Last month I argued that the European Commission should go back to first principles with its proposed reform to the IORP Directive and focus on cross-border DC activity. Since then, conversations and debates at a number of conferences have reinforced that view.

Other aspects of the response of the European Insurance and Occupational Pensions Authority (EIOPA) to the EC’s call for advice (CfA), which I did not have space to mention last month, are worth discussion ahead of draft legislation.

Parts of the EIOPA document are pragmatic, such as the “holistic balance sheet” proposal which would take into account the sponsor promise as an asset similar to reinsurance. But this would be highly complex in practice.

EIOPA’s proposed obligation for supervisors to take into account “potential pro-cyclical effects of their actions in case of extreme stress” also sounds pragmatic. But the Commission should beware of unintended consequences.

The herd effect of piling into ‘risk free’ assets was evident in the Netherlands after the introduction of the FTK, as pension funds tried to hedge their liabilities at the same point on the swap curve. The net result was a depression in the swap rate and a commensurate increase in the liabilities of all funds.

Pension security is important but too much security is detrimental to the economy if company sponsors have to make up deficits too quickly. Any approach to funding of deficits under new EU solvency rules will have to be pragmatic but the end result would probably just be longer recovery periods.

An aspiration for a 99.5% confidence level for solvency capital ratio is also admirable. But as the EIOPA document notes, this may give members a false sense of security. Value-at-risk models, upon which such calculations are made, are questionable and were originally designed to measure short-term volatility of investment banks’ proprietary trading books.

In its current form, IORP II will end up as a Directive that primarily regulates the UK, the Netherlands and Ireland, since so many EU pension systems are effectively outside the scope of the IORP Directive. This is itself highly undesirable.

Four words are still spooking Europe’s pension fund community - “economic risk based solvency” - which is the European Commission’s term for applying a variant of Solvency II rules to occupational pension funds.

The EC accepts the differences between insurance and occupational pensions but, nevertheless, seeks “to maintain consistency across economic sectors”. This sounds like code for applying rules akin to Solvency II and the two objectives appear irreconcilable.
Rarely can the European Commission have been so greatly at odds with an industry it intends to regulate.