Facing up to Europe

Written by Edmund Tirbutt
February 2014

The EU’s obsession with achieving a level playing field and ensuring that financial organisations are sufficiently robust to withstand major shocks has never sat comfortably with a UK pensions industry that has less to gain from it than most member states and more to lose.

Aries Pension & Insurance Systems director Ian Neale says: “European directives, court cases and other interventions are at best often an irritating distraction for UK pension finds. The impact is always to add to an administrative and cost burden, which already places the future viability of schemes in doubt. Not infrequently the fundamental problem is the huge difference between UK pension provision and the various systems in other EU member states, allied to their very different tax regimes.

“Attempts to impose community-wide rules often amount to comparing not merely apples and pears but chalk and cheese. It only adds to the sense of bewilderment and grievance felt by UK pension funds when EU bureaucrats fail to understand why, for example, the cross-border provisions have had so little take-up. If interference is to be forced upon us, the least we are entitled to expect is a proper understanding.”

IORP Directive

Most discontent has been expressed in relation to reforms intended to the 2003 Institutions for Occupational Retirement Provision (IORP) Directive, as the original plans threatened to incorporate significant funding elements of the Solvency II Directive currently proposed for the insurance industry.

The European Insurance and Occupational Pensions Authority (EIOPA) was suggesting the introduction of a ‘holistic balance sheet’, which UK pensions experts warned would increase funding requirements for defined benefit (DB) schemes to an extent that would result in more scheme closures and hamper economic growth by requiring capital that could be otherwise used for business expansion. Because the UK holds 60 per cent of all EU DB liabilities it stands to be disproportionately affected.

National Association of Pension Funds (NAPF) policy lead: EU & international James Walsh says: “The big concern for pension schemes was that the new funding scheme would include elements such as a risk-free discount rate for calculating pensions liabilities. EIOPA’s own research has shown that the proposals would increase the deficits of UK DB schemes from £300 billion to £450 billion.”

But in May 2013 the UK pensions industry breathed a huge sigh of relief when Commissioner Barnier decided to relegate the pillar one funding proposals to the back burner. Since then the focus has switched to pillars two and three, involving governance, communications and reporting, and also to new proposals dealing with cross-border schemes.

Walsh continues: “The cross-border reforms proposed are welcome as cross-border schemes must currently be fully-funded at all times, which is very demanding. But we are concerned that the proposals for governance and communications would increase costs without adding much value.

“For example, pensions have to produce a rigorous risk evaluation which would involve a lot of work and little benefit. They will also have to report to members using a standard EU form even though different states have different pension rules and formats.”

Even if, as expected, the draft directive is released this February, the advent of the European elections this May makes serious progress unlikely until 2015. Pension schemes should be vigilant about the risks, but at the same time they need to keep the matter in perspective.

Punter Southall head of research Jane Beverley says: “There could be some complex documentation around risk which could be very time consuming but IORPs is probably not the immediate matter on the agenda and should perhaps be a subsequent priority to UK requirements like the DB funding code of practice and DC governance code of practice.”

It’s also important to keep an eye out for a resurrection of the funding proposals, which have only been temporarily shelved.

JLT Benefit Solutions director Charles Cowling says: “Don’t take your foot off the pedal just because Europe is taking a break and having an election. Solvency II is not going away and we are not going to wind the clock back to where regulators gave pensions a very light touch.”

Emir

A watching brief is also highly necessary on the investment side, with this year likely to see the implementation of two further tranches of the European Market Infrastructure Regulation (Emir ) – introduced originally in 2012 to reform the derivatives market.

From 12 February 2014 all counterparties will be required to report details of any OTC or exchange-traded derivative trades outstanding on 12 February or that have been traded since August 2012.

Then, of potentially even greater significance is likely to be the implementation in late 2014 of a clearing obligation designed to have a clearing body sitting between two parties of any trade to ensure that if either party becomes insolvent the other can be refunded. Pension schemes initially have an exemption from this requirement until 2015, and this could potentially be extended until 2018 if issues with central clearing haven’t been sorted. But, as with pillar one, the issue isn’t going to conveniently go away.

P-Solve managing director Mark Davies says: “The transparency standards require around 85 bits of data about every trade to be given to the repository, so lots of data will need to be uploaded. Nevertheless, this will only have an operational impact that affects the back office as opposed to the investment side. So it’s really just a question of being efficient to ensure it doesn’t increase costs.

“But moving to a central clearing model is likely to be more onerous because the central body has to be heavily collateralised, so it could have a significant investment impact on pension schemes. Schemes will ultimately have to clear, either because the exemption runs out or because market pricing demands it, and the collateral needed will potentially leave less assets available for return generation. The requirements also imply schemes must hold significantly more cash than they currently do.”

AIFMD

Fortunately, UK pension schemes appear to have less to worry about than other European counterparts with regard to the Alternative Investment Fund Managers Directive (AIFMD), which came into force in July 2013 to provide an EU-wide harmonised framework for monitoring and supervising risks posed by alternative investment fund managers and for strengthening the internal market in alternative funds.

Aurum Funds CEO Kevin Gundle says: “Rather than creating a harmonised regulatory market place for investment funds, the AIFMD may have had the opposite effect for non-European based managers of alternative products looking to market their funds to EU based pension funds. Many non-EU managers will significantly reduce, if not abandon, EU marketing efforts, citing the cost of compliance as being too great.

“Pension funds in the UK are, however, likely to be less impacted by this that their peers in mainland Europe as non-EU based managers are able to continue to market in the UK under its long established and highly regarded private placement regime. If non-EU managers wish to choose just one EU jurisdiction in which to focus their marketing efforts, it will likely be the UK.”

Personal pensions

But last September’s renewal of calls by EIOPA for its mandate to be expanded to include personal pensions is enough to send shivers down many pension experts’ spines.

Russell Investments managing director of consulting and advisory services at Sorca Kelly-Scholte says: “Individuals will increasingly rely on the personal pensions sector as DB declines. Unless the focus shifts more towards investors’ need to generate wealth, it’s hard to feel enthusiastic about the European regulator’s powers being extended to personal pensions.”

Edmund Tirbutt is a freelance journalist

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