Date Published 07/12/2022
Letter on LDI Funds
The Central Bank of Ireland (the “Central Bank”) has written a letter (the “Letter”) to industry participants in relation to Liability Driven Investment Funds (“LDI Funds”). This followed interaction with other regulatory bodies including ESMA which was occasioned by the volatility in yields experienced by UK gilts which highlighted vulnerabilities of LDI Fund products to collateral calls and forced sales.
While the Central Bank expects related volatility to be lower in the future, in light of recent experiences and to ensure resilience towards future movements they do not expect yield buffers to be reduced at this time. Furthermore for funds with real interest rate exposure, inflation expectations should be held constant so that the real interest rate is stressed appropriately in stress tests. Managers that do wish to proactively lower buffer levels for sterling denominated LDI funds will need to make advance notifications to the authorities supervising the fund manager and, where they are managing funds on a cross border basis, that of the fund domicile. This will need to be accompanied by the preparation of documentation reflecting a detailed analysis justifying the reduction, a risk assessment showing that this will not cause negative impacts in both standard and stressed environments and a step plan to increase resilience if necessary, as well as clear related policies and procedures. All such documentation must be provided to the relevant authorities on request.
The Letter also sets out expectations where the resilience level is inadvertently decreased, such as due to declining market values of the assets held. Interestingly in such cases a distinction is made between sterling denominated funds and those in other currencies. While managers generally will be expected to maintain resilience at the sub-fund level in order to absorb market shocks, in the case of sterling denominated funds there is an expectation that they have procedures in place to recapitalise and/or de-risk their portfolios by reducing their exposures in a timely manner following exceptional market circumstances. The Central Bank notes that it reserves the right to define additional requirements and safeguards where deemed appropriate.