Buy Side Slams EU Pension Directive Proposals

Terry Flanagan

Industry groups are worried that potential changes to the European Union’s revised pension fund directive could bring catastrophic consequences to the region’s equity markets.

The directive, known as IORP II, which is unlikely to come into effect before 2017, is about to undergo an impact study by the European Insurance and Occupational Pensions Authority (EIOPA), the pan-European pensions regulator, as it assesses different options for the valuation of the holistic balance sheet and the calculation of capital requirements.

But many pension funds are worried that the Solvency II insurance regulations, which are new capital requirements that insurers will have to hold from 2014 to reduce the risk of insolvency, may well used as a template for the revised pensions directive. Market participants say that pension funds and insurance companies have vastly different set-ups and liabilities to contend with and cannot be compared.

“Applying Solvency II style regulation to pension funds would accelerate the overall shift away from equity in global asset allocation, making it more difficult for companies to raise equity, thereby constraining their long-term funding and the growth potential of the European economy,” said Peter de Proft, director-general of the European Fund and Asset Management Association (Efama), a major buy side industry body.

“Furthermore, forcing all institutional investors with long liabilities to invest under the same rules, even if their structure is very different, would increase volatility and contribute to systemic risk. The quantitative impact study should therefore take into account the negative macroeconomic and financial impact of the proposed new regulatory framework for IORPs, in particular regarding market volatility and pro-cyclical effects.”

Pension funds are big buy-side institutional investors and critics of the proposed European Union reforms say the region’s pension schemes may be forced to adopt new trading strategies once the law is in place.

“Applying the market consistent approach of Solvency II to IORPs could create a perverse incentive for pension schemes to attempt to meet long-term liabilities with short-term investments,” said Dörte Höppner, secretary-general of the European Private Equity and Venture Capital Association, a trade body.

“This will be further exacerbated by erroneous risk weights for long-term investments such as infrastructure, private equity and venture capital. A more certain future for Europe’s savers and pensioners is certainly warranted. Protecting the virtuous relationship between long-term growth asset classes and long-term investors is the way to start.”

Under the planned proposals, the European Commission is looking to force pension funds to avoid risky investments and to hold larger cash buffers to guard against market volatility, while increasing cross-border competition and tightening supervision.

A main bone of contention revolves around the holistic balance sheet approach, which EIOPA introduced in February as a way of assessing scheme funding which would take into account sponsor support and contingent assets as well as financial assets. The value of liabilities would include a capital buffer as well as the value of benefits.

“We continue to question the appropriateness of this tool and fear that the outcome of the exercise will be to impose a Solvency II-like framework for pension fund supervision,” said Efama.

The European Commission intends this to be the only study into the effectiveness of the proposals, despite industry groups wanting more exercises carried out. Efama is also concerned that sponsor support, pension protection schemes and risk margins will also not be considered in the EIOPA study.

Some economists also believe that the proposals may hasten the demise of the remaining defined benefit pension funds across Europe as they will become too expensive for employers to maintain.

The Solvency II directive, meanwhile, is currently being held up in Brussels and it may be delayed for a further two years—with a possible start date of 2016—given the failure of the European parliament and the Council of the European Union to reach agreement on the regime’s treatment of products with long-term guarantees.

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