More safeguards are required to ensure that pension schemes can “never again” jeopardise the stability of the UK economy, according to a parliamentary report into the tumult that rocked the gilt market following former prime minister Liz Truss’s disastrous “mini” Budget last year.
Pension schemes sold multibillion-pound holdings of UK government bonds in just a few days during September, creating a self-reinforcing doom loop that threatened to crash the gilt market until the Bank of England intervened to restore order with a £65bn emergency support programme.
A report by the House of Commons work and pensions committee published on Friday found that lax oversight had allowed systemic risks to fester in the complex derivative-linked strategies — known as liability-driven investments — which defined benefit pension schemes were encouraged to adopt by the Pensions Regulator (TPR).
The regulator did not monitor the use of LDI strategies by smaller schemes but TPR “should not have been blindsided” after a warning by the BoE about the risks of LDI as early as 2018, said Stephen Timms, chair of the committee.
“Gaps in regulation and the system for managing systemic risks must now be addressed to ensure that [defined benefit] pension scheme investments never again threaten the stability of the UK economy.”
Before the September crisis, about £1.4tn was invested in LDI strategies that were used by about 60 per cent of the UK’s 5,131 DB pension schemes, representing almost 10mn members.
The committee recommended that TPR should work with the government on a detailed analysis of how LDI strategies affected the value of the assets and liabilities of pension schemes to understand how many have lost out and report back by the end of the year.
The aggregate value of DB pension sector assets dropped by £591bn, or 32 per cent, last year to £1.23tn by the end of December, according to the Office for National Statistics.
The committee also said the government should consider new restrictions on the use of LDI based on an assessment of a trustee board’s ability to understand and manage the risks involved.
Timms also asked TPR to report back to the committee by October on whether pension schemes were investing in LDI strategies with enough liquid assets to withstand a sudden 2.5 percentage point jump in gilt yields, the minimum safety margin suggested by the Bank of England.
The report also called on the government to pause the introduction from next April of new rules affecting the funding of DB pension schemes until a full assessment of their impact was completed.
The new funding code is expected to force DB schemes to raise holdings of low-risk assets, such as bonds, while also reducing investments in equities.
However, the committee said it was also concerned that the new funding rules could result in more “herding” by schemes, posing a potential risk to financial stability.
The £90bn Universities Superannuation Scheme has expressed “deep misgivings” about whether the new funding regime would discourage investment in assets that will support economic growth and the transition to net zero.
TPR said it had “taken decisive action to learn lessons from the impact of last year’s economic turmoil, including to improve the data we hold. Pension trustees are acting on our latest guidance on using leveraged liability-driven investments, which clearly sets out our expectations. We continue to work closely with the Bank of England and other partners to ensure a well-functioning system.”
The government said it welcomed the committee’s report and would respond formally in due course.