Pensions Authority issues guidance on strategies that lead to illiquidity risks

Ireland’s Pensions Authority has issued guidance on investment strategies that may lead to “significant” liquidity risks.

This includes strategies such as liability-driven investment (LDI), leveraged LDI, sale and repurchase agreements (repos), swaps, currency hedging and inflation hedging.

“The liquidity risks that may arise from such strategies include the requirement, in certain market conditions, to urgently post collateral so that a derivative or hedging exposure can be maintained,” the authority explained.

“Such strategies involve more complexity than traditional strategies and may incur losses requiring the liquidation of scheme assets. Therefore, greater understanding and proactivity is required on the part of trustees in managing the risk.”

Its guidance sets out areas where, in the authority’s view, special attention is needed to fulfil the requirements of its Code of Practice for trustees.

It suggests that trustees pursuing such an investment strategy should, particularly regarding derivative instruments and borrowing, ensure that their investment strategy complies with legislative restrictions on investment.

They should also set out detailed information on the investment strategy in their statement of investment policy principles (SIPP) and be mindful of the distinct roles of investment advisers and investment managers.

In addition, the authority’s guidance note states that trustees should be satisfied that their investment managers have the necessary expertise and operational capability.

In conjunction with their advisers, they should also establish a target level of liquidity appropriate to the collateral and cash call requirements that may arise and have a liquidity preparedness plan in place to restore the target level of liquidity following adverse market movements or during periods of decreased market liquidity.

The plan could include a prepared asset liquidation program and a support agreement with the sponsoring employer. Furthermore, they should have operational arrangements to ensure that the scheme’s decision-making process can cope with rapid market movements. Finally, trustees should closely monitor the risks and performance of their investment strategy and include information on these in the trustee annual report.

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