Victims and Villains

With light touch regulation getting a tarnished reputation, tighter regulation looks set to extend to pensions schemes, says Christine Senior

The market turmoil and financial crisis have led to calls for tighter regulation among financial institutions. Before the crisis the European Commission had agreed that the tighter rules proposed for insurance company regulation in the form of the Solvency II directive would not apply to pension funds, though whether similar rules should be brought to bear on them through an update of the IORPs directive is an ongoing debate. In the current climate, where light touch regulation has been cited as a prime cause of financial ills, there are demands for stricter rules for funding of pension schemes.

European member states fall broadly into two camps along lines defined by the structure of
their pension regimes. Northern European states such as the UK, Ireland and the Netherlands, home to funded defined benefit schemes, strongly oppose any move in the direction of Solvency II type regulation for pension funds. France, on the other hand, with its largely pay as you go pension regime and powerful insurance industry, is calling for pension funds and insurance companies to be subject to similar rules on solvency. Other southern states, such as Spain, Italy and Portugal, follow the French line.

Chris Verhaegen, secretary-general of the European Federation for Retirement Provision (EFRP), dismisses the idea that recent events mean tighter regulation is needed for pension funds.
"Pension funds are victims of the financial crisis, not organisers of it," she says. "I don't see a correlation. The pension funds have to redress their financial situation not because they were loosely supervised or regulated but because they are invested in financial markets and it's just asset meltdown there. So I cannot see what difference regulation put on them would have made.
"For the moment pension funds have solvency levels down, but that is mainly due to a decrease in asset values and an increase in liabilities because interest rates are coming down," she says. "That's a consequence of the financial crisis."

Verhaegen does not see a solution in stricter rules because, she says, the funding rules that already exist under the IORP Directive are flexible enough to allow member states to implement Solvency II type regulation if they wish.

A period in limbo
Right now discussion on the next step for regulation is essentially in limbo. The European Commission ran a consultation process to canvass opinion on solvency rules for certain types of pension funds last November. This relates to so called article 17 pension funds, such as industry wide schemes with no corporate sponsor, and cross border pensions. Discussion of its findings, originally due to take place in February, has been postponed to May.

The insurance industry, which regards some pension funds as posing a competitive threat to its business, is calling for the IORP Directive to be amended. It wants similar solvency rules for pension funds as those that will apply to insurers, in order to create a level playing field.
Verhaegen thinks it's too soon to be thinking about such a move: "The insurance industry would like a legislative process to be initiated as soon as possible to change the IORP Directive. We don't want that, at least not at this stage. We want to work with it for longer, then we will see the flaws it might have, and we can start a fully fledged legislative process. Additionally we call for a holistic policy debate on private pensions, which should establish the different pension 'markets'."

Verhaegen is also keen to see responses to the consultation as soon as possible, but she says the position of the EFRP has already received widespread support. This has come from Business Europe and the European Trade Union Confederation. The three Dutch pension fund organisations, VB, UvB and OPF, also back EFRP's stance, and they issued a position paper in September.
The paper said an extension of Solvency II to pension funds would seriously undermine the pensions of many European citizens, in the Netherlands and several other countries. And because insurance companies and pension funds were different in structure and in the way financial risks are underwritten, they need different funding regimes.

Wijnanda Rutten, a pension lawyer with Allen & Overy in the Netherlands, thinks it would be disastrous if Solvency II rules were extended, particularly at the moment, when Dutch pension
funds are trying to address their pension deficits.

"It would not only make it worse because funding requirements are going to change, but also the restrictions on investments are going to be changed," she says. "It means pension funds will have limited possibilities to choose their own most prudent investment strategy. Pension funds hope that by actually having diversity in their investment portfolio they have a better chance to recover. If you
look at Solvency II you will be obliged to have a more conservative investment strategy. At this time that would not be the best message to pension funds that are underfunded and working at drafts of their recovery plan."

Oliver Drewes, a spokesman for the internal market and services at the European Commission says the Commission was looking at the need to review prudential requirements for defined benefit pension funds, but this did not necessarily mean applying Solvency II to them.

But he adds that the financial crisis has focussed attention on risk management: "It should be clear that Solvency II is a risk based approach – prudential requirements are set in a manner that takes account of the risk underwritten by the insurance undertaking. The financial crisis has shown that these risks must be looked at very carefully."

Two overlooked pillars
Discussion about Solvency II has tended to focus on its first pillar which relates to capital adequacy rules, though in fact the Directive is more broadly based than that. The two other pillars which address regulation and governance have been relatively overlooked. Jane Beverley, head of research at Punter Southall, expects a change of emphasis to take place.

"In the past we have been focusing on the first pillar [of Solvency II]," she says. "People are looking more and more at the second and third pillars and asking what are the messages from those for pension schemes in terms of supervision, in terms of what the pension regulator does, in terms of governance, in terms of information given to members? And these are just as effective in managing risk as having the solvency capital. I think the debate is broadening out. It's making us ask questions about what are the key messages of Solvency II and to what extent do we already have those in pensions. The IORP Directive has a framework which arguably does have the
three pillars."

If pension funds are victims of the financial crisis, the villains are widely considered to be the banks. Proposals to beef up Europe-wide financial regulation have recently been unveiled by a team under the leadership of former IMF managing director and former Bank of France governor, Jacques de Larosiere. This has suggested a two-pronged reform of supervision, consisting of a Europe-wide council to monitor risk in banking, insurance and securities supervision and a new system to carry out day to day supervision. The focus is particularly on banking, but also on rating agencies and insurance.

Nigel Peaple, director of policy at the NAPF in the UK, thinks banks will be targeted for tighter regulation.

"Now that the dust is settling a bit on the financial crisis and we're beginning to get considered analysis and assessment of what happened, it all points primarily to issues around regulation of banks. I think the primary focus of everyone's attention in the EU and elsewhere will be banking regulation. But that doesn't mean we won't get people saying we need to tidy up this area of pension funds, we need to look at them too. What has come out clearly there is nothing obviously wrong with pension fund funding, and it certainly had no contribution to the current crisis. The key issues are banking regulation and, from a European perspective, this idea of reviewing their system of cooperation between national regulators."

So the jury is still out on what the effects of the crisis will be on pension fund supervision, regulation and funding requirements. The debate is nowhere near over yet.

WRITTEN BY CHRISTINE SENIOR, A FREELANCE JOURNALIST