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Impact Investing

IPE special report May 2018

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Something for everyone

It was expected to be the final piece of the European financial services jigsaw.
In time-honoured European tradition, though, it came as something of a shape-shifter … a little bit of everything for everybody.
The draft directive on supplementary pension funds has at times been held up as the potential lever for a Europe-wide consensus on labour law, investment rules, freedom of movement and competition – the bedrock for truly pan-European pensions. There is some way to go, but the direction is undoubtedly sound.
The generic name plumped for by the Commission in dealing with supplementary pensions ‘Institutions for Occupational Retirement Provision’ (IORP) gives some clues as to the difficulties encountered in producing such a directive.
What the directive did represent is a firm step in the right direction towards cross-border pensions, with the introduction of a ‘European passport’ type arrangement.
Companies setting up pension funds in another member state will now be able to manage these according to the investment and prudential rules of the home country, whilst ‘respecting’ the labour and social laws of the host nation.
The Commission also notes that it is seeking ways to move towards tax neutrality between domestic funds and funds established in other member states.
On the subject of prudential investment rules, the Commission holds up a qualitative approach to investment as ‘preferable’ for IORPs.
“As a general rule, asset allocation must be prudent. This requires above all, a proper diversification in terms of issuers, types of securities, country/geographical zone, currency and industrial sector.”
But, qualifying its original statement, the Commission adds: “Member states should be given some discretion on the precise investment rules they wish to require from institutions in their own territories” – following, as the directive notes, the outline of the former insurance directive.
Dig deeper in the proposals and the Commission has laid down a kind of preferential framework for IORPs, stating that they should be given the ‘possibility’ to invest up to 70% of the assets in shares or corporate bonds and hold assets in non-matching securities to the liabilities of at least 30%.
This of course does not preclude anything when the member state opt-out to “require the application of more stringent rules on an individual basis, provided they are prudentially justified” is applied.
As the Commission notes: “Supervisory methods and practices vary amongst member states. Therefore member states should be given some discretion on the precise investment rules that they wish to require from the institutions established in their territories. However, these rules must not inhibit the free flow of capital, unless justified on prudential grounds.”
Much will depend on how strict member state interference is for non-domestic pension funds.
The directive does completely remove restrictions regarding the free choice of investment manager and custodian within the EU.
It also lays down clear ground on the issue of competition between entities offering long-term savings products – including life assurance groups.
Somewhat controversially perhaps – particularly in the political arena where the directive must go for ratification – the report makes scant mention of ‘biometric risk’ as an element of occupational retirement provision – an issue regarded as a potential stumbling block.
And some adverse reaction may also emanate from member states such as Greece and Portugal with regard to the opt-out clause for exclusion from the scope of the directive companies with less than 100 members, bearing in mind the high proportion of their respective workforces this will represent.
Eyebrows have also been raised at the complete exclusion of the book reserve system and Germany’s ‘Unterstutzungskasse’ from the remit of the directive, which the Commission says is due to the fact that “members have no legal rights to benefits of a certain amount and where their interest are protected by a solvency insurance”.
As expected, clear separation of the sponsor and fund is stressed in the paper.
Reporting to members via annual accounts and regular briefings is also set in stone as a necessary move toward proper pension fund accountability.

Beneficiaries will be provided with details of the ‘financial soundness’ of the institution, ‘contractual rules’, ‘benefits’ and the actual financing of accrued pension entitlements.
A statement of investment principles (SIP) must also be drawn up by the IORP at least every three years – and be available on request to members.
The directive also notes that these powers of accountability can be transferred on to ‘outsourced’ elements within the pensions management chain.
At its base the report states that IORP’s have to be run on a sound actuarial basis, with cross border elements kept “fully funded at all times”.
It is interesting to note, however, that the directive allows for some dynamism in the funding levels for the scheme of the home country as long as the plan conforms to existing legislation on this (directive 80/987 – 20 Oct 1980).
A detailed plan must be in place for re-establishment of full funding and any shift from full liability cover must be in accordance with the local regulator.
Funds which do provide for biometric risk or offer any guarantees, however, will have to hold on a permanent basis additional assets above the scheme’s technical provisions.
On investment rules, the requirement for prudent rules for DC schemes with proper diversification and no more than 5% investment in the sponsor plan, is reiterated.

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