TPR confirms 250bps market buffer for UK LDI plus fund-specific buffer on top

The Pension Regulator (TPR) today set out its updated, detailed guidance (link) for UK LDI funds in the wake of the gilt crisis last Autumn, and the recommendation by the BOE FPC that funds should be able to weather to a 5-day 250bps move in 30y real yields (see Total Derivatives). Gilt yields are little-changed and just a bp higher in 10y and 30y after the announcement, lagging long USTs but only marginally underperforming Bunds. Long gilt asset swaps are little-changed and cash breakevens (and RPI swaps) are both about a bp wider.     

TPR’s new guidance sets out specific steps trustees should be taking when investing in LDI, looking at:

• ”Where LDI fits within a scheme’s investment strategy

• “Setting, operating and maintaining a collateral buffer

• “Testing for resilience

• “Making sure schemes have the right governance and operational processes in place monitoring LDI"

The new guidance retains the BOE FPC’s recommendation of a 250bps minimum ‘market buffer’ with an fund-specific ‘operational buffer’ on top, as it explains. In the wake of the crisis, regulators suggested that a 300-400bps total buffer was appropriate. Today's detailed guidance is broadly in line with that. 

“There are two elements to consider in the buffer: Having sufficient liquidity to manage day-to-day volatility in the market (an operational buffer). Additional liquidity to provide resilience during severe market stress (a market stress buffer). These elements are cumulative. If an arrangement’s operational buffer is set at 100 bps, and the market stress buffer at 250 bps, the total buffer the arrangement needs to operate is 350 bps."

 

“In pooled funds, the buffer will be set by the fund manager. In segregated funds it will be set by the LDI manager and the trustees. In either case, you should satisfy yourself that the buffer provides sufficient resilience and is operable with your scheme’s governance arrangements."

The two elements of the buffer are defined as follows: 

Market stress buffer: “This buffer should be, at a minimum, 250bps. This minimum level assumes you are able to provide additional cash or assets to replenish the buffer within five days. If it is likely to take you longer, a larger market stress buffer may be appropriate."

 

"A larger market stress buffer may also be appropriate in other circumstances, for example if the assets held within the buffer are more volatile than assets typically held in LDI arrangements. Similarly, if the composition of the LDI fund is intrinsically less volatile than a gilt related LDI fund, it may be acceptable to use a lower market stress buffer"

 

"The 250bps minimum resilience level should be maintained in normal times but can be drawn down on in periods of stress.”

 

Operational buffer: “”When assessing the appropriateness of the operational buffer, you should consider the following: Volatility in the gilt market…How quickly and effectively assets can be accessed, sold or otherwise converted to cash to replenish the buffer…The cost of making asset sales to meet collateral demands or replenish the buffer."

 

“The operational buffer should at least reflect gilt yield volatility in normal market conditions.”

Note that the UK FCA has also issued its own guidance for LDI funds today (link).