Defined benefit pensions schemes and Liability Driven Investments

Thank you for your letter dated 20 December following the oral hearing I attended on 7 December. I am grateful for the opportunity of giving evidence to this important inquiry. You asked in your letter whether there was anything further I wanted to raise with the Committee, although I have no further points to raise, I would like to reiterate some of the key points I raised in the session I attended:

The value of liability driven investments (LDI)

LDI has served as an invaluable tool for defined benefit pension schemes and their sponsoring companies over the last twenty years. This has resulted in schemes having stronger funding levels, lower dependencies on their sponsoring company and has helped ensure many schemes did not end up in the PPF.

Derivatives are used globally across financial markets and are a sensible tool for pension schemes to use. I believe that in the vast majority of cases, their use by pension funds within LDI programmes has been at prudent levels of leverage. There may, however, be a minority of outlier schemes who have used leverage excessively. As I mentioned when providing oral evidence, if new regulations were to be applied, it is likely that these regulations may help to move those outliers into alignment with the rest of the market.

Market reaction off the back of the mini budget

There is no doubt that the mini budget had a negative impact in destabilising the market and off the back of this, the LDI and Gilt markets experienced an acute and highly idiosyncratic stress and liquidity event beyond that of any reasonable scenario test. Financial regulators and market participants came together to limit the impact on pension schemes. The experience across schemes differed depending on the structure of their investments and level of governance.

The Bank of England has a crucial role to step in when necessary to stabilise markets. We saw this previously during the financial crisis in 2009 and it was appropriate that it responded in a similar way in September 2022, providing reassurance to the market and investors.

Future regulation

I expressed the view that some regulation of leverage would make sense by The Pensions Regulator

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(TPR). Given the level of gilts (specifically index-linked gilts) held by pension schemes is significant relative to the size of the UK Gilt market, a key policy decision may be required to balance the benefits of a leveraged LDI market and the vulnerability it introduces to the Gilt market.

I don’t feel a one size fits all approach is suitable and any review of the regulations should take into account the type of LDI arrangement and the liquidity of the collateral assets it can call on, the governance model and the strength of the sponsor covenant.

We acknowledge the complexity of the situation and any changes in regulation should be thoughtful, being cognisant of the impacts on the security of DB savers benefits, the sponsoring companies and the UK Gilt market.

As a side note, at Cardano we are currently taking the time to digest the newly published TPR DB Funding Code consultation. When responding we’ll be considering the learnings and our experience of the events around September 2022 and beyond to make sure the next phase of DB funding regulations are fit for purpose for the whole industry and most importantly continue to protect savers.

I’d be happy to continue to support you and the Committee with this inquiry, and from all of us at Cardano, we wish you well in the next steps.

Yours sincerely

Kerrin Rosenberg CEO

January 2023

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