UK watchdog tells LDI funds to stress test buffers for market shocks

By Huw Jones

LONDON (Reuters) -Britain’s financial watchdog on Monday set out guidance on stress testing and risk management for liability driven investment (LDI) funds, saying it was a “matter of urgency” to implement them.

Last September’s near meltdown in the sector, when yields on UK government bonds rocketed following a government budget statement, left LDI funds scrambling to find extra collateral.

The Bank of England had to intervene to buy UK government bonds, helping to bring down yields and relieve pressure on LDI funds.

The BoE’s Financial Policy Committee set out policy recommendations last month to bolster LDI liquidity buffers on a permanent basis, and on Monday the Financial Conduct Authority began fleshing out these recommendations.

“Where they have not already done so, we expect LDI managers to complete and embed as a matter of urgency all necessary improvements to their operating practices to address the deficiencies identified,” the Financial Conduct Authority (FCA) said in the new guidance.

“Some of the weaknesses these events highlighted are unlikely to be unique to the LDI sector.”

Britain’s Pensions Regulator also published guidance on Monday which said trustees of pension schemes should ensure that LDI funds have a liquidity buffer to cope with day-to-day market moves, and a separate buffer for times of severe market stress.

LDI funds are listed in Luxembourg and Ireland, where regulators have also tightened rules, but managed in London to help UK pension schemes ensure they can meet long-term payout commitments.

Sarah Pritchard, the FCA’s executive director for markets, said the LDI sector is now more resilient but more needs to be done.

“This guidance sets out what we expect in terms of risk management, stress testing and client communication, so that the necessary lessons are learned from last September’s extreme events. Many of these lessons will be relevant to firms beyond the LDI sector,” Pritchard said.

Problems with LDI has thrown a spotlight again on the wider non-bank sector and sufficient liquidity to ride market shocks unaided.

(Reporting by Huw JonesEditing by David Goodman, Louise Heavens and Andrew Heavens)