Central Bank of Ireland publishes Markets Update 12 (30 November 2022)

On 30 November 2022, the Central Bank of Ireland (the Central Bank) published Issue 12 of its regular Markets Update.

This contained a single item, an Industry Letter, “Liability Driven Investment Funds” (the Letter), which was sent on 30 November 2022 by Darragh Rossi, Head of the Central Bank’s Securities Markets and Funds Supervision Division.

The Central Bank’s Industry Letter on Liability Driven Investment Funds

The Letter follows interactions between the Central Bank, the Luxembourg regulator, the CSSF and ESMA (together, the NCAs) in the wake of volatility in yields associated with UK gilts.

This exposed vulnerabilities in Liability Driven Investment (LDI) funds - especially sterling denominated (GBP) LDI funds – led to a cycle of collateral calls and forced sales. As the situation has since improved, the NCAs do not consider that any reduction in the resilience at individual sub-fund level is appropriate at this juncture.

However, the Letter specifies a number of steps to be taken by managers who consider it necessary to reduce an individual GBP LDI Fund’s resilience below the levels achieved in the period following the dislocation in the UK gilt market. These include:

• giving advance notice to the fund manager’s NCA (and where relevant, the NCA of the fund’s country of domicile) of both the intention to reduce a GBP LDI Fund’s resilience and the level
• prior to making any reduction:
  • undertaking a detailed analysis justifying the need to reduce the fund’s resilience
  • completing a risk assessment of how the proposed reduction will not impact the fund’s orderly functioning in the current and in stressed environments
  • detailing a step-by-step plan for returning the GBP LDI Fund to current levels of resilience in the event of increased market volatility.

Clear policies and procedures must be established to increase resilience should there be further volatility in the market.

For non-sterling LDI Funds, this notification system does not apply for the time being. Managers, though, are expected to maintain “an appropriate level of resilience at an individual sub-fund level” for such funds in order to be able to absorb possible market shocks.

On 30 November, ESMA released a statement welcoming the Central Bank’s initiative (and that of the CSSF in Luxembourg) in relation to LDI funds.