FCA letter addresses oversight of liability drive investment funds following gilt market turmoil

The Work and Pensions Committee has published a letter from Nikhil Rathi, CEO of the FCA, on the FCA’s oversight of liability-driven investment (LDI) funds in the light of turmoil in the gilt market during Autumn 2022. The letter sets out how the FCA is responding to the Bank of England’s recommendations to its December 2022 Financial Stability Report.

Points of interest:

• The FCA expects asset managers to ensure they operate in a way that does not pose risks to market integrity or financial stability. Measures such as liquidity buffers are only a partial solution since, as was apparent in the shocks in the gilt market in September 2022, there is always the potential for events or conditions to exceed the protections they provide. Managers of LDI funds should learn operational lessons, including on the speed at which they are able to rebuild buffers or rebalance funds, client and stakeholder engagement and reliance on third parties.
  
  
• Asset managers should consider whether they are capable of communicating critical information at an individual client level, in a timely manner. They should also ensure they and their key stakeholders (such as bank counterparties) have arrangements to ensure that sufficient liquidity in LDI funds can be realised in the event of a stress. It is also important that lessons are learned by all parts of the market that were exposed to LDI-related events, including banks and custodians.
  
  
• All market participants should factor into their risk management considerations the extreme market conditions experienced in Autumn 2022. The FCA will maintain a supervisory focus on ensuring firms identify and address their vulnerabilities in this area. It is reviewing firms' operational contingency planning and intends to publish a further statement on good practice towards the end of Q1 2023.
  
  
• While the FCA is not the regulator of LDI funds which are domiciled overseas, it is currently working with the Bank of England and the Pensions Regulator to develop a longer term resilience standard for LDI funds for the Financial Policy Committee to consider in the first half of 2023.

The letter dated 18 January 2023 is available here.