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Are pension fund trustees at risk of legal action following UK gilts’ meltdown?

Published on 07 October 2022

The value of pension funds utilising liability-driven investing fell dramatically following the rise in UK gilt yields

To minimise the risk of legal action, trustees should review their current market positions and ensure that they can react quickly to market changes

Rachael Healey, Partner at RPC, the international law firm, says: “Trustees of pension funds that had to unwind positions and suffered losses or did not react appropriately to instability in the gilt market, could find themselves in the line of fire.”

“Trustees are ultimately responsible for the scheme’s investment decisions. If they fail to review the investment position of a scheme or revisit their deficit reduction plans, then they could find themselves facing legal action.”

In response to the volatility, the Pensions Regulator reaffirmed that trustees and advisors should monitor the resilience of their investments, risk management practices and funding arrangements.

RPC says actuaries also need to be aware of the risks that LDI strategies can pose. They are responsible for establishing the investment principles of a pension scheme and should review all investments following market volatility.  Actuaries offering fiduciary management services (broadly monitoring investment managers) should also be reviewing their respective positions.

Rachael Healey adds: “Trustees and actuaries need to ensure they are well-placed to react to market volatility. While not all market moves are foreseeable, trustees and actuaries should have plans in place to react appropriately to market falls and implement solid risk management practices to limit losses in pension value.”

Liability-driven investing is intended to manage exposure to inflation and interest rate risk, so that the value of scheme assets fluctuate with the value of scheme liabilities to stabilise the funding level. However, when UK gilt yields spiked, schemes had to recapitalise their hedges to cover their positions after margin calls.

If the pension scheme does not have enough available cash, they would have to sell other assets, resulting in realised losses from the sale of UK gilts.

RPC points out another issue pension funds are having to face is the sale of more illiquid assets, such as stakes in private equity funds, which they may have to do at discounts to their asset values.  Although overall schemes are better funded as a result of increases in gilt yields, there will be an assessment of whether schemes had sufficient liquidity and were over leveraged (i.e. over exposed to LDI) resulting in a fire sale of assets to meet collateral calls (and selling assets at a discount/loss as a result). This may well result in employers (who will be responsible to make up any scheme deficit) questioning the investment decisions made by trustees (and trustees in turn, actuaries and investment managers).