Pensions experts ‘shocked’ at hidden borrowing across UK schemes


Pensions experts have told MPs they were “absolutely shocked” at the level of “hidden” borrowing across UK pensions schemes, which nearly toppled some funds during the bond market crisis in September and forced cash-strapped trustees to sell up to £500bn in assets.

Speaking to politicians on the work and pensions committee on Wednesday, academics and pensions experts laid bare the risks that certain kinds of liability-driven investing, or LDI, posed for retirement savings.

Defined benefit pension funds, which guarantee a set pension on retirement no matter how well or badly investments have performed, were caught out during the bond crisis. It emerged they had relied heavily on LDI hedging arrangements, which involved holding government bonds as collateral. When the value of government bonds dropped dramatically after the disastrous Liz Truss-Kwazi Kwarteng mini-budget, pension trustees were forced to sell their holdings at speed to raise cash. This drove down the value of bonds further, causing a “doom loop”.

Within days, the Bank of England had to step in with a £65bn emergency bond-buying programme to prevent a large number of LDI funds from going bust.

John Ralfe, an independent consultant and pensions expert who previously managed Boots’ pensions scheme, said he was worried about how much leverage – effectively borrowing – was used by pensions schemes as part of their LDI strategies.

UK rules bar pensions schemes from borrowing money to fund investments, but experts such as Ralfe and Henry Tapper, executive chair at Agewage, have said LDI hedging arrangements are the same as borrowing.

“Pension funds should not borrow money, and leverage is in my mind borrowing,” Tapper told MPs. “There’s a difference between matching your assets and liabilities, which is hedging, and leveraged LDI which is pure speculation.

The thing that has absolutely shocked me in what we’ve seen over the course of the last few weeks, is … hidden leverage”, he explained, referring to levels of borrowing that otherwise did not appear on pension scheme or company balance sheets.

“I don’t think it was widely known. If you look at all the information produced by the Pensions Regulator and the Pension Protection Fund … there’s nothing,” Ralfe said. “If you look at individual company accounts, there’s nothing there. So it was hidden.”

Iain Clacher, a professor at Leeds University business school, also blamed leveraged LDI schemes for the bond market meltdown.

“If you look at just the asset side, based upon the calculations that myself and Con [Keating] have done, we estimate that roughly £500bn is probably missing somewhere. And this isn’t a paper loss. This is a real loss because pension funds were selling assets to meet the collateral calls,” Clacher said.

And while the Pensions Regulator has admitted to encouraging the use of hedging strategies including LDI, experts told MPs on Wednesday that watchdogs had failed to track the systemic risks associated with their widespread use.

The Pensions Regulator launched a survey on the use of LDI after the Bank of England drew attention to the schemes in its financial stability report in 2018. However, experts have said the regulator failed to properly understand the systemic risks created.

“The most important thing is there is not a single numerical risk estimate anywhere in that [pension regulator] report,” said Con Keating, the head of research at Brighton Rock Group.

About 60% of pension schemes are thought to use LDI, according to the Pensions Regulator.

Keating added that the regulator was aware of the risks before the market meltdown in September and claimed that the crisis was “entirely predictable”, contradicting claims by watchdogs including the Financial Conduct Authority, who have also appeared before parliamentary committees in recent weeks.

However, Jonathan Camfield, a partner at Lane, Clark & Peacock defended the use of LDI, and told MPs that leverage was an important part of ensuring that corporate pension schemes could pay retirees.

He said that while leverage did create systemic risk and LDI did require “some better management going forward, those strategies were an “efficient” way to hedge against interest rate movements and inflation.

“LDI will have been a success for schemes that have been in LDI [in the] midterm,” he said.

The Pensions Regulator declined to comment.



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