Written evidence from JOHN RALFE CONSULTING LDI0020

1. There has been a lot of mis-information and dis-information about the “LDI” debacle, which I hope the Committee will help to dispel, and I welcome the invitation to give oral evidence on November 23rd.

I have been an independent consultant advising companies and trustees on pensions since 2003, and in 2022 the Financial Times described me as “the founding father of pension scheme de-risking”.

My clients have included FTSE100 and FTSE350 companies, with pension liabilities up to £2.5bn, as well as non-quoted companies. I am also chair of trustees of a small pension scheme.

In 2016 I was an Expert Advisor to the Work and Pensions Committee on BHS pensions.

I was also a consultant to the UK Accounting Standards Board on FRS17 on pensions, and the International Accounting Standards Board on share options, and I worked with Harvard Business School to develop Boots Pensions as a Case Study.

Until 2002 I was Head of Corporate Finance at Boots and instrumental in moving the £2.3bn Boots Pension Fund to 100 per cent AAA/Aaa long dated sterling bonds, followed by a company share buyback, described by The Economist in 2006 as a “landmark”.

My full biography is attached as an appendix.

2. I also attach as an appendix my two recent Financial Times articles.

The first sets set out my overall views on “LDI”, and the second analyses BT pensions - BT has the UK’s largest company DB pension scheme with £40bn of IAS19 accounting liabilities, calculated using the AA discount rate, and over £50bn of long dated interest and inflation linked swaps.

The Committee should be absolutely clear that the real underlying problem is not “LDI” – which is hedging - but “Leveraged LDI” – which is speculating.

3. My “interim” recommendations to get-to-grips with “leveraged LDI” are:

3a. The Pensions Regulator, the Financial Conduct Authority and the Bank of England should produce better, and more coordinated information about the current extent of leverage in pension schemes. The Purple Book [1] on DB schemes produced by TPR and the PPF is silent on “Leveraged LDI”.

3b. The International Accounting Standards Board and the UK Financial Reporting Council should require employers to disclose more information in their published accounts about the current extent of leverage in their individual pension schemes.

3c. Current regulations from 2005 prohibit borrowing by pension schemes with more than 100 members.[2]  These regulations should be strengthened and clarified to prohibit pension schemes taking on leverage, however cleverly disguised, as well as explicit “borrowing”. 

4. I would like to make some other comments for the Committee.

4a. Although I don’t use the term "LDI" - it is consultants' jargon, and an excuse for complexity, opacity and expense, "LDI" is no more or less than matching DB pension assets and liabilities - selling equities, and buying long dated matching bonds. This is exactly what Boots pioneered 20 years ago.

Matching assets and liabilities reduces risk for:

-         members, reducing the likelihood of assets being less than liabilities, if the employer goes bust

-         The Pension Protection Fund, which provides compensation for members if their employer does go bust

-         shareholders, who have less financial risk “off balance-sheet” in the DB pension scheme

-         the financial system as a whole, since leverage or gearing, and the level of “cross shareholdings” of one company by another, is reduced.

4b. Most asset/liability matching can be done through buying bonds, but interest rate swaps can also be used to improve matching.

At the end of the 15-month transition in 2001 Boots Pensions had 100 per cent long dated AAA/Aaa bonds from supra-national bodies such as the World Bank and EBRD, split 75/25 fixed/inflation linked.

To move to 50/50 fixed/inflation linked – a better match for DB pension promises which had annual inflation increases capped at 5 per cent, Boots Pensions did a series of interest rate swaps in 2001/02 – the first by any pension scheme.

Under these swaps Boots Pensions paid fixed rate from the AAA/Aaa bonds and received inflation linked from the counterparty bank for periods of around 20 years.

These swaps tapped into a source of inflation linked “payers” separate from index linked gilts, and could also be tailored precisely. Pensions in payment cannot be reduced with deflation, so, unlike index linked gilts or bonds, the inflation receipts did not reduce with deflation.

The swaps were “marked-to-market” with collateral or margin calls being paid – which was part of the “LDI” debacle following the “mini-Budget, but the “margin” call could be paid by Boots plc directly, if necessary.

4c. I left Boots in 2003 and started to advise companies on pensions, after the The term “LDI” became common, although, again, I never used it.

At some point between 2002 and 2015 “LDI” became “Leveraged LDI”

The first time I heard the phrase “leveraged swaps” was in 2015 when I had an email from a company out-of-the-blue, saying their pension scheme consultants were pushing “leveraged swaps”, which the trustees and company didn’t understand.

The pension scheme was being encouraged to do a series of £300m “leveraged swaps” to match their interest rate and inflation risk.

£100m of each £300m swap would be “covered”, ie the scheme owned the underlying bond used to make the periodic payments, but £200m would be “uncovered” or “naked”, ie the scheme did not own an underlying bond used to make the periodic payments.

Instead, the scheme could continue to hold equities, Private Equity, Hedge Funds and property.

The clue is in the name - "leveraged swaps" - the “physical” equivalent of borrowing £200m and then investing in equities, PE, HFs, property etc.

Following my advice the company refused to allow the pension scheme to do this.

4d. There are various other mechanisms allowing pension schemes to do “Leveraged LDI” – “leveraged” gilt repos, buying “leveraged” gilt funds, buying equity futures etc, which are all opaque, complex, and expensive.

These opaque, complex and expensive products are pushed by investment consultants – usually the consulting arms of actuarial firms - whose whole business model requires complexity to make-a-living.

I am clear that trustees – and, indeed, many consultants - don't understand what they are about.

Again, I look forward to giving oral evidence to the Committee.

https://www.ft.com/content/98c35e6a-079b-498a-9842-f8b0f3faf232

https://www.ft.com/content/3169285a-3f25-4b16-971b-e27ac9aa4eea

November 2022