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From Our Perspective: Unity in opposition

They may not be wielding pitchforks but Europe’s pension fund community is of one mind: the stress test proposal of the European Insurance and Occupational Pension Fund Authority (EIOPA) is something they, their sponsors, their regulators and, above all, their members, do not need.

No-one wants to see weak or poorly managed retirement institutions but there is a balance to be struck between EIOPA’s right to understand and analyse the risks pension funds face and the need for funds and national regulators to get on with their job. It is not clear that EIOPA (the European Insurance and Occupational Pensions Authority) is getting that balance right.

As it has expanded in recent years (staff numbers grew by over 20% in 2013 alone, from 91 to 110), EIOPA has matured in its vision and has widened its scope. This has included carrying on with the highly criticised holistic balance sheet proposals, despite the fact that the European Commission has dropped the proposal from the IORP II Directive. 

Those who run Europe’s occupational pensions sector and know it best do not share EIOPA’s vision. The Frankfurt-based authority’s stress test exercise has left the industry nonplussed, and even more so in the face of the decision to stress test the impact of the holistic balance sheet. The results of the stress tests may not be a foregone conclusion, although it is highly likely that they will ‘reveal’ vulnerabilities to the two main scenarios – a negative demand shock and a negative demand-and-supply shock. The imposition of a risk-free benchmark through the holistic balance sheet would, unsurprisingly, lead to a perhaps unsustainable rise in liabilities. 

One key objection from the industry is that stress tests are simply a snapshot that bears little relation to the long-term ability of institutions to bear the shocks. That is the job of good prudential regulation (which already exists). Stress tests reveal symptoms but not underlying issues causing problems. It is ironic that pension funds (as other investors) have endured since 2009 a macroeconomic environment that would have been considered extreme outliers in a pre-crisis environment.

For its part, EIOPA is keen to emphasise that it has not indulged in a ‘copy and paste’ exercise derived from insurance sector stress tests, and will take into account sponsor support mechanisms and the ability to reduce benefits. Regarding defined contribution pensions, the aim is to look at replacement rates and system design. But it is hard to determine what EIOPA believes it will learn from the whole exercise.

Flagging the stress tests last year, the chairman of EIOPA’s financial stability committee, Patrick Derlap, noted that the biggest problem for Europe’s pension funds was the lack of unified regulation. Given the complexity of national regulation and the diversity of tax treatment, this is hardly a novel point. And given the EU’s lack of scope on taxation matters, there is little incentive or need for this to change in the immediate term. 

To put matters in perspective, defined benefit pension funds are increasingly a legacy issue. One of the key risks these funds face is regulation that fails to understand the necessary balance between retirement security and freedom to invest with an appropriate level of risk for the underlying members. As has been seen in the Netherlands, the desire to promote security has a profound impact on stakeholders and the wider economy. Insurance-like security comes with a high price that may not be affordable. 

What can be measured can be managed, is an old adage of management consultancy. In this measurement exercise, however, it is not clear what could be managed differently or better in the future. 

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