04 July 2013

JPMAM dismisses reintroduction of capital requirements for pension funds

In a paper entitled 'IORP II Lite: the end of Solvency II for pensions?', the asset manager argues that the Commission's recent decision to remove solvency requirements due to the Council's system of voting weights would have made it "very difficult" to push IORP II through, in light of Belgium, Germany, Ireland, the Netherlands and the UK's opposition.

Whilst the focus of the paper is the first pillar of IORP II, it is  important to remember that work is continuing on pillars two and three, which will make up IORP II Lite. These concentrate on governance, transparency and reporting requirements for pension schemes. Whilst they will not have a direct impact on defined benefit schemes’ funding, they could still herald important changes.

In an earlier paper, JPMAM discussed some of the elements that might feature in this regard. Many of these, such as the Own Risk and Solvency Assessment (ORSA) – a process by which the risk and solvency in a pension scheme are better understood – have their roots in Solvency II. They have the clear potential to help protect pension scheme members. However, they also have the potential to be a major draw on the resources of pension schemes in terms of both time and finances unless there is a degree of proportionality. The same is true of potential requirements for compliance and internal audit functions. This is still the case even if functions are outsourced, as EIOPA envisages might be the case.

As yet, it is unclear which requirements will appear in IORP II Lite. There have been no significant developments in this regard for well over a year. The draft legislation is currently scheduled to be presented in the Autumn of this year, and market participants are waiting to discover the precise form these proposed measures will take. We await the results with interest.

Even before the three pillars of the final IORP II legislation had been drafted, it looked likely that the Council of the European Union would at least delay the legislation, if not block it completely – only one additional vote was needed to achieve this. Even after the accession of Croatia, the smallest country in the EU would be able to give the five opposing nations – Germany, the UK, the Netherlands, Belgium and Ireland – the support needed to block any new attempt to bring in a Europe-wide solvency requirement for pension schemes. Nor would the Lisbon treaty ensure that such legislation would pass. Using current population information, the five countries have combined populations of 177.19 million people, or 34.87 per cent of the EU’s total population. This is only a few hundred thousand people short of the 35 per cent blocking minority required. As such, it seems unlikely that there will be a level playing field for pension schemes and insurance companies – at least in terms of solvency requirements – in Europe.

Pillars two and three have so far generated fewer objections than pillar one, and so it may be that IORP II Lite is more likely to be accepted. However, whilst this could offer a range of improvements for pension scheme governance, transparency and reporting, introducing legislation in these areas by autumn 2013 could still be a challenge for the Commission. Much of the criticism of IORP II surrounded the lack of clarity in terms of how the proposals would be employed by regulators, the way in which impacts were assessed by the Commission, and doubt that the benefits of IORP II would outweigh the costs. It is likely that those Member States which have already raised concerns would want to see a demonstration that the costs of the new package would not be allowed to exceed its benefits.

Full document

© JP Morgan