FPC recommends minimum resilience levels for LDI funds

The Financial Policy Committee (FPC) of the Bank of England recommended in March 2023 that The Pensions Regulator (TPR) take action as soon as possible to mitigate financial stability risks by specifying the minimum levels of resilience for the LDI funds and LDI mandates in which pension scheme trustees may invest¹. The recommendation followed rapid and large moves in the interest rates on UK government debt in late 2022, which exposed weaknesses in liability-driven investment (LDI) funds¹.

The FPC's recommendation was set out in its Financial Stability Report published on 12 July 2023, which restated the March position¹. The report said the authorities responsible for regulating these funds have since published new guidance in this area¹. It did not name those authorities or give the content of the guidance.

The report described the September 2022 episode as one in which the impact of a shock in the LDI sector led to further market dysfunction in UK government bonds, and said such episodes can push up the cost of borrowing¹. It said there continues to be an urgent need to increase resilience, and that many firms involved in market-based finance are not regulated by the Bank of England, so the Bank is working with other regulatory authorities¹.

The Bank also said it has launched a system-wide exploratory scenario (SWES) exercise, described as the first exercise of its kind, designed to consider how banks and non-banks act in stressed financial conditions¹.

Why it matters for households

Defined benefit pension schemes use LDI funds and mandates to manage the mismatch between their assets and their liabilities. The FPC's recommendation concerns the resilience of those funds to interest rate shocks, which is a condition attached to the investments trustees may hold rather than a change to anyone's pension entitlement¹.

The report does not set out what the minimum resilience levels would be, when they would take effect, or how they would be enforced. Those details have not been reported in the July 2023 Financial Stability Report¹. The report also does not state which schemes or which trustees would be affected, or whether any change would alter member benefits, contribution rates or scheme funding positions¹.

The wider household context in the same report is separate from the LDI recommendation. The FPC said around half of mortgage accounts, around 4.5 million, are estimated to have seen increases in repayments since mortgage rates started to rise in late 2021, and that higher rates are expected to affect the vast majority of the remainder by the end of 2026, around 4 million accounts¹. It said monthly interest payments would increase by around £220 if a mortgage rate rises by the 325 basis points implied by current quoted mortgage rates¹. Rates on a 75% loan to value mortgage fixed for five years stood at around 5% in June, and for an equivalent two-year fixed-rate mortgage rates were around 5.5%¹.

The FPC agreed to maintain the UK countercyclical capital buffer rate at 2%¹. Since December 2021, Bank Rate has increased from 0.1% to 5%¹. The market-implied near-term path for UK Bank Rate is expected to peak at around 6.2% in early 2024, with market expectations for Bank Rate to average around 5.5% over the next three years¹.

What happens next

The report says the authorities responsible for regulating LDI funds have published new guidance since the March recommendation¹. It does not give a date for that guidance, nor a timetable for TPR to specify minimum resilience levels. No further dated steps on the LDI recommendation are set out in the report¹.

The Bank has launched its system-wide exploratory scenario exercise, which it says will provide insights to help it better understand and address vulnerabilities in market-based finance¹. No results date is given in the report¹.

For how workplace pensions are supervised, see The Pensions Regulator: how workplace pensions are supervised and Who regulates what: FCA, PRA, Bank of England, PSR and The Pensions Regulator. For pension scheme rules and reform, see Pension reforms in progress and the pensions guide.