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TPR issues leverage and liquidity research

Ref: PN19-53

Issued: Tuesday 17 December 2019

The Pensions Regulator (TPR) has published new research on leverage and liquidity to better understand the potential risks for defined benefit (DB) pensions, and to help inform the Bank of England’s Financial Stability Report.

TPR’s initial analysis of the data shows that encouragingly many schemes are well-diversified and are actively monitoring the risks in their portfolios that may arise in relation to leverage and liquidity.

However, the research also shows that some schemes are pursuing more risky investment strategies that seek extra returns, which could be damaging in the event of adverse economic shocks.

DB pension investment arrangements evolve over time and new approaches to managing risk and implementing investment strategies develop. Recently there has been a significant increase in the number of schemes developing strategies based on matching pension scheme cashflows, often with significant reliance on building portfolios of assets with contractual cashflows and/or where an illiquidity premium is expected to be captured.

Although the development of these strategies is not wholly unexpected, particularly as schemes are becoming increasingly cashflow negative as they mature, these strategies have been developing within a relatively benign investment environment where interest rates are close to historic lows and credit conditions have generally been accommodative.

Fred Berry, TPR’s Head of Investment Consultancy, said: “In a low yield environment, the search for yield has led to some schemes seeking riskier and more illiquid investments to earn their targeted return. We believe that some of these strategies introduce additional risks which may not be adequately rewarded, and which may amplify market impacts in the event of adverse shocks. We also believe that some of the longer term illiquid investments may not adequately allow for the risks that climate change may introduce.

“Our initial analysis of the results is encouraging. It shows that many schemes are well diversified and are actively monitoring the risks in their portfolios that may arise in relation to leverage and liquidity. However, we believe that some of the survey data shows a potential for concentrations of risk within individual schemes. We will be considering further how best to address those issues across the wider pensions landscape.

“We will analyse the survey responses in more detail and consider how we can use the findings to help trustees to improve their risk management practices further.”

Notes to editors

  1. TPR commissioned OMB Research to carry out the survey, entitled DB pension scheme leverage and liquidity survey (PDF, 1,178KB , 53 pages).
  2. OMB had responses from 137 schemes between 3 October and 1 November 2019. which hold over 40% of the total DB assets.
  3. In its November 2018 Financial Stability Report, the Bank of England’s Financial Policy Committee (FPC) presented its assessment of risks from leverage in the non-bank financial system. It concluded that the use of leverage by non-bank financial institutions could support financial market functioning but it could also expose these institutions – which includes pension schemes – to greater losses and sudden demands for liquidity, which could give rise to financial stability risks. The FPC said that the Bank of England would work with TPR to enhance the monitoring of possible systemic risks that might arise.
  4. Over the past year, TPR had a number of discussions with the Bank of England in relation to the potential for leverage and certain other DB pension scheme market dynamics to give rise to systemic market risks.
  5. TPR is the regulator of work-based pension schemes in the UK. Our statutory objectives are: to protect members’ benefits; to reduce the risk of calls on the Pension Protection Fund (PPF); to promote, and to improve understanding of, the good administration of work-based pension schemes; to maximise employer compliance with automatic enrolment duties; and to minimise any adverse impact on the sustainable growth of an employer (in relation to the exercise of TPR’s functions under Part 3 of the Pensions Act 2004 only).

Press contacts

Matt Adams

Senior Media and Parliamentary Manager
01273 662086

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