Focus on DC
It is difficult to retain sight of the founding principles of the EU's Pensions Directive (IORP) when confronted with the 500-page response of the European Insurance and Occupational Pensions Authority (EIOPA) to the EC's call for advice last April on its review of the legislation.
The pan-European pension goal was already alive in the 1990s and the IORP Directive accepted the European Federation for Retirement Provision's 2000 proposal for a European IORP that would pool assets in a single vehicle while beneficiaries' entitlements remain subject to national social and labour laws.
Multinationals were the target audience and it was thought that the likes of Unilever or Shell would eagerly embrace this concept. In fact, today, there are currently only just 84 cross-border pension funds, many of which are active in the UK and Ireland - the two EU member states with the most in common, in terms of pensions legislation.
Beyond that, the complexities start: in the IORP Directive's current version, a cross-border entity is subject to a funding standard that references Solvency I; therefore the Directive will be obsolete by the enactment of Solvency II.
Now the original aim of the IORP Directive has been equalled by the Commission's desire to maintain consistency in financial services legislation to avoid regulatory arbitrage. The idea is that all EU member states should enact an economic risk-based approach to pension supervision.
This is inadvisable for several reasons. First, an "economic risk-based approach" is code for one based on Solvency II to a greater or lesser extent. Solvency II itself is based on Basel risk-capital requirements for banks; the flaw is that these require notions of 97.5% or 99% certainty of capital ratio - themselves based on backward-looking investment return assumptions. In practice, these promote herd behaviour and might discourage prudent long-term investment behaviour.
Second, the Commission accepts the inherent differences between insurance companies and pension funds with a company as sponsor, so it should accept the need for a ‘different systems, different standards' approach.
EU member states are also moving away from traditional defined benefit systems and towards more flexible, hybrid risk-sharing approaches. Given the long-term nature of the liabilities of what are in many cases legacy DB arrangements, and noting the economic cost of moving to immediate full funding, member states like the UK are going to have to continue with very long recovery periods anyway.
The revised IORP Directive should focus on promoting cross-border activity and harmonising defined contribution pensions - particularly since the latter are likely to provide the main source of growth for the former. This would align a revised Directive with some of the main principles that informed the first.