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The current Institutions for Retirement Provision (IORP) Directive covers the retirement provision of over 25 per cent of the working population of the European Union. The European Commission is now proposing regulation for pension funds similar to the capital adequacy regulations that apply to the banking and insurance sectors.
Under Solvency II, insurers’ solvency capital requirements are calibrated to correspond to the value at risk, marked to market, over a 12 month period. As a consequence, much of the focus is on the liquidity of investments rather than the capital at risk. If applied to pension funds, such requirements would have two highly undesirable effects: first, they would diminish pension funds' ability to be funded appropriately for pension liabilities as they fall due; second, they would significantly reduce the supply of investment available for capital projects and, through the private equity and venture capital funds in which pension funds invest, for investment in small to medium-sized enterprises.
The exaggerated risk weightings applied to private equity investments, currently in place under insurance and banking regulation, serve to exacerbate the problem. In recent years, banks have sold €20 billion of private equity portfolios at an estimated market discount of 15 per cent to 20 per cent. This will have resulted in a value erosion of €3 billion to €4 billion. Applying this to pension funds would, in the short term, destroy enormous value for future pensioners and, in the long term, prevent pensioners benefiting from the value creation associated with growth asset classes.
Karsten Langer, EVCA Chairman, says: “In their efforts to minimise systemic risk, regulators are in danger of negating the stabilising effect of long-term investors in global financial markets and reducing the ability of institutions to invest in the real economy. The European Commission, by committing to reviewing the relationship between regulation of the banking and insurance sectors and investment in venture capital, has already taken the first steps to recognising the damaging effects of current capital adequacy-based regulation on economic growth. An impact assessment covering the full macro-economic implications of the review of the IORP Directive must be taken prior to issuing any proposals for reform.”