On 30 November 2022, the Central Bank of Ireland (the “CBI”) issued an industry letter in respect of liability driven investment funds (“LDI Funds”) (here).

Background

ESMA states that LDI funds denominated in GBP (“GBP LDI Funds”) showed themselves to be vulnerable to the volatility surge in the UK gilts market in September 2022. At that time, competent authorities engaged with managers of GBP LDI Funds who increased the resilience of those funds.

The CBI and the Luxembourg regulator, the CSSF, have now issued industry letters to ensure that current levels of resilience and the reduced risk profile of GBP LDI Funds are maintained. In the UK, the FCA has also issued a similar communication to fund managers (here).

CBI Industry Letter

GBP LDI Funds

The CBI industry letter details expectations for fund managers in the event they are considering reducing resilience levels for their GBP LDI Funds below the levels that were achieved in the period following the dislocation in the UK gilt market (referred to as an “advertent” reduction in an individual GBP LDI Fund’s resilience level).

Those fund managers should inform the CBI1 in advance of the proposal to reduce resilience levels and prior to making any reductions:

  • undertake and document a detailed analysis justifying the need to reduce the GBP LDI Fund’s current resilience;
  • complete and document a risk assessment with relevant modelling of how the proposed reduction in the GBP LDI Fund’s resilience will not impact the orderly functioning of the GBP LDI Fund in current and in stressed environments; and
  • detail and document a step-by-step plan for returning the GBP LDI Fund to current levels of resilience in the event of increased market volatility.

In addition, the GBP LDI Fund must ensure that clear policies and procedures are established to increase resilience in the event of further volatility in the market.

Where an inadvertent decrease in GBP LDI Fund resilience occurs, the CBI expects GBP LDI Funds to have procedures in place to recapitalise and/or de-risk a fund’s portfolio by reducing its exposures following exceptional market circumstances in a timely manner. The CBI states that these procedures should include accounting for the second-round effects of actions taken by other market participants on the individual funds.

LDI Funds denominated in other currencies

The CBI’s industry letter also sets out expectations for LDI Funds denominated in other currencies. While advance notification to the CBI will not apply to those funds for the time being, the CBI expects that managers of those funds will maintain an appropriate level of resilience at an individual sub-fund level in order to be able to absorb possible market shocks. The CBI states that this should take account of the second-round effects of actions taken by other market participants on the individual funds.

Next Steps

Managers of GBP LDI Funds and LDI Funds denominated in other currencies should take note of the CBI expectations set out in the industry letter and, in particular, remain cognisant of the regulatory focus on resilience levels to ensure those resilience levels are managed in line with expectations.