A year on from the immediate aftermath of the “mini-budget” which gave rise to the leveraged liability-driven investments (LDI) pensions crisis, we reflect on the current state of play, and assess the prospects of future LDI-related litigation claims.
What have been the legal impacts?
This time last year we were busy putting in place loan arrangements to allow companies to provide their pension schemes with temporary liquidity to meet collateral calls under their LDI arrangements. In practice, we have seen relatively few of these arrangements needing to be called upon. Nonetheless they were an important tool in helping pensions schemes to weather the storm and for some schemes, will continue to play a part in future strategies for maintaining a buffer against unforeseen market volatility.
We’ve also seen a trend towards maximising investment managers’ ability to sell-down assets to increase liquidity when needed. Whilst in principle this flexibility may be very sensible, it is important to ensure that any amendments to investment management agreements bake in appropriate protections.
What have regulators and policy makers been doing in response to the crisis?
The regulators and policymakers have also been busy getting their arms around the LDI crisis. For example, the Financial Policy Committee (FPC) have recommended certain steps to build the resilience of LDI funds in the future whilst the Pensions Regulator (TPR) and the Financial Conduct Authority (FCA) have produced guidance aimed at preventing a repeat of the 2022 LDI crisis (see our blog post here). Most recently, the House of Commons Work and Pensions Committee (the Committee) published findings from its inquiry, launched in October 2022, into the lessons to be learned from the LDI crisis (see here). It's worth noting the words of the Committee that “DB pension scheme investments must not be allowed to jeopardise the UK economy again”.
Risk of legal claims
With the stakes being so high there is the question of legal risk and exposure in the industry: are LDI-related claims inevitable or has the risk of litigation subsided?
In the immediate aftermath of the 2022 LDI crisis, various commentators suggested that the crisis might reasonably be expected to result in claims by scheme trustees and potentially sponsors against the LDI platform providers and/or LDI investment consultants (and others) for compensation for any losses suffered by schemes. We are, however, not aware of any active LDI claims in the market presently.
So, why not? There are probably three main reasons:
Long time lag in litigation. We experienced this in 2009 in relation to the Global Financial Crisis. Litigation arising from the market turbulence then took years to emerge (indeed a number of cases are still ongoing in the courts). So, it is possible there is pre-litigation positioning etc. going on below the radar.
Difficult to bring claims. Despite the many complaints by lobby groups, politicians, journalists, etc., it is not easy to see how pursuing an LDI strategy was necessarily negligent / in breach of investment mandates, mainly because it was market standard and widely regarded as sensible at the time (it is only in hindsight that the sensitivity to a very sharp rise in the cost of government borrowing is evident). In addition, any claim would need to be highly fact-specific, based on such matters as whether the level of collateral was appropriate, the liquidity of the pension scheme’s funds was sufficient and so on, which means that each case would be individually expensive to prosecute. This means that these types of claims are not obviously ripe for action.
It is not immediately obvious what the claimable loss is. In particular, in relation to those schemes that pursued LDI strategies, any short-term losses suffered by the scheme may be outweighed by the longer-term benefit of having adopted an LDI strategy in the first place. In other words, it may be challenging for the claimant to show that the LDI strategy was a mistake when the position is looked at in the round.
Without having the benefit of a crystal ball, it remains to be seen whether any claims relating to the 2022 LDI crisis will materialise or whether the crisis has been overtaken by events given the improved funding position of many impacted schemes in recent months. It’s a difficult one to call, but if you would like to discuss any of the issues discussed in this blog post, please get in touch with your usual Freshfields contact or any of the authors.
