By Alex Gillespie and Victoria McCarron

On 26 January 2023, the UK Parliament published a letter from Nikhil Rathi (CEO of the FCA) to the Chair of the House of Commons Work and Pensions Committee. This letter sets out the FCA’s oversight of Liability Driven Investment funds, (LDIs) which have been an area of particular focus since the shocks to the gilt market in Autumn 2022.

This letter clarifies and outlines the FCA’s response to the Bank of England’s recommendations in their financial stability report of December 2022. Key areas of guidance are as follows:

  • The FCA expects firms to take any necessary or appropriate action in response to their discussions with the FCA to ensure that they operate in a way that does not pose risks to market integrity or financial stability. Measures such as liquidity buffers should be considered a necessary but only partial solution. Managers of LDI funds should learn lessons from the earlier events to understand and reduce the impact of such “tail events”.
  • Asset managers should consider whether they are capable of communicating critical information at an individual client level, often in large batches, in a timely manner. They should also ensure that key stakeholders (such as bank counterparties) have arrangements in place to carry out required actions such that sufficient liquidity in LDI funds can be realised in the event of a stress.
  • The FCA expects all parts of the market that were exposed to LDI-related events, such as banks and custodians, to learn lessons from these events. Market issues involving leverage, volatility and concentration have arisen with increased frequency. The FCA expects other firms which were not directly exposed to LDI risks to give appropriate consideration to these broader underlying themes.
  • All market participants should factor market conditions like those of last Autumn into their risk management considerations. The FCA will maintain a supervisory focus on ensuring firms identify and address their vulnerabilities in this regard. It is currently reviewing firms' operational contingency planning and intends to publish a further statement on good practice towards the end of Q1 2023.
  • In light of these events (and as previously recommended by the CMA), the FCA believes it would be beneficial for investment consultants to be brought into the regulatory perimeter.
  • The FCA is working with the Bank of England and the Pensions Regulator to develop a longer term resilience standard for LDI funds. The Financial Policy Committee is to consider this in early 2023.

For further information a copy of the letter can be found here.  For further UK financial services regulatory updates, please visit the Burges Salmon blog.