Member preferences and risk management: how sustainability is showing up in IORP III

When the European Commission published its proposed update to the IORP II Directive recently, it wasn’t its sustainability elements that caught the market’s attention.

The spotlight was instead on headline-grabbing plans to force pension funds to explain underperformance, and attempts to boost supplementary pensions.

But buried in the 90-page document are two proposed changes to how IORPs must address ESG factors.

Risk management becomes a must

First, the Commission wants to strengthen the language around the management of sustainability-related risks by stating that pension funds “shall” take them into account as part of the law’s prudent person principles.

“It may seem minor, but it’s actually quite important, because the previous version just said that member states must allow IORPs to take sustainability risks into account if they want to,” observes Jorik van Zanden, from Dutch investment consultancy AF Advisors.

“Now, they are saying pension funds must actually do so; so it’s moved from voluntary to a full-on requirement.”

According to the proposal, sustainability risks are – as per the Sustainable Finance Disclosure Regulation (SFDR) – those that, if they materialise, could have an actual or potential material negative impact on the value of an investment.

The Commission also says that, in line with SFDR, “IORPs shall take into account the potential long-term impact of their investment strategy and decisions on sustainability factors”.

“That shall be done in a proportionate manner, taking into account the nature, scale and complexity of the activities of IORPs,” it states.

Sustainability preferences make an appearance

The second proposed sustainability update to the IORP Directive is a completely new addition, rather than an amendment.

Back in 2023, the European Insurance and Occupational Pensions Authority (EIOPA) advised the Commission to revise IORP II to require investment decisions to “reflect the sustainability preferences of members and beneficiaries where IORPs can gauge those membership preferences”.

The integration of sustainability preferences into financial products has been a long-standing topic of debate among financial institutions, campaigners and regulators.

The EU has already introduced a requirement into MiFID II, to ensure retail investors are asked about their appetite for environmental and social impacts when choosing a new product.

Last year, Laura van Geest, the president of Dutch financial regulator AFM, said pension funds should consult their members on the topic, and base their investment policies on their wishes.

Pensioenfonds Detailhandel has already introduced a process through which it teaches its members about sustainability topics and then asks them for a steer on which ones its board should prioritise.

EIOPA advised: “IORPs should be required to pursue positive sustainability goals in their investment and engagement activity if it is in line with the members’ and beneficiaries’ preferences and it is in their long-term best interest”.

And the Commission appears to have listened.

“Member states shall require that investment decisions of IORPs reflect the sustainability preferences of members and beneficiaries, where IORPS are able to gauge those membership preferences and to the extent those preferences are consistent with the investment principles set out in paragraph 1,” says its legislative proposal.

Paragraph One refers to the prudent person principles.

The text doesn’t specify how a pension fund would “gauge” member preferences, and EIOPA’s previous advice acknowledges they “may not always be easy to determine”.

It’s likely that, if the plan makes it through political negotiations, the details will be left to national lawmakers so that they can draw up rules that suit the varying domestic structures and traits of IORPs.

SFDR and Taxonomy

While the Commission isn’t prescriptive about how to canvass pension savers, it is quite clear on the sustainability choice they should be given.

According to the document, members and prospective members should be asked whether and how much they want the EU Taxonomy, the SFDR and the concept of Principle Adverse Impacts integrated into their investments.

It’s perhaps not an obvious time to introduce these three legislative concepts into IORP III.

The same week the Commission tabled its proposal, it unveiled another one, which will see it remove Principle Adverse Impact requirements from the SFDR, and loosen the regulation in other ways.

It is also in the midst of reducing the scope of the Taxonomy Regulation by around 90%. Those efforts are part of the EU’s Omnibus I initiative, which will deregulate sustainable finance, and mean much less information is provided to pension funds.

On the surface, the two agendas – adding more sustainability into IORP III while pursuing the Omnibus – are at odds with each other. But van Zanden notes that IORP III is part of the bloc’s Savings and Investments Union.

“So it’s part of a package to establish an internal capital market, and stimulate investment into the EU’s two flagship agendas: the digital transition and the green transition.”

“If you were to activate workplace savings for sustainable investment, you’d have a lot of capital to funnel into green assets, so the proposals are actually compatible with the EU’s current approach,” he says.

Council is expected to begin its negotiations on the proposal on Monday 1 December 2025. Trialogues are likely to begin in the new year.

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