Regulators and policymakers are calling for action to address the risks associated with pension funds’ use of derivatives, after key watchdogs admitted last week that they were unprepared for the crisis that hit the industry in September.

The meltdown, now the focus of four separate parliamentary probes, revealed regulators did not have a reliable picture of the scale of hidden leverage in liability-driven investment (LDI) strategies, which cover about £1.4tn of the future promises made by UK defined benefit pension schemes.

The crisis exposed a risk that regulators had failed to anticipate: derivatives commonly used by retirement funds had built up leverage to such an extent they posed a threat to the entire UK gilt market.

Last week, the heads of the Financial Conduct Authority and The Pensions Regulator conceded to a House of Lords committee that they had not been paying sufficient attention to the use of LDI by pension funds. A succession of experienced regulators told the Financial Times that action must be taken.

Sarah Breeden, executive director for financial stability at the Bank of England, called for regulators, banks and investment managers to ensure the risks embedded in derivatives were managed more safely.

“The root cause is simple,” she said. “Poorly managed leverage.”

“There needs to be a greater focus on areas where there is less transparency so the authorities can understand the exposure of financial market participants to these risks,” said Dietrich Domanski, secretary-general of the Financial Stability Board, a global committee of regulators and central bankers.

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