EU Pensions initiatives and cross-border pension provision. Tim Reay Double Century Club 11 November 2004

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1 EU Pensions initiatives and cross-border pension provision Tim Reay Double Century Club 11 November 2004

2 EU Pensions initiatives and cross-border pension provision EU update and progress report What do employers want? What does everyone here think? 2

3 EU update and progress report Milestones 1975: Double Century Club formed 1989: Leon Brittan s draft directive 1992: Bachmann v. Belgium 1998: Posted workers pension directive 1999: First draft of IORP Directive 2001: Tax Communication 2002: Danner v. Finland 2003: Skandia v. Sweden 2003: IORP Directive to be implemented by 2005 Ongoing: Legal action by Commission 3

4 EU update and progress report Background : Motivation behind IORP Directive Level playing field for providers pension fund seen primarily as a product open funds across the Continent No impact on benefit design was intended Two distinct relationships contract between employer and employee, promising a level of benefit contract between employer and financial services provider, financing that benefit UK/Irish trust model doesn t always fit this 4

5 EU update and progress report IORP Directive and Tax Communication Tax relief on contributions within the EU cannot be refused on grounds of nationality/location in itself non-conformity with national supervisory rules but tax relief subject to local limits no obligation to discriminate in favour of non-domestic plans local employment law applies 5

6 EU update and progress report European Court rulings Danner v. Finland Finnish income tax law discriminates against foreign providers Discrimination cannot be justified on the grounds of better tax control / tax evasion Skandia v. Sweden Swedish company tax law discriminates against foreign providers Discrimination cannot be justified on the grounds of tax coherence 6

7 EU update and progress report European Commission infringement procedure Leonardo Sforza 7 London, 24 October 2003

8 EU update and progress report What is actually happening? Implementation of Directive UK Ireland Spain Germany Recall that 19 out of 20 articles don t deal with cross-border issues Application for cross-border registration At least two UK plans in Ireland 8

9 EU update and progress report Some of the challenges Funding requirement stronger for cross-border plans than for domestic plans fully funded at all times (on a locally-set basis) UK: 100% at each annual check how much stronger than for domestic plan? is it worth it? when does a plan become cross-border? 9

10 EU update and progress report Some of the challenges Local restrictions on plan design UK: lump sums limited to 25% of benefit NL: no lump sums (or lose approval) not much use for a Belgian resident, then 10

11 EU update and progress report Some of the challenges Local tax legislation German system favours unfunded plans no obligation to discriminate in favour of foreigners 11

12 EU update and progress report Some of the challenges How can host country investment restrictions be enforced? Ring-fencing of assets by home country? employers, and some authorities, are trying very hard to avoid this 12

13 EU update and progress report Biggest perceived challenge Home country (Where plan is based) Host country (Where employee is living/working) Supervisory/prudential requirements must follow home country laws the single passport principle behind the Directive Employment law must follow host country laws i.e. where employee is living and working Is it always clear which is which? 13

14 EU update and progress report Biggest perceived challenge What about, for example, vesting rules? e.g. preservation legislation in UK Should preservation apply to Any member of a UK-registered plan ( Home ) doesn t protect UK resident members of non-uk plans UK-resident members of any plans ( Host ) doesn t protect non-uk members of UK plans Both ( Home-and-host ) politically expedient! 14

15 Hewitt s 2003 survey of about 20 multinational employers: roughly a third of each of UK, US, Continental Europe, various sizes (15, ,000 employees, 2bn- 200bn turnover, EU plans) Other surveys by other organisations gave broadly the same message 15

16 Have you considered the possibility of establishing a single pan-european IORP? Yes, not yet, and no : equally distributed Are no and not yet in fact different? Did we ask the right question? big bang : introduce a pan-european IORP softly softly : choose a multi-country scheme and add countries one by one 16

17 Most important advantages of a multi-country plan: Better control over plan governance/benefit management/internal management time Savings on investment management fees Implementation of corporate investment strategy 17

18 Least important advantages of a multi-country plan: Savings in actuarial fees Increased purchasing power for risk insurance Enhanced corporate branding throughout region Maybe because some of these are independent of whether or not a multi-country plan is used? Most significant barriers to a multi-country plan: Current tax discrimination National regulatory restrictions Unions/member rep s/trustees against the idea 18

19 Better plan governance / saving management time? Governance is an increasingly important issue Shared best practices, potentially easier administration Some research shows that good governance can actually contribute to investment performance This appears to be a key issue and benefit 19

20 More flexible funding of DB plans? One global minimum funding requirement instead of one in each State Very attractive reason for setting up a multi-country plan BUT have to start with what is already there Trustees s attitude to sharing surplus with other plans? (or sharing with plans with larger deficits?) Ring-fencing may be required, but only if decided by the home country Will most multi-country plans be DC, anyway? 20

21 Savings on investment management fees? By far the largest operational cost of a pension fund Hewitt s survey, and others, showed that this was a key perceived advantage of having a single pan- European pension fund But this may be achievable anyway, with separate pension funds all using the same managers or preferred providers 21

22 Circumvent local investment restrictions? Quantitative investment restrictions may be set by a Member State for all the assets of a plan in that State BUT even in worst case, can always have up to 70% in stocks or corporate bonds, and up to 30% in nonmatching currencies Host country can in some cases impose some investment restrictions on home country plan assets only in respect of host country employees Will there be ongoing regulatory arbitrage between Member States? 22

23 Implementation of corporate investment strategy? A real practical advantage: a single set of investment rules, instead of one for each Member State Potentially substantial advantage if there are significant assets in several Member States How centralised are the investment policies; in how many countries are there sizeable assets; how successful has implementation of policy been? BUT host countries can still impose some restrictions on a home-country IORP, in respect of employees resident in the host country 23

24 Asset pooling Increased control Setting of investment strategy Greater flexibility in setting strategy Manager appointments Cost savings Reduced investment management fees Simplified monitoring Monitoring of managers/portfolio(s) 24

25 Asset pooling Typical Fees Basis Points of Assets under Management Million Global Fixed Interest Global Equity European Equity 25

26 Asset pooling a few scenarios Scenario 1: Different providers in each country Scenario 2: Use of common managers for each country No physical pooling of assets Separate funding vehicles in each country Scenario 3: Physical pooling of assets Separate funding vehicles in each country Scenario 4: Use of common funding vehicle (after September 2005 ) 26

27 Asset pooling tax considerations Scenario 3 (pooled assets, separate funding vehicles) Taxes on assets will depend on countries where each pension fund is located Very complicated in practice Scenario 4 (one plan) Taxes on assets will depend on country where the single pension fund is located therefore, taxation of assets much simpler than Scenario 3 27

28 Asset pooling governance considerations Scenario 3 (pooled assets, separate funding vehicles) Convince local operations of the benefits Some multinationals have coordinated their asset (and liability) management for some time Others are starting to do this Scenario 4 (one plan) Similar to Scenario 3, but more complex However, only a one-off effort 28

29 Different types of employer Symmetric v. asymmetric Who might benefit most from the opportunities? 29

30 Symmetric employers Similar-sized plans in all countries Potential efficiency gains may be limited Trend towards best practice in each country Biggest gains will be where plans are too small in each country (e.g. 50m?), but large enough overall to benefit Otherwise, size could imply that any financial gain might be significant (in monetary terms) e.g. 10 basis points x 1bn of funds is still 1m cf. total fees paid to other advisers? 30

31 Asymmetric employers Large in a few countries, small in others Inefficiencies in the smaller countries due to size use of insurance high fund charges high per capita expenses Significant potential efficiency gains in these smaller countries Small size would imply that any financial gain would be small in global monetary terms, although still important to small funds But the issues of governance and central management resources are also significant to multinational employers 31

32 Where could a multi-country EU plan be based? Choices driven by employer-specific considerations Regulatory arbitrage could be limited lowest common denominator in directive perhaps a choice between large (pension) countries UK/IRL/NL new countries e.g. LUX Where you are starting from is far more important e.g. many UK multinationals have vast majority of pension assets in home country perhaps different for French and German? 32

33 How do they see multi-country plans? Just like a regular single-country pension plan and fund with multiple contribution or benefit structures with some extra regulatory complexity and perhaps more than one currency Just like a series of pension plans and funds with easier governance and consolidated management 33

34 Conclusion: Two key issues Governance and risk reduction doing the right thing, and being seen to be doing the right thing management time and effort Funding cost savings through reduced management fees implementation of investment strategy more flexible investment strategy possible cost/cash savings from offsetting deficits/ surpluses (remember those?) 34