How good is your governance?

This has always been a difficult question to answer. Establishing clear objectives, determining responsibilities, having plans, risk registers, training and taking good professional advice are all components of good governance.

Arguably, however,  the real test of good governance is how a Trustee Board reacts to specific situations.

COVID-19 may be a harsh test against which to test the resilience of a Trustee Board’s governance as it took everyone by surprise. More realistic would be the spike in long-term interest rates that has occurred since the start of 2021. Longer dated nominal and real gilt yields have risen by around 50bp, which is the most significant shift in yields that we have seen in some years.

How this impacts different schemes will be different depending on situations.  The first point to consider is how has this actually affected the scheme for which you are responsible. Hopefully, with the prevalence of online funding monitoring tools, this should not be that challenging. If you don’t have such visibility, this should be a trigger to get such monitoring in place.

The more challenging issue is what one should be doing. There are a range of issues to consider and the shift has been material enough for these issues to still be considered even if you already have a dynamic approach with some steps towards de-risking agreed in advance.

An overview of the questions you should be asking and issues to raise

1. How should we be adopting our approach to hedging of interest rates or inflation?
   1. Is this an opportunity to increase the hedge ratio?
   2. Might there be arguments for reducing?
   3. Or maybe it needs to be rebalanced?
   4. How robust are your collateral arrangements?
2. What are the implications for the growth assets?
   1. If your funding level has improved materially perhaps less growth assets are needed. Is this an opportunity to transition out of an asset class that worries you or that you are less comfortable with, such as equities which have had a very strong run of late?
   2. How does the lift in government bond yields affect your corporate bond investments and any other yield driven assets? Does this give you more confidence to adopt a more fixed income-based approach?
3. Does this now put buy-out within reach?
   1. How prepared is the scheme for this?
   2. Has enough attention been given to data?
   3. Where are you with GMP equalisation?
4. Future planning
   1. If you are able to think through events when they actually happen then why don’t you plan for actions in advance?
   2. It is fairly common but not universal to have funding level based de-risking triggers. Even if not baked in as automatic, the discussion of a preferred approach can help with decision making.
   3. It is also common, but not standard, to have LDI triggers. Certainly, if one’s main justification for not hedging is the level of interest rates, determining at what rates one would hedge is a sensible course of action.
   4. More generally, with growth assets it makes sense to have a broad plan in place as to what assets you will sell down as funding improves.
   5. All the above could be done automatically, or with consent, if one is worried about exceptional events.

   So, really good governance needs really good planning and good planning takes time, insight and advice. If you aren’t there yet perhaps this is a wake-up call to get there.