IORP II marks an underwhelming farewell from the EU

The UK has until January 13 2019 to transpose the Institutions for Occupational Retirement Provision Directive II into its laws. IORP II will seek to continue efforts made at European level to improve governance and accountability standards at workplace pension funds across the continent.

The directive’s predecessor was implemented in the UK via the Pensions Act 2004. New rules emboldened the Pensions Regulator with greater powers and gave rise to the statutory funding objective.

I don’t see anything which would necessitate a substantive overhaul of existing processes and procedures within DB and DC schemes

John Wilson, JLT Employee Benefits

Efforts to shore up scheme funding levels did not survive the drawing board. Plans for quantitative capital requirements for schemes were dropped during negotiations over IORP II.

The UK is readying itself to leave the EU just two months after the deadline for IORP II. It will be implemented here, but experts are divided on the difference it will make to UK schemes. Some have argued that the UK has already achieved more on its own two feet without intervention from Brussels.

The EU is playing catch-up

Central to the new directive is the reform of three ‘key functions’ of scheme governance – risk management, internal audit and the actuarial function.

Contingency planning, internal control systems and environmental, social and governance assessment, among other plans, will now become de rigeur across European schemes. These ideas are not new to the UK.

John Gordon, counsel at law firm Ashurst, says most well-run schemes will already deal with most of these points through their risk register, conflict of interest policy, and their general approach to governance.

“It may be that what IORP II does is [that] it imposes a requirement on all schemes to have a minimum level of governance,” Gordon adds.

The directive also includes revisions to actuarial activity with greater emphasis on quality assurance and transparency over the use of data. Changes to the actuarial function are unlikely to pose a challenge for schemes.

“We already have that concept within UK pensions law – it’s the scheme actuary, the person who is responsible for advising the trustees, and we think those will pretty much mirror each other,” says Jonathan Camfield, partner at consultancy LCP. “There’ll be hardly any changes needed to UK law to reflect the actuarial function, if any.”

Chief among the EU’s revisions to the internal audit function is the introduction of a fit and proper test for those operating schemes.

In order to qualify as ‘fit’, trustees will need adequate qualifications, knowledge and experience to ensure proper management of the scheme.

‘Fit’ external function holders will have to demonstrate similar capabilities. They will not need to hold specific qualifications.

It will be left for EU member states to determine a suitable threshold for ‘proper’ scheme managers.

Regardless, UK trustees are already required to pass background checks before entering trustee boards. Last month, the Professional Trustee Standards Working Group laid out a set of draft standards for professional trustees, imposing a “comply or explain” regime.

Ian Neale, director at policy specialists Aries Insight, does not see many new obligations coming towards UK schemes. “We are ahead of the game in a number of respects here,” he says.

IORP II introduces benefit statements

The UK may be ahead of the EU, but we are not out of sight. From next January onwards, schemes will have to produce annual benefit statements.

The document, which must even include the words “pension benefit statement”, will be provided to every member.

It will lay out a wealth of information on the scheme. Along with basic details, it will also include information on investments, benefit projections and detail on employer contributions.

According to Neale, benefit projections have “been an effective requirement for many years” for defined contribution schemes.

“Some [DB] schemes have been providing annual benefit statements, but others haven’t, because there hasn’t actually been a requirement to do this,” he says. “So I think for many DB schemes this will be something that’s new, as an obligation,” he adds.

Camfield describes the benefit statements as “a big administration hurdle for schemes” but adds that “once it’s up and running, it’s done”.

Schemes without borders

The impact of IORP II on cross-border schemes is an interesting, if slightly academic phenomenon. The European Insurance and Occupational Pensions Authority’s latest research shows that by the end of 2015, there were just 79 cross-border schemes in Europe.

The UK’s cross-border schemes reside in Northern Ireland. Regardless of the solution to the Irish border question, the imminent removal of European jurisdiction over Northern Ireland will prevent any potential benefits of IORP II being felt at the tip of the Emerald Isle.

UK schemes operating across frontiers will cease to be cross-border schemes following Brexit.

The directive permits cross-border transfers, and previous rules demanding fully funded status for all schemes operating across borders have been slightly relaxed.

James Walsh, policy lead on engagement, EU and regulation at the Pensions and Lifetime Savings Association, says: “If there is essentially a deficit then the national regulator will be required to intervene and make sure the IORP draws up a recovery plan, which is what you would normally expect to happen anyway.”

He adds: “We read that as saying, ‘Yes, you can be a cross-border scheme, and you can have a deficit’.”

Assuming the UK holds its commitment to departing the EU at the end of March 2019, members will have less than two months to enjoy the benefits of a more liberal attitude to cross-border schemes.

No capital requirements

There is also much to be said about what did not enter IORP II. Efforts to introduce capital requirements for schemes met with resistance during negotiations over the directive.

The Basel III accord and the Solvency II directive have asked banks and insurers respectively to build up their ability to withstand economic shocks through, among other measures, raising the amount of capital they hold.

Matti Leppälä, secretary general and chief executive of the operational arm of lobby group PensionsEurope, was pleased that capital requirements have been left out of IORP II.

“All through this process the solvency requirements were the main issue, and the starting point of the European Commission was to have solvency requirements very much based on the same line of thinking as Solvency II for insurance companies,” he says.

The commission wanted to use risk-free interest rates as the discount rate, according to Leppälä.

“That would have been really detrimental for pension funds. That would never enable defined benefit pension funds to continue and the requirements in the low interest rate environment would have been just disastrous for pension funds,” he says.

According to the directive, any further progress with 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”.

Plus ça change

The difficulty with developing pan-European legislation is that member states move at different speeds. The EU either risks placing unrealistic expectations on those who need the most reform, or presents those at the top of the table with lacklustre new rules.

The UK will take IORP II in its stride; IORP II is largely an example of its European peers improving their standards. By contrast, the Markets in Financial Instruments Directive II, which came into effect this month, is a case study in Brussels delivering massive change to UK financial services.

John Wilson, head of technical at consultancy JLT Employee Benefits, says he sees little in IORP II that concerns him.

“I don’t see any requirement for a rewrite of existing legislation or Pensions Regulator codes of practices, and I don’t see anything which would necessitate a substantive overhaul of existing processes and procedures within DB and DC schemes,” he says.

Wilson suggests that gains made by IORP II might be overtaken by the lessons learnt from events such as the government’s recent auto-enrolment review, the Work and Pensions Committee’s recommendations on freedom and choice reforms, and the government’s white paper on the future of DB schemes, expected in February.

He is not alone in his scepticism. “All in all, the directive isn’t a big deal, there are bigger things happening,” says Neale.