Major step in right direction
I t has taken 12 years for the Directive to be approved by the European Council earlier this year. It was a long saga starting in 1991 with the first initiative of Commissioner Sir Leon Brittain; there were many ups and downs with the darkest point in 1994 when the European Court of Justice ordered the withdrawal of the proposal on a case introduced by France and supported by Spain.
Now all member states have approved the directive including France and Spain with only one, Belgium oddly enough, abstaining.
There was a lot of controversy about this proposal and about the whole subject of supplementary pensions, even about the need for a directive and this is not surprising. The second pension pillar in an EU context is characterised by its large diversity of types of plans, financing methods, providers, regulation, taxation and supervision.
It was, however, not conceivable that the single currency and European capital markets could function properly without a pensions directive. As without greater convergence in pension matters imbalances between member states would be accentuated and for that a heavy price would need to be paid sooner rather than later.
Later on there was another pressing reason: a directive was needed before the 10 new member states from central and eastern Europe would join the union. The directive for them would become an “acquis communautaire”, which would facilitate their quicker integration into the EU to reduce their enormous cost burden related to pensions financing.
After the commission was beaten down by the ECJ, many predicted that it would take years, even decades, before new initiatives would emerge. This was proven to be wrong. In 1997, Commissioner Monti relaunched the programme and was readily assisted by the European Federation for Retirement Provision1 with this.
Much had to be done after Commissioner Monti dared to take a new initiative to avoid the previous stumbling blocks and to put a new Proposal on the right track. One of the tools employed was the ‘Rebuilding Pensions’ report, which we had the honour to write and which was published by the European Commission in 1999.
According to this report, an ideal directive should ensure security on the asset and liability sides and improve efficiency and affordability. It should create an environment of transparency and introduce responsibility and accountability at the level of each fund while establishing a qualitative approach to investments as opposed to quantitative restrictions. It should apply best practice in terms of communication to members and beneficiaries. The responsible authorities should ensure adequate supervision including co-operation between the member states; it was also necessary to create a level playing between providers for similar operations and to allow for cross-border membership and ultimately pan-European pension funds.
Whereas in 1994 many were relieved with the withdrawal because the eternal compromising had emptied the directive of its content and the slogan “Better no directive than a bad one” was widely heard.
We cannot say this about the new approved text. However incomplete it may be, most would agree now on “Better a directive than none” and that it is more than the “lowest common denominator” of agreement between the member states. We dare to add that it is a major achievement considering the still wide divergences among the member states on this subject.
Once the directive exists it needs to be implemented in national regulation within only two years.
We recognise that a lot of good work was done by the Spanish presidency and thereafter by the European Parliament and the Council. We regret that the whole procedure before approving a directive is long and cumbersome and that the Commission has no right of initiative once a proposal is official. We also regret that those that had this opportunity (The Council, the European Parliament) have not adapted it, at least not sufficiently in our view, to current needs.
Much has changed after the bull market which ended in 2000 and many pension funds, irrespective whether these are DB or DC, are a lot poorer now. Although the directive firmly established the link between assets and liabilities which was a major improvement vis-à-vis the 1991 proposal, we have always regretted that the opportunity to introduce a much more modern system of ‘Dynamic minimum funding requirement’ (DMFR), which establishes the minimum funding ratio on the basis of risk budgeting by combining three factors – assets, liabilities and the age profile of members/maturity of the plan - has not been taken on board.
The current experience and problems demonstrate that the old solvency requirements are too rigid, inadequate and do not offer the required level of protection.
Once a directive exists, it can be improved upon, to take into account these changed circumstances and the Commission ought to take new initiatives, in our view, as soon as possible.
Another area where new initiatives may be needed later on is on the assets side related to investment restrictions. Although the basis is the prudent man principle, member states may be more restrictive if they wish. This is fortunately corrected and there is now a transition period of maximum five years for this exception. This may, however, not be enough in view of the hectic circumstances on the capital markets. All tools required to support better and more secure returns may need to be made more explicit. There is a real danger that member states will be over-restrictive and that opportunities may be lost. We particularly think of better risk management.
We agree that sponsors and participants need to be protected against their own greed to some degree. We are very happy that there is a limit on self-investment and that therefore the Enron pension drama of concentrated investment in their 401(k) plan is impossible.
We think, as opposed to many, that the directive needs to be a framework regulation – it cannot be more in view of the subsidiarity principle – and that it is sufficiently detailed to guide member states. We are particularly happy with article 12 which imposes a written statement of investment policy (and risk) principles (SIPP) on trustees. It combines assets, liabilities and risk. It should not be another piece of paper or another layer of bureaucracy as some pretended, but acts as a central instrument to make usually risk averse trustees more aware of risks and opportunities. They are now directly responsible for the strategic asset allocation, the risk measurement and risk management processes, all related to the “nature and duration of pension liabilities”. It is a major step in the right direction for modern asset and risk management as it makes trustees accountable vis-à-vis the supervisory authority and the members.
Transparency and the role of the supervisory authorities are strongly enhanced and there is now a foundation for greater convergence to a common approach for their supervisory tasks.
This is all the more important now that the ground work for cross-border provision is laid down (article 20); it is to be hoped that progress will be made on taxation issues which are still a major stumbling block for cross-border provision and pan-European pension funds. Those that think that taxation issues should have been integrated in the directive are wrong: that would have killed it… unanimity at the level of the Council is required, as much as social protection issues would have killed it for the same reason. If some think that social protection issues are not sufficiently covered, let them take initiatives at the level of the Council admitting that unanimity is required or let them change the treaty; we are not opposed to that, but most will admit it would take a very long time to achieve this.
The commission will have to make sure that member states implement the directive correctly and positively and it must from now on start preparing new initiatives in areas where the directive can be improved upon, some of which we have already referred to.
A lot more is indeed needed to co-ordinate and guide second pillar pension systems because in today’s reality, countries are growing apart with pension reform rather than together. It is, therefore, a challenge for member states and candidate member states to grasp this opportunity to reform second pillar pensions with a common objective of security, efficiency and affordability and with plenty of opportunity - in the true meaning of subsidiarity - to emphasise certain unique local needs and characteristics. We hope that the member states will be positively inventive and converge where possible to their own benefit to ensure good as well as secure second pillar pensions at the lowest possible cost for the largest number of people.
Only then will second pillar funded pensions be of sufficient assistance to the gigantic challenge of sustaining first pillar pensions which are much more than the second pillar vulnerable to the irreversible ageing process. Second pillar pensions are less vulnerable to this but all the more so to the vagaries of the capital markets. Together they can re-enforce each other and assure a decent replacement income.
We think that the service providers have a major role of promoting the correct implementation of the directive in the member states and we are convinced that they can do that to their own advantage as potential for business will expand.
With all the gloom and doom nowadays and with the objective of sustainable first pillar pensions and affordable funded second pillar pensions it is conceivable that European capital markets will expand in quantum leaps over the long term and that the now sub-optimal recycling of European savings will be reversed to the benefit of job creation, capital market expansion and, last but not least, pensions security. For this, initiatives on a grander scale are required, maybe a “Welfare Maastricht”. If that can help to avoid the spectrum of deflation, we should not wait a day.
1 EFRP Report 1996 ‘European Pension Funds: their impact on European Capital Markets and Competitiveness’
Koen de Ryck is managing director of Pragma Consulting in Brussels. He acted as the representative of the European Federation for Retiremant Provision in Brussels from 1990 to 1997.