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Holistic Balance Sheet: Damned if you do, damned if you don’t

The European Insurance and Occupational Pensions Authority (EIOPA) is often seen as the bogeyman of the industry, and many criticise even the smallest point put forward by the team surrounding chairman Gabriel Bernardino in Frankfurt.

So it comes as no surprise when, after a technical consultation surrounding the holistic balance sheet (HBS), some would seek to damn the supervisor with faint praise, or even point out that, now that it has caved in to industry demands, the whole project is pointless. 

The consultation was unwanted and viewed by many as an attempt by EIOPA to continue work on despised capital requirements even after the European Commission dropped them from the revised IORP II Directive. 

In response to the question of whether EIOPA should consider a transitional period for the introduction of the HBS, or even a clause whereby past accrual is excluded, the UK’s National Association of Pension Funds (NAPF) says it is to be welcomed. 

The association goes on to say that this would exclude large parts of the UK defined benefit (DB) industry, either closed to new accrual or likely to be closed in near future. 

It then adds: “This approach would, of course, reduce the effectiveness of the HBS as a means of protecting the full range of members’ benefits and, therefore, call into question the value of the whole exercise.”

Several pension associations, including Germany’s aba, were blunt in their assessment of the HBS. “If it is sound, it isn’t practical; and if it is workable, its results are questionable,” the aba says. 

“While without doubt EIOPA has invested a lot of time in the HBS, we do not think the presented concept is to any degree satisfactory. 

“The parts that are intellectually coherent are impossible for IORPs to comply with, given their limited resources.”

The Dutch Pensions Federation (PF) is also critical, noting the proposed HBS has “fundamental shortcomings [and] is too complex”. 

It adds: “If properly analysed, there might be a possibility to apply the HBS for the purpose of risk management. But even then, the HBS remains a very complex and expensive instrument.”

EIOPA’s occupational pensions stakeholder group is less blunt in the assessment, but nonetheless warns that accommodating a prolonged transitional period could cause problems and would not be recommended, even where necessary. 

“Therefore, the choice of the supervisory framework should also be evaluated compared with the duration of transitional periods.”

Protection schemes
The way in which the HBS would account for pension protection schemes, both in Germany and the UK, has also come in for scrutiny, with the UK’s Pension Protection Fund (PPF) raising concerns that it could be in conflict with a trustee’s duty.

It says that, depending on how the HBS is implemented, it could result in trustees breaching their fiduciary duty, as the protection calculated as part of the balancing item would be below the total guarantee offered as long as any UK fund stayed outside the PPF.  

“In cases where protection is 100%, we can see that inclusion of the pension protection fund on the balance sheet is less problematic, as it avoids the risk that scheme managers will target a level of benefits less than the full scheme promise,” the fund’s response adds. 

“However, we do not think this prevents including on the balance sheet a pension protection scheme that protects less than 100% of scheme benefits – so long as it is not used as the basis for funding/solvency requirements.”

Solvency requirements
The PF also takes issue with the imposition of solvency capital requirements (SCR), as it would introduce further cross-generational subsidies due to the need to fund requirements from current contributions. 

“Irrespective of the initial financial situation of the fund,” it says, “current members would always have to make transfers to future generations, which implies an unbalanced approach to the different generations of participants in the IORP.”

The sentiment is echoed by PensionsEurope, which raises issues with how the SCR will impact a fund’s ability to offer conditional benefits, as is the case in the Netherlands, and become unconditional.

“Once the initially calculated capital charge is met by means of a higher funding ratio, the capital charge will have grown, as the value of the conditional benefit will be higher at a higher funding ratio,” it says.

“This leads to a spiral that will only stop once the maximum of the originally conditional benefit is granted, making it implicitly unconditional.”

Additional problems could arise, as conditional benefits would incur a double charge from both the upward potential and downward risk. 

“This,” PensionsEurope concludes, “would result in taking less risk, which is likely to be harmful for members of a pension fund as lower returns lead to lower pensions and higher contributions.” 

Stifled growth
Finally, the industry warns that growth could be stifled by the HBS. Armed with information stemming both from the previous quantitative impact study (QIS) and analysis conducted by UK government and industry groups, the majority of submissions conclude that the requirement to address the underfunding in schemes would reduce GDP, as funds will no longer be able to commit to long-term assets that boost the economy.

“Investing in long-term investments such as infrastructure, for example, will lead to high(er) capital requirements, where government bonds/interest-rate swaps are treated as ‘risk-free’,” PensionsEurope says. 

The NAPF also warns of the impact, citing other European institutions to back up its claim. 

“The European Central Bank has warned that an HBS-based regulatory regime could undermine investment in growth assets and push more investment towards low-risk bonds,” it says.

“This is a significant critique, directly relevant to Europe’s economic future, and the NAPF urges EIOPA to take careful note of it.”

The next step for EIOPA will be to conduct a further QIS, although Aon Hewitt recommends it set such an option to one side until deciding on the fate of legacy deficits to retain the good will of the industry and reduce unnecessary workloads. 

Whether it heeds the industry’s advice or pushes ahead with further research, the supervisor will be open to criticism from all sides. It remains firmly lodged between a rock and a hard place. 

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