By Sven Kasper
Amid funding gaps, exacerbated by the shift from defined benefit to defined contribution schemes and rising longevity expectations, pension funds face an acute dilemma.
While the low-return environment demands a move into new assets to drive yield, they are at the same time under pressure to de-risk their portfolios amid an overall risk-averse climate. Asset owners face another significant challenge: regulatory change is fundamentally overhauling the operating environment for pension funds, with far-reaching implications for the way they operate and the cost of doing business.
For example, the review of the Markets in Financial Instruments Directive (Mi- FID) will change the way markets operate, and require additional reporting and transparency requirements. A Financial Transactions Tax (FTT), as currently progressed by a number of EU Member States and being piloted in France, could put further pressure on pension fund returns by adding to the cost of financial transactions.
In some cases, new regulations take into account the specific needs and characteristics of pension funds. While pension funds will be affected by the European Market Infrastructure Regulation (EMIR), they have obtained a temporary, three-year exemption from the clearing obligation — and this reprieve can be extended further subject to certain conditions.
In addition, there are several examples of regulations aimed specifically at pension funds. The European Commission’s White Paper, “An Agenda for Adequate, Safe and Sustainable Pensions”, published in February 2012, covered the gamut of pension provision from state schemes through occupational to personal pensions.
While the Commission recognises that EU member states have primary responsibility for designing their pension systems according to their individual situations, the paper proposes a set of initiatives to reinforce social protection in policy-making across the EU. It could lead to a more rigorous standards regime for company pensions. Meanwhile, the Packaged Retail Investment Products (PRIPs) proposal, published in July 2012, suggests a key investor document (KID) for a broad range of retail products, including certain personal pension products.
It also remains to be seen to what extent the requirements of Solvency II for insurance firms will be read across to pension funds under the review of the Institutions for Occupational Retirement Provision (IORP) Directive expected in 2013. This review could usher in similar prudential requirements, as well as more rigorous investment rules and reporting and possibly a requirement for a depositary, all of which could add further cost for pension funds.
As part of the process to advise the Commission on the review of the IORP Directive, the European Insurance and Occupational Pensions Authority (EIOPA) recently launched its Quantitative Impact Study. This initiative includes an assessment of different options for valuing the holistic balance sheet and calculating capital requirements. Running until 17 December, the study is targeted at IORPs that run defined benefit pension plans, and the resulting report is expected in spring 2013.
Meanwhile, a green paper on long-term investing to be released at the end of 2012 will examine in greater depth the impact of the Capital Requirements Directive IV (CRD IV) and Solvency II, and how long-term saving can be encouraged. Overall, pension funds face an increasingly complex regulatory environment. While it is incumbent on regulators to ensure that they take into account pension funds’ needs, the funds themselves must recalibrate to a new environment as part of their ongoing search for yield. Against this backdrop, operational efficiency is key, and many pension funds will review their value chain to examine where they can extract cost, possibly by outsourcing more of their operations.
In addition, funds are likely to examine new strategies for risk management and hedging amid the overall tough environment.
Sven Kasper is director EMEA, regulatory, industry and government affairs at State Street
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