Charles Counsell said it was the speed and the magnitude at which gilt yields increased that caused the squeeze on liquidity.
The Pensions Regulator (TPR) has responded to a series of 12 questions asked by Work and Pensions Committee chair Sir Stephen Timms in a letter last week.
In his correspondence, Timms asked the regulator, among other things, to set out the nature of the problems that have been faced by defined benefit (DB) schemes and the impact it thought recent market movements would have on pension funds and the security of member benefits.
In its response, published by the WPC yesterday (12 October), the regulator's chief executive Charles Counsell said the problem facing DB schemes at the end of September was primarily an issue about short term pressure on liquidity, rather than a funding problem - adding that many DB schemes that operated liability-driven investment (LDI) faced large cash demands from their investment managers at short notice due to the steep rise in long-term gilt yields.
TPR said the risk of long-term gilt yields rising and the consequent need to post capital was "well understood" by the industry and dealt with through liquidity plans - adding it was the speed and the magnitude at which gilt yields increased at the end of September that caused the squeeze on liquidity.
This squeeze, it said, resulted in LDI funds seeking additional collateral at a greater speed and scale than in any previously experienced market move - something that created "operational difficulties" for some schemes due to the time it took to raise an instruction to both raise an instruction to sell assets and for cash proceeds to settle into bank accounts (often three to four working days).
The regulator said a similar increase in yields spread over a number of months would not have resulted in the same challenges.
Impact on schemes
TPR said its view was that most trustees of DB schemes - as well as their investment advisers and LDI managers - do think carefully about collateral requirements for their LDI funds and would have pre-determined plans for the sources of collateral and how they will post collateral should the need arise.
It said that LDI managers typically work with a scenario of bond yields increasing by 1% within a few days - but noted the change experienced in September was twice this amount and came against a backdrop of long-term gilt yields rising by 2% already in 2022.
The regulator said that, at the end of September, counterparty banks asked for greater collateral - "very significantly more than had been anticipated by the usual downside scenarios envisaged" - something trustees of schemes and LDI managers found "challenging" to source this liquidity at short notice.
It said that if this additional collateral was not posted - or LDI managers decide to reduce their exposure - then LDI managers begin to sell the LDI assets and sell gilts.
But it said this collective selling of gilts pushed the price of gilts down further, further exacerbating the problem and creating a negative feedback loop - a loop that prompted the Bank of England to step in and stabilise the market.
TPR said the result of the turbulence for pension schemes was "mixed".
"We understand that many pension schemes were able to continue with their LDI programmes but some may have been adversely affected by selling LDI at a low price and subsequently replacing it at a higher price. Pension schemes which did not have a significant amount of LDI in general will have seen their funding levels improve materially."
The regulator said it was too early to say what the longer-term impact would be, but said increases in yields will have generally resulted in improved funding positions, in some cases materially so, and employers will have seen the absolute size of their DB obligations fall materially.
But it said the significant fall in gilt prices relative to other asset classes will also cause schemes to look afresh at their asset allocation and whether they should rebalance their portfolio and consider the balance of illiquid to liquid assets.
And it added that, where schemes have seen a significant improvement in their funding position, it was "highly likely" that they will seek to lock in that improvement. Some schemes might be significantly close now to achieving a full buyout.
LDI market size
On the question of what proportion of schemes use LDI strategies and for what proportion of their investments, TPR admitted it did not record in-depth data on the scale of collateral or leverage agreed to by DB schemes, and did not ask every scheme to provide this data.
It did say, however, that it had considered a number of external sources, and broader scheme data it holds to generate some estimates of the current size of the LDI market.
The regulator said that, at the end of 2018, there were around 2,400 LDI agreements adding that it expected this had grown to around 3,000 agreements by the end of 2021. Of these agreements, it expected about 60% were in pooled funds and 40% segregated. Given there are just over 5,000 DB schemes in the UK, it said this means about 60% of pension schemes have LDI.
The regulator said when it considered assets under management in DB schemes, it said its landscape analysis suggested around 85% are in segregated LDI while around 15% are in pooled agreements.
In terms of the size of liability hedging in the leveraged LDI market, one LDI survey it studied indicated that the total level of liability hedging was just over £1trn at the end of 2018. The regulator estimated that by the end of 2021, total hedging with LDI funds covered around £1.4trn of liabilities for DB pension schemes.
The impact without BoE intervention
The regulator also responded to the WPC's question on what would have happened without BoE intervention.
TPR said, without the BoE's intervention, some schemes would have faced much larger collateral calls and would either have been forced to reduce levels of hedging or possibly seek support in the form of liquidity from their sponsoring employers to protect their LDI investments.
It added that, while the impact of this rise in yields has been favourable to schemes, if a scheme's deficit had increased, the sponsoring employer may be required to increase its payments to the scheme to reduce the deficit over the period of a recovery plan.
