A new European pensions directive (the Directive) came into force on 1 January 2017. Formally titled Directive (EU) 2016/2341 of the European Parliament and of the Council of 14 December 2016 on the Activities and Supervision of Institutions for Occupational Retirement Provision (IORPs), the Directive was first published in the EU Official Journal of 23 December 2015.
As with much of the financial sector legislation to emerge since the 2008 financial crisis, the Directive’s aim is to improve governance and accountability – in this case, in relation to workplace pensions.
Many of the new Directive’s provisions are aimed at improving protections of members’ and beneficiaries’ pension benefits.
The rules for schemes operating across borders have been tweaked, with a view to reducing barriers to cross-border activity.
The Directive does not include solvency measures for pension schemes, but we may not have heard the last of such proposals.
EU member states had until 13 January 2019 to incorporate the Directive into their national legislations.
According to EUR-Lex data, the Directive had been implemented in Austria, Belgium, Croatia, Denmark, Estonia, Finland, Italy, Lithuania, Hungary, Slovakia and the United Kingdom, but not (yet) in the other EU member states.
The original pensions directive (known as IORP I) introduced a number of new rules for IORPs – broadly, occupational pension schemes.
The latest Directive – referred to as IORP II – was nearly three years in the making, with the European Commission’s initial proposal for a new directive having been published in March 2014.
One of the European Commission’s main aims with the Directive is to introduce clearer and more consistent communications between schemes’ members across EU member states.
Aimed at both defined benefit (DB) and defined contribution (DC) schemes, the new Pension Benefit Statement will require standard key information to be given to each member, such as a benefit projection using standard assumptions.
Environmental, social and governance (ESG) factors are firmly on the agenda in the Directive, as it builds on the requirement for IORPs to invest in accordance with the ‘prudent person’ principle. There is a new obligation on member states to ‘allow IORPs to take into account the potential long-term impact of investment decisions on environmental, social and governance factors’. Trustees’ investment decision-making processes will also need to build in ESG factors and schemes’ statements of investment principles will need to state how the investment policies take ESG factors into account.
Member states will have discretion, but not an obligation, as originally planned, as to whether to require DC schemes to appoint a depositary (a custodian), with responsibilities including the safekeeping of assets and oversight duties. However, if a depositary is not appointed, a scheme will need to make arrangements ‘to prevent and resolve any conflict of interest in the course of tasks otherwise performed by a depositary and an asset manager’.
The Commission remains keen to encourage cross-border pension provisions – a key aim of IORP I that, to date, has only been realised by a limited number of pension funds. According to the latest European Insurance and Occupational Pensions Authority figures, only 83 out of a total of 155,500 pension funds in the EU operated cross-border (2017 Market Development Report, 30 January 2018).
Cross-border transfers of pension scheme assets and liabilities will be permitted (in whole or in part), provided that the costs are not passed on to members and beneficiaries remaining in the transferring scheme, or to those in the receiving scheme.
Such transfers will be subject to the prior approval of a majority of the transferring scheme’s members and beneficiaries (or, where applicable, their representatives) and that of the sponsoring employer (where applicable). They will also need the prior consent of the transferring scheme’s regulator and must be authorised by the receiving scheme’s regulator. There will be a number of safety checks as part of the cross-border transfer process.
The ‘fully funded’ requirement
The obligation for schemes operating cross-border to be fully funded at all times has always been contentious and one of the bigger obstacles to cross-border activity. It was therefore no surprise that the issue inspired much debate while the Directive’s details were negotiated. The new provision that emerged is slightly more flexible, allowing cross-border schemes to have deficits and put recovery plans in place for limited periods, subject to regulatory supervision.
The Directive emphasises improving governance and transparency in pension schemes.
Overall, schemes will be required to have proportionate and effective systems of governance in place that provide ‘sound and prudent management of their activities’.
Risk assessment is an important element of the Directive’s governance focus, with the introduction of a requirement for an ‘own risk assessment’, under which schemes will need to identify long and short-term risks that could affect their abilities to meet their obligations.
The ‘fit and proper’ test
Collectively, trustees will need to have suitable qualifications, knowledge and experience to enable them to carry out their roles. There is not, as originally feared, any requirement for trustees to hold professional qualifications.
Schemes will need to establish and apply ‘sound remuneration’ policies for all those effectively involved in running a scheme, those who perform ‘key functions’ (see below) and for ‘other categories of staff whose professional activities have a material impact on the risk profile of the IORP’.
The policy will need to be publicly disclosed and reviewed every three years.
A new concept of ‘key functions’ is introduced in relation to risk management, internal audit and actuarial functions.
Apart from the internal audit function (for which the person responsible must be independent), key functions may be carried out by a single person or organisation. However, generally speaking, any person carrying out a key function cannot perform a similar role for the sponsoring employer. But there is scope for exceptions, where the management of conflicts of interest is explained.
The common framework balance sheet
Part way through negotiations on the Directive, a proposed introduction of quantitative capital requirements for schemes was shelved. The Directive’s text now explicitly states that the further development of solvency models ‘is not realistic in practical terms and not effective in terms of costs and benefits, particularly given the diversity of IORPs within and across member states’.