Mini-budget chaos uncovered ‘lax approach’ to pensions regulation, MPs say
M
ore must be finished to deal with “significant weaknesses” in pension schemes uncovered by the disruption that adopted the Liz Truss mini-budget, MPs have stated.
A fast rise in gilt yields after the September 2022 mini-budget threw pension funds with liability-driven investments (LDI) into chaos, threatening the soundness of the UK financial system and forcing the Bank of England to intervene.
In a report printed on Friday, the House of Commons’ Work and Pensions Committee criticised The Pensions Regulator (TPR) for not paying sufficient consideration to the dangers posed by LDI and the extent to which funds have been utilizing “leverage” – or borrowing – to assist it.
The committee stated: “We question whether TPR had understood the ‘doom loop’ risks inherent in LDI products.”
It added that the Bank of England had assessed the dangers posed by borrowing and LDI in 2018, however TPR had not paid sufficient consideration to those risks “until a crisis hit”.
Sir Stephen Timms, chairman of the Work and Pensions Committee and a former pensions minister, stated: “The turbulence around last year’s ‘mini-budget’ exposed a lax approach to regulation.
“Despite the dangers of the use of LDI being identified five years ago, there was a lack of focus from TPR and inadequate data. The use of leverage by DB (defined benefit) pension funds grew, giving rise to systemic risk in a way that was not visible to regulators until crisis hit in September last year.
“Although the speed and scale of the rise in gilt yields was unprecedented, the consequences for DB pension funds should have been foreseen and TPR should not have been blindsided.
“Gaps in regulation and the system for managing systemic risks must now be addressed to ensure that DB pension scheme investments never again threaten the stability of the UK economy.”
LDI entails pension schemes investing in property whose worth strikes in the identical course as their liabilities as rates of interest change, offering extra stability.
Many schemes used leverage to attempt to shut the hole between their property and liabilities, which the committee stated labored “relatively well” whereas rates of interest have been low however posed extra issues when charges rose rapidly as they did after the mini-budget.
The committee discovered that the September disaster uncovered “significant weaknesses” in pension funds’ defences in opposition to the dangers posed by LDI, together with the funds’ personal trustees and TPR’s oversight.
Trustees of smaller pension schemes didn’t at all times absolutely perceive the dangers related to LDI, whereas TPR didn’t gather sufficient information to evaluate whether or not its steerage was being adopted or spot the rise in the usage of borrowing to fund LDI schemes.
The committee questioned why TPR didn’t pay extra consideration to LDI and inspired schemes to make use of complicated monetary merchandise regardless of having had considerations about trustees’ capacity to handle threat “for some years”.
It stated: “(TPR) should have focused earlier on the risks of encouraging trustees to use such complex financial products and worked with DWP to consider what further action was needed to mitigate the risk.”
It additionally criticised some funding consultants for giving schemes standardised recommendation “rather than thinking through what is best for the pension fund”.