What do regulators need?
Pension regulators come in a variety of shapes and forms. Sometimes those forms change to reflect prevailing wisdom on the best constitution of financial regulatory and supervisory bodies.
The Netherlands merged its Pension and Insurance Chamber with the Nederlandsche Bank in 2004 to create a body with supervisory powers for pension institutions and insurers that also has responsibility for financial stability and acts as economic adviser to the Dutch government.
In the UK, the Labour government took the macro-prudential capabilities away from the Bank of England over 10 years ago when it wrapped a variety of product regulatory and institutional supervisory bodies into the Financial Services Authority.
Occupational pensions remained separate, however, in the guise of the Pensions Regulator and that institution will survive the current government’s latest reorganisation, which returns macro-prudential supervision to the Bank of England.
And in Frankfurt, of course, the European Insurance and Occupational Pensions Regulator (EIOPA) is a reconstituted CEIOPS (the former Committee of European Insurance and Occupational Pensions Supervisors) with enhanced powers. And at the beginning of this year it announced its intention to almost double its staff, from 28 to 50.
So here’s a tricky question: what do good pension regulatory and supervisory bodies need? Of course, they require detailed technical, legislative, regulatory and institutional knowledge, depending on their field, or a combination of all of the above to different degrees.
They also, of course, need granular knowledge of pension institutions, their goals, mission, modus operandi and everything in between. They also need the art of flexibility - to understand and adapt when olds rules are no longer fit for purpose.
In this sense it is perhaps more pertinent to ask what they don’t need. One thing they don’t need is organisational instability. Another thing pension supervisors shouldn’t have is a blind faith in models that have proven not to work. If pension solvency rules are predicated on capital buffers using a value-at-risk (VaR) type calculation, or a variation thereof, the regulator risks not understanding that the world has changed.
If some euro sovereign bonds are downgraded to CCC then it no longer makes sense to allocate them zero capital cost.
If left-tail risks have become more common, then longer recovery periods should be built into the system.
Following the G20 meeting in Pittsburgh in 2009, the EU and the US took the lead in financial reform to better navigate our financial system through turbulent times - the assumption being that we may live through turbulent times more often than we think.
In devising a funding framework for pension funds separate to Solvency II, the European Commission and EIOPA will doubtless also be preparing to navigate future storms. But it would be wrong not to build a level of flexibility into the system to ensure that institutions can take risk in good times and that they are not forced to sell risk assets at the same time as the herd in rocky periods, potentially condemning themselves to perpetual underfunding or costly sponsor bailouts.
Risk is an integral part of a funded pension system; it is also an integral part of an unfunded pay-as-you-go system: how do we know our governments will still be around in coming decades to pay pensions?
Regulators and supervisors of all types should build up their expertise on all aspects of capital markets. They should also recognise the role that risk plays in our pensions system and should work towards creating funding and solvency rules that take better account of it.