(Bloomberg) --

UK pension funds at the heart of recent turmoil should hold their newly increased cash buffers to protect against a selloff in bonds given the market outlook, according to regulators.

Officials in Ireland and Luxembourg, countries where the bulk of sterling liability-driven investment products are domiciled, said they didn’t consider it appropriate for these kinds of funds to reduce resilience at this point. Any move by an asset manager to do so must be justified to the relevant regulators in advance via a notification system, they added.

Funds must ensure “clear policies and procedures are established to increase resilience in the event of further volatility in the market,” the Central Bank of Ireland and Luxembourg’s Commission de Surveillance du Secteur Financier said in statements on Wednesday.

Regulators are stepping up their intervention after a historic rout in UK bonds driven by forced pension-fund selling in late September. The market came within an hour of “severe” problems and is still not back to normal, according to Bank of England Governor Andrew Bailey.

The Irish and Luxembourg regulators expect funds to take into account “second-round effects,” such as the market impact of asset disposals triggered by rising yields. A similar event forced the BOE to intervene last month to avert what it called “fire sale” dynamics. The new policy was welcomed by the UK’s Financial Conduct Authority and Pensions Regulator.

LDI strategies, which are used by the likes of pension funds to hedge liabilities spanning decades into the future, were caught out by a sudden rise in UK rates in late September. That forced the BOE to start buying long-dated and inflation-linked gilts favored by such investors. UK regulators have been working with European Union peers owing to the fact many of the strategies are domiciled in Luxembourg and Ireland. 

Read more: Pensions Drama Sparks Call for Rethink of $1.8 Trillion Market

The average yield buffer of funds -- defined as the change in long-term gilt yields a fund can withstand before its capital reserves are exhausted -- had increased to between three to four percentage points after engagement from regulators, the watchdogs said. Previous stress tests had accounted for a maximum instantaneous 100-basis-point move, according to the BOE.

LDI funds in currencies other than sterling are not subject to the notification system requirements, the Luxembourg and Ireland regulators said. However, they should maintain “an appropriate level of resilience at an individual sub-fund level in order to be able to absorb possible market shocks,” also accounting for second-round effects.

The UK’s Pensions Regulator added that while the statements referred to pooled funds, it believed the “same level of resilience” should also be maintained for segregated leveraged LDI funds and single-client funds. The UK’s FCA said it would publish a further statement on “good practice” toward the end of the first quarter.

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