Mini-budget chaos exposed ‘lax approach’ to pensions regulation, MPs say

A rapid rise in gilt yields after the September 2022 mini-budget threw pension funds with liability-driven investments (LDI) into chaos, threatening the stability of the UK economy and forcing the Bank of England to intervene.

In a report published on Friday, the House of Commons’ Work and Pensions Committee criticised The Pensions Regulator (TPR) for not paying enough attention to the risks posed by LDI and the extent to which funds were using “leverage” – or borrowing – to support it.

The committee said: “We question whether TPR had understood the ‘doom loop’ risks inherent in LDI products.”

It added that the Bank of England had assessed the risks posed by borrowing and LDI in 2018, but TPR had not paid enough attention to these dangers “until a crisis hit”.

Sir Stephen Timms, chairman of the Work and Pensions Committee and a former pensions minister, said: “The turbulence around last year’s ‘mini-budget’ exposed a lax approach to regulation.

“Despite the dangers of the use of LDI being identified five years ago, there was a lack of focus from TPR and inadequate data. The use of leverage by DB (defined benefit) pension funds grew, giving rise to systemic risk in a way that was not visible to regulators until crisis hit in September last year.

“Although the speed and scale of the rise in gilt yields was unprecedented, the consequences for DB pension funds should have been foreseen and TPR should not have been blindsided.

“Gaps in regulation and the system for managing systemic risks must now be addressed to ensure that DB pension scheme investments never again threaten the stability of the UK economy.”

LDI involves pension schemes investing in assets whose value moves in the same direction as their liabilities as interest rates change, providing more stability.

Many schemes used leverage to try to close the gap between their assets and liabilities, which the committee said worked “relatively well” while interest rates were low but posed more problems when rates rose quickly as they did after the mini-budget.

The committee found that the September crisis exposed “significant weaknesses” in pension funds’ defences against the risks posed by LDI, including the funds’ own trustees and TPR’s oversight.

Trustees of smaller pension schemes did not always fully understand the risks associated with LDI, while TPR did not collect enough data to assess whether its guidance was being followed or spot the rise in the use of borrowing to fund LDI schemes.

The committee questioned why TPR did not pay more attention to LDI and encouraged schemes to use complex financial products despite having had concerns about trustees’ ability to manage risk “for some years”.

It said: “(TPR) should have focused earlier on the risks of encouraging trustees to use such complex financial products and worked with DWP to consider what further action was needed to mitigate the risk.”

It also criticised some investment consultants for giving schemes standardised advice “rather than thinking through what is best for the pension fund”.

A spokesperson for The Pensions Regulator said: “We note the recommendations in the committee’s report and will work with DWP to respond to it.

“We have taken decisive action to learn lessons from the impact of last year’s economic turmoil, including to improve the data we hold.

“Pension trustees are acting on our latest guidance on using leveraged liability-driven investments which clearly sets out our expectations.

“We continue to work closely with the Bank of England and other partners to ensure a well-functioning system.”

A DWP spokesperson said: “We welcome the committee’s report. We will fully consider its findings and respond formally in due course.”