4 questions to ask about the recent gilt yields turmoil
There are four key questions sponsors should now be asking themselves and their scheme’s trustees.
The last few days have seen defined benefit pension schemes hit the headlines as soaring gilt yields have caused liquidity challenges for LDI strategies. Some schemes have needed emergency support from their sponsors.
The Bank of England’s timely intervention has allowed schemes to weather the initial storm but underlying fiscal and monetary conditions remain challenging.
There are four key questions you should now be thinking about and asking your scheme’s trustees:
- Were trustee governance structures streamlined enough?
As the crisis escalated, some schemes faced governance challenges with key individuals unavailable to support necessary decisions. Once the dust has settled, we expect the record will show that the schemes that could move the fastest were best placed to weather the storm.
With sponsors being the ultimate fall back for all schemes, trustee governance is first and foremost a corporate concern and sponsors should be asking how can trustee governance be improved in preparation for this (or another) event. - What will happen if gilt yields surge again?
The BoE’s intervention is currently short term and challenges could return. If they do, you must understand your risk exposure. Answers to the following questions will identify what actions can be taken now to reduce the risks of having to provide schemes with an emergency contribution:- What level of prudence is run in the LDI portfolio i.e. how many basis points can the market fall before the assigned liquid collateral is depleted?
- Do the trustees have a collateral waterfall agreed and, if so, does it need to be reviewed and tested?
- What is the strategy if collateral can’t be liquidated in time? Will hedging be reduced or can the sponsor provide a liquidity backstop?
- Is my scheme’s strategy still on track?
Many schemes may find that collateral calls have caused imbalances in their investment strategy. Sponsors should be asking whether the balance of illiquid and liquid assets is right and, if not, whether liquidity can be improved. If this comes at the cost of impacting funding levels, the next question for is how can we get the scheme back on track without additional funding needs. - Is there an opportunity to redeploy pension funding?
The silver lining for some schemes, particularly those that are underhedged, is that they may have seen sharp falls in the measurement of their deficit. Sponsors should be engaging with their trustees to explore opportunities to ‘lock in’ any gains and to reduce surplus funding arrangements at a time when it may be possible to use capital better elsewhere in the business.