The top brass of Legal & General, one of the biggest providers of liability-driven investment strategies, have defended their risk management and laid the blame for September’s pension fund liquidity crisis squarely on the former chancellor’s “mini” Budget.
Answering questions on the LDI crisis from the House of Lords’ industry and regulators committee, L&G’s chair and chief executive defended the insurer’s modelling and use of leverage but conceded that the FTSE 100 group should be on a closer lookout for such “black swan” events.
“No one involved in this — the regulators, the central bank, the government, the advisers, the funds, the sponsors, or us — believed that it was a plausible scenario that the government would do something that would create such extraordinary instability in the market in two trading days,” said L&G’s chair Sir John Kingman. “That’s what really happened here.”
The overriding cause of the market panic, said L&G’s management, was the significant fiscal loosening in ex-prime minister Liz Truss’s growth plan, which compounded market nerves over the Bank of England’s plan to reduce its stock of gilts and sent government borrowing costs racing higher.
Sir Nigel Wilson, L&G’s chief executive, said the speed of the bond sell-off had “caught us all by surprise”. “Our modelling had never taken into account the degree of stress that there was in the market,” he added.
L&G’s modelling would now take such scenarios into account, he said, adding that their LDI strategies were now being run more cautiously, with more “headroom” against a sharp rise in market interest rates.
Last week, L&G estimated that its profits had been trimmed by £10mn after clients sold out of certain funds to meet collateral calls. The company was insulated from further damage as it takes no balance-sheet risk in LDI strategies, instead acting as an agent between pension funds and investment banks.
Committee member Baroness Sharon Bowles questioned the use of leverage in LDI strategies, which she suggested was effectively “the same thing as borrowing” and thus not permitted under legislation. Kingman said L&G’s “clear understanding is that the LDI products that we offer are . . . within the law” and that the repurchase agreements used in the strategies are legally distinct from borrowing.
He told the committee that there were lessons to be learnt more generally on the use of leverage, as well as the collateral that pension funds were allowed to post.
The committee also discussed the multiple regulators that are responsible for this area, with the Bank of England’s Prudential Regulation Authority, the Financial Conduct Authority and the Pensions Regulator all having a role. Last week, the FCA told the same committee that the scenario that played out following the “mini” Budget had not been “right at the top of the radar”.
“There needs to be some clarity around who would be the principal regulator for this particular part of the pensions industry,” said Wilson.
He suggested that the PRA could take a closer look at defined benefit pension funds, given that so many of them end up transferring their liabilities to insurance companies that are then under its purview.
The firms consulting with pension funds on LDI are not currently regulated for their investment advice. Wilson portrayed the insurer’s role as a “hired help” to the advisers, while Kingman told the committee that in his view these firms should be brought within the scope of regulation.