Watchdog calls for tougher tests on UK pension funds

The financial watchdog has called on liability-driven investment funds (LDI) to urgently introduce new stress tests and improve their risk management following last year’s industry chaos.

The industry, which ran into trouble in September in the wake of then-Chancellor Kwasi Kwarteng’s mini-budget, has been a long time coming.

Last month the Bank of England made policy recommendations to strengthen LDI buffers and yesterday the Financial Conduct Authority and the Pensions Authority finally started to elaborate them.

The FCA said stress tests and related contingency plans must account for a plethora of scenarios ranging from a change in prices or liquidity for assets or even system failures or cyber-attacks.

LDI strategies are designed to help pension funds reduce funding volatility. But schemes were forced to dump tens of billions of pounds of government bonds within days to meet the demand for cash from LDI managers.

The fire sale threatened to destabilize the UK’s financial system after government bond yields rose sharply in response to the government’s disastrous mini-budget.

Shortcomings revealed during the near-meltdown included managing multiple risks in LDI funds, including stress testing and scenario planning, communications and customer service, the FCA said.

“Cumulatively, these contributed to market dysfunction and the resulting threat to financial stability,” it added.

Sarah Pritchard, executive director for markets at the FCA, said asset managers should “take the necessary steps” so that their LDI portfolios can withstand future market volatility.

The Pension Supervisor (TPR) also published guidelines yesterday. It said it wanted to emphasize the importance of ‘having the right governance and controls in place to reduce risk’ for schemes. Fund managers must be able to “react quickly to events,” it added.