18 July 2011

IPE: Pensions regulation - convergence over harmonisation

On 30 March 2011, the European Commission sent a call for advice to the European Insurance and Occupational Pensions Authority (EIOPA) for the review of the IORP Directive. The call for advice aims to achieve full harmonisation of pension fund regulations “where EU legislation does not need additional requirements at the national level”. Basically, EIOPA is presented with almost 100 articles from Solvency II and requested to turn them into a regulatory framework for pension funds. The Commission has identified the “lack of harmonisation of prudential regulation” as a barrier to cross-border activity of pension funds. However, it is hard to see how differences in national prudential regulation might negatively impact cross-border activity, since pan-European pension funds are only subject to the prudential rules of the home Member State.

Redefine scope of IORP Directive

The IORP Directive takes a horizontal approach as it may be applied not only to traditional pension funds, but to all institutions for occupational retirement provision. This includes the pension activities of insurance companies and investment funds, which also have in place their own vertical regulations (Solvency II, UCITS IV). As a result, EU regulation is applied in an inconsistent manner, as identical institutions are subject to different prudential rules in different Member States. In addition, it gives rise to calls for an inappropriate extension of insurance and retail investment fund rules to pension funds as well as the opportunity of regulatory arbitrage. The IORP Directive could be used to circumvent restrictions in the UCITS Directive on illiquid investments – private equity, infrastructure, real estate – of retail investment funds.

Other occupational pension schemes

Some occupational pension schemes – as mentioned by the call for advice – are not covered by the IORP Directive. The question is whether and how to broaden the scope of the IORP Directive respecting social and labour law of the Member States.

Redefining scope

The overlap between EU regulation of insurers, investment funds and pension funds, can be undone by restricting the scope to collective, not-for-profit pension funds in which the risks are borne by employers and/or employees. Occupational pension schemes such as pay-as-you-go schemes would naturally fit this definition and their exemption could be abolished. This would not necessarily mean that these schemes would have to increase funding. The ability to raise future contributions – possibly backed up by insolvency protection – may be recognised as an asset, a possibility that is also put forward by the call for advice.

Different risks, different rules

The Commission is advocating a harmonised solvency regime for pension funds to avoid regulatory arbitrage between and within financial sectors. Pension schemes containing similar risks should be subject to similar regulatory requirements. However, these goals can also be achieved by limiting the IORP Directive to social institutions. While the benefits of the Commission’s plans seem unclear, the imposition of a harmonised solvency regime will be accompanied by substantial costs. The introduction of an alien prudential framework might be good news for actuarial consultants but will very likely pose a heavy burden for pension schemes and, as a consequence, their beneficiaries. Moreover, a short-term solvency regime with mark-to-market accounting will increase pro-cyclicality and – as happened with the introduction of the IFRS accounting rules – further discourage occupational pension provision. It will increase systemic risk and reduce the amount of long-term risk capital available to companies.

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