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The Pensions Regulator was forced to defend its risk assessment processes after it emerged the industry’s lifeboat scheme was better prepared for September’s market turmoil than thousands of corporate plans overseen by the watchdog.
The regulator is under scrutiny after shortcomings in pension stress testing were exposed when gilt yields soared at an unprecedented rate, leaving corporate schemes struggling to meet urgent margin calls on widely-used liability-driven investing contracts.
Giving evidence to MPs probing the LDI crisis, the Pension Protection Fund — a statutory body and lifeboat scheme for collapsed corporate plans — said it was set up to withstand a 200 basis point move in bond prices. “We had much more room [for] rates to rise before we started to run out of collateral,” said Evan Guppy, head of LDI and Credit with the PPF.
Before the crisis the pensions regulator had expected the pension system to be “robust” against a 100 basis points move in bond prices. Following the mini Budget, bond prices moved 150 basis points over a four-day period.
Nigel Mills, a Conservative MP and committee member, highlighted the PPF’s collateral buffers and put to the chief executive of the regulator that a 100 basis point movement “wasn’t that unforeseeable”.
“We thought a (100 basis points) was a reasonable scenario,” Charles Counsell, head of the regulator, told the committee hearing on Wednesday.
Counsell added that what happened at the end of September was “extraordinary and absolutely unprecedented”. “We didn’t foresee the speed rise of bond yields that happened,” he said.
However, he conceded it was now clear the “level of collateral wasn’t sufficient”.
The work and pensions select committee inquiry had earlier heard that the pensions regulator had encouraged defined benefit schemes to adopt LDI to better mitigate against the risks of interest rates and inflation on their liabilities.
Counsell said LDI had in large part helped improve the funding position of the UK’s 5,200 defined benefit pension plans, and that a ban on leverage use in LDI strategies could lead to sponsoring employers having to pay more to make sure pensions promises were met.
Giving evidence at the same session, Nikhil Rathi, chief executive of the Financial Conduct Authority said it was “always going to be challenging” to prepare for black swan events, such as the bond yield turmoil in September.
However, Rathi added: “I think there was perhaps inadequate preparation in a number of the pension funds. There probably wasn’t the financial and operational acumen there to really understand what would happen if things went wrong.”
He added that there was “work to be done” all the way through the chain including the regulation of investment consultants advising on LDI strategies, improvements in the processing of collateral by custodian banks and the management of risks by bank counterparties.
“We need to be planning for failure in the environment where we are seeing these 100-year events, frankly happening every three or four months at the moment,” said Rathi.
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