Published on 23 November 2023 Email this Share this on LinkedIn Share this on Facebook Communiqué CSSF communication on GBP Liability Driven Investment Funds consultation The CSSF is consulting on a proposal to introduce macroprudential measures by imposing a minimum yield buffer to GBP denominated Liability Driven Investment (LDI) funds, via the use of Article 25 of the Alternative Investment Fund Managers’ Directive on the use of information by competent authorities, supervisory cooperation and limits to leverage, as implemented into Luxembourg legislation by Article 23 of the Law of 12 July 2013 on Alternative Investment Fund Managers. The proposed policy, prepared in coordination with the Central Bank of Ireland, aims to codify the existing minimum yield buffer measure from the industry letter in November 2022 and strengthen the steady-state resilience of GBP denominated LDI funds managed by Luxembourg Alternative Investment Fund Managers. In the document published today, the CSSF is seeking input on the yield buffer proposal which comprises the following aspects: the level of the yield buffer and its calculation; the scope of measures, including a definition of LDI funds; third party assets; the buffer usability and the reporting requirements. The consultation is open to everyone, and we are seeking views and feedback from all relevant stakeholders on the proposed measures. Where possible we would welcome evidence to support the views submitted in response to this consultation. The public consultation process will be open for submissions using the CSSF’s response form that can be sent to the following address: opc_prud_risk@cssf.lu until Thursday, 18 January
(3)AIFMD: "the CSSF (…) shall impose limits to the level of leverage that an AIFM are entitled to employ or other restrictions on the management of the AIF (…) 8 The Bank of England staff paper “LDI minimum resilience – recommendation and explainer” for instance recommended a 250 bps buffer and an additional undefined buffer. 9 Where exposures = assets (excl. m-t-m derivative positions) + net notional of derivative positions. MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 10/18 It is proposed that targeted guidance on liquidity also accompanies the yield buffer codification proposal, recognising the particular circumstances of LDI funds. The proposed high-level guidance is as follows: “Funds should ensure that they maintain sufficient holdings of assets which are eligible to meet margin or collateral calls that result from adverse market circumstances, or assets which can be transformed into such eligible assets with requisite speed.” QUESTION 1: Do you consider that the proposed calibration of the minimum yield buffer is appropriate and the calculation of the actual yield buffer sufficiently clear? QUESTION 2: Would you see merit in setting a minimum speed for the transformation into eligible assets (in days)? What would you consider the right minimum number of days, considering the settlement period for posting collateral to maintain leverage (repurchase agreements and/or derivatives)? 3.2 Scope of Measures It is proposed that the yield buffer will apply to all GBP LDI funds managed by a Luxembourg AIFM. At this point, the CSSF is of the view that these funds, as part of the cohort of EU domiciled GBP LDI funds, can pose a systemic risk given their leverage and concentrated ownership position in the gilt market. Euro-denominated LDI funds managed by a Luxembourg AIFM are out of scope as they do not pose the same risk to the European sovereign debt market given that they hold a much smaller share of the overall market. The population of GBP LDI funds that the codification would apply to will be identified from their investment strategy. The proposed definition of the LDI strategy is “Any fund whose investment strategy seeks to match the interest rate or inflation sensitivity of their assets to that of their investors’ liabilities”. It will be the responsibility of fund managers to determine whether LDI funds they manage are in scope of the measures. New funds seeking authorisation as GBP LDI funds managed by a Luxembourg AIFM will be required to notify the CSSF that they are in scope of the measures. The CSSF may conduct thematic analysis on the in-scope population of funds, so managers will need to ensure that this is up-to-date for the funds they manage. QUESTION 3: Do you agree with the proposed definition of LDI funds? In particular, do you consider that the definition is sufficiently clear and specific (i.e. only covering LDI funds)? 3.3 Third Party Assets The CSSF is considering to what extent assets owned by LDI funds’ investors that the LDI fund is authorised to use can be part of the yield buffer. The inclusion of assets external to the fund’s balance sheet could form a potential contagion channel in times of stress. For example, if assets external to the fund are considered as part of the yield buffer, shocks to LDI fund portfolios will be rapidly transmitted to the assets that the LDI manager is authorised to use. In addition, the feasibility of applying a haircut to such external assets is uncertain. Future shocks may not share the same pattern as those that have occurred to date, such that the impact of a given crisis on external assets could be much greater than anticipated by a haircut. MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 11/18 QUESTION 4: Do you agree that LDI funds should not be allowed to consider for the yield buffer calculation any assets that are not part of their balance sheet? If not, please elaborate. In this case, what safeguards should in your view be considered? 3.4 Buffer Usability A key objective in the design of the yield buffer is that it should be usable and should not lead to procyclical dynamics. It would be counterproductive if funds sell gilts in times of stress in order to meet the yield buffer. If such procyclicality occurred, the replenishment of the yield buffer could replicate the forced sale dynamics observed in the gilt market crisis during a future stress, amplifying any initial shock. To promote usability of the buffer, the CSSF proposes to adjust how the yield buffer is applied. It is proposed that GBP LDI funds managed by Luxembourg AIFMs would be required to calculate their yield buffer at the end of each month. This would be calculated as the monthly average of the yield buffer based on the yield buffer at the end of each business day of the month. The monthly average yield buffer would then need to be reported as a single observation to the CSSF following each month-end and should be greater than or equal to 300 bps. In order to provide limited flexibility to facilitate buffer usability, it is tolerated that, on a rolling basis, one out of the last four reporting observations (i.e. monthly average yield buffer at the end of each month) be below 300 bps in exceptional circumstances. The use of this flexibility will be monitored, with the expectation that it is not used on a regular basis. Additionally, the CSSF may temporarily disapply the yield buffer requirement should there be a significant, market-wide shock to financial stability. Disapplication of the yield buffer would be considered in the case of a severe market wide shock or event, where it is anticipated that it may take a substantial period for funds to return to the required levels of resilience, and that forcing them to expedite this process would further amplify the shock. This would ultimately be a judgement, based on the review of a range of data and external indicators, coupled with ongoing market intelligence and firm engagement. The following example describes how the CSSF envisions these elements combining. Consider a 5-month period. A GBP LDI fund has been maintaining a monthly average yield buffer of 300 bps in each of months 1-
- In month 4 a shock occurs such that the fund expects that there will be a prolonged and/or substantial deviation of the buffer below 300 bps. At this point, the fund should notify the CSSF that such a deviation in the yield buffer has occurred. The fund may be able to recapitalise by month-end such that the monthly average equates to 300 bps. However, if this is not feasible, then the proposed measures provide some limited flexibility that does not require the fund to procyclically deleverage to return to a 300 bps monthly average. In month 4, their monthly average buffer can remain below 300 bps. In month 5, it is expected that by the end of this month the monthly average yield buffer should have returned above 300 bps, unless the CSSF temporarily authorised the dis-application of the yield buffer limit for a longer period of time. MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 12/18 The 300 bps yield buffer level should be viewed as a minimum, rather than a target. The CSSF anticipates that to avoid the yield buffer deviating below the minimum, GBP LDI funds managed by LU AIFMs should consider maintaining their yield buffer above the 300 bps in order to manage idiosyncratic variations in the value of their portfolio. The CSSF considers that maintaining a yield buffer above the minimum requirement would be prudent, particularly where operational challenges may prevent investors being able to meet capital calls quickly (e.g. if a fund needs to co-ordinate amongst a large number of investors and believes it may be operationally challenging for some investors to meet capital calls in a stress situation). Furthermore, funds should ensure that their investors are prepared and able to meet capital calls that can be expected in both normal and stressed market conditions. It is proposed that fund managers will only notify the CSSF that their yield buffer has fallen below 300 bps in real time if they expect the deviation to be prolonged and/or substantial. Minor deviations of the yield buffer below the minimum 300 bps do not need to be reported in real time, thus providing LDI funds with the incentive to rebuild their buffers appropriately and without resorting to fire sales of gilts to immediately replenish their yield buffers. QUESTION 5: Do you consider that the mechanism driving the buffer usability is appropriate and sufficiently clear? 3.5 Reporting The buffer usability proposal will require changes to the existing LDI data template utilised by peer NCAs, including the CSSF. Following the gilt market crisis, a data template was jointly introduced by the CSSF, the CBoI and the Financial Conduct Authority (FCA) to monitor GBP LDI funds on a weekly basis. In addition to the fields in the existing template, LDI funds will also have to report the monthly average of the yield buffer as described above. This will form part of the ongoing monitoring process by the CSSF and will be used for ongoing supervisory engagement with relevant funds.
- Implementing the Yield Buffer The yield buffer will be codified under Article 23 of the AIFM Law transposing Article 25 of the AIFMD. Article 23 of the AIFM Law gives powers to impose restrictions on the leverage that AIFMs are entitled to employ with respect to the AIFs they manage, where leverage is judged to contribute to systemic risk or disorderly markets. It is proposed that the yield buffer would be codified as an ‘other restriction’ under Article 23 of the AIFM Law, rather than as a single leverage limit. As previously highlighted, the yield buffer will limit each fund’s leverage based on the duration of their portfolio. This necessitates the use of an alternative power under Article 23 of the AIFM Law as the CSSF does not intend to codify the yield buffer as a single leverage limit. The proposed yield buffer would be imposed through Article 23 of the AIFM Law. MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 13/18 Article 23 of the AIFM Law notes: “The CSSF shall assess the risks that the use of leverage by an AIFM with respect to the AIFs it manages could entail. If the CSSF deems such action necessary in order to ensure the stability and integrity of the financial system, it shall, after having notified ESMA, the ESRB and, if applicable, the competent authorities of the relevant AIF, impose limits to the level of leverage that an AIFM is entitled to employ or other restrictions on the management of the AIF with respect to the AIFs under its management to limit the extent to which the use of leverage contributes to the build up of systemic risk in the financial system or risks of disorderly markets. The CSSF shall duly inform ESMA, the ESRB and, if applicable, the competent authorities of the AIF, of actions taken in this respect, through the procedures set out in Article 50 of Directive 2011/61/EU.” It is proposed that there will be an implementation period of 3 months following the finalisation of the codification process. As this is largely a codification of existing measures the CSSF does not anticipate that that compliance will require substantial adjustments for those LDI funds in scope of the measures.
- Expected Impact of Yield Buffer The benefits of a yield buffer to investors arise from the reduced probability of a similar crisis reoccurring. If LDI funds are not forced to sell gilts to unwind their leverage, unrealised losses on gilt positions will not be realised by their investors. Equally, other investors in gilts will see less volatility in the performance of their gilts, which is preferable. As gilt yields are core to credit markets generally, there should also be less volatility in rates. LU AIFMs managing GBP LDI funds have already undertaken significant adjustments to comply with the measures outlined in November 2022’s letter. LDI funds now have yield buffers that are above 300 bps, with this adjustment largely coming via deleveraging. In addition, they have incorporated 300 bps as a trigger point at which they request recapitalisations and target a yield buffer level in excess of 300 bps after recapitalisation. As the CSSF is proposing to codify a yield buffer that funds have already installed following the industry letter, it is anticipated that the initial costs of such a policy have in principle already been absorbed. As funds have already adjusted their yield buffer level, they do not have to sell any additional gilts to deleverage, nor do investors have to provide additional capital to the fund. Any secondary impact from funds and investors activity to come into compliance with the yield buffer will also have been absorbed. There may be costs that will accrue over time from the immediate costs imposed. If investors have allocated more capital to their LDI funds to maintain the same level of hedging, this capital will not be receiving a superior return on other assets elsewhere. Thus, there may be an opportunity cost for investors, in the form of lower returns for scheme members. Likewise, if LDI funds have less demand for long-ended gilts, then future crises may demonstrate that there is even less liquidity in long-ended gilts. QUESTION 6: What potential unintended consequences or other impacts (including costs) do you see from the proposed measures, and how could these be mitigated? QUESTION 7: Do you have any other comment on the proposal? MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 14/18
- Providing Feedback The CSSF invites all stakeholders to provide comments on this Consultation Paper. Please provide feedback by filling in the response form and submitting it at the following address: opc_prud_risk@cssf.lu. The deadline for receiving feedback is 18 January
- The CSSF requests that reasons are given for the responses to all questions answered and that submissions that suggest changes to the proposals in the Consultation Paper be supported, where possible, by evidence, which will aid our consideration of the issues. The CSSF intends to make feedback available on its website after the deadline for receiving responses has passed. Please do not include commercially sensitive material in your response, unless you consider it essential. If you do include such material, please highlight it clearly, so that reasonable steps may be taken to avoid publishing that material. This may involve publishing feedback with the sensitive material deleted and indicating the deletions. While as indicated above, the CSSF will take reasonable steps to avoid publishing confidential or commercially sensitive material, the CSSF makes no guarantee that it will not publish any such information and accepts no liability whatsoever for the stakeholders’ consultation responses that are subsequently published by the CSSF. Please be aware that you are making a submission on the basis that you consent to us publishing it in full. Summary list of questions: • QUESTION 1: Do you consider that the proposed calibration of the minimum yield buffer is appropriate and the calculation of the actual yield buffer sufficiently clear? • QUESTION 2: Would you see merit in setting a minimum speed for the transformation into eligible assets (in days)? What would you consider the right minimum number of days, considering the settlement period for posting collateral to maintain leverage (repurchase agreements and/or derivatives)? • QUESTION 3: Do you agree with the proposed definition of LDI funds? In particular, do you consider that the definition is sufficiently clear and specific (i.e. only covering LDI funds)? • QUESTION 4: Do you agree that LDI funds should not be allowed to consider for the yield buffer calculation any assets that are not their balance sheet? If not, please elaborate. In this case, what safeguards should in your view be considered? • QUESTION 5: Do you consider that the mechanism driving the buffer usability is appropriate and sufficiently clear? • QUESTION 6: What potential unintended consequences do you see from the proposed measures, and how could these be mitigated? • QUESTION 7: Do you have any other comment on the proposal? MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 15/18
- Annex – Summary table of measures Item Description Buffer level GBP LDI funds must maintain resilience to a minimum of 300 bps increase in yields. Scope of buffer The yield buffer applies to all GBP LDI funds managed by a Luxembourg AIFM. Definition of GBP LDI funds The population of GBP LDI funds that the codification would apply to will be identified from their investment strategy: Any fund whose investment strategy seeks to match the interest rate of inflation sensitivity of their assets to that of their investors’ liabilities. Buffer composition The CSSF considers requiring that only assets on the funds balance sheet are included in the calculation of the buffer, and not assets its investors own (but the fund is authorised to use). All fund’s exposures considered are to be considered in calculating the buffer. Reporting Monthly averages of daily yield buffer are reported at month-end. Buffer usability The yield buffer in each reporting observation should be greater than or equal to 300 bps. In order to provide limited flexibility, one of the last four monthly reporting observations can be below 300 bps in exceptional circumstances. Buffer dis-application The CSSF may temporarily disapply the yield buffer requirement should there be a significant, marketwide shock to financial stability. This would ultimately be a judgement, based on market intelligence, firm engagement and external indicators. Liquidity guidance It is proposed that targeted guidance on liquidity also accompanies the yield buffer. The proposed high-level guidance is as follows: “Funds should ensure that they maintain sufficient holdings of assets which are eligible to meet margin or collateral calls that result from adverse market circumstances, or assets which can be transformed into such eligible assets with requisite speed.” MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 16/18 Notification to the CSSF If funds in scope of the measure anticipate substantive and/or prolonged deviations below 300 bps, they must notify the CSSF. MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS 17/18 Commission de Surveillance du Secteur Financier 283, route d’Arlon L-2991 Luxembourg (+352) 26 25 1-1 direction@cssf.lu MACROPRUDENTIAL MEASURES FOR GBP LIABILITY DRIVEN INVESTMENT FUNDS www.cssf.lu 18/18