Written evidence from the Pension Insurance Corporation (LDI0087)

As promised, I’m sending you a follow up to our discussion about the regulatory landscape and how the LDI crisis was partly a result of the gaps in the respective remits of the three main financial services regulators – the PRA, the FCA, and tPR. 

As we discussed, it was clear during the crisis that one of the issues was that there are different regulators for different parts of the system:  the PRA is responsible for banks, insurers, and macro prudential / systemic risk, the FCA is responsible for asset managers (amongst other types of institutions), and tPR, as you know, covers pension schemes. The problem is that the issues that lie at the heart of the LDI crisis cut across all three areas, with no one regulator joining the dots before the crisis to ensure that risks were being headed off before they could become systemic.  The PRA did an excellent job once the crisis kicked off, but the question is prevention, especially when many market participants could see the risk building over years. 

In particular:

• The PRA is responsible for insurers like PIC, who manage the exact same pension liabilities as defined benefit pension schemes. But because DB schemes sit within tPR’s remit, there was no scope for the PRA to actively consider on an ongoing basis how those schemes are being run and the liabilities managed. By contrast the PRA ensures that insurers have sufficient liquidity and collateral to cope with extreme market volatility, such as we saw following the mini-budget. The PRA does comment on DB pension issues from time to time (an example is the well-flagged point they raised in their November 2018 Financial Stability Report about schemes’ exposure to interest rate and inflation risk) and the Bank of England did eventually intervene in the superfund debate.  The Bank of England also published a paper about 10 years ago on herding / procyclicality in DB schemes’ investment strategies, available here: https://www.bankofengland.co.uk/-/media/boe/files/paper/2014/procyclicality-and-structural-trends-in-investment.
• The FCA is responsible for asset managers but had no incentive to intervene in how pension schemes were using LDI, including use of leverage within LDI funds more generally as they are more focused on consumer protection, not necessarily market stability. They also seem to have been happy with the governance structures around LDI funds, including overseas domicile (where many of them were based.) From the FCA’s perspective as the regulator overseeing asset managers, the asset managers were working as they should – providing a low risk product that looked appropriate as a risk management tool for the professional / professionally advised investors accessing it.
• Finally, tPR’s long-term approach has been to encourage DB schemes to de-risk, with a view to self-sufficiency / moving to buyout to ensure members get their promised pensions. So at an individual level, each scheme seemed to be doing the right thing by hedging interest rate risk through LDI, following the direction of travel set by tPR. It’s just when you look across the DB universe you can see, as we can in hindsight and many did pre-crisis, the build-up of risk – but that wasn’t specifically within the remit of tPR either.

So you can see that the individual regulators were all doing the right thing as far as their objectives and remits went. However, what this demonstrates is that some thought needs to be given to how we address these significant gaps between respective objectives to help prevent future crises. Clearly the BOE has taken a lead on some of this work subsequently, and are probably the best placed to expand this, but it might be something your Committee also considers.

April 2023