Written evidence from UK Shareholders' Association LDI0013

I write following the Committee’s request for evidence on the lessons to be learned from the experience of the recent volatility in gilt yields on DB schemes with LDI strategies and their regulation and governance.

UKSA is the oldest shareholder campaigning organisation in the UK, with 14,000 members. We are a not-for-profit company that represents and supports shareholders who invest in the stock market. Our interest in the present case is the possible impact on shareholders of losses in DB pension schemes leading to capital injections ultimately funded by shareholders.

I respond to the questions you have asked in your Call for Evidence.

- The impact on DB schemes of the rise in gilt yields in late September and early October;

Reports in the media, and the letter from Sir Jon Cunliffe at the Bank of England, suggest that the rise in gilt yields corresponded to a fall in long term gilt prices which generated margin calls on the scheme. We are concerned that this risk was never spelled out in the accounts of companies that our members invest in, and that the risk of such falls was not accounted for in stress testing.

- The impact on pension savers, whether in DB or defined contribution pension arrangements;

UKSA is concerned about the impact on shareholders as well as pensioners, given that any pension scheme deficits will ultimately be met by shareholders. The promised future enquiry into DB schemes should consider the role of shareholders as the ultimate support for company pension schemes.

- Given its responsibility for regulating workplace pensions, whether the Pensions Regulator has taken the right approach to regulating the use of LDI and had the right monitoring arrangements;

We are concerned by reports, as yet unverified, that the Pensions Regulator had encouraged the use of LDI. The Committee should investigate this matter as a priority.

- Whether DB schemes had adequate governance arrangements in place. For example, did trustees sufficiently understand the risks involved?

Anecdotally, trustees were not properly apprised of the risk of leveraged liability matching. For example, we have heard that the term ‘leverage’ was not used. Moreover, the ‘equity’ of the LDI fund is not limited liability. Rather, the lender can pursue the borrower (the scheme) by means of margin calls.

- Whether LDI is still essentially ‘fit for purpose’ for use by DB schemes. Are changes needed?

Our understanding is that LDI converts a long term risk of long dated fixed rate liabilities, which can be addressed over time by management action, into short term floating rate risk. Pension schemes were thereby turned into a form of bank, and thus part of the ‘shadow banking system’. This is suggests that LDI is not fit for purpose, and that changes are urgently needed.

- Does the experience suggest other policy or governance changes needed, for example to DB funding rules?

Yes. Many people assumed that the DB funds were adopting a 'safe' strategy of simply trying to match their promises to pay pensions with assets that delivered income when those promises became due. The reality seems to have been very different with many schemes speculating - investing in equities, private equity and hedge funds with disguised borrowings or leverage - not hedging.

Please note that we have additional comments on your consultation document, ‘Enabling Investment in Productive Finance’. We will follow these up in detail when you issue your promised consultation on DB schemes in 2023.

November 2022