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Liability Driven Investments (LDIs) and Leveraged LDIs

Liability Driven Investments (LDIs) and Leveraged LDIs

We are working with leading experts and barristers to prepare litigation strategies following the liquidity crisis of September 2022 in respect of decisions made in the investment in Liability Driven Investments (LDIs). Whilst Trustees have spent the past months actively considering if deficits and losses can be recovered, where there is no other option, it is highly probable that many will be looking at the litigation option for recovering some of the losses.

Our lawyers’ history of dealing with complex banking mis-selling claims, fraudulent misrepresentation claims, professional negligence and pensions related litigation, means that we are able to assist Trustees, Investment Consultants, Fund Managers and other intermediaries in the sector consider their options and the financial risks of pursuing a claim.

Liability Driven Investments

LDIs are understood by very few investments managers and their purpose/design is shrouded in complexity. They are often described as an investment tool adopted to mitigate the risks on swings in interest rates and inflation. The intention behind the design of LDIs was for such investments to mitigate the impact of interest rate and inflation fluctuations. LDIs have limited liquidity and were supposed to provide a buffer against historical fluctuations. But September 2022 took these products out of their comfort zone and led to the need for a rapid sale of gilts, in order to meet the need to recapitalise.

Leveraged Liability Driven Investments

Some commentors have noted that the fall in gilts themselves was not the main systemic problem but that the adoption of Leveraged LDIs was the critical problem as this enabled access to a broader range of investments. Although LDIs are essentially illiquid, the problem with Leveraged LDIs is that they do require a rapid ability to find liquidity in the circumstances which arose in September 2022. It is going to be important for any potential claimants to consider how these products were sold to them and what representations were made as to their suitability for the purpose for which they were apparently designed. Much will turn on what advice was given in respect of collateral and liquidity requirements. Operational and governance matters will also be a significant factor.

September 2022

Following the September 2022 financial troubles, the spotlight was thrown on these little understood financial products. There was an escalation in the sale of gilts to meet contractually required collateral calls, the value of the gilts in turn dropped significantly (as the problem spread in the industry), leaving many financial intermediaries to deal with the aftermath as deficits increased.

The rapid fire sale of assets (largely gilts) at lower values creates conditions for large claims in relation in particular to Leveraged LDIs, where losses could be substantial. The firm’s partners have considerable experience in investigating and pursuing claims against financial institutions (most notably in relation to the bank sales of interest rate hedging products) and in advising intermediaries. We are therefore well placed to act for stakeholders including pension schemes, product managers, independent trustees, investment consultants and portfolio managers, on claims relating to LDIs.

Whether there were adequate and effective risk management processes in place to assist in avoiding some of the challenges that impacted on LDIs and whether stakeholders should have been aware of the potential problems, are likely to be key issues going forwards.

The FCA published further guidance in April 2023.

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