Getting a place at the public hearing on the revised IORP Directive in Brussels was quite a challenge. The 400 seats the European Commission set aside for the pension fund industry were all spoken for within a matter of days. Nobody wanted to miss the chance to hear what Brussels had to say on the topic of solvency. And Commissioner Michel Barnier did not disappoint when he kicked off the day by grouching that the Commission had never "said or implied" that pension funds would be subject to the same rules as set out in Solvency II.

One would be forgiven for thinking this opening remark would come as a breath of fresh air for attendees who had been fighting for years to convince Brussels to abandon the notion of a ‘level playing field' with insurance companies. But quite the opposite happened. It set off a wave of grumbling in the audience, with a number of pension figures asking the Commission to then stop mentioning Solvency II if it had no intention of copying and pasting it into the IORP Directive.

Solvency II - the main issues
The question of whether the revised IORP Directive should be in accord with the Solvency II framework adopted for insurance companies has dragged on for years now. Yet the debate over whether to create a level playing field between pension funds and insurers remains as heated as ever.

The Commission has stipulated that the IORP Directive should serve as the starting point for any new pensions supervisory regime. But it has also indicated that the resulting regime should be compatible with the approach and rules set out in Solvency II.

This last point has proven to be by far the most controversial. As Brendan Kennedy, chief executive at the Irish Pensions Board, points out, IORPs are not merely financial institutions. "In many member states, they are not only subject to financial rules but they are also in many cases governed by social and labour laws," he says. "As opposed to insurance companies, we have a wide range of pension types, as well as a wide range of funding scenarios and a wide range of security mechanisms to take into consideration."

Kennedy's views on the matter are unequivocal, and he would appear to speak for many in the industry, yet it is still not immediately clear exactly what impact a Solvency II regime would have on pension funds. The Solvency II framework is based on three pillars - the first focuses on valuation and the calculation of minimum capital requirements, while the second and third provide guidance on governance and transparency. While the industry has embraced the latter two, the first pillar has obviously been a sticking point.

The reason for such concerns is the additional costs some pension funds would incur. Several sets of data published by a number of bodies conclude that a solvency framework would prove extremely costly for defined benefit (DB) pension schemes. Studies by JP Morgan Asset Management and PwC, to name but two, show that the overall extra cost would range between £600bn (€722bn) and £1trn.

It is fair to say that, with all the uncertainty surrounding the ultimate impact of Solvency II, there will be no shortage of worst-case scenarios. But because we still do not know where the fundamental modelling of cost is going to end up, the only thing we are left with is a very approximate final outcome.

One option might be to substitute the first pillar of Solvency II with a holistic balance sheet approach - a proposal supported by EIOPA in its response. That would require pension plan sponsors to post additional capital to cover operational risk where the members bear the risks - such as in defined contribution (DC) plans. But this option still entails additional capital requirements, which has been rejected by much of the industry.

Respecting the second and third pillars, the need to ensure good governance and a transparent system remains one of the cornerstones of the revised IORP Directive. But again, a copy and paste exercise from Solvency II would be unwelcome. Klaus Stiefermann, managing director of the German Occupational Pensions Association (Aba), points out that his country's regulator has already covered this ground. "The questions raised have already been addressed in Germany," he says.

Yet another bone of contention has been the timing of the whole affair, which many in the industry consider rushed. But even though the industry has questioned the "tight" deadlines the Commission has imposed on itself to publish a draft version of the revised Directive, others remain confident the powers that be will weigh EIOPA's advice very carefully. Gerard Riemen, director at the Dutch Pensions Federation, just might be the voice of reason when he says: "I cannot imagine a process at the Commission where they would ignore the results of the impact studies and where they would ignore the advice from EIOPA."

White Paper on Pensions
After several delays, the White Paper on Pensions was finally published on 29 February. The report had been long awaited for at least two reasons.

First, the Commission clearly set the tone of how it intends to reform European pension funds. Brussels said it would encourage member states to implement wide-ranging reforms by providing financial support, as well as extend the working lives of employees. Pension reforms already set in motion would see lower replacement rates from public schemes, while complementary retirement savings would be expected to play a more important role.

The second reason the industry was so keen to get a glimpse of the White Paper was to see whether the Commission had softened its stance on Solvency II, and many reading proposal number 11 will have been dismayed. "The Commission," it reads, "will in 2012 present a legislative proposal to review the IORP Directive. The aim of the review is to maintain a level playing field with Solvency II."

Matti Leppälä, secretary general of the European Federation for Retirement Provision (EFRP), speaks for many when he attacks the Commission's very starting point. He says the explicit reference to a level playing field is not the right way to take the review forward, as the ‘same risks, same rules' argument on which it is based "does not hold".

What is more, two leaked draft versions of the White Paper made no reference to Solvency II whatsoever, leaving many in the industry feeling misled by its inclusion in the final version.

Not everyone feels caught off guard by the move, however. James Walsh, senior policy adviser at the National Association of Pension Funds, points out that the Commission had been clear throughout the review that its objective had been to bring the IORP Directive into line with Solvency II. If we want to judge the state of the Commission's thinking on the Directive, he says, we should "look at the Directive directly, rather than looking at the White Paper".

At the time the Green Paper was published, Brussels did indeed suggest the solvency regime for pension funds might be improved. It also conceded that the sustainability of Solvency II for pension funds would need to be considered in a rigorous impact assessment, examining the influence on price in particular.

And to be fair, this idea of conducting quantitative impact studies has been mentioned many times by the Commission and EIOPA in the recent months, with both saying at length that they would take into account all the results of such tests.

In the meantime, the pensions industry has not missed a single opportunity to voice grave concerns over the ‘level playing field' scenario. The fact the Commission continues to allude to a Solvency approach for pension funds - or refuses to rule it out - has only added to the industry's sense that it has not been listened to. This is where the real issue lies.

Yet another spanner
Jonathan Faull, director general of internal markets and services at the Commission, warned that past service could not be ignored for DB schemes. "Pension promises have been delivered in a manner that has undervalued the real cost of the pension promise," he said. "If we were to apply more rigorous rules to the back book of the pension funds, this would most likely be financially unsustainable."

This last remark highlights the Commission's awareness that additional capital requirements for accrued rights are inapplicable. More important, Faull's comments suggest that Brussels is currently considering a two-tier regime approach. This would mean it might either exclude accrued rights from the solvency capital requirement measures, or adopt the solvency capital requirements for accrued rights gradually, say, over a 20-year period.

However - and as opposed to past rights - the Commission would still be likely to impose the solvency capital requirements for accruing rights. This would either be implemented immediately after the revised IORP Directive is put in place or over a short period.

The two-tier approach appears to be more appropriate than applying capital requirements to full rights. But this approach could still worry DB pension schemes, according to Dave Roberts, senior consultant at Towers Watson in the UK. "If you increase the solvency requirements for future rights, it is still likely to increase the closure of DB plans," he says. "But it is also fair to say that, if the industry was faced with the choice to either apply the rules to full rights or to future rights only, the response would obviously rather head towards accruing rights."