CEIOPS Conference 2007 Frankfurt, 20 November 2007»The Supervisory Framework for Occupational Pensions Where Now and What Next?«The Implementation of the IORP in View of Fostering the Single Market in the Pension Funds Sector Elemér Terták Director Financial Institutions European Commission / DG MARKT Ladies and Gentlemen, Four years elapsed since the Directive on the activities and supervision of institutions for occupational retirement provision (the so called IORP Directive) had been adopted, and two years since the laws, regulations and administrative provisions necessary to comply with this Directive had brought into force. The Directive had been elaborated on the anticipation that the social security systems are coming under increasing pressure, and occupational retirement pensions will increasingly be relied on as a complement in future. In the coming decades Europe will experience rapid population aging. This demographic trend is expected to put significant pressure on public finances. The pressure from aging is not limited to any one country or region, but will occur in most of the Member States at broadly the same time, albeit with different magnitudes and starting fiscal positions. The European Commission s Aging Working Group (AWG) projects that age-related spending would increase by 8 percentage points of the GDP by 2050, with
2 most of the increase accounted for by a rise in pension expenditure. It was clear to policy-makers and experts alike that, in order to achieve an adequate level of retirement benefits, the public pillar had to be supplemented by a well developed private pillar. Occupational pensions should therefore be developed, which should guarantee a decent standard of living in old age and should therefore be at the centre of the objective of strengthening the European social model. The development of the private / occupational pension pillar thus witnessed acceleration in recent years, which will continue in the forthcoming years. In the recitals it is rightly recognized that the Directive represents a first step on the way to an internal market for occupational retirement provision organised on a European scale. The Directive requires that four years after entering into force the Commission shall issue a report reviewing: (a) the application of the investment rules and the progress achieved in the adaptation of national supervisory systems, furthermore (b) the application of the rules related to custody, in particular the situation prevailing in Member States regarding the use of depositaries and the role played by them where appropriate. The review work shall begin in the next year to enable a thorough review in due time. Needless to say that this review will be part of the big puzzle Pensions and long term savings, a fairly complex and broad issue, in which four DGs are dealing with the different aspects of the pensions. State of implementation All Member States have notified their implementation measures of the Directive on the activities and supervision of institutions for occupational retirement provision (IORP Directive) by now. Likewise have the EEAcountries (Iceland, Norway and Liechtenstein) enacted their transposing
3 legislation. There are however three infringement procedures ongoing for incorrect implementation. Making the Directive work (better) The purpose of the IORP Directive is two-fold: first, to promote supervisory convergence between the Member States with regard to the prudential aspects of the IORP business, and secondly, to promote cross-border business of occupational pension funds. In respect of achieving the first objective to enhance supervisory cooperation the centre of gravity is with the CEIOPS. Substantial work has been done by the Occupational Pensions Committee: it worked tirelessly to develop a common understanding of the Directive and to carry out the preparatory work for dealing with issues related to pension funds. A true success was the adoption of the Multilateral Cooperation Protocol ( Budapest Protocol ) in 2006. It is more complex to assess the progress on the second objective. Launching cross-border business remains difficult because of divergent national social and labour law requirements. The differences across the Member States are deep-rooted in socio-economic trends, demographic structure, fiscal position, and the power of the trade unions. A convergence of these factors is a long gradual process. Furthermore, the time past since coming into effect is short to judge whether the Directive had delivered its full potential. Commission s services main task will be to review of the Directive in 2008/2009, based on: implementation report by Occupational Pensions Committee; findings and advice by Solvency Sub-Committee. In accordance with the requirements of the «Better Regulation Agenda» any
recommendation has to be subject of a thorough Impact Assessment. 4 Main Issues for the Review 1) Definition of «cross border activities» 2) Host law vs. Home law 3) IORP and Solvency II Let's see these issues more detailed: 1) Assessment of the development of «cross border activities», unfolding the practical obstacles in cross border activity and based on the findings review of the definition of «cross border activities» as set forth in Article 20. 2) Analysing where there are conflicts between the objectives of the directive and the national legislation. Home law is applicable to the IORP, Host (social + labour) law to the scheme but where is the dividing line? To allow workers to choose the funds and products best matching their needs, competition should be enhanced. In this respect however, the fact that employers contributions cannot be transferred out of occupational funds limits workers mobility and restrains competition in the asset management industry, with potentially significant adverse effects on workers welfare. Moreover, to improve governance and reduce agency problems between investors and fund managers, the separation between asset management, auxiliary services, and consulting services should be pursued. The traditional way of encouraging voluntary savings for retirement has been through tax incentives. However, these can be not only expensive (and there is strong evidence that they are inefficient), or
5 favouring without motive higher earners, but they constitute strong although unintended obstacle to cross-border business of IORPs, as it forces them to redesign their products if they wish to market their products in such jurisdictions. 3) IORP-Directive and Solvency II In the Member States the retirement landscape is changing as the number of the traditional occupational Defined Benefit plans is decreasing whilst there has been a corresponding increase in Defined Contribution plans. In spite of shifting considerable risks from sponsors to beneficiaries there remain several solvency issues to be addressed. Past years have highlighted the vulnerability of pension funds to adverse developments, such as a stock market crash or continuing low interest rates. The lesson to be drawn from the experience of recent years is that such risks need to be adequately priced. This is true of investment risk, but equally so of, for instance, inflation risk and the uncertainty surrounding longevity projections. The latter create problems both in DC systems (where individuals and households are left alone to bear longevity as well as market risks) and in DB systems (where entitlements guaranteed by the state and by corporate sponsors might prove unsustainable). Another major condition for continuity is an adequate level of pension contributions. Although pension funds and life insurance companies have in many respect similar peculiarities, there are also essential differences between them. The most relevant is that pension funds can exploit the potential of intergenerational risk-sharing, whereas insurance companies cannot. These differences were the primary reasons for carving out pension funds from the scope of Solvency II project, on condition that the issue of whether and how to extend the new
6 regulatory framework to pension funds will be examined in the context of the review of the Directive in 2008. Due attention has to be paid to pledge level playing field between concerned sectors of the industry as well as between certain Member States. Furthermore the extension of Solvency II to the pension funds will require careful impact analysis and calibration as it could force a sharp increase in capitalisation. This however could have serious consequences both for persons entitled to benefits under such pension funds and for the sponsors. In countries, where the provision of such benefits is provided by the employer on voluntary basis, the introduction of any requirement that discourages employers from providing private pensions would not be in the interests of workers. Following a fact-finding exercise CEIOPS «Solvency Sub-Committee» will receive Call for Advice in early 2008. Depending on advice received, and on results of further consultation under «Better Regulation Agenda», Commission has to decide if and how to proceed towards a solvency regime for IORPs. A legislative proposal might be envisaged, possibly including other issues too, but not before 2009. What other issues might be reviewed? a) Commission intends to launch a public consultation on Insurance Guarantee Schemes early next year. Considering on the one hand the similarities between the ISGs and the pension benefit protection schemes, on the other hand the call of OECD for reforming pension benefit protection schemes, it is likely to take a look at this matter as well. Furthermore issues as (i) appropriate funding levels to ensure that a fund s assets can meet its potential liabilities, (ii) reasonable maximum time-frame for reducing any funding gap and (iii) rules that
7 determine to what extent the employer is responsible for filling any funding gap if a pension plan closes, could be considered in this frame. b) Changes in the accounting field also affect the pension arrangements. The introduction of IAS 19 about employee benefits has an effect on companies which must apply the IFRS, because it relates to the financial consequences of the pension commitment. IAS 26 on pension plans is quite an old standard that some countries had not adopted when they converged with IFRSs. Furthermore in July 2006, the IASB added a project on post-employment benefits to its agenda. The project, to be conducted in two phases, would involve a fundamental review of all aspects of post-employment benefit accounting. The aim is to issue an interim standard that would significantly improve pension accounting by 2011. Thus issues connected to accounting principles deserve consideration if the fact-finding exercise confirms their relevance for the regulatory work. c) The increase in defined contribution plans in many countries raises important challenges, as responsibilities are shifted to individuals, who may not be well equipped to manage them. This requires an urgent improvement of financial literacy and awareness. Commission launches next year a project on financial education. One of the focal points will be the provision of adequate knowledge to people empowering them to choose the funds and products best matching their needs. I am confident, that the coming review as demanding it promises to be will contribute to the improvement of the existing regulatory framework and thus to more sustainable and stable occupational pension systems.