plans, then they could find themselves facing legal action.”
Con Keating and Ian Clacher have also argued in the last issue that the role of The Pensions Regulator should be examined critically. In the words of Agatha Christie hero Miss Marple: “Nemesis is long delayed sometimes, but it comes at the end.”
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