UK regulators failed to spot threat from pension scheme borrowing, says Lords report

Regulators failed to anticipate the dangers that borrowing by pension schemes posed to the stability of the UK’s financial system, according to a parliamentary report into the turmoil that hit the gilt markets following Liz Truss’s disastrous “mini” Budget in September last year.

Pension schemes suffered multibillion-pound losses after they were forced to sell assets to ensure that complex derivative-linked strategies — known as liability driven investments (LDI) — did not implode when gilt yields jumped as investors rejected the then prime minister’s economic strategy.

In its findings published on Tuesday, the House of Lords industry and regulators committee called on the government to review the requirement for retirement income promises to be recognised in a company’s annual accounts because this pushed pension schemes into LDI strategies that relied on borrowed money.

“We are calling for regulators to introduce greater control and oversight of the use of borrowing in LDI strategies and for the government to assess whether the UK’s accounting standards are appropriate for the long-term investment strategies that are expected of pension schemes,” said Lord Clive Hollick, chair of the committee.

Truss said on Monday that neither she nor her chancellor, Kwasi Kwarteng, had been informed about the pensions “tinderbox” before the mini-Budget. “We didn’t necessarily understand the issue and that is a difficult position to be in as PM and chancellor,” she told The Spectator.

Some Tory MPs have privately described Truss as “delusional” as the former prime minister tries to defend her 49-day record in Downing Street. She was forced to quit in the wake of her controversial debt-funded £45bn tax-cutting plans.

The report by the committee marks the conclusion of the first of three parliamentary probes into the pension scheme crisis last year, which forced the Bank of England to intervene with a £65bn gilt-buying programme.

About £1.4tn was invested in LDI strategies, which were used by about 60 per cent of the UK’s 5,131 defined benefit pension schemes, representing almost 10mn members.

In a letter to ministers, the 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 act if risks went unaddressed.

The Pensions Regulator said it noted the committee’s recommendations and was already “taking action to learn lessons and address many of the issues raised”.

The report also recommended regulation of the advice provided by investment consultants to pensions schemes, an idea previously floated by Nikhil Rathi, chief executive of the Financial Conduct Authority, the 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 allowed pension schemes to buy exposure to up to £7 in gilts for every £1 invested in the most highly leveraged LDI strategies. Lord Hollick said that tighter control and supervision of LDI strategies was needed with “far stricter limits” on the leverage allowed.

The two other inquiries into the pension fund crisis by MPs have heard calls for a complete ban on the use of leverage in LDI strategies.

In evidence to the probe 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” if it was well managed.

The central bank will next month outline plans to boost the resilience of the LDI sector, which will include guidance on appropriate leverage limits for these funds.