Work and Pensions Committee

Oral evidence: Defined benefit pensions with Liability Driven Investment, HC 826

Wednesday 1 February 2023

Ordered by the House of Commons to be published on 1 February 2023.

Watch the meeting

Members present: Sir Stephen Timms (Chair); Debbie Abrahams; Siobhan Baillie; Steve McCabe; Nigel Mills; Selaine Saxby; Sir Desmond Swayne.

Questions 209 - 276

Witnesses

I: Tim Bush, Head of Governance and Financial Analysis, Pensions and Investment Research Consultants; Professor David Blake, Director, Pensions Institute and Bayes Business School; and Toby Nangle, Independent Economic and Financial Markets Commentator.

II: Sarah Breeden, Executive Director for Financial Stability, Strategy and Risk, Bank of England.

Written evidence from witnesses:

LDI0063 Tim Bush, Pensions and Investment Research Consultants (PIRC)

LDI0053 Professor David Blake, Pensions Institute and Bayes Business School

LDI0043 Toby Nangle, Independent Economic and Financial Markets Commentator

Examination of witnesses

Witnesses: Tim Bush, Professor David Blake and Toby Nangle.

Q209       Chair: Welcome, everybody, to this meeting of the Work and Pensions Select Committee, an evidence session in our inquiry on liability driven investments for pension funds. We are very grateful to the three witnesses joining us for the first panel and I will ask each of them to very briefly introduce themselves, starting with Toby Nangle.

Toby Nangle: Thank you very much. I am an independent markets and financial commentator. I spent 25 years working in asset management until last year.

Professor Blake: I am the Director of the Pensions Institute at Bayes Business School.

Tim Bush: I work for Pensions and Investment Research Consultants Ltd. My background is in fund management, equity fund management, but I originally qualified as a chartered accountant.

Q210       Chair: Thank you all very much for being here. I will put the first question to you. Defined benefit pensions have switched very largely from equities to bonds over the past 20 years. Can I ask each of you why you think that has happened and whether we should be worried about it?

Toby Nangle: I think it is market reaction or market response to two principal developments, the first of which was the move to mark-to-market accounting. There was a development called [1]IFRS 17 in 2004, which became FRS 102, and so firms were very keen to reduce the balance sheet volatility that they reported during their quarterly reports or annual reports. If they had a very large set of liabilities and a relatively stable level of assets, those liabilities would be moving up and down inversely with bond yields, and unless their assets moved in line with them they produced mark-to-market volatility through their P&L. That is the first parent.

The second parent is the Pensions Act 2004, which saw the creation of the PPF and Pensions Regulator, with the Pensions Regulator seeking to safeguard the solvency of the PPF and measuring that solvency by the potential claims on it. The size of underfunding of individual schemes became of great import, given the very high level of long-term insolvencies of sponsors, so the PPF would be on the hook. As such, there was a remit to protect the PPF and also protect the scheme beneficiaries of these pension funds.

Those two things together created an imperative for sponsors and schemes to more closely align the present value of their assets with the present value of their liabilities. One way of doing that is by moving assets from equities, which should deliver good, strong long-term returns, but very uncorrelated with bonds, towards something more bond-like so that there was a smaller degree of mismatch between the way in which those things are measured.

Q211       Chair: Considering the interests of the economy as a whole, should we be worried about the fact that that switch has taken place?

Toby Nangle: It is a big question. Pension funds could continue to invest in things like infrastructure, property, long-term investment assets, but they were investing less in equity. Someone else needed to be buying that equity from them. That typically went to international investors and a fair chunk of that went to international takeovers. The UK, more than pretty much any other developed country, has had a higher degree of international takeovers of its businesses. I think over the past 10 years or so about a third of FTSE 100 companies have disappeared and about 70% of those by value have gone to international buyers. If you looked at other market indices, the proportion of international buyers might be 25%, 30%, that sort of thing. The equity ownership of the UK has transferred overseas as part of this rather than domestic. That is one thing.

Given that the UK runs a current account deficit, it needs to fund that and so someone will be buying the debt or the equity or the property, but ultimately, because we have a current account deficit, it needs to be financed by someone. Our regulatory framework has meant that our pension funds have financed the UK Government essentially and reduced the cost of borrowing for the Exchequer, which potentially is public good, but the equity ownership in the UK is more international than it would be otherwise. That could have productivity benefits because firms that are taken over by US firms tend to have high levels of productivity, but the equity benefits of that have dispersed overseas.

Professor Blake: In addition to those two reasons, going back to your first question about whether the switch to bonds was inevitable, pension funds have matured, they have closed to new entrants in many cases. They are much more concerned about paying out the pensions than they are about growth. The additional reason for the switch to bonds is the maturity of the pension funds and the closure to new members and therefore the need to have more bond-like instruments to deliver the regular cash flows that are needed.

To the second part of your question—is this bad for the economy?—this was always going to be unavoidable with mature DB schemes, but you have defined contribution schemes coming up behind them. They will have a younger set of members and therefore it is much more important that those schemes have equity investments. They are immature and have much greater equity investments in them.

An issue we may discuss later on, because productivity was mentioned, is that, despite the fact that we have this long-term pool of assets, the biggest pool of long-term assets in pension funds in Europe, they have not gone into companies. There has been no research and development, no capital investment increasing the productivity of UK companies, and we have the lowest productivity in Europe. There is a very big problem, with the fact that our pension funds have not done the job that they could have done and should have done, which is channel those long-term savings into long-term investments and long-term capital and long-term improvements in productivity. That is another serious issue that we have.

Tim Bush: I broadly agree with everything that David and Toby have said. The only emphasis I would change slightly is that none of this was inevitable. The accounting standard basically frightened companies because of the effect it had on their balance sheets, as opposed to the pension funds’ own accounts. The accounting is taken only into the sponsor’s accounts and the good old pension funds should still be doing proper accounting that is coming up with sensible numbers. Then the Pensions Regulator followed the same approach by effectively being frightened by the same thing.

The drift into bonds becomes inevitable once you look at the business model for a pension fund. A typical two-thirds final salary, with a 15% contributions rate, needs about a 7.25% yield to work in the long run. For anything over that you will have a surplus. The local government schemes are a good example because they have remained about 80% invested in equities, their average 30-year returns are 9% and their return last year, even though the Ukraine war came in the last month before the measurement period, was 8.8%. You can’t get much worse than a Ukraine war in a year and their return was only 8.8% but still well over the 7.25%.

As soon as you shift from a 7.25% return to something like 3% or 4% for gilts, you condemn the scheme to death or it will take extortionate contributions to keep it on the road. There is a fascinating example, which is the Bank of England scheme. That has switched to gilts and it is non-contributory by the employees. The bank now pays 50% of salary rather than 15%, which I find extraordinary. Also, it is very odd that it has done it because I can’t see that the Pensions Regulator would be pushing the Bank of England because it is worried about its own covenant.

It is not a closed scheme either. As soon as you close a scheme, effectively you are increasing the risk, because over the long run, if you have a stable workforce, the pension contributions from the workforce and the employer will exceed pension payouts. Most pension funds with a stable workforce would never draw on their fund. The fund would be cash flow positive for years and years. Looking at the local authority schemes as an example, most of those have always been 30 years away before they go cash flow negative and many of them still are not.

It was not inevitable. On the productivity side I think it has clearly been extremely harmful because the biggest supplier of capital to UK companies has been withdrawn over a 10, 15-year period. I find it very interesting that UK finance directors originally were critical of the accounting, but now they are used to it and have stopped criticising it. The corollary of the accounting is that FTSE 100 companies are no better than being invested in a gilt. That is the way the discount at the accounting standard looks at them. It basically says it will not give any credit for the fact that you should be yielding in excess of 8%, “We are going to say you will only be yielding 3%”. We have this odd situation where finance directors of FTSE 100 companies do not have the confidence for their own pension funds to be investing in each other, which is a very odd position.

Q212       Chair: You have made the point to us that local government pension funds are more heavily invested in equities and in infrastructure and have performed well. It is not quite clear why private sector DB schemes have not done that.

Tim Bush: It is the fact of the accounting standard and the fact that it frightens the companies in a market position. More recently the accounting standard was pushed into local authorities as well, for no apparent reason, but anyway, it is what it is. They are not so worried about an accounting number that they can explain away, so there has not been the drive away from equities into bonds.

Professor Blake: The schemes are not closed either. That is the other important critical issue.

Q213       Chair: I will put a final point to you. The Government Actuary said to us that a main factor behind last year’s gilts crisis was the large volume of assets aligned to the same strategy. Do you think he is right about that?

Toby Nangle: I think that is absolutely right. If you think about the volume of assets in LDI, it is estimated by the Investment Association to have been about £1.6 trillion. To put that into context, the UK Government debt is £2.4 trillion and about £800 billion is held by the Bank of England. It is not so much like a big fish in a small pond; it is more like a tuna fish in a paddling pool, any swivelling of the tail will destroy the whole structure. If they all invested in the same way, they can unsettle the market in a way that is unavoidable, simply because the size of them is so large that there is no counterbalance. They can’t be counterbalanced. There are not enough gilts out there.

Professor Blake: Can I give you an historical example, which is very similar? The 1987 crash was caused by a strategy called portfolio insurance. I don’t know whether you can all remember that far back, but portfolio insurance was a strategy for an individual fund whereby you increased the equity weighting if the market was rising and you sold equities if the market was falling. That was a very sensible strategy for an individual fund, but collectively all these funds together, all the strategies were driven by computer-generated trading strategies, they all had the same trigger points about when you are going to sell, so a small fall into the market led to an instruction to sell. There was not the liquidity in the market to deliver all those sells and so the price fell even further and that delivered even bigger falls in the market, more triggers to sell.

That is exactly what happened this time, but it was interest rates that moved rather than share prices. It is the systemic risk that has not been taken into account. What was sensible on an individual basis for an individual scheme does not become sensible if you have all these similar trigger points happening at the same time. We have seen many historical examples of this, so this is not unusual. The idea was that this big shock rise in interest rates—they caused it, they were part of it. The small rise in interest rates set the trigger points, which led to the much bigger rise in interest rates. They said, “This has got nothing to do with us”. It was entirely to do with them because once you have big trades and the liquidity is not there on the other side, as you mentioned, that will be an inevitable consequence of this. It is hard for regulators to do anything about it, but they must try to do something about it if you are going to avoid.

Another point is leverage. All banking crises are caused by excess leverage. Throughout history, all banking crises are caused by excess leverage and now we have our sleepy little pension funds classified as shadow banks and they have been responsible for this particular issue as a result of these LDIs.

Toby Nangle: One final thing. The Dutch were very concerned after the British LDI crisis because the Dutch are investing in very similar ways, in fact potentially more so. A bigger portion of their GDP is invested in that way. Ultimately it was not an issue, because huge though the Dutch pension system is compared to the Netherlands, within the European bond market it was not big enough to cause this systemic issue. It is the ratio of the size of the sets of schemes all doing a similar thing and the size of the market that they operate in.

Q214       Sir Desmond Swayne: Professor, why was it a serious error to advise schemes to stick with LDI when interest rates started to rise last year? Has it changed?

Professor Blake: That is a good question. That is one of the things I raised in my note. The LDI strategies were in place because falling interest rates were going to raise the value of the pension liabilities and therefore you put these LDI strategies in place for that purpose, but a change in monetary policy was announced last December. The Bank of England announced that quantitative easing was going to end, quantitative pricing was going to begin. The Federal Reserve Bank and the European Central Bank were saying the same thing. Everyone knew that interest rates were going to go up. Ukraine then added to the inflationary pressures that would lead to interest rates going up even further.

That strategy was no longer suitable. It was no longer the appropriate hedge and I think that the advisers should have suggested that you unwind those strategies. The Financial Policy Committee said that we now have a trend rise in interest rates and this has exacerbated the trend, but even the Bank of England say there was a trend rise in interest rates. The existing LDI strategies were entirely inappropriate, given that, and that is why when the spike came the pension funds had to pay out the collateral and that simply exacerbated the problem.

Q215       Sir Desmond Swayne: To what extent was it the case that leverage had been increasing for some time but the Bank of England simply had not spotted it?

Professor Blake: I think that is another very important point. It did a survey jointly in 2019, I think, when they kind of mooted this thing, but nobody would have understood the implications of the systemic effect of that. Nobody would have done that; everyone was shocked at it. I was shocked and most of the people I know were not aware of the extent of the leverage: most of my academic friends were not, and neither were readers of the pension trade press. None of this was there at all. There were hints of it. Chris Flood did an article in the Financial Times in June and I responded to that in a letter, but nobody understood the significant effects of this. Everyone was wrong-footed.

Q216       Sir Desmond Swayne: To what extent therefore should leveraged LDI be prohibited, given the systemic risks that all three of you have drawn attention to?

Tim Bush: I think the only rational case for having any LDI is when a scheme is in perfect runoff, it only exists to pay pensions and it is completely closed. You know your obligations and your assets. We have seen the problems when LDIs get very leveraged. I would argue that they probably should be prohibited and there is a debate as to whether pension funds can borrow or not, according to the EU directive. I think that debate is going on in the House of Lords Industry and Regulators Committee.

I do not buy the argument that you can find a workaround by getting pension funds to hold more collateral. Collateral means that they have to hold it as cash. I would not feel comfortable as a pension fund trustee depositing hundreds of millions of pounds with a bank that is not protected. One reason why people hold short-term gilts is that they don’t want to deposit cash with other financial institutions. I am not sure that the argument that you can get around the problem by holding more collateral works if people start to ask the question, “What other form of herd behaviour have we now created?”

I would not call these strategies. I think they were basically herd behaviour. What is the impact of the herd behaviour of everybody dumping hundreds of millions—in fact, with some pension funds it would have been billions—with banks?

Toby Nangle: It is nice for us not to agree. I would absolutely advise against banning leverage. There are systemic issues, but one of the impacts of banning leverage is that you would need to have a huge divestment of growth assets. For the market response to this variety of impetuses of mark-to-market accounting for corporates and also the Pensions Act 2004 and the existence of the PPF, there still is an impetus to reduce the mismatch between assets and liabilities. Removing the ability to use any leverage will simply mean that you need to have a lot more invested in physical bonds and a lot less invested in things that might be illiquid, such as infrastructure, venture capital or equity and these sorts of things. I think paradoxically that this would be problematic.

I did some calculations. [2]There has been about £740 billion injected into pension schemes since 2004 in contributions. About £340 billion of that was special contributions to try to reduce that deficit. Something else could have been done with that money and it was put into the pension funds over the past 15, 20 years or so. I think that banning leverage would mean that schemes would be less well funded and they would need to inject more money into the pension funds to make up that difference.

Professor Blake: Can I add something? This obviously had a big shock on the industry and it has frightened the pension funds. The rise in the yields has increased the surpluses. A lot more schemes in surpluses are closed, so they are going to go to buyout. This will increase the trend towards buying out their liabilities altogether. This LDI may be a shorter-term concern because funds are saying, “This is just too much, the risks are far too great. We are just going to sell our liabilities to an insurance company”. That will definitely increase.

Tim Bush: Can I go back on my point of disagreement with Toby? Toby’s answer assumes that the accounting that is causing a problem is left in place. I would argue that if you deal with the problem at root, which is an accounting standard that does not deal with the type of assets you are invested in properly, the need to be so heavily weighted towards bonds goes away. The problem is rooted in having an accounting standard that creates a very odd kind of hall of mirrors effect. It does not give enough credit for being invested in equities and pushes people towards bonds. As I say, the natural progression of being invested in a bond, unless you go for leverage, is that the scheme is dead, but the problem is coming from the accounting standard and the Pensions Regulator then mimicking that fear by regulating in the same way.

The Pensions Regulator is basically assuming that it wants every pension fund to be fully funded at any one time because that company could go bust. That sounds compelling until you think how many large FTSE-type companies would go bust in a 10-year period, say one out of 100 perhaps. That should be a form of manageable risk, not saying to everybody, “We think you are all going to go bust”. The insurance industry would not work on that basis. You would not insure anything if you took that view of risk where you eliminate the risk completely.

I add my answer, but clarify that you have to deal with the accounting standard and the Pensions Regulator. I said in my evidence that a bad regulator is worse than having no regulator because people left to their own devices would not come up with the same silly idea.

Chair: I will make a declaration at this point that part of the regulatory background to the use of leverage in the way we are discussing was the Occupational Pension Schemes (Investment) Regulations 2005, which have been criticised in previous evidence sessions we have had. I thought I ought to declare the fact that I was the Minister who signed those regulations in 2005. I think that ought to be on the record.

Q217       Nigel Mills: Did we accidentally then kill DB schemes by a stupid accounting policy or did DB schemes die and lead to a stupid accounting policy? What was first, the chicken or the egg? Tim, you were nodding at the first one.

Tim Bush: There was one other factor, in that basically the concept of people working for the same company all their working lives drifted away some years ago and DB pension funds were very much based on employee loyalty, although if you were in a DB scheme you could transfer out to another. You got a transfer value and you basically carried on as if you had never left the previous employer.

There were plenty of people who did predict it at the time. At that time I was working for Hermes Asset Management and my chairman was a guy called Alastair Ross Goobey. As soon as IFRS 17[3] was being mooted, he kept telling people that this is what would happen and he was a voice in the wilderness. The accounting standard setters don’t listen in the same way that other people do if they are hearing rational, coherent arguments. They just carry on digging down to Australia and that is what happened.

Interestingly, the concept was based on an American standard, but the Americans used a higher discount rate and you can see in the US they have not drifted out of equities in the same way. The state pension funds or the large corporate pension funds still have quite high weightings towards equities because they were not pushed into bonds in the same way. I think that there is a direct causation from the accounting standard and then the Pensions Regulator taking that approach.

Professor Blake: That is a very interesting question: could we have saved defined benefit schemes, which were wonderful? One of the best things our country ever did was having final salary defined benefit schemes for its pensioners, so it is a tragedy that they have gone in the private sector. The very first time I heard that there was a problem, it was not the accounting standards, which I agree have had these unintended consequences. It was the fact that the scheme actuaries had discovered that people were living much longer than was anticipated at the beginning of the 1990s.

The scheme actuaries revise their mortality tables once every 10 years. They had assumed that mortality was effectively a deterministic process and it was during the 1990s that they discovered that this huge increase in life expectancy that we have experienced since the 1950s was having an impact on the value of the liabilities. The human resources director who had run the company said, “That is fine,” but once the finance director got involved in pensions—which they had previously left it to the human resources director—they were saying, “This is costing us a lot of money. Do our members value it, do our employees value it?” The sad truth was that most people in schemes did not know they had a pension scheme, they did not know they were contributing to it and they did not value the pension. It was only the unions in the public sector that made sure that public sector employees knew the importance of the pension. Those were some of the factors that were in play before these tragic accounting standards came into play.

Toby Nangle: My understanding of the long dark history of pensions is that within the UK over a series of decades there was a variety of reforms that crystallised the potential of “nice to have, we’ll give you a pension if you can afford it”, into something that became deferred compensation. At the point it becomes deferred compensation and transferable, which I think is a good thing, it meant that you had to think about how you valued that.

You asked specifically about the accounting standard. I think that the accounting standard was one parent. The other parent was the appetite to bear risk on the part of the PPF, because say one in 100 companies goes bust every 10 years—there are 2,500 schemes that have disappeared since the PPF was put together. That is a lot of schemes. There are only 5,200 left. Business churn and demography in this country means that businesses will die, they won’t be immortal, and someone has to pick up that bill. We saw that with the Maxwell affair and a variety of other big affairs: will people simply let the pensioners swing? No has been the answer. There is a public liability and so the Pensions Act 2004 essentially made that a collective liability of the industry and you create a Pensions Regulator to stop bad actors deciding they are simply not going to fund their schemes.

How do you work out whether a scheme is funded or not? You think about if these are cash-like payments that out in the future look like bonds. I have a lot of sympathy with a lot of these individual pieces. Collectively you are right, it killed the private sector DB.

Professor Blake: Could I add to that? The pension schemes in the private sector were offered on a best-efforts basis, with a lot of flexibilities built in. Over the years those flexibilities were turned into guarantees. One of the worst cases of that was the inflation uprating. The inflation uprating became statutory and that ruined it for private sector schemes. In the Netherlands, which was mentioned, inflation uprating is not mandatory. It depends on how the assets are performing. They are able to uplift the pensions if they have the funding, but it is not a statutory requirement to have uplift them. Therefore, the inflation conversation that Parliament insisted on introducing, and a lot of other Acts of Parliament that gold-plated these pensions, have also contributed to this.

Q218       Nigel Mills: On that topic, a naïve non-pension specialist might think that in a situation where we have inflation running at 10%, gilts have lost some value—although they may have it back by now—and the economy is in a bit of turmoil, this would be a pretty disastrous time to be running a pension and you would be quite nervous. However, the accounting numbers tell us that pension schemes are in their healthiest financial position in 20 years. You think, “Well, that’s an unusual set of calculations”. Is that real or should we be a bit worried about the fundamental health of pensions?

Tim Bush: Can I take your point? You raised this point in the session that you had the Pensions Regulator in, you were looking at the real numbers as opposed to the discounted numbers. If inflation is going up, that is very often the cause of interest rates going up, but inflationary rises to pension schemes means that the liabilities go up. There is something very odd happening with the maths and I am not sure that they have done the algebra right, simple as that. Therefore, I would be very concerned to assume that everything is healthy, because the discounted numbers are showing the liabilities going down.

Actuaries do have a record of getting things wrong. They got the returns on investments wrong over endowment mortgages; they got the returns wrong over guaranteed annuities at Equitable Life. They do not even have mortality right, because mortality seems to have peaked. One reason why there was increasing mortality was that the second-world diet and lifestyle was, ironically, quite healthy for people. The numbers are now going down quite a lot. I think that more work needs to be done to see the extent to which this increase in the discounting is reflecting the liabilities going down. A lot of people don’t think that it is.

Toby Nangle: I have a lot of sympathy with the idea that asset values have fallen a lot, so how come everyone is so happy on the pension side? On the idea that liabilities are some accountant’s dream or some actuary’s dream so we should not think about it that much, to make it very personal, I am going to retire in 2043. If I wanted to buy a £100,000 cash pot that just appeared on my birthday in 2043, at the end of 2021 that would have cost me £77,000. Today that would cost me about £45,000. That would be thought of as if that is the liability that I am trying to meet, then it does cost me a lot less to meet that liability by buying those cash flows in the market.

I always bear that in mind when I am thinking, “The liabilities have gone down in value. What does that actually mean?” Actually, it does cost less to secure those outcomes, so while the funding position might not be quite as healthy as it looks on the P 7800 chart at 136%, there has been a meaningful improvement in solvency and people should feel better about the security of their retirement despite all the challenges that we see. That in itself poses new challenges to the economy because pension funds generally have been big investors. However, at the point where they have already passed that finish line and they have no new problem to solve, they do not need to do the kind of investment that would be as productive for the UK economy as they would otherwise have had to do.

Q219       Nigel Mills: Presumably some schemes will have taken a hit from the turmoil, but we do not yet know which ones and we will have to wait for annual reports or the regulator or somebody to work it out. Do you have any feel for how many have had a negative hit from this and what they can do about it? Is it just going to have to be a long-term recovery? There is no magic way of undoing the damage, is there?

Tim Bush: This is a question that is partly about what I call losses due to fire sales, because if people are distressed sellers of gilts and also distressed sellers of equities to meet the margin calls, then that is an irreversible loss because they will effectively have sold low to then buy back high. One quick way of finding out what the losses on gilts are is to ask the Bank of England how much it made on its market support operations, because if people were selling gilts cheaply to the Bank of England and buying them back high, the Bank of England’s profit is the contra of their losses, at least on the bond side.

Professor Blake: Was that £4 billion? I think that the Governor of the Bank of England said that it made £4 billion profit on that, which means that someone is making a loss.

Tim Bush: Somebody has lost £4 billion, which will not be the pension funds.

Nigel Mills: It might be their own pension scheme.

Tim Bush: It could be their own pension scheme. The equity number should be available. What was interesting when I looked at the evidence to the Treasury Select Committee, the Bank of England’s response was that it would take a year to see the effect because you would have to look in a set of company accounts. You do not, because the company accounts are not the same as the pension fund account. Any pension fund should know on a monthly basis how many equities it sold at a loss in the last month and had to buy back. The numbers should be available for the equities as well as the bonds, but I think that we can come up with a number of about £4 billion for the bonds if that is the Bank of England’s profit.

Q220       Selaine Saxby: Good morning. Will the increased collateral buffers now in place prevent another LDI crisis?

Toby Nangle: In short, I think that they will, yes. The industry has taken this 300 to 400 basis point that has been applied to pooled funds, but the Central Bank of Ireland and the CSSF in Luxembourg and then the Pensions Regulator have said, “This is reasonable practice across segregated accounts here”. Three hundred to 400 basis points is a lot. Putting it in proper numbers, if you had £100 in your LDI portfolio, half of it has to sit as collateral. That is a lot; it is a huge buffer. There are arguments that that buffer is even too large, but it will certainly be enough to stop another run dynamic that we have had.

It is not that that buffer has to sit in a bank deposit, it can be in anything that can be liquidated in order to satisfy a movement in yields in a few days. We saw an unprecedented rise in yields in a very short period of time over last September/October. The buffer would be fine for that. A good portion of that yield was the run dynamic itself, so you are removing that element from it. The buffer can be invested in equity funds; it can be invested in credit funds; it can have some cash component to it. Yes, I absolutely do think that is the case.

Professor Blake: I think that it will, but not because of that particular number. It is because people are being frightened off, schemes have been frightened off the leverage. The leverage will have gone down naturally. As I said earlier on, more schemes—now that they are in surplus—will be looking to buy out. The combination of those two factors will lead to a reduced risk of the systemic risk happening again. However, I think that that would have happened even if they had not changed the basis points.

Tim Bush: I am still unclear where the cash will go for margin calls that could be called on as quickly as it was this time around. Any asset that you have to sell carries a risk of a run on that asset’s price if you have to liquidate it in a rush. As I say, I would feel very uncomfortable depositing that much cash with a bank.

There is another angle as well. According to some of the press, there is now a chance of litigation against some of the LDI providers and possibly the investment advisers as well. I would have thought that if that is the landscape that we face, many pension funds clearly will not revert to the strategy that they had that they are now going to be suing somebody for advising them on. What I have seen is a lot of people suggesting what I call workaround answers: “Let’s work around it”. Very often if you draw it out and look at the map of it, some of these workaround answers do not all fit together. There are a lot of lawyers looking at the prospects of litigation because some funds may be advised that they have to litigate.

Professor Blake: Can I ask my colleagues a question? There is a puzzle here. I am not sure why cash is involved, because in some of these strategies the assets could have been pledged. You could have pledged the assets without having to sell them. I know in some cases, not necessarily to do with pensions, you could just pledge the assets and you would not have to sell them. I am wondering why with these strategies you were forced sellers of these assets to provide cash. Does anyone know that? You do?

Toby Nangle: It is a technical yes.

Professor Blake: I am going to learn something.

Toby Nangle: EMIR regulations require cash posting collateral on central counterparties. Pension funds have had an exemption. That exemption runs to this year and it cannot be postponed any more than that, other than, “This is genuinely a Brexit dividend and we can now not do that”. However, ahead of that sunset clause on an EMIR exemption for posting collateral and instead moving to a cash collateral movement, some managers moved ahead of that. Where they were centrally cleared they did need to pledge cash collateral and they could not pledge gilts to the central counterparty.]]

Professor Blake: That is a regulatory reason.

Toby Nangle: Yes.

Professor Blake: There was no technical reason, was there? There is no technical reason why you could not.

Toby Nangle: You could not do that with a central counterparty, you can only do it on a bilateral basis. For example, LGIM traded with a central counterparty and had it centrally cleared, whereas someone like Insight did not have the thing centrally cleared. That meant that there was a different thing.

Chair: Thank you for clarifying that for us.

Q221       Selaine Saxby: Do you think that the levels of buffers required vary according to the circumstances of the scheme and do you agree with the FCA that buffers can and should be reduced over time if operational changes are made?

Toby Nangle: Large schemes that had a couple of hundred basis points buffer, pretty much to a scheme there was not a problem with them. They had strong levels of governance and delegated authority. They had arrangements in place whereby this was a real test. It seemed like a real fire drill and it was a real emergency, but they came out unblemished. It seems reasonable to me that if you had some arrangements whereby schemes could have their governance recognised and their arrangements in place, they should perhaps need to have a lower buffer than other schemes that might have more primitive arrangements in place. Some kind of discrimination between schemes seems entirely rational.

Selaine Saxby: Anything that you would like to add to that?

Tim Bush: I am still sceptical of the “Let’s find a workaround approach”, because I have not been convinced that the Bank fully understood what was going on and therefore I would not be convinced that people fully understood the workaround. It is just like sticking plaster.

Q222       Selaine Saxby: What are the implications for pension funds of giving asset managers control over more of their other assets?

Toby Nangle: As a former asset manager, it means that those who are able to do LDI will have a greater claim on the pension assets more generally. I have heard a number of instances where schemes have been asked for a 500 or 600 or 700 basis point buffer and this has been understood as an asset grab by the asset managers to say, “We just want to have more of your assets. We will charge fees on more of your assets and this is a prudential thing to do”. It means that there is potentially great concentration among individual asset managers of assets under the banner of it all being to reduce systemic risk, but I think that schemes have started to push back on that because it is seen as an asset grab.

Tim Bush: Could I add that the number of asset managers providing LDI-type solutions is relatively low? Aviva did not do it. It was Legal and General, Insight and Columbia Threadneedle. Some people did not want to offer the product. That is interesting in itself. It is quite unusual for the asset management industry not to act as a whole and all follow the same products.

Chair: Siobhan wanted to ask a point, quickly.

Q223       Siobhan Baillie: We heard evidence before on what Toby said about the different schemes, the small schemes versus the big schemes and how they coped. To your point, Tim, do you see having different approaches for different-sized schemes as a workaround? Do you still see that as a risk or do you think that if we do change the governance requirements and make some hard, nailed-down changes for these different schemes, that would help?

Tim Bush: This distinction between large and small schemes is a bit of a red herring. There may be some practical issues between being a small scheme and a large scheme, but there is this assumption that only the large schemes had smart trustees and the small schemes somehow had naïve people from the backwoods who did not really understand. In my experience, the latter type, the type of people who might be running small schemes, may be less subject to group think than professional trustees who are all doing the same type of training and coming out of the same stable. Therefore, I would be wary of looking at small schemes and large schemes in the same way.

Also, it was not small schemes that were causing the macroeconomic effect. They would not have had enough gilts to make the effect. The systemic effect must be coming from the large schemes. The other ones are a drop in the ocean. Again, I think that the small scheme thing is potentially players trying to pass the blame to the little people.

Siobhan Baillie: I do not think anyone was being derogatory about the small schemes. My understanding of the evidence that we have had was that it was about the ability to respond quickly. It was the speed, and the bigger schemes and the bigger companies had those people and strategies in place.

Tim Bush: It was not critical of your question.

Siobhan Baillie: No, I did not take it like that.

Q224       Steve McCabe: Good morning. I want to ask first a little bit about the regulation. I understand that the Pensions Regulator says that the trustees are the first line of defence. The more I read about this and listen to you, the more I wonder how any trustee copes at all, to be honest. However, if I have it right, back in December the Pensions Regulator issued some guidance that it says will help trustees maintain appropriate buffers and be capable of meeting collateral calls. Given what happened back in the latter part of the year, is this guidance likely to be effective?

Toby Nangle: When the Pensions Regulator issues guidance, it is generally followed. It is effective insofar as it reduces the possibility of a repeat of what we have just had. However, what you mean by effective is—

Q225       Steve McCabe: I am trying to understand if you think that the guidance that has been issued is going to address the problems that the Pensions Regulator fears could occur again. They are broadly about the inability of the funds to cope with higher interest rates, is that right?

Toby Nangle: LDI works quite well in a high interest rate or a low interest rate environment or indeed a gradually rising or gradually falling one. However, it does not work well when you have a huge shock. The size of the buffer is essentially the size of the shock. We had a couple of hundred basis points of yield shifts in a very short amount of time, which was too much for the industry to be able to accommodate without going into a bit of a tailspin. Now that that buffer has been increased to 300 to 400 basis points, then if you were to somehow create a crisis that created a 300 to 400 basis point shock in a period of two to five days, you would get a repeat of what we had. I do not think that we have data that that has ever happened. That is not to say that it cannot happen, but if you had the similar test that you had in September/October, the new buffer would allow schemes to survive it without being a feature in the Financial Times.

Q226       Steve McCabe: I just want to make sure that I have understood this correctly. The guidance will enable the schemes to cope with steadily rising interest rates because the schemes can cope with rising or falling, it is only the pace or the shock of the interest rates that has the—

Toby Nangle: Yes. Preguidance, anything that moved slowly up or slowly down or stayed low in terms of bond yields was all fine.

Q227       Steve McCabe: This is guidance for planned events but not guidance for an unforeseen event, is that right?

Toby Nangle: The guidance is how big a buffer you have to guard against an unforeseen event. It is what magnitude of unforeseen event would be problematic. Precrisis, the magnitude of an unforeseen event would be bond yields moving up very quickly between 100 and 150 basis points. Now the magnitude of an unforeseen event would be bond yields moving up in a very short period of time between 300 and 400 basis points. Everyone has been talking about unprecedented times because we had a move up of 200 basis points in a very short period of time. You would need to double that and then the system breaks. The system is always going to break at some point, with some kind of shock, but the shock that we had last year would need to be doubled in magnitude before you had a similar kind of testing of the operational infrastructure.

Steve McCabe: Thank you. Do Professor Blake or Tim have anything to add to that?

Professor Blake: I do have one comment. We do not really know if this 150 basis points, 300 basis points will do the job. That is because the stress testing has not been there. Going back to something like Solvency II, the insurance directory, you have to have regulatory capital in place to protect against the one in 200-year event over the course of one year. A lot of stress testing has been done on that to ensure that you have the regulatory capital in place to protect you. I do not know—my colleagues here know more about this than I do—whether we have seen the stress testing of an equivalent kind to know whether the 300 basis points is going to be enough at all.

However, I agree that the point is the speed. We are talking about trustees in smaller schemes only meeting on a very infrequent basis. At the last meeting it was mentioned that there were collateral calls four times a day. There were sometimes collateral calls four times a day and small, sleepy schemes would not be able to cope with that, therefore it is the speed. That is one thing that was unprecedented. However, as we have agreed, people have backed off from this and a systemic risk will be less and it is unlikely that you will get such a big shock again. However, the stress testing needs to be done to work out what probability the 400 basis points gives you in terms of a crisis happening. They have done that very well in banking and they have done it very well in insurance.

Q228       Steve McCabe: If the stress testing has not been done, how did the Pensions Regulator come up with these figures? Is this a best guess strategy?

Professor Blake: I think that they have done this.

Toby Nangle: I understand the Pensions Regulator has simply followed the Central Bank of Ireland and the Luxembourg regulator, CSSF, which issued this guidance for pooled funds that they regulate. The Pensions Regulator picked this up and said, “This should be best practice across—”

Professor Blake: Have they done the stress testing in Ireland or Luxembourg?

Toby Nangle: By stress testing, do you mean looking back over 200 years to see what—

Professor Blake: Why they picked 300. Why would they pick 300?

Steve McCabe: I am just going to go to Tim.

Tim Bush: I would not trust any guidance from a regulator that has clearly failed. If the regulator’s system is by grubbing around the world and coming up with half a view of what somebody else is doing when we do not know if it is the same, I would be very distrustful of that guidance. I am also very distrustful of people talking about once in every 100 years, once in every 200 years events, because they seem to be happening all the time. I said in my evidence that a black swan event was a cliché for a dodgy product. If a car keeps breaking down, you would not be very happy if the garage that sold it said, “That was a black swan event”. Therefore, this whole black swan thing has become too full of itself.

I will just refer to precedents in recent times, where a review post-crisis came up with the wrong answer. After the banking crisis, the Walker review of 2009 said that the banking crisis was a liquidity crisis and better governance was the answer. Two years later Mervyn King said, “Right through this crisis from the very beginning...an awful lot of people wanted to believe that it was a crisis of liquidity. It wasn’t and it isn’t. Until we accept that, we will never find an answer to it. It was a crisis based on solvency...Initially financial institutions and now sovereigns”.

It took two years for the Governor of the Bank of England to overturn the kneejerk response of the Walker review that it was liquidity, whereas it was basically that the banks were not holding enough cash. Mervyn King was saying that the banks had grossly overvalued assets and did not have capital. It took two years for that to come through. People selling shares in the markets knew; we knew.

Q229       Steve McCabe: This is quite central to our inquiry. Would I be out of order to say that the balance of the evidence that you are giving us at the moment is that on the surface it would appear that the regulator has fulfilled a function, and taken the necessary action and provided guidance and imposed obligations on the trustees, but in reality this is giving the appearance of something being done rather than any assurance that something is being done? Would that be a fair summary?

Tim Bush: Two things made me very, very wary of the regulator. The first was when Sir Stephen asked about coercion of companies to follow LDI strategies along the line that the regulator wanted. He was told that it was not happening until you said, Sir Stephen, that you had had e-mails that said that it was happening. There was then a debate about what was coercion.

Secondly, in the session of the other Committee in the Lords, the regulator had been pushing people to hold buffers of 1% but the Pension Protection Fund was already itself holding buffers of 2%. There was discrepancy between one party and another. Therefore, yes, I am still very sceptical of any form of regulatory reform where the failed regulator is still in place. It took a long time to recognise that the FSA was not fit for purpose. Once it was decided that the FSA was not fit for purpose, the floodgates of criticism then opened because people felt that they could criticise the regulator. However, there are some people, particularly once you get to a certain age later in life, who find it very difficult to be openly critical of regulators. That is fortunately where you get left with parliamentarians, who are probably the last people standing in terms of being able to throw tomatoes.

Q230       Steve McCabe: That is fairly clear in terms of what you are telling us there. One last point. Given the comments that you made about smaller schemes and not being sure there was much difference, there has been an argument doing the rounds that maybe smaller schemes should be banned from using LDI altogether. Is there any argument for that?

Tim Bush: Smaller schemes had a problem, but smaller schemes did not cause the problem because they were not big enough. The analogy is that if everybody jumps to the other side of the ship at the same time and causes it to tip, you do not go and blame the baby, who is just a small part of it. Some of the issues around whether small schemes will continue with it will probably be down to the risk departments of fund managers as to whether they feel that they want to sell them with the risk that they have from this, particularly given that there is a whiff of resignation in the air. Is it worth their while?

Steve McCabe: That is helpful. Toby, David, do you have anything?

Professor Blake: One more point on it. Some of the small schemes, it was mentioned that they had concentration and they had big directors with big pension pots. They could also be in deficit. The scheme already has an unsecured loan from those companies because that is what a deficit is, it is an unsecured loan from the sponsor. Therefore, you have all this volatility as well. If you add the leverage on top of that, it does not seem very sensible for the small schemes with under 100 members to be going in this direction at all.

Toby Nangle: My understanding is that about a third of schemes that have less than 100 members were typically not involved in LDI in the first place. However, it does seem peculiar that they are automatically treated as professional investors. Being treated as a professional investor means that an asset manager or an investment consultant or anything can treat them in a particular way. They do not have to worry about things being too complex or not explaining it to a depth that would satisfy a retail client, for example.

There is a question as to whether smaller schemes might benefit from the protection of being not recognised as professional investors, although I think it would cause a huge headache for fund managers to have to work out and discriminate between different pension funds. Also, as Siobhan has said, there are some smaller schemes that are impeccably governed with the highest level of processes in place. Just because they are small does not mean that they don’t have everything in place, but it tends to be that they are less well resourced.

Q231       Steve McCabe: I want to turn briefly to this question about systemic risk. Is it possible to better manage systemic risk? If so, how? I don’t know who the best person is to start with. Do you want to start, David?

Professor Blake: You mention though the source of it and it is almost always related to leverage and similar organisations being in a similar position with similar trigger points at the same time. What is sensible for an individual scheme, because you know the daily liquidity in the gilts market, is one scheme being able to sell its bonds. The UK Government bond market is one of the most liquid bond markets in the world, but if you are all having schemes having to do this at the same time, that liquidity dries up and so it is the liquidity issue here. That is why I would consider why you need to sell these assets and why you could not have the pledge. I know there is a legal reason there.

This would not necessarily have gone this way. The schemes had plenty of assets. They were not short of assets, plenty of assets. Why should you sell your assets for this reason? Why should you? Why couldn’t you pledge them? There were plenty of assets. You could have pledged 10 times the amount that you owed without having to sell them. I think that is a fundamental problem here, why this was all forced to go through the cash market when the liquidity is not there.

Q232       Steve McCabe: Is that a fundamental problem with the LDIs themselves?

Professor Blake: I think it is the collateral. It is the central counterparty issue that it seems to be.

Toby Nangle: The central counterparty issue or central clearing is one of the things that contributed to this particular situation, but I would say that even if you were pledging, if the price of something that you are pledging is going down, you are going to have to post more of it anyway. If you cannot post more of something, you are going to have to sell it. There were large schemes that were pledging gilts as collateral. They were forced to sell assets because they had illiquid assets elsewhere that they could not inject to provide more collateral to their counterparties. I think that it is not entirely solved by being able to pledge things, unless you—

Professor Blake: It might have reduced it.

Toby Nangle: It might have reduced it. It might have, a bit.

Professor Blake: It would have reduced the extreme changes in the gilt.

Toby Nangle: If you go down the route of saying 10 times as much, would you pledge your stake in a large piece of infrastructure?

Professor Blake: That shows you how dangerous the leverage was in the schemes if they were in that position.

Toby Nangle: I am just saying there were lots of assets that no counterparty would think about taking on board as part of its collateral management if you asked the investment banks.

Professor Blake: The Bank of England estimated that it had to sell £70 billion worth of assets to meet its collateral calls.

Steve McCabe: Let me take you back to this previous—

Chair: Briefly, if you would, Steve. We are running a bit behind.

Q233       Steve McCabe: I was reading, Professor Blake, some of the things you said about all the different parties that were involved, all the disciplines, and that one person doesn’t understand what the other person does. Yet everybody is saying that the solution to this is more information and more data. How is that going to work? If I do not understand your information or how you derive it or what is motivating it, how is giving more of it going to make me better informed?

Professor Blake: I think that is a very good point and—

Steve McCabe: Then I will come to Tim.

Professor Blake: The issue is that these disciplines do not understand each other. Ten years ago, I was going to set up a masters degree in pensions at my university. We would have had courses in pensions finance, pensions economics, regulation in law and accounting, in which we would bring all these people together. I went around the town in London and said to the law firms and the accounting firms and all the people, “I am setting this up”, and they said, “This would be great. Let us know when you have set it up”. When I did set it up and I came back to them they said, “We can’t release our staff. Our staff are far too busy”, and the course never got off the ground. It meant that they did not see the need to come together and learn all the disciplines.

You would never have had this, so there is a big weakness here and I personally think it is because the pensioner doesn’t know that the pension plan is a good plan for 40 or 50 years. There is no incentive for these professions to get together because it doesn’t come back and impinge on them and 40 years later they have all retired. For example, commercial airlines, you have a lot of disciplines as well. You have metallurgists; you have hydraulics; you have a whole range of disciplines. They had to get together and learn about each other, because the customer knows very shortly after take-off whether the product works. They don’t know whether the product works for 40 years in pensions and I think that is a big weakness.

Steve McCabe: That is a good but frightening analogy.

Tim Bush: Your question is very important, because you said basically, “How do you manage systemic risk?” and I will say what sounds like the obvious: is the whole system being looked at properly? Because what I am picking up from your question is that you see it as being all chopped up, with each silo not seeing what the other is doing. Again, I was not impressed with the evidence from the Bank of England to the Treasury Committee, when it kept saying it didn’t do micro when it came to talking about pension funds. I would say that is like a doctor who has never met a patient. A good analogy is when covid was being managed, we had Jonathan Van-Tam and Chris Whitty on TV. They were managing a pandemic but they understood the impact at patient level. They weren’t getting away with saying, “We only kind of really understand the macro. We are not getting into this level of detail”. Certainly, when I started working in finance all those years ago in what was then the City of London, I expected the Governor of the Bank of England to almost know what everybody’s job was and what everybody was doing.

I think it may have been distracted by inflation, because what you have is the Governor of the Bank of England has to get his head around economics as well as get his head around what is happening with everybody else’s job in the City. If a system starts to come off its bearings, which I think has happened, you don’t solve it by workarounds. I do not feel that there is a proper systemic view. If there was, I don’t think you would need to be asking the questions you are asking.

Steve McCabe: That is helpful, thank you. Toby, do you have anything to add to that?

Toby Nangle: Talking about systemic risk, I would agree with the panellists that you look at what the market is trying to solve, because I think that LDI is not something that has been heavily sold on unwitting clients or anything like this. I think it is a market response to a variety of impetuses and those are primarily about the Pensions Act 2004 and then the move to mark-to-market accounting in 2004, also on [4]IFRS 17. That market response I think is fairly rational. As long as those impetuses are there, I think that there will be a willingness and a need to align assets with liabilities, which involves leverage for those schemes that have less good funding, so they are seeking to have higher exposure to growth assets like infrastructure or commercial property or venture capital, all these sorts of things, which are generally good for the economy. The operational bits I think are addressed quite well by the regulator, in contrast to maybe some of my panellists.

Steve McCabe: Let me ask you one last thing.

Chair: Steve, we are running quite seriously late now.

Q234       Steve McCabe: Are we? I was just going to ask about this risk to investments and that will be very short. It is obvious there is going to be a series of guidance, interventions and things to try to affect the pension market as a result of this. Whose role is it to make sure that we don’t end up with pension scheme investments that create new kinds of societal risks? Whose job is it to make sure that that doesn’t happen? The obvious thing I am thinking about is underinvestment in the economy because of the way you can strain them.

Toby Nangle: That is a very important question because it goes to the heart of it. It is no one’s job right now, right? You could say that it is the Treasury’s job, but then the Treasury does not have a regulatory role in a lot of the stuff, but I think it would sit with the Treasury.

Steve McCabe: We will leave it there. Thank you very much.

Chair: Thank you all very much indeed. You have given us extremely interesting and helpful evidence. We are very grateful for it. Thank you all for coming along.

Examination of witness

Witness: Sarah Breeden.

Q235       Chair: We welcome our second panel, comprising one witness. Welcome, Sarah. Thank you very much for joining us.

Sarah Breeden: My pleasure, Chair.

Chair: Can I ask you very briefly to introduce yourself to the Committee and to everyone who is watching this Committee hearing?

Sarah Breeden: Thank you, Chair. I am the Executive Director at the Bank of England, responsible for financial stability, strategy and risk. I am a member of our Financial Policy Committee too.

Chair: Thank you. Our first question comes from Sir Desmond Swayne.

Q236       Sir Desmond Swayne: Where does the responsibility lie for poorly managed leverage?

Sarah Breeden: The responsibility for leverage in the first instance lies with the funds and the schemes that take on that leverage. In the first instance, it is for them to understand the strategies that they are taking on and the liquidity risk that they run as a result of taking on that leverage. Of course, this is a regulated market as well. The Pensions Regulator is responsible for the regulation of work-based pension schemes. In addition, there are individual funds that are part of LDI strategies that contain leverage, which are the responsibility of overseas regulators in general. They are domiciled in Dublin and Luxembourg, so that is the Central Bank of Ireland and the CSSF. Our responsibility as the FPC is to think about the systemic risk, the system-wide consequences of the leverage of the pension fund sector.

Q237       Sir Desmond Swayne: The Governor told the Treasury Select Committee that the amount of leveraged LDI had been increasing for some time. The last set of witnesses said it took everyone by surprise and nobody spotted it. When was it spotted?

Sarah Breeden: We have been aware of the risk of leverage in the non-bank sector broadly for many years. As part of the FPC, our responsibility is to understand financial stability risks from banking, but financial stability risks from non-banking entities as well, which obviously includes pension schemes and the LDI strategies they follow. We did an exercise in 2018 that looked at leverage across the entirety of the non-bank financial sector, so that was hedge funds, open-ended funds, insurance companies and it included pension funds as well. We did a simulation at that point to understand what would be the liquidity impact on all of these players from a rise in interest rates from that leverage leading to liquidity risk. We have been following that up with TPR and other regulators since then, but we were first looking at it in 2018 and have continued to try to ensure that leverage is well managed since then.

Q238       Sir Desmond Swayne: Scheme fund managers say that the real problem was the fragility of the gilt market. Was it?

Sarah Breeden: I see three causes of this stress. First, the unprecedented speed and scale of the move in interest rates that we saw. Second, the lack of liquidity resilience, the lack of buffers that the funds had, given the size of the shock, and then the third thing—and this is important, I think—relates to a subset of the LDI strategies, the pooled funds.

The LDI market is split into segregated funds and pooled funds. Segregated funds are the larger share. They represent 85% of the market. Pooled funds are 15%. Segregated funds—I think this came up a bit in your evidence before—have a single fund entirely for that one corporate, so their levered investments and their unlevered investments are in the same place under the same manager. What that means is when there is a liquidity call on the levered bit, you can use your other assets to fund that liquidity call.

For the pooled funds—there are about 175 of them, 1,800 individual schemes were members of them—when they face a liquidity call because of interest rates rising, they have to sell assets elsewhere and transfer that money into the fund. It takes time, the operational processes can take a couple of weeks. In addition, you have to get the agreement of the trustees to sell those funds. That takes time. The problem, given the speed and scale of this move, was that they did not have time to recapitalise the fund to get the liquidity into these pooled funds, which made them forced sellers.

If you are a forced seller into a declining market, you end up with a self-reinforcing spiral. There may have been illiquidity in the gilt market because of the wider news about the fiscal position, but the thing that created the severe dysfunction, which caused us to intervene, was this forced selling as a result of the operational and governance complexities of recapitalising these pretty small pooled funds.

Q239       Sir Desmond Swayne: The work that the Bank did in 2018 on LDI leverage focused primarily on the large funders.

Sarah Breeden: Absolutely.

Sir Desmond Swayne: Presumably we have drawn the lessons from that.

Sarah Breeden: Absolutely. When I reflect, I think we did a plausible thing at that time in that exercise. We stress tested for 100 basis points instantaneous increase in interest rates. That was three times the largest daily move that had ever been seen since 2000. We did a big stress and we focused on the big players. To your point, we have learned the lessons twofold: think about more extreme stressors, not just the historical, but what might be plausible in the macro and the financial environment. Also think about what the other players in the market are doing, don’t just focus on the big players, try to get close to the structural complexities of perhaps small bits of the market.

That is quite a tough job for us to do because the non-bank world is very broad and to get down to that level of depth is a challenge, but it is something that we have learned a lesson from. We are undertaking a repeat exercise this year and we will make sure that we will manage to address those lessons through it.

Q240       Nigel Mills: It is surprising, what happened here. I think the previous panel would call it a herd approach. What might have been good for one ended up being used by everybody, to the extent that we had a tuna fish in the paddling pool, I think the phrase was, and if it starts shaking its tail it destroys the whole structure. Is that a fair description of what happened here: we just ended up with too much concentration of gilts in too few pension schemes, in effect, and it becomes mutually self-destructive if we are not careful?

Sarah Breeden: Again, I would come back to the distinction between the pooled and the segregated fund. The pooled funds had to sell. They had no choice but to sell into a falling market because they had to reduce the leverage in the funds. They had to raise liquidity. Given the funds could not come in from elsewhere, they had to sell gilts. Because they had to sell gilts into a falling market that created a spiral. That was one source of stress and, in our judgment, was the most serious source of stress.

You raise a good point though about the segregated funds because they are large. If they all decide to make a small change to their portfolios because they all have the same concerns in mind, the tuna fish in a paddling pool issue is probably a nice analogy, but they can internalise that. They can think, “If I sell, I am forcing the price away from me. Am I sure that I want to sell?” whereas the distinction with the pooled funds that absolutely had to sell I think is important.

The final thing I would say is that for us, ensuring that there is better visibility of what different players in markets are likely to do will be an important output of that stress test that I mentioned earlier, so that the segregated funds, the pooled funds and the other investors in the gilt market can get a sense about what the resilience of that market might be. Then they can incorporate it into their stress testing and have that effect, how much liquidity they hold and their trading strategies in the market.

Q241       Nigel Mills: This seems—I am no expert—to be a classic case of some sort of clever financial system product thing maybe bringing the whole economy down. I read your biography and it says, “The Financial Policy Committee is the United Kingdom’s macroprudential authority. It is tasked by Parliament with guarding against the financial system damaging the wider economy”. You are responsible for the Bank of England’s work to deliver that objective. It did not go all that well, did it?

Sarah Breeden: Let me make two points. The first is, as I was explaining to Sir Desmond, we knew in advance about this risk and we had done some simulations to try to judge whether the system was resilient to that. Given the nature of that test, we thought that the system was. In practice, there were these other factors. The shock was bigger. The liquidity buffers that had been used through the summer and the pooled funds created a dynamic. With hindsight, we learned some things through the real stress that we will incorporate into our future analysis of systemic stress from here.

The thing I wanted also to say is that leverage is not inherently a bad thing. If it is well managed, it can be a good thing. We use leverage to buy houses. Banks use leverage to lend us the money to buy houses. What is important is that we understand the risks that come with that and that we have resilience built in advance. That is where it is our stress testing and the work of TPR to ensure there is greater liquidity resilience in these schemes so that leverage isn’t dangerous.

Q242       Nigel Mills: It looked from the outside like it was a bit of a panic. There wasn’t a plan in place to know how to stop the market slide. That one was cobbled together, which worked pretty well in the end. Is that fair?

Sarah Breeden: I would challenge that. The mini-Budget happened on the Friday and we intervened on the Wednesday. The intervention lasted two and a half weeks and then we were out. We had, during that time, spotted the problem, worked out what needed to be done to intervene, to offer to buy gilts, to stabilise the market, stopped these forced selling dynamics, and then we worked with the LDI fund managers over the next two and a half weeks to support them as they built their liquidity resilience, which meant we could stop.

I accept that the exercise that we had done in 2018 and the follow-up that we had done with TPR subsequent to that had not built sufficient liquidity resilience, given the unprecedented scale and speed of the shock that we saw, but I think we were pretty swift off the mark and managed that. It was not a financial stability event. Our interventions stopped it being such an event.

Q243       Nigel Mills: I think that is fair enough. Did you have an outline of a plan prethought out? You get one of these scenarios where the market is forcing itself down by basically forcing itself to sell things in a falling market and that will intervene and buy the things so that we can stop the fall. Was that a preplanned thing? I think you said that you worked that out in those intervening few days.

Sarah Breeden: We had done that in the run-up to the summer, working with my colleagues in the markets area, recognising that in contrast to the previous stress in financial markets that had occurred in March 2020, the dash for cash, for monetary policy reasons that the Bank of England had been intervening in markets. We knew through 2022 that our money policymakers would not want to be buying assets. They were tightening monetary policy, so what my colleagues in the markets area had been working on was a plan for a financial stability set of purchases. That is why we had something to start with. We did not have a blank sheet of paper.

Q244       Nigel Mills: It was somewhat ironic, wasn’t it, that the Bank of England pension scheme had ended up at one stage almost 100% invested in these things and then had come down a bit before we hit the problem? Did you ever think, “Oh God, we ought to disclose the fact that our own pension scheme, where we are about to intervene in the market, is actually in the same boat as everybody else”? To the tune of £4 billion, I think. I don’t remember seeing any disclosures about that.

Sarah Breeden: It is very important to say that I am not involved at all in the management of the Bank of England pension scheme. Like all pension schemes, our independent trustees manage and determine the investment strategy.

Nigel Mills: That you appoint a majority of.

Sarah Breeden: Once they are appointed, they determine the investment strategy. It is not something that I am involved in at all as part of my job. Indeed, arguably there would be a conflict of me commenting on any individual pension scheme. We enforce strict Chinese walls. I am commentating and understanding risk to the sector, not being involved in individual decisions about our own pension scheme, in the same way we manage conflicts about owning bank shares or those kinds of things.

Q245       Nigel Mills: You don’t think it was slightly unfortunate though that there was never a disclosure of, “By the way, our own pension scheme is on our balance sheet and in effect is actually in this position, so by intervening we are rescuing ourselves as well”?

Sarah Breeden: I think it is best if I do not answer that question. We can write to you with a response. As I say, there is a strict Chinese wall. Those of us who were managing the stress and the independent trustees who manage our pension fund, there is a very strict Chinese wall between those two.

Q246       Nigel Mills: It is interesting, isn’t it? On a policy perspective we are told the advantage of using LDI was to prevent volatility on the sponsor balance sheet, but the Bank of England owns tens and hundreds of billions of gilts, so I presume you would not have been worried about the volatility of gilts in the pension scheme because it was a tiny percentage of the gilts you owned already. It seems—

Sarah Breeden: Look, I am not on the Monetary Policy Committee, which is the policy committee responsible for the quantitative easing portfolio that you are referring to. Across our gilt market intervention that I was involved with for financial stability purposes, and across quantitative easing where we have purchased gilts for monetary policy purposes, in both those cases all of our actions are driven by our statutory objectives given to us by Parliament. We are accountable for our delivery of those to you through the Treasury Committee, so as we are intervening we are thinking, “How am I reducing financial stability? How am I providing monetary stimulus to meet the inflation target?” That is what underlines our actions in the gilt market.

Q247       Nigel Mills: So there would be no reason at all why you would tell your pension scheme trustees, “Would you mind hedging out this risk because you might sink the Bank of England”? That would be ridiculous, wouldn’t it, so they just chose to do something there was no real need for you to do at all. Yes, it just seems rather bizarre to have effectively part of your balance sheet—and therefore UK plc’s balance sheet—hedging against gilts in case they had volatility in their market price when it is your job to manage. It seems counterintuitive that you would ever get involved in that.

Sarah Breeden: The one thing I would underline is that, putting our pension scheme to one side, our actions in the gilt market can help us to deliver both our price and financial stability objectives. At times those go in the same direction and the monetary policymakers want to provide stimulus. In so doing, that can support the stability of markets. At times they can pull in opposite directions. That was what we were worried about in March 2022 and why we had done the preparatory work that enabled us to intervene for the purposes of financial stability in September.

Q248       Nigel Mills: You also lead the Bank’s work on climate change, don’t you?

Sarah Breeden: I do.

Q249       Nigel Mills: Would you quite like pension schemes to be willing to invest in climate finance to help put the capital in the market so we can achieve the changes we want? Is that not likely to be riskier than investing in gilts? It looks as if we have ended up with a set of policies that have driven pension schemes to be quite low risk, when in fact you are probably sitting in nice meetings around the network saying, “We want to have more people investing in this”. Do we not need some policies that would make this work rather than fighting it?

Sarah Breeden: I think that goes to the question that you were debating with the earlier witnesses. Defined benefit pension schemes have made commitments to their pensioners about the benefits that they will receive in future and regulation and accounting drive investment strategies off the back of that. The first and most important thing is that those strategies support financial stability. We work with the TPR and with the other regulators to make sure that systemic risk from those investment strategies is adequately managed. Separately obviously there is a desire to support the transition to net zero, but first and foremost our interest in the pensions industry is about ensuring that financial stability is maintained. Then of course there are also many other investors, including defined contribution pension schemes.

Q250       Siobhan Baillie: Stepping away from your pension schemes, more generally do the Bank of England have a view on the extent of leverage that is appropriate for pension funds?

Sarah Breeden: Let me say one important thing first. The FPC is in the middle of discussing and deliberating on what the appropriate steady-state response to this episode should be. As you were discussing earlier, through the period of stress we increased resilience and we reduced leverage in the LDI strategies. The TPR, alongside the regulators in Luxembourg and Ireland, have sought to ensure that that degree of resilience is maintained and the FPC is now thinking about what a steady-state framework would look like.

In answering the question of how much leverage should there be, I should say that we are midway through our thinking about steady-state levels of resilience, which is the other side of the coin to leverage.

Q251       Chair: When do you expect to reach a conclusion?

Sarah Breeden: We are hoping to do so in our first quarter round. I think the record of that comes out on 20 March or sometime around that. The second half of March, Chair, that was our aim. We may fail to achieve that aim, but that is what we are working towards.

As for what is the right level of leverage, what are the principles underlining that thinking? First we need to ensure that there are sufficient liquidity resilience and buffers to cope with historical stresses and plausible stresses as we look forward from here. Obviously we had an episode in September of a 160 basis point move in four days that will influence our thinking, but we need to look forwards as well as historically and think about what some plausible but severe shocks might be. That is one aspect of ensuring leverage is appropriate.

The second thing—and this came up earlier in our discussion of pooled funds and in your discussion with the previous witnesses—is that we need to make sure that there are operational processes to replenish liquidity. Liquidity buffers get used as interest rates move and payments are made. It needs to be smooth operationally and from a governance perspective to get more liquidity into these strategies if they are to be safe.

The third important thing is that we need to ensure that people deciding to use these strategies know what they are getting into, that they have understood the risks and are ready to manage them, so financial resilience, operational resilience, smooth operational processes and an understanding of the consequence of the leverage that has been taken.

Q252       Siobhan Baillie: So you expect to get to a point where you are going to have a clear view on the extent of leverage and that is the work that is going on?

Sarah Breeden: That is our intent. It is important to explain that as the FPC our interest is on the financial stability consequences of that leverage. What we will be doing is describing the outcomes in terms of financial operational resilience and understanding that we think is needed to reduce risk to financial stability. The TPR and fund regulators may have additional requirements, reflecting their views on the issue. Our focus is on avoiding the systemic risk that we saw in September.

Q253       Siobhan Baillie: Thoughts about financial stability—do you have a view at the moment about whether leverage and LDI should be banned altogether for some or all the schemes?

Sarah Breeden: Leverage has a role to play in the economy generally. It enables me to buy a house; it enables banks to lend me the money to buy a house; it can enable a pension scheme to be hedged for the interest rate and inflation risk in its liabilities, while still investing in growth assets to close its funding deficits. It can have a purpose, but it does need to be well managed. We will set out the resilience outcomes that we want to see. If there are some schemes that perhaps because they are so small are unable to meet those standards, it is reasonable to ask whether an LDI strategy is appropriate for them, but I do not think it needs to be banned outright. We set out the outcomes and what well-managed leverage in an LDI strategy requires, then it is for individual schemes and the TPR, working with them, to understand whether they can meet those requirements.

Q254       Siobhan Baillie: Is repo economically equivalent to borrowing?

Sarah Breeden: Economically I would say it is, because as the price of the asset that you have borrowed changes, you need to make good on it and make a payment to reduce the credit exposure. I know that lawyers have a different view, but economically it provides leverage, which is exposure to an asset price, and in that sense is similar to secured borrowing.

Q255       Debbie Abrahams: Do you agree that given their fiduciary responsibility, trustees are the first line of defence for managing LDI risks?

Sarah Breeden: Those that determine LDI strategies are the first line of defence. The second line of defence is the regulators of those, TPR, and then we ensure that any systemic risks that arise—yes, I would agree with that first line of defence. It goes to the point we were discussing earlier, that it is important when signing up to an LDI strategy trustees know what the risks they are taking on are.

Q256       Debbie Abrahams: Given the different sizes of trusts and so on—you might have heard in the previous panel that the difficulties the smaller trusts faced were not the main causes of issues in September—how do you think that could be resolved?

Sarah Breeden: I’m sorry, I didn’t quite get your question. Ask me again.

Debbie Abrahams: Given the smaller sizes of some trusts, how do you think you can make sure that they are more in a position to be able to respond to these sorts of issues?

Sarah Breeden: It is a great question. I think it goes to the operational and governance processes and the size of the buffers, the degree of resilience you build in advance. Say you are a smaller scheme and it takes you a bit longer to get liquidity into the right place: hold more of it to start with and have greater buffers because it takes you longer to replenish them. But then, importantly, I do think it is necessary to have operational and governance processes that are as smooth as possible to get necessary funds from elsewhere in the pension scheme into where they are needed. You can do that by giving instructions to your fund manager to be able to act on your behalf. You do not have to do it yourself, but you have to have given them the power of attorney or the mandate to act on your behalf. There are ways for how smaller schemes ought to be able to, but they might require greater financial and operational resilience, reflecting the scale of the fund.

Q257       Debbie Abrahams: I understand from the December 2022 “Financial Stability Report” that you welcomed the guidance from TPR and it addressed some of the issues you just mentioned. However, given the concerns about the levels of understanding that trustees have of LDI, do you think that is enough?

Sarah Breeden: I think a steady-state resilience framework is required. What was put out in November by TPR and by the Irish and Luxembourg regulators was a greater interim step. It was a holding measure that meant that the resilience that was built up at speed in those two and a half weeks while we were intervening was kept in the fund, but what we need to do now is put all that on a steady-state basis, working with TPR and the fund regulators. That is what we are aiming to do and ensuring that the responsibilities of trustees are clear is an important part of that. That is mainly for TPR. Our interest is in the systemic risk consequences of it, but it is an interest, that is clear.

Q258       Debbie Abrahams: On that, you mentioned the simulation exercises that you did in 2018 and that you focused mainly on the larger trusts.

Sarah Breeden: That is right.

Debbie Abrahams: Will you be focusing more on smaller trusts?

Sarah Breeden: Absolutely. After our experience of September, pooled funds will very much be a part of our exercise.

Q259       Debbie Abrahams: Would it help if collateral could be posted in forms other than cash and gilts?

Sarah Breeden: It gives greater flexibility, that is for sure. Indeed, I think there were a number of arrangements where, for example, corporate bonds could be pledged so this is not an in theory issue; it is available in practice. My understanding, though I am not super close to it, is that that is relatively unusual and that vanilla arrangements involving cash are more common, but certainly if you can use other assets as collateral that avoids the need for a sale.

Q260       Debbie Abrahams: Is there any awareness of that in smaller trusts?

Sarah Breeden: I honestly do not know—it would be a question for TPR—but it is an obvious thing to do as part of our next phase, to be clear that there are different ways to have financial resilience: for example, cash waiting in a money fund, an asset that you would sell or an asset that is pledged.

Q261       Selaine Saxby: What do you think are the main information gaps in managing systemic risk associated with LDI for the future?

Sarah Breeden: The complete absence of data on leverage in the sector. The exercise that we did in 2018 and the follow-up in 2019 jointly with TPR was based on a one-off survey that got information in on which we could do analysis. We do not have basic data, whether it is about the size of funds, the assets held, their exposure or the leverage and how that associates with the schemes’ growth assets. That data is just not routinely available and will need to be. It is an important part of the steady-state resilience framework from here.

Q262       Selaine Saxby: The Government proposed more systemic regular collection, but TPR is concerned about the burden on schemes. Where do you fall on that sort of conversation?

Sarah Breeden: It is very important that we are able to manage the systemic risks that come with LDI investment strategies. In this period, in September we saw that the pooled funds were an important part of that stress and therefore it will be important for us to have data on them if we are to be confident that financial stability risks are managed.

Q263       Selaine Saxby: TPR decided only to require schemes to notify if collateral buffers fell below a certain threshold. Would that be enough?

Sarah Breeden: That is one of the things that the FPC will be actively debating as part of our views on the resilience standard. The outcome that any requirement needs to meet is that notification is sufficiently early so that action can happen as a result of it and not when it is too late. That will be the area to explore.

Q264       Selaine Saxby: Does there need to be more transparency in the accounts of individual pension funds, irrespective of their size?

Sarah Breeden: Our interest is in the system as a whole. I do not know that an annual statement would help that because exposures can change a lot through time. From my perspective as a financial stability macroprudential authority, I am not sure that that would help. There may be many other reasons why it would be valuable, but from my seat less so.

Q265       Chair: Can I put a final group of questions to you? You said in September that the root cause of these problems was poorly managed leverage. As I am sure you will have seen, LDI fund managers giving evidence to us disagreed with that. They said that it was more to do with gilt market fragility partly caused by your announcement on unwinding quantitative easing. How do you respond to their rejoinder to you?

Sarah Breeden: Our Deputy Governor, Jon Cunliffe, wrote a letter to the Treasury Committee when we intervened back in October, which sets out very clearly the timeline of events. I think it is clear from that that the news that prompted this stress was first and foremost the fiscal news that came from the mini-Budget and the behaviours of LDI funds as a result of that. I explained before about pooled funds that had insufficient liquidity when this event hit and that made them forced sellers as asset prices were anyway falling, which creates this self-reinforcing spiral. That is poorly managed leverage because the liquidity was not there in advance to be able to absorb the shock.

I accept that the speed and scale of the move was beyond what many of us had expected. In our simulation exercise, we used a stress of 100 basis points, not the 160 shock that we saw. I would say that the funds had, in general, in sizing the liquidity buffers they wanted to hold, only considered their own actions. They had not thought that when they were selling so might everyone else be selling and it seems to me that that is an inadequate approach to thinking about the liquidity that they should hold. They should not think about it atomistically, supposing that they are the only seller, but about the market environment in which they will be selling and therefore whether they need to hold more. That is what our exploratory exercise on this is going to look at.

Q266       Chair: Wasn’t at least the timing of your quantitative easing announcement a factor in all of this?

Sarah Breeden: I am not as close to the monetary policy side of things as the financial stability side, but I will tell you how I see it. Our announcements about quantitative tightening, the active sales of gilts, had been very well telegraphed in advance. The meeting minutes of the Monetary Policy Committee show it had been talking about developing a strategy for some considerable time. I think it was in August, Chair, that we put out a proposed way of selling gilts. Therefore, on 22 September, when we said that the MPC took the decision to undertake active sales as part of quantitative tightening, there was no market news in it because it had been so well telegraphed in advance. The news in the gilt market came with the mini-Budget.

Q267       Chair: In his statements to us, John Ralfe told us that the problem has been fragmented regulation, where everyone thought someone else was responsible. Do you think he has a point?

Sarah Breeden: I agree that it is a complex regulatory landscape. The FPC is responsible for thinking about the systemic risks that come with LDI funds. TPR is responsible for thinking about schemes. The FCA thinks about fund managers and the Irish and Luxembourg regulators regulate the funds themselves. That is a complex landscape.

What we have done in advance of the stress was work with TPR to try to raise awareness of the systemic issues that I care about. What we did in the stress was work very closely with TPR, the FCA and the Irish and the Luxembourg regulators to build resilience and we continue to engage with them now to make sure that these risks are better managed in future. While it is complex, and it is obviously for Parliament to determine the regulatory landscape, we are working together collaboratively, including internationally, to try to make sure that these risks are well managed.

Q268       Chair: Do you think there is a case for changing the regulatory landscape, given that complexity and the difficulties that arose?

Sarah Breeden: The FPC has an interest in systemic risk and we have a power to make recommendations to Treasury about where the regulatory parameter is. What we have asked for in the Financial Services and Markets Bill that is going through Parliament—and it is happening—is a new regulatory regime for stablecoins so that does happen, that the regulatory parameter changes. We tend to think about doing that only when we cannot achieve it through other means and at the moment we are working with those other regulators to ensure that financial stability risks are managed. It may be that we find we are unsuccessful in achieving it. In that case, there may be a case for thinking about how the regulatory parameter might be adjusted, but first and foremost we are having a go at making the existing one work.

Q269       Chair: Might you indicate that in your statement on 20 March?

Sarah Breeden: What we will do in the March statement is set out what we think the framework needs to look like. It would then be for the regulators to say whether or not they would be able to implement it. If they cannot, that would be the natural next stage. It is a part of the debate.

Q270       Chair: Whose job is it to ensure that pension scheme investments support the wider economy?

Sarah Breeden: I think you asked that of your other witnesses, didn’t you? The FPC has a primary objective to ensure financial stability. We have a secondary objective to support the Government’s policy on economic growth. As we were talking about with Nigel Mills, one of the things that we have done for defined contribution schemes is work with DWP, FCA and Treasury to identify ways that defined contribution pension funds can invest in long-term infrastructure assets. We can aim to do that as part of our secondary objective, but first and foremost the FPC’s objective is to make sure that systemic risk does not arise and financial instability is avoided, as took place in September. I am sure there is some debate between DWP and Treasury as to how pensions and economic growth come together, as evidenced, for example, in our debate on LTAFs.

Q271       Chair: That subject is of interest though to the FPC?

Sarah Breeden: It is. We have a very wide remit and so careful prioritisation is needed. I would not want to raise hopes too high.

Q272       Chair: It has been suggested to us by some witnesses that the Pensions Regulator’s new scheme funding guidance could increase the herding of investments and therefore the risk of problems.

Sarah Breeden: We have looked at the consultation paper on the funding schemes. The regime is designed to deliver TPR’s objectives of pensioners being paid and minimising calls on PPF. Of course, TPR do not have a financial stability objective or an economic growth objective—

Q273       Nigel Mills: It does have to support business growth and the viability of individual businesses though, doesn’t it? That is one of its statutory objectives.

Sarah Breeden: Yes, right. What we are doing is looking at that to see if there are financial stability risks that might arise. It is well covered in TPR’s document, which identified three or four areas where it could matter. TPR’s judgment was that the proposals were unlikely to make the risks worse, given our close interest in ensuring that how pension schemes behave in markets does not cause systemic risk.

Q274       Chair: In your statement of 20 March you may well make some responses to the TPR proposals.

Sarah Breeden: Our first focus will be dealing with the regime as it is, which is how LDI is currently invested, currently used, not thinking about the regime as it might be because that is in active consultation, but it will of course be part of the debate.

Q275       Chair: If you conclude that TPR’s proposed new scheme guidance does risk financial stability, how will you communicate that and when?

Sarah Breeden: That goes to the constructive engagement we have with TPR all the time and have at the moment. Our judgment now is that what we need to do is fix the problem that materialised in September and ensure that there is a liquidity resilience framework for the steady state that covers financial and operational resilience and that all understand the risks being taken. That is our priority. We judge other issues to be less important, but of course we will keep our eyes open.

Q276       Chair: If you say to the Pensions Regulator, “We think what you are proposing could risk financial stability”, and it says, “Well, sorry, our remit is protecting pensioners and their pension funds”, what happens?

Sarah Breeden: Two things. First, our record of our discussions is very important. Whenever we meet as the Financial Policy Committee, there is a public record. Afterwards, we can note concerns in there.

Secondly, I come back to that power of recommendation. If we are sufficiently worried that there is a risk to financial stability, we can recommend that TPR do something. That is what we did in December. We recommended that TPR maintain current levels of resilience in pension schemes. We could use that in a different context if we thought it was warranted. My judgment is that we do not think those risks are of the same scale as the ones we experienced in September, but will keep close to it.

Chair: They are risks, nevertheless.

Sarah Breeden: Herding is always a risk. It is the tuna in the paddling pool analogy.

Chair: That was very interesting. Thank you very much for being willing to give evidence to us this morning. If anything occurs to you afterwards that you think we ought to be aware of or have not picked up, please do let us know. We are very grateful to you.