Written by Christine Senior
The review of the IORP Directive has dominated discussions throughout the industry in recent months. Christine Senior asks what the implications of the process are for the development of pan-European pensions
Cross-border pensions in Europe have been slow to evolve; true pan-European pensions are still a distant goal.
The revision of the IORP Directive currently under consideration seems unlikely to bring great strides in that direction. And raises strong feelings for it and against it.
EIOPA reported a total of 84 cross-border IORPs in July last year. Of these perhaps 15 are true cross-border IORPs covering a number of countries with a significant member-ship. The most numerous cross-border schemes cover the UK and Ireland where existing cross-border pension structures that pre-dated the directive could convert most easily into the IORP format.
A revision of the legislation was provided for under the terms of the original directive and the pension landscape is much changed since its adoption in 2003. But it raises some contentious issues, with critics in the UK and Ireland most vocal in opposition to the revision. These two are set to lose out the most under any new rules to strengthen solvency of pension schemes.
Unlike in most other European jurisdictions, pension schemes in the UK and Ireland do not have the automatic backing of their sponsoring employer. Elsewhere, companies have a legal responsibility to make good deficits in DB schemes; in the UK and Ireland trustees have to negotiate with the sponsor to fill any funding black hole.
A widespread view is that the revised directive is doomed to fail, if its aim is to bring pan-European pensions a step closer. There is too much disparity between the systems that apply throughout the union for a new directive to have a transforming effect.
EIOPA’s proposal of a ‘holistic balance sheet’ is meant to deal with the lack of harmonisation in super-vision. It aims to create a flexible regulatory framework that explicitly recognises the value of security features of different types of structures existing across Europe.
The holistic balance sheet is regarded by some as a way to introduce Solvency II, or a version of it, to pensions by the back door.
The ideal would be for all IORPs to be subject to the same solvency requirements so scheme members have similar protection across the union. The holistic balance sheet is an attempt to recognise and value existing solvency measures.
Robeco head of pensions business Jacqueline Lommen thinks it will be good news for pension schemes across Europe, including the UK.
“The holistic balance sheet approach – in contrast to Solvency II for insurers - tries to take into account different funding regimes in member states. IORP2 will introduce solvency buffers as a starting point. The holistic balance sheet would make it possible for the UK to value the sponsor covenant, value the Pension Protection Fund and deduct it from the solvency buffer. So it might turn out in the UK you wouldn’t need a solvency buffer, or just a small one.”
But others are not so optimistic. The holistic balance sheet is complex and unlikely to work, according to Dexia Asset Management’s head of financial engineering Kristof Woutters.
“EIOPA want a harmonised supervision system,” he says. “Since in every country you have big differences, the biggest difference being whether IORPs are sponsor-backed or not, they needed to have a system that could take into account the differences. That’s why they came up with the holistic balance sheet. It’s well thought out, but it’s too complex. I think companies will say running a pension fund has become too complex, too time consuming, and therefore too expensive.”
Multinational companies with multiple pension schemes across Europe ideally would like to be able to pool their liabilities, not just pool their assets, which can be done relatively easily. Woutters says: “You don’t need to have cross-border pension schemes to do asset pooling; you just need to have a Ucits. But multinationals wanted the advantage of pooling liabilities. The advantage there is you can create solidarity on the liability side, and transfer surpluses to pension schemes with a deficit.”
But liability pooling is effectively blocked by the various fiscal regimes and social and labour legislation across the European Union, which the European Commission is powerless to remove.
Woutters says the commission uses the argument of pan-European pensions to justify IORP1 and IORP2, but in reality it’s irrelevant. “The directive is about prudential super-vision. It doesn’t touch on fiscality and social and labour law. The commission doesn’t have power on fiscality, so it’s a non-argument. The problem with cross-border schemes is not in prudential regulation.”
Lommen on the other hand feels IORP2 would make the environment more conducive to the establishment of cross-border schemes. If conditions are right, more cross-border schemes will be set up. She makes a comparison with electric cars:
“As long as we don’t have electric charging stations there won’t be many electric cars. Somebody has to make it run. If we facilitate cross-border pension solutions by making the directive even better, then for sure there will not be 85 cross border IORPs; there will be 500.”
Demand for cross-border schemes from multinationals exists, says Lommen, and is being driven by three factors - the need for more control by multinationals over their different pension schemes, to improve quality and to save costs.
“In the past pensions were dealt with by local HR departments,” she says. “Nowadays pensions have become a boardroom issue. Because of IFRS rules, compliance, solvency funding requirements, low interest rates and poor financial markets, a lot of extra money has to be put in DB pension schemes. CFOs and risk officers would like to be more in control.
“The second driver is quality enhancement. They want better risk management, better providers, better governance. And the third reason is cost saving. If you are bigger you have buying power with asset managers, insurance companies and administrators.”
But European Federation for Retirement Provision secretary general Matti Leppälä is not convinced demand is there: “There hasn’t been the demand from the multinational companies. They have been able to arrange asset pooling pension arrangements that have been good enough for them, or at least effective.”
Aon Hewitt head of research and EU affairs Leonardo Sforza is clear about the role of the legislation in facilitating cross-border pensions.
“The beauty of this directive is that if it’s improved it can be a real tool for employers to have freedom of choice on where to set up arrangements. The second element is they can choose freely the best financial service providers and advisers in the market irrespective of the country where they operate. They have greater flexibility on the way to build an investment policy that makes sense to them.”
At the very least some less important problems of interpretation should be resolved in the revised directive. So even if the higher goal of pan-European pensions is no nearer, some less important barriers should be swept away.
“The process for setting up such [cross-border] funds is cumber-some, is often not fully transparent and requires in-depth analysis,” says Sforza. “There are different interpretations of definitions of what makes a cross-border arrangement, what makes social and labour law versus financial law. These are the things that need to be fixed. I am not against revision that can improve the usefulness and business friendliness of the two. I think that can be achieved.”
But perhaps the greatest hope for pan-European pensions is for DC schemes. DC was not covered in the original directive. The revision focuses on regulation in governance, investment rules such as lifestyle funds, and costs and fees.
“There can be more harmonisation in DC schemes, for example providing information to scheme members and beneficiaries,” says Leppälä. “Improvements could be made in the governance structure and having different types of hybrid schemes that have some risk sharing. A lot more could be done at European level. There it would be far more easy to have pan-European arrangements. You wouldn’t need to harmonise the technical provisions that are very different in different countries, you wouldn’t have to harmonise mortality tables etc. That would make much more sense.”