Download increasing the sustain ability of european pension systems

Background
for policy advisors, managers, politicians and academics
September 2012 | no. 1
Increasing the
sustain­ability of
European pension
systems
How can eurobonds help to solve
Europe’s problems?
Wim Boonstra
Chief economist at Rabobank Netherlands
The impact on pension funds of a
mandatory clearing regime for
OTC derivatives
Nicole Grootveld
COO NL Cardano
Zöhre Tali
Bas Zebregs
APG Asset Management
The European Pension Agenda
Jurre de Haan
Wilfried Mulder
Corporate Strategy & Policy APG
IORP: Some chances
and challenges ahead
Pieter Omtzigt
Member of Dutch Parliament
The Dutch and British pension sector Converging towards a steady state?
Ruben Laros
Stefan Lundbergh
Innovation Centre APG
Introduction
Contents
Introduction
How can eurobonds help to solve Europe’s problems?
3
4
Wim Boonstra
Chief economist at Rabobank Netherlands
The impact on pension funds of a mandatory clearing regime for
OTC derivatives
10
Nicole Grootveld
COO NL Cardano
Zöhre Tali
Bas Zebregs
APG Asset Management
The European Pension Agenda
18
Jurre de Haan, Wilfried Mulder
Corporate Strategy & Policy APG
IORP: Some chances and challenges ahead
26
Pieter Omtzigt
Member of Dutch Parliament
The Dutch and British pension sector -
Converging towards a steady state?
Ruben Laros
Stefan Lundbergh
Innovation Centre APG
32
It is my great pleasure to present to you the new edition of Pension Background, the
English version of Pensioenachtergrond. This is a special issue of our regular magazine,
reflecting the great importance that APG attaches to developments in the EU.
Although from a subsidiarity point of view pensions and pension arrangements remain
predominantly a national policy issue, there are important aspects linked to EU policies
to be taken account of, such as the functioning of the internal market and the stability
of the financial system. The ongoing crisis in the eurozone makes it even more pres–
sing to make progress on these issues.
Therefore, this edition provides a good mix of articles related to the currently unfolding euro
crisis and the European Commission’s proposals for a new regulatory framework. One of the
key elements in solving the euro crisis is debt mutualisation by the introduction of eurobonds,
as Wim Boonstra of Rabobank argues in this issue. At the same time, new EU regulation on
derivatives has been adopted to increase the transparency of the derivatives markets and to
mitigate systemic risk. Zöhre Tali and Bas Zebregs of APG and Nicole Grootveld of Cardano
explain the impact of this regulation on the pension sector, a sector that is known for
enhancing financial stability by having a longterm view on investments.
The current crisis is also one of the factors putting increasing pressure on the sustainability
of pension systems. The European Commission therefore proposes new regulation for pension
systems. Jurre de Haan and Wilfried Mulder of APG explain some highly topical developments
in European pension policy making and their possible implications for the Dutch pension
system. Pieter Omtzigt, member of Dutch parliament, provides his view on the proposed
revision of the IORP Directive by the European Commission.
Finally, this edition concludes with some reflections by APG colleagues Ruben Laros and
Stefan Lundbergh on developments in the UK market. In the past, the UK chose a marketbased approach to pension provision, and now the policymakers and the public are coming to
terms with the shortcomings of (individual) defined contribution schemes.
I would like to thank the authors from inside and outside APG for sharing their views, and I
hope this magazine constitutes a worthwhile contribution to the pension debate at large and
to the personal and professional insight of you, our readers.
Dick Sluimers
Chief Executive Officer
Pension Background September 2012 no 1
3
Between 1999 and 2008, markets failed to differentiate
between public debt within EMU. Only after the collapse
of the American investment bank Lehman Brothers did
markets increasingly start to factor in differences in risk.
Therefore it was only in times of crisis that financially
stronger states enjoyed more advantageous funding
compared to weaker states.
How can eurobonds
help to solve
Europe’s problems?
However, this advantage has been cancelled out almost
entirely by the cost of the bailout packages, losses
incurred on government bonds issued by problem coun­
tries and the costs of the recession in Southern Europe,
which has impacted on the northern countries, too.
As a result, the question of eurobonds has once again
found its way to the top of the European political agenda.
The problem is that the generic term “eurobond” conceals
many variations. Some (e.g. Mario Monti) see eurobonds
as instruments to stabilise the EMU. Others (e.g. François
Hollande) would want to use eurobonds to boost
economic growth. Others still (e.g. Angela Merkel) expect
that eurobonds will undermine discipline in weaker
countries and push up interest rates sharply for strong
member states. However, rarely is the question raised
of whether it might be possible to design a eurobond
system in such a way as to boost stability and increase
budgetary discipline while also offering tangible benefits
to the financially stronger states. After all, every­thing
depends on the way a eurobond programme is given
shape.
This article proposes a temporary programme of shortterm eurobonds (Euro T-Bills), launched by the European
League for Economic Cooperation (ELEC). It is argued
that a temporary regime of conditional eurobonds, if
well designed, can create long-term stability, present
policymakers with the right incentives and offer benefits
to all participating countries.
Criteria for eurobonds
Eurobonds are bonds issued by a central European agency
in order to finance the participating member states’
national debt.1 A well designed system of eurobonds
could help to rein in financial markets and improve
discipline. But first we should start with asking questions
such as: what do we want to achieve by introducing
eurobonds? Is this feasible, and if so, under what
conditions?
Successful eurobonds should, first, give all countries
access to funding under reasonable conditions. Second,
they should produce benefits for all participating states,
both weak and strong. Third, they should not introduce
moral hazard but rather increase budgetary discipline
where possible. Fourth, they would preferably be selffunding, so that any problems in future might be
addressed without having to bother the stronger member
states with them. Fifth, they would ideally strengthen
financial stability by breaking the strong financial links
in EMU member states between national governments
and local banking systems. Finally, the eurobond
programme should free the ECB of its interventions in
the market for national debt, so that it can refocus its
attention on its primary goal: the execution of monetary
policy with the ultimate aim of maintaining price
stability.
Only a eurobond programme which fulfills all these
conditions would be acceptable to all member states.
1
Eurobonds are also known as Stability Bonds (EC, 2011) or EMU
Bonds (1989; ELEC, 2012).
Pension Background September 2012 no 1
5
‘However, rarely is the question
raised of whether it might be pos­
sible to design a eurobond system
in such a way as to boost stability
and increase budgetary discipline
while also offering tangible benefits
to the financially stronger states.’
However, most existing proposals do not meet all these
criteria. Moreover, it is also important to realise that the
most we may expect from eurobonds is that they might
contribute to creating the circumstances under which
a policy of stability can be executed. Eurobonds do not
relieve countries from the need to reduce fiscal deficits
and restore their competitiveness and potential for
growth either.
set of budgetary rules, to which participating countries
would have committed, as well as effective and automatic
sanctions for states that breach the agreements.
Therefore the proposed T-Bill programme complements
the new budgetary rules agreed upon in late 2011.
Euro T-Bills: a transitional regime
The programme is open to all member states of the
eurozone which have so far managed to get by without
financial support from the other member states.
Countries which are already in need of financial support
(at the time of publication Greece, Ireland and Portugal)
therefore cannot yet take part. The EFSF is open to those
states. In addition to this, the intended policies of the
participating countries must first have already been
approved under the European semester. Finally it is
essential that all the large states participate, including
Germany2.
The introduction of eurobonds represents a far-reaching
redesign of the eurozone. It will take time to work out
the details and complete all the necessary political, legal
and constitutional procedures. But we are pressed for
time: even though the ECB’s LTRO “bought” three extra
years, financial markets could still spoil things. This is
why the European League for Economic Cooperation
(ELEC) is proposing to start with a temporary programme
(ELEC, 2012). This programme should be able to provide
all the funding the governments of the participating
countries need through collectively guaranteed shortterm eurobonds (Euro Treasury Bills). This guarantee
should be a cross-guarantee, i.e. every member state
guarantees the national debt of all other member states.
Obviously, this is only possible if accompanied by a strict
Conditions for participation are the following:
Solvent countries only
2
Through the programme, participating countries can
cover all their funding needs (financing deficit and due
debts) over the next four years (2013-2016) through
collectively guaranteed short-term bonds (Euro T-Bills).
These will have a maximum maturity of 2 years and will
be issued by a new agency, the EMU fund. Participating
countries will refrain from issuing short-term bonds
themselves, but would be free to issue longer-term
government bonds without a collective guarantee.
Accordingly, if the programme were to be discontinued
after four years, the last eurobonds would be repaid after
six years, i.e. in 2018, at the latest.
Discipline through extra premiums
States whose budget deficit exceeds 3% and/or states
with a national debt exceeding 60% of GDP would be
lia­ble to pay a premium on top of the necessary costs to
finance the agency. This premium will vary according to
an automated formula in which the relative size of the
pu­blic deficit and debt is taken into account (Boonstra,
2012).
Building up reserves
Through the premiums levied, the EMU fund would by
definition make a profit, which would be added to the
agency’s reserves. These reserves are not meant to be used
for bailouts, but intended as a cover for the collective
guarantee on eurobonds issued.
Even if they have to pay a premium to the EMU fund, the
weaker countries will still find this a cheaper solution
than having to access the markets on their own. Note
that the premium mechanism does, however, begin
to discipline these countries much earlier than the
financial markets have done in the past. Moreover, states
can influence the premiums they are being charged by
adjusting their policies in the right direction. Finally, the
premiums paid to the EMU fund would be used to build
up reserves, where the market’s high interest rates would
be collected as a risk premium by investors.
More recently, Spain also needed help for its banking problems.
Spain (like Italy) is too large to keep out of the system. Moreover,
Spain has a good track record in following the rules of the Stability
and Growth Pact. Therefore, it would be better to include Spain in
the scheme. One could say that a timely introduction of eurobonds
would have prevented the Spanish banking problems to run out of
Expulsion as an ultimate sanction
If states fail to implement the agreed policies, ultimately
the decision could be taken to gradually phase them
out of the programme. In any case the programme does
have a “big stick” waiting at the end, as countries which
behave badly can be excluded from participation in a
follow-up programme, should this be decided upon.
Moreover, in such a situation the cross-guarantees on
already issued bonds, as well as the reserves that were
built up to cover these, will prevent problems from
spilling over into other states to a large degree. This will
considerably improve the EMU’s bargaining position
against unwilling countries.
Advantages and disadvantages
Advantages
One important benefit is that as a short-term eurbond
programme is temporary in nature, it can be introduced
quickly. Moreover, it provides the opportunity of learning
lessons along the way. Additionally it will allow Europe
some time to carefully design any future system and to
embed it in law. If a permanent eurobond programme
does not function optimally after its launch, it will be
extremely difficult to make changes to it, so for this
reason alone a trial period in the shape of a temporary
programme would be desirable.
The programme’s duration would allow states the time
to get their policies in order without having to fear
financial markets’ reactions from day to day. This period
would provide enough time to design the right policies,
implement these and demonstrate the policymakers’
sincere intentions of executing them. The temporary
nature would also offer a strong and credible sanction
against countries which do not adhere to the agreed rules,
as they would not qualify for the follow-up programme.
The problem of moral hazard can be addressed by
means of the premium levied in the internal allocation
mechanism, and the possibility to phase a country out of
the programme. At the short end of the yield curve, Euro
T-Bills would be the only high-quality paper available.
This would also provide the EMU with its so-called riskfree asset as a collateral for transactions with the central
bank. It would also offer the ECB the possibility to adopt
a more traditional policy of quantitative easing without
having to intervene in national markets for government
debt should circumstances demand this.
The direct link between governments and their national
hand.
6
Pension Background September 2012 no 1
7
banking systems would be severed by the introduction
of Euro T-Bills. This constitutes a major improvement
on the current situation. Note that the ECB’s operations,
especially the LTRO, actually caused those ties to become
a good deal tighter.
The monetary union can be consolidated by the
introduction of eurobonds, without more political
integration than had been planned already on the basis
of the agreed tighter governance of the eurozone. It is
debt of the weaker countries would decrease. Therefore
it is advisable to extend the maturities in a follow-up
programme. Finally, the formula needed to calculate the
premiums must be determined, although this also seems
to be a minor problem (see Boonstra, 2012).
Consequences for investors
The introduction of eurobonds along the lines of
this proposal will change the investors’ landscape
‘As time goes by and the govern­
ments in the countries under
pres­sure use the bought time well
and implement the right policies,
we will see the first real economic
results of their efforts.’
not just the weaker countries which will benefit, there
are advantages for the stronger states too. Apart from
the continuation of the EMU, the above-mentioned
self-funding character of the programme is the main
advantage. A further benefit for stronger states concerns
the expected liquidity premium. This is because the
ample liquidity of the market for Euro T-Bills will result
in lower interest rates due to these instruments’ greater
tradability (ELEC, 2012).
Disadvantages
There are disadvantages too. Phasing out a member
state might cause unrest, although given the crossguarantee on the outstanding debt, the chances of
serious contagion are slim. Therefore the bargaining
position of transgressor states would de facto be seriously
undermined by the introduction of eurobonds. Another
disadvantage is that the average maturity of the national
8
considerably. First, the participating countries will have
to stop the issuance of short-term debt. The short end of
the euro yield curve will only consist of Euro-T-Bills. Only
in the longer maturities will national government bonds
be traded. One may expect that in the medium (2<x<5
years) maturities yields will converge, owing to the fact
that the credit risk of government bonds of the perceived
weaker countries will diminish, as they will always have
access to liquidity for the duration of the scheme. Bond
yields in the weaker countries will come down, yields
in the stronger countries will go up. As time goes by
and the governments in the countries under pressure
use the bought time well and implement the right
policies, we will see the first real economic results of
their efforts. This will improve confidence and result in a
further normalisation of the public bond spreads on the
financial markets. The resulting increase of government
bond yields in the stronger countries will also lead to an
increase in the swap yieldcurve, which will help pension
funds to improve their coverage ratios.
Conclusion
What is the way forward if we decide against introducing
eurobonds? In that case, it must be feared that the
eurozone will experience much deeper crises over the
coming months and years than the current one. The
proposed temporary Euro T-Bill programme would give
policymakers time to implement good policies and to
consider a permanent reform of eurozone governance.
The temporary nature of the programme is an important
asset, as it will be possible to accumulate some
experience with eurobonds as an instrument, which can
prove itself in this period. Any desired changes can be
included in a follow-up programme. Once the new fund
also takes over most of the portfolio of weaker states’
government bonds accumulated by the ECB and places
these in the eurobond programme, the central bank will
once again be able to focus its energy on its core task:
monetary policy with the ultimate goal of combating
inflation.
After four years, the Euro T-Bill programme could, if
desired, be converted into a new temporary, or even a
permanent eurobond programme covering all maturities.
Should the programme be less successful than hoped for,
and should the decision be taken not to extend it, then
we may well have lost one illusion, but we would not be
in a worse position than we find ourselves in today.
References
Bishop, G. et al. (ELEC, 2012), The ELEC “Euro T-Bill Fund”,
A proposal for a two-year refinancing for all € bills /
optional refinancing of bond maturities until 2015,
January, http://www.elec-lece.eu/documents/doc/mon12jan-EmuBondFund.pdf
Boonstra, W.W. (1989), EMU Fonds: het ei van Columbus?,
Economisch Statistische Berichten, 6 December.
Boonstra, W.W. (2012), Conditional Euro T-Bills as a
transitional regime, Rabobank Special, 2012/05, 13 June.
European Commission (EC, 2011), Feasibility of
introducing Stability Bonds, draft Green paper,
23 November.
Wim Boonstra
Chief economist at
Rabobank Netherlands,
lecturer of Monetary and
Banking Systems at VU
University, Amsterdam,
and President of the
Monetary Commission of
ELEC, Brussels
Pension Background September 2012 no 1
9
The impact on
pension funds of
a mandatory
clearing regime
for OTC
derivatives
On 15 September 2010, two years after the collapse of
Lehman Brothers, the European Commission published a
draft Regulation for the OTC derivatives markets
(Regulation).1 This Regulation is expected to come into
force with immediate effect in August 2012, with no
additional EU Member States legislation being needed.
The Regulation will change the regulatory framework of
OTC derivatives and the way OTC derivatives markets
operate. The main reforms are:
1. Regulation /supervision of derivatives market
participants will be increased.
2. A push will be made towards greater standardisation
of derivatives contracts.
3. Mandatory clearing through a central clearing
organisation (Central Counterparty-CCP) will be
introduced for all OTC derivatives contracts that are
determined to be eligible for clearing. All market
participants will be obliged to clear OTC derivatives
contracts. To eliminate counterparty risks, CCPs will
require the posting of collateral in the form of initial
and variation margin.
4. Strict rules will be introduced for uncleared
derivatives contracts to manage operational
and credit risks and higher margin and capital
requirements.
5. Reporting of OTC derivatives contracts to a central
repository will become mandatory.
§
The introduction of mandatory clearing is part of a
broader package of measures, agreed upon by the G-20
countries, to improve the transparency of the OTC
derivatives markets and reduce systemic risk. The G-20
agreed that this standardised regime for clearing OTC
derivatives
1
‘Proposal for the European Parliament and of the Council on
derivative transactions, central counterparties and trade
repositories’, <register.consilium.europa.eu>.
See also: B.J.A. Zebregs, ‘Verplichte clearing voor OTC-derivaten in
Europa’, Tijdschrift voor Financieel Recht, 2011-1/2, p. 5-17.
must be implemented in 2012 at the1 latest.2 Similar
legislation is therefore in preparation in other
jurisdictions including the US, Japan, Australia, Hong
Kong, Singapore and Canada.
Although coming into force in August 2012, the
Regulation will not yet be fully enforceable. Current
expectations are that the mandatory clearing regime will
not become effective until mid-2013. This mandatory
clearing regime will have a huge impact on the OTC
derivatives markets and market parties. For clearing
members, the parties through which a CCP is accessible,
the regime involves specific risks and costs. Similarly, the
clients of clearing members will also incur additional
risks and costs, especially the more creditworthy clients
who have one-way derivative exposure due to using
derivatives as hedging instruments.
Below, we will highlight some important elements of a
mandatory clearing system from a pension fund perspective..
Do CCPs reduce systemic risk?
CCPs take over the counterparty risk inherent in OTC
derivative contracts (see Figure 1), and thus potentially
reduce systemic risk. As long as the CCP is able to absorb
the bankruptcy of one or more of its clearing members,
this can prevent a domino effect of additional bank­
ruptcies. If the CCP itself were to go bankrupt, however,
given the concentration of risks within such an institu­
tion, the effect could be dramatic. CCPs will be the
2www.pittsburghsummit.gov
Pension Background September 2012 no 1
11
Figure 1: Clearing members and novation
Change and impact
Figure 2: Bilateral and multilateral netting
(amounts in EUR m)
Buy Side
‘End’ User
Multilateral netting
Bilateral netting
Sell Side
‘End’ User
20
A
B
50
Clearing
Member
CCP
Clearing
Member
Sell Side
‘End’ User
OTC derivatives transactions are agreed bilaterally between the two market participants. In a clearing structure,
however, the final transactions are not established between the market participants (end users) who initiated the
transaction, but between a limited number of clearing members and a Central Counterparty (CCP).
Market participants who do not have the status of clearing member must therefore establish a clearing relationship
with a clearing member, in which they authorise the clearing member to conclude transactions on their behalf
(client clearing).
Under the terms of novation, the transactions between two clearing members are split into two, as it were, with the
CCP interposed. There is a transaction (1) between the clearing member of client A and the CCP, and (2 between the
CCP and the clearing member of client B. The counterparty risk between clearing members is taken over by the CCP.
ultimate too big to fail institutions. The question is, how
likely is this to happen? The large amounts of collateral
that are required to be posted with a CCP mean that the
risk of a CCP going bankrupt is small. However, it is not
inconceivable, and in this case a CCP could also become
too big to save.
In view of the inherent concentration risks, it is
incomprehensible that under the new regulations these
infrastructural CCPs will operate as commercial
organisations. The same applies, to a lesser extent, for
clearing members. They perform infrastructural tasks
and should not have been permitted to combine their
clearing activities with that of proprietary trading.
A CCP potentially provides netting benefits, as the
positions of its clearing members are set against each
other to reduce the counterparty risk (multilateral netting,
see Figure 2, page 13).
These benefits cannot be achieved, however, if the market
is fragmented, which it will be in the clearing system as
12
envisaged by the Regulation. Market fragmentation can
only be avoided if (1) there is only one CCP, (2) everyone
uses the same clearing member and (3) all OTC
derivatives contracts are cleared. In practice, however,
none of these conditions will be met. First of all, there
will be various competing CCPs. In current European
practice, SwapClear is dominant in the clearing of inter­
est rate swaps, whereas ICE is the undisputed market
leader for the clearing of credit default swaps. Secondly,
many parties do not want to be dependent on a single
clearing member, not only for commercial reasons, but
also to ensure that positions can be transferred at short
notice to a back-up clearing member in the case of default
of one of its clearing members (portability). Finally, far
from all OTC derivatives are sufficiently standardised,
liquid, and suitable for automatical pricing to qualify for
clearing. This means that, in addition to centrally cleared
transactions, bilateral uncleared transactions will
continue to exist. Significant netting benefits may thus
be lost, and counterparty risk could become even greater
(see Figure 3, page 14).
C
D
30
60
B
B
5
10
15
Buy Side
‘End’ User
A
C
20
50
D
55
Counterparty risk:
Counterparty risk:
A = 70, B = 5, C = 70, D = 10
A = 60, B = 0, C = 20, D = 0
With bilateral netting, the mutual obligations of
counterparties are netted to a single payment obligation.
This corresponds with the current situation under ISDA
contracts.
Multilateral netting is possible if a CCP operates as a
central counterparty. The bilateral derivative contracts
between Parties A to D are replaced by contracts between
Parties A to D with the central clearing organisation. This
results in netting not only of contracts between each of the
counterparties themselves, but also of the obligations
across the counterparties as a whole. As a consequence, the
counterparty risk for Parties B and D becomes zero, and the
counterparty risk for Parties A and C is reduced. In this
graph we assume that the Parties A to D all have the status
of clearing members. However this will not be the case for
most market parties. Suppose that Party A is not a clearing
member and uses Party C as its clearing member, then
Party C will receive a total of EUR 80m(20 + 60). Then
Party A will receive an amount of EUR 60m on the basis of
the clearing contract with C.
Given that there will be some measure of market
fragmentation, it is highly questionable whether the
potential netting benefits provided by CCPs will be
realised in the clearing system as envisaged by the EU
regulators. An important advantage of a structure with
CCPs compared to the bilateral, uncleared structure is
that the valuation method of the CCP will take
precedence. This will lead to fewer disputes concerning
valuations of positions and the corresponding amount of
collateral to be exchanged.
The Regulation will have a huge impact on pension
funds. Pension funds make extensive use of OTC
derivatives to meet obligations arising out of pension
plans. To minimise volatility between assets and liabil­
ities and to offer regulatory protection for pension
beneficiaries, they hedge their liabilities against inflation,
currency and interest rate risks by means of OTC deri­
vatives. In general, pension fund investment strategies
create “one-way” OTC derivatives exposure, especially in
long-term interest rate swaps.
A CCP is exposed to counterparty risk during the lifetime
of an OTC derivatives transaction. Depending on the
amount and type of open derivative positions, the CCP’s
counterparties, the clearing members, must maintain
collateral with the CCP. The clearing members in their
turn require collateral from their clients. In a CCP
structure, much more collateral will be provided than in
the current bilateral structure. Not only is collateral
exchanged for the current counterparty exposure (varia­
tion margin), but also additional margin must be
deposited to protect the CCP against potential counter­
party exposure (initial margin). Although not prescribed
by the Regulation, at present CCPs only accept cash as
eligible collateral for variation margin. Cash collateral
provides the most security and is operationally the
easiest to process. Under the current non-cleared
structure, both cash and securities are considered eligible
collateral. Many asset managers and pension funds prefer
to have the option to post securities as well.
A requirement to accept cash only for variation margin
purposes could lead to liquidity problems. After all, if a
client has no cash available, it must generate cash either
by borrowing cash or selling assets. The 2008 crisis has
taught us that the impact of liquidity problems should
not be underestimated. It is anticipated that many
clearing members will offer financing and collateral
transformation services. We expect strong growth in the
market for repurchase agreements (repos), which by
definition will increase counterparty risk. Given the low
levels of interest earned on cash collateral and the
maintenance of cash buffers, combined with the fact that
Pension Background September 2012 no 1
13
Figure 3: Market fragmentation – Bilateral versus centrally cleared
Bilateral netting leads
to net exposure
of EUR 3m.
Inflation
Swap
ISDA/CSQ
+5mln
+3 mln Net.
exposure
Interest
Swap
ISDA/CSQ
+5mln
Inflation
Swap
ISDA/CSQ
+5mln
+5 mln Net.
exposure
Interest
Swap
ISDA/CSQ
+5mln
If bilateral ILS and
centrally cleared IRS cannotbe
netted,exposure is +EUR 5m.
this cash cannot be invested otherwise (opportunity loss),
the costs of cash collateral can be very substantial.
Temporary exemption for pension funds
For pension funds, with their large one-way OTC
derivatives positions, the requirement to post (cash)
collateral in a clearing system would mean having to
provide massive amounts of margin. Given that pension
funds aim to be fully invested and their portfolios are
very heavy on government bonds and very light on cash,
the EU institutions decided that pension funds and their
dedicated investment vehicles should be exempted
temporarily from mandatory clearing. This would give
the CCPs time to adjust for the acceptance of non-cash
financial instruments for variation margin purposes.
Following a successful lobby by APG and the Dutch
Pension Federation, pension funds and their dedicated
investment vehicles are exempted from the mandatory
14
The more standardised and liquid derivatives
contracts, such as many interest rate swaps and
credit default swaps, are relatively easy to clear.
CCPs are already active for these products. For other
derivative contracts, such as inflation-linked swaps
and swaptions, this is not (yet) the case. Although
CCPs will try to broaden their product offerings, a
significant percentage of derivative contracts will
remain unsuitable for clearing. If only some
derivative transactions are cleared centrally while
others are traded through bilateral CSAs, the market
will be fragmented. Operationally, this means that
collateral must be exchanged both bilaterally and
with clearing members.
In addition, netting benefits will be lost and
counterparty risk could increase. This is made clear
in the following example, in which a market
participant can net its exposure from inflationlinked swaps (ILS) against its exposure from interest
rate swaps (IRS) in a bilateral structure, whereas
this is not possible if only IRS transactions are
cleared centrally.
clearing requirement for a period of three years, with the
possibility to extend this period for another two years,
and finally for one more year. Meanwhile pension funds
have the option to start clearing voluntarily or to
continue the current bilateral structure until the
exemption expires.
The Regulation will also establish more stringent
requirements for OTC derivatives transactions that do
not (yet) qualify for mandatory clearing or that are
exempted. This includes the requirement to exchange
collateral on a daily basis for the outstanding obligations,
comparable with variation margin. In itself, this is a good
idea. However, a daily exchange of collateral can be
problematic and costly for market participants, especially
smaller ones.
The so-called level two rules to be adopted by the
European Commission will also require initial margin to
be posted for uncleared derivatives contracts. The aim of
this requirement is to encourage clearing. In the current
uncleared structure, pension funds do not need to post
initial margin because of their creditworthiness.
Although the level two rules under the Regulation still
have to be drafted and adopted, it is likely that pension
funds and their dedicated investment vehicles will be
obliged in future to exchange or post initial margin for
their uncleared transactions. This could have a
considerable impact on pension funds. In our opinion,
this measure punishes the wrong parties. The
creditworthiness of pension funds and their dedicated
investment vehicles needs to be taken into account in the
initial margin calculation. Effectively they should be
required to post a smaller amount of initial margin than
more leveraged/risky entities, or none at all. It is
important that the initial margin requirements do not
undermine the value of the exemption by discouraging
the use of uncleared derivatives contracts.
Mandatory clearing requires pension funds to use
clearing members in the future.3It is expected that a
relatively small group of CCPs and clearing members will
dominate the clearing market. The danger of this
scenario is that, in comparison with the current scenario
featuring bilateral ISDA contracts, there will be little
room for negotiation and high fees will be charged to
pension funds.4
The fees charged by clearing members and CCPs, the
requirement to deposit collateral partly in cash, and the
possible requirement to generate liquidity on short
notice will increase the costs for pension funds
significantly. They will then have several options:
•Continuing the use of OTC derivatives with the
higher costs and therefore accepting lower
performance. Other investments could be
divested to generate cash (collateral). Then they
3
The International Swaps and Derivatives Association has developed
standardised Master Agreements that can be declared as
applicable to all OTC derivatives transactions concluded between
parties. Usually collateral is exchanged regularly on the basis of a
supplementary Credit Support Annex, <www.isda.org>.
4
For example, SwapClear, the European market leader for the clearing
of interest rate swaps, pays EONIA minus 30bp on cash collateral.
could attempt to replicate the risk profile of the
reduced investments with OTC derivatives. This
would therefore lead to an increased use of OTC
derivatives, and higher collateral requirements.
•Reducing the use of OTC derivatives, for example
by accepting more risks rather than hedging these
risks, or by using other hedging strategies that are
not as good and can result in a greater mismatch.
Bankruptcy of the clearing member
If a clearing member goes into default, the CCP holds the
positions of the defaulted clearing member on its own
book. The CCP will first try to transfer the positions of the
defaulted clearing member, including the outstanding
initial and other margins, to another clearing member
(portability). The Regulation provides for this in the
appointment of back-up clearing members, but they will
stipulate conditions to enable refusal. The absence of a
system of guaranteed portability is a serious
shortcoming. The Regulation also says nothing about
portability when a CCP goes bankrupt. Finally, we note
that parties must be able to act swiftly in chaotic
situations. For example, SwapClear has a procedure by
which transfers must be made within 48 hours, other­
wise all positions are liquidated, with all the replace­ment
risks that this entails. Another shortcoming is that in
some cases, for instance with SwapClear, se­curities
collateral is immediately liquidated upon a default.
Asset segregation is essential when a clearing member
goes bankrupt. In this context, it is important whether
collateral is held in a segregated client account or a joint
omnibus account. Segregated accounts offer more
protection, but less netting opportunities. Omnibus
accounts offer more netting options, but if there is a
deficit, the CCP recovers this deficit from the collateral
deposited by the joint clients. This means that a client is
exposed to risks caused by third parties. Pension funds
should be aware of this. At present there is a wide variety
of segregation models available or under development,
each of which needs to be carefully examined.
We believe that the provision of initial margin should
also be made possible by means of guarantees or
Pension Background September 2012 no 1
15
pledges. This would soften the blow for many financial
institutions, because the number of settlements (and
with that the transit risk) could be reduced and the CCP
would only obtain access to the margin assets in the
actual event of a default.
Nicole Grootveld
COO NL Cardano
Transaction reporting
OTC derivatives transactions should be reported as soon
as possible to a central repository (trade repository). If
transactions are cleared centrally, the CCP or the clearing
member will report them. However, uncleared
transactions must also be reported and, depending on the
degree of detail required and the reporting deadline, this
can be an operational challenge. Reporting can be
outsourced, but this has to be agreed with each
counterparty. The transaction details can be used by
supervisory bodies. Any disclosure to the market,
however, should take account of the commercial
sensitivities of this information. This problem can be
solved by disclosing this information only after a
mandatory waiting period and on an aggregated basis.
Conclusion
Zöhre Tali
APG
Asset Management
Bas Zebregs
APG Asset Management
The Regulation will soon come into force, but many loose
ends remain to be dealt with in more detailed level two
rules. Meanwhile, the industry is preparing as well.
SwapClear and ICE can expect competition from CME
Europe and Eurex. It seems however that the risks and
costs that centralised clearing entails are still
underestimated by many market participants and
supervisory bodies. Also, it is becoming increasingly clear
that although systemic risk may be reduced with the
introduction of CCPs, for individual users it could mean
that they must actually accept greater risks and costs.
Their involvement in the rulemaking process of the level
two rules is essential to limit the negative impact on
their business.
16
Pension Background September 2012 no 1
17
The European
Pension Agenda
The recent debate on the Dutch pension system, pension
agreements, pension fund governance and discount rates
may seem to be primarily a national debate, but Brussels
may have quite a significant influence on Dutch pensions
too. This article looks at the European Commission’s latest
policy initiatives regarding pensions and their impact on
the Dutch pension system.
The European Treaty and the European Six-Pack
governance structure authorise the European
Commission to give instructions to all member states to
improve their national economies and public finances1.
This implies that the Commission can also make
recommendations regarding pensions. A good example is
the recent advice of the Commission to the Netherlands,
and also to the national governments of other member
states, to raise the retirement age and to link this to the
national life expectancy rates2.
In addition to this advisory competence, the Commission
has an important role in the coordination of pension
policy across member states. The final responsibility for
pension policy, however, is primarily with the individual
member states. The European Commission’s most
important policy initiatives regarding pensions in recent
months have been the publication of the White Paper on
Pensions and plans to revise the IORP Directive.
White Paper on Pensions
The publication of the European Commission’s White
Paper on Pensions3 is the most recent step in a new
1
European Commission (2011), EU Economic Governance “Six-pack”
Brusseectiels, December.
2
European Commission (2012), Council Recommendation on the
Netherlands’ 2012 national reform programme and delivering a
Council opinion on the Netherlands’ stability programme for 20122015, Brussels, 30 May.
3
European Commission (2012), White Paper An Agenda for Adequate,
Safe and Sustainable Pensions for Europe, COM (2012) 55, , Brussels,
16 February.
policy process on pensions. The process started in 2010
with a Green Paper on Pensions4 . The idea of this Green
Paper, applying a so-called holistic approach to many
pension-related issues, was to get a European debate
going on the (fiscal) sustainability of public pensions in
the member states and the adequacy of pension provision
for European citizens. The second step in this process was
a statement by the Commission in 2011 summarising the
main conclusions from consultation on the Green Paper5.
In the White Paper on Pensions, the European
Commission puts forward twenty initiatives which
could promote the security, adequacy and sustainability
of the pension provision for European citizens. These
initiatives are based on the Commission’s conclusion that
accelerated ageing of the population has become a severe
threat to future growth in the EU and will, even without
factoring in the consequences of the current financial
and economic crisis, lead to heavy pressure on the public
finances of the EU member states. In the Commission’s
view, reforms of the national pension systems are
therefore a matter of utmost urgency, particularly in
those member states where retirees still depend largely
on pay-as-you-go first pillar government pension
schemes for their income.
4
European Commission (2010), Green Paper Towards adequate,
sustainable and safe European pension systems, Brussels, 7 July.
5
European Commission (2011), Summary of consultation responses to
the Green Paper “Towards adequate, sustainable and safe European
pension systems”, Brussels, 7 March.
Pension Background September 2012 no 1
19
and expenditures till 2060
Reduction first pillar
pension till 2060
(compared to 2010)
Increase expenditure
first pillar pension
till 2060 (% GDP)
Going forward, these first pillar public pension schemes
based on pay-as-you-go financing will come under
increasing pressure. In the EU, the so-called dependency
ratio will double from 26% in 2010 to 53% in 2060: the
number of persons of working age (15-64 years) per
retiree (65 +) will decrease from four to two6.
Meanwhile, the sovereign debt crisis is causing further
pressure on pensions. Since the mid-1990s, therefore,
many countries have been drastically cutting back their
6
European Commission (2009). 2009 Ageing Report: Economic and
budgetary projections for the EU-27 Member States (2008-2060),
European Economy 2, April 2009, Brussels.
20
Given the large variation in pension systems from
member state to member state, the Commission
emphasises that the responsibility for pension policy
should be primarily with the member states, and
that its own role will be mainly a facilitating one. As
a consequence, most of the Commission’s twenty
initiatives are not proposals for new European regulation,
but recommendations to national member states.
Box 1 summarises the initiatives proposed by the
European Commission.
The policy initiatives to improve the balance between
time spent in work and retirement will have a positive
effect on national budgets and the entire economy.
As such, they are likely to benefit the Dutch pension
sector. As for the initiatives to improve and develop
complementary pension savings, the European
Commission concludes that supplementary funded
pensions will have to play an increasingly important role
in the future pension provision and should therefore
be encouraged. The Commission furthermore argues
140
120
100
80
60
40
20
0
ce
ee
Gr ce rg
an ou
Fr mb
xe
Lu nia
ve
Slo ium
lg
Be
ly y
Ita an
rm
ic
Ge ria ubl
st ep
Au h R
ec
Cz k
va
Slo n
ai
Sp en
ed l
Sw ga
rtu
Po gary
n
Hu nd
la
Po nd
la k
Ire ar
nm
De d
lan
Fin
nd
UK zerla
it
Sw nd s
la nd
Ice erla
th
Source: Europese Commission, The 2012 Ageing Report:
Economic and budgetary projections for the EU-27 Member
States (2008-2060), European Economy 2, April 2012,
Brussels
One of the reasons for these differences is the current
starting position. In some EU member states, total
pension income is almost completely dependent on
public pensions, which are pay-as-you-go financed
(first pillar). In some other member states, like the
Scandinavian countries, the UK and the Netherlands,
total pension income is to a substantial degree dependent
on funded pension arrangements (second and third
pillar). Figure 2 shows an overview of the pension savings
in different member states. Compared to other member
states, people in the Netherlands save a lot for their
retirement.
Figure 2: Assets in pension funds 2010 (%GDP)
Ne
Belgium-5,60%
Bulgaria-6,00% 1,10%
Cyprus18,00% 8,70%
Denmark-0,60%-0,60%
Germany-13,00%
2,60%
Estonia-16,00%-1,10%
Finland-16,00% 3,20%
France-10,00% 0,50%
Greece-43,00% 1,00%
Hungary6,00% 2,80%
Ireland2,00%4,10%
Italy-14,00%-0,90%
Latvia-68,00%-3,80%
Lithuania-6,00% 3,50%
Luxembourg-26,00%
9,40%
Malta-13,00%5,50%
The Netherlands-
3,60%
Norway-23,00% 4,90%
Austria-22,00% 2,00%
Poland-62,00%-2,20%
Portugal-13,00% 0,20%
Slovenia-7,10%
Slovakia-42,00% 5,20%
Spain-23,00%3,60%
Czech Republic-5,00%
2,70%
United Kingdom 35,00%
1,50%
Sweden-36,00% 0,60%
traditionally generous pension schemes. As a result
of the various austerity measures, pension benefits as
a percentage of wage will, on average, be 20% lower
in 2060. Despite these austerity measures, average
expenditure on first pillar pensions will continue to
climb. Figure 1 shows that the differences between the
EU member states are considerable, in terms of both the
austerity measures affecting the first pillar pensions and
growth of expenditure on these pensions.
Pension Funds Assets (%GDP 2010)
Figure 1: Developments public pensions
Source: OECD 2012 Statistics
that already existing supplementary pension systems
could be improved in some member states. In the
Commission’s view, supplementary pensions need to be
made more secure, cost-efficient and tailored in order
to achieve a more flexible labour market in the EU. Tax
incentives and agreements between social partners
(employers and employees) can play an important role
in this respect, the Commission believes. She therefore
Box 1: Main initiatives proposed in European Commission’s White Paper on Pensions
A.Balance time spent in work and
retirement, for example:
- Link the retirement age to life expectancy
- Abolish early retirement schemes and
other early labour market exit options
- Equalise retirement ages for men and
women where this has not already been
done
B. Develop complementary private
C. Enhance the EU’s monitoring
savings, for example
tools on pensions and strengthen
- Support initiatives in member states to
synergies across policy areas,
develop supplementary pension schemes
for example:
- Develop a code of good practices for occu- - Prepare the 2012 Ageing Report
pational pension schemes (second pillar) assessing the economic and budgetary
- Review good practices with regard to
impact of ageing, which will form
individual pension statements, with the
the basis for a thorough assessment
aim of encouraging member states to
of the sustainability of public
provide better information to individufinances (envisaged for release in the
als for their retirement planning
Commission’s 2012 Sustainability
- Improve cross-border pension mobility
Report)
for all occupations (To this end, the
European Commission must resume
work on a pension portability directive
setting Europe-wide minimum standards
for the acquisition and preservation of
supplementary pension rights)
- Review the IORP Directive
Pension Background September 2012 no 1
21
Figure 3: Participation in supplementary pension
schemes, % of current employees
100
80
% workers
60
40
20
0
l
ga rg
rtu ou
Po mb
xe
Lu
ain
Sp and
l
Fin tria
s
Au ce
an
Fr y
l
Ita 27
EU and
l
Ire rus a
p i
Cy an
hu ia
Lit an
m
Ro
UK nia
to a
Es gari
l
Bu ium
lg a
Be eni
v ry
Slo ga y
n n
Hu a
rm a
Ge aki
v
Slo d
lan rk
Po ma
n
De ia ds
tv lan
La her
t
Ne den
e
Sw
Source: EFRP, Workplace pensions – Defined Contribution, Survey, March 2010, Brussels or The Social Protection Committee,
Privately managed funded pension provision and their contribution to adequate and sustainable pensions, 2008, Brussels
aims to develop a code of good practices for occupational
pension schemes (second pillar), addressing issues such
as better coverage of employees, the payout phase, risksharing and mitigation, cost-effectiveness and shock
absorption. Especially with respect to the coverage of
employees, there is a lot of room for improvement,
given how many employees are still not entitled to
a supplementary pension. At present, only 40% of
employees in Europe participate in occupational pension
schemes or individual pension plans made mandatory by
the government (see Figure 3).
Furthermore, the Commission will investigate whether
national level tax rules on cross-border transfers
of occupational pension capital and cross-border
investment returns of pension providers present
discriminatory obstacles. If necessary, infringement
procedures will be initiated against member states
imposing such tax obstacles. In resuming work on a
Pension Portability Directive, the Commission can help
22
set Europe-wide minimum standards for the acquisition
and preservation of supplementary pension rights.
Measures like (1) reducing vesting periods (which imply
that employees only acquire pension rights after having
spent a minimum number of years in a job, e.g. five
years), (2) guaranteeing equal treatment of pensioners
and sleepers (e.g. when granting indexation) and (3)
promoting pension tracking services will certainly
also promote cross-border mobility of European
employees. On the other hand, cross-border portability/
transferability of the acquired pension rights of such em­ployees (as earlier proposed by the Commission) would
lead to many technical and budgetary com­plex­­i­ties. This
is not necessary to achieve cross-border mobility, might
hamper well-functioning existing pension systems and
should therefore not be proposed again.
Revision of the IORP Directive
Another policy initiative by the European Commission
that could change the pension landscape is the planned
revision of the IORP Directive.This is a major concern
for the Dutch pension sector, as it could hamper pension
provision across Europe. Occupational pensions are
regulated at EU level by the Institution for Occupational
Retirement Provision (IORP) Directive, which was
introduced in 2003. The objective of the IORP Directive
is to provide a regulatory framework for occupational
pension funds across Europe.
In 2011, the Commission initiated a debate on potential
adjustments to the IORP Directive by submitting a Call
for Advice to the European Insurance and Occupational
Pensions Authority (EIOPA) 7. The ultimate aims are:
•To simplify the legal, regulatory and administrative
requirements for setting up cross-border pension
schemes
•To introduce risk-based supervision
•To modernise prudential regulation for pension
funds that operate DC schemes, given the
increasing number of DC schemes across Europe
Figure 4: Impact of applying Solvency II on value liabilities
and capital requirements
FTK
Solvency II
Assets (bn €)
775
775
Liabilities (bn €)
662
738
Initial coverage ratio
117%
105%
Required coverage ratio
117%
126%
0
155
SCR shortfall (bn €)
Source: De Haan, Jurre, Agnes Joseph, Siert Vos and JanWillem Wijckmans (2012), De impact van Solvency II op
pensioenfondsen, ESB 4629, February 2012
more stringent than the current FTK rules. Applying
Solvency II to Dutch pension funds means that they will
be confronted with a higher required level of assets (see
Figure 4). The impact of applying Solvency II to pension
‘The capital requirements out of
Solvency II aim to provide a high level of
security on the short run and are more
stringent than the current FTK rules.’
The Call for Advice covers a broad range of topics, like
the scope of the IORP Directive and transparency and
governance requirements. A controversial question put
forward in the Call for Advice is whether some of the
quantitative requirements from the Solvency II Directive
for insurance companies could be incorporated into a
revised IORP Directive.
For European pension funds, this is a point of concern.
The capital requirements out of Solvency II aim to
provide a high level of security on the short run and are
7
European Commission (2011), Call for Advice from EIOPA for the
review of Directive 2003/41/EC (IORP II), Brussels, 30 March.
funds in other member states with large IORPs, such as
Germany, Ireland and the UK, will be even greater.
Increasing the level of assets to the required minimum
could be achieved by adding to the asset side (higher
contribution rates and additional sponsor support)
and/or by subtracting from the liability side (reducing
pension benefits). The latter option seems more likely, as
under current circumstances it is questionable whether
em­ployers and employees will be able to finance the
short­­fall. Another possibility for a pension fund could be
a de-risking of the asset mix. A more conservative asset
mix implies lower capital requirements in the short run.
Pension Background September 2012 no 1
23
How­ever, in the long run this means lower expected
in­vestment returns and consequently lower pension
benefits.
Even though EIOPA – as well as the European
Commission – has emphasised on several occasions that
the Solvency II requirements will not be copy-pasted
into the revised IORP Directive, and that the unique
Figure 5: Traditional vs holistic balance sheet
Traditional balance sheet
Assets
Holistic balance sheet
Liabilities
Assets
Sponsor
Support
Surplus
Assets
Assets
Technical
provisions
Liabilities
Surplus
Increasing
conditional
liabilities
Technical
provisions
Lowering
conditional
liabilities
Directive proposal before the summer of 201310.
The concerns with respect to the quantitative requirem­
ents do not mean that other recommendations in the
response to the Call for Advice will not contribute to the
improvement of second pillar pensions across Europe.
The recommendations with respect to governance of pen­
sion funds, the embedding of good risk management and
clear and understandable transparency requirements will
certainly be helpful in this respect.
Conclusion
On the one hand, initiatives from Brussels could be bene­
ficial for the Dutch pension system. European steps to
create more stability and to improve national budgets as
well as the entire European economy will have a positive
impact on the return of pension funds, especially in the
long run. Besides, pension systems in many EU mem­
ber states are highly dependent on the government and
public finances. These pay-as-you-go financed pension
systems are very vulnerable to the ageing of the popula­
tion. Spiralling national government budget deficits put
the public pension provision under even more pressure.
Its advice to the European Commission8, EIOPA
responded that some of the (quantitative) requirements
in Solvency II can theoretically be applied to pension
funds, but that the revised directive should take account
of certain unique characteristics of pension funds that
distinguish them from insurance companies. EIOPA
therefore proposes the so-called Holistic Balance Sheet
approach. As shown in Figure 5, the Holistic Balance Sheet
enables pension funds to assess and attribute a value to
the steering mechanisms (sponsor support, increasing
contributions) and adjustment mechanisms (conditional
indexation, cutting pension rights) that they use. As it
makes the differences between insurance companies
and pension funds explicit, the Holistic Balance Sheet
approach can be seen as intellectually tempting. However,
as it constitutes a whole new way of supervision and is
quite complex, EIOPA suggests first investigating the
impact of this new method. Pension funds in different
member states will be asked to perform Quantitative
Impact Studies.
characteristics of pension funds should be taken into
account, the revision of the IORP Directive continues to
be a major point of concern for the pension sector. The
threat of quantitative requirements based on Solvency
II provides a strong incentive for pension funds to focus
on providing a high level of security in the short term
instead of delivering adequate pensions in the long
run. Meanwhile, the draft Technical Specifications for
the Quantitative Impact Study9 show that the proposed
Holistic Balance Sheet approach is not only highly
complex, but above all very dependent on subjective
assumptions, making it very sensitive to model risk.
The draft Technical Specifications of the upcoming
Quanitative Impact Study also shows that some fun­
damental issues with respect to the valuation of the
steering and adjustment mechanisms are not clear. This
means that the Quantitive Impact Study will certainly
not provide answers to all the relevant questions nee­
ded to rewrite the IORP Directive. Nevertheless, the
Commission intends to use the output of the QIS for a
If deficits are not addressed, there is a severe risk that
the public finances of the relevant member states will
eventually prove to be unsustainable. This risk might
tempt these member states to “shrink” their pension
liabilities by increasing inflation. This would be to the
detriment of the pension capital which has been built
up in the Netherlands. We welcome the European
Commission’s acknowledgement of the importance of
properly functioning complementary pension provision
across Europe, as well as the Commission’s intention
to improve regulation for governance, information and
transparency in the pension sector. These proposals could
contribute to the creation of more occupational pension
schemes in the EU and to the key goal of achieving
pension security for EU citizens.
On the other hand, European initiatives could entail
risk for the Dutch pension sector. New EU regulations
could lead to an unnecessary increase of costs and
administrative charges and consequently to lower
pension benefits for participants. Because the Dutch
8 EIOPA (2012), Response to the Call for Advice on the review of
9
10 EFRP (2012) , Response to EIOPA Consultation on Quantitative
Directive 2003/41/EC: Second consultation Frankfurt, 15 February. 24
EIOPA (2012), Draft Technical Specifications for the QIS of EIOPA’s
Advice on the Review of the IORP Directive, Frankfurt, June.
pension system is quite unique in Europe, there is a
danger that new European regulation will not sufficiently
take into account its specific characteristics. The review
of the IORP Directive could be considered a case in
point. It is causing grave concern in the Netherlands,
both at government level and in the pension sector and
with politicians (see also the article by Pieter Omtzigt in this
Pension Background). With respect to current proposals for
the revision of the IORP Directive, we are not convinced
that these will lead to a better pension provision in the
EU going forward. Future developments with regard to
these proposals therefore need to be carefully monitored
by the Dutch pension sector and government.
Jurre de Haan
Corporate Strategy
and Policy APG
Wilfried Mulder
Corporate Strategy
and Policy APG
Impact Study (QIS), Brussels, July.
Pension Background September 2012 no 1
25
IORP: Some chances
and challenges ahead
The European Commission’s recent White Paper on
pension systems contains a number of interesting
proposals. As it is in the interest of all EU countries that
each country has its pension system in order, the
Commission is justified in taking initiatives. However,
Dutch Parliament has objected to two proposals: those
regarding a new IORP-directive and the portability of
pension rights in a new portability directive.
As under the Lisbon treaty parliaments can issue a yellow
or an orange card if they feel that the Commission’s
proposals are in conflict with subsidiarity, Dutch
parliament has appointed Pieter Omtzigt as rapporteur
on this White Paper with the aim of convincing the
European Commission and other parliaments that these
two proposals should be withdrawn or heavily modified.
Introduction
Currently, one of the greatest political challenges for
Europe is ensuring the sustainability of pension systems
that have come under increasing pressure due to an
ageing population and the current economic crisis.
Recent initiatives taken by the European Commission, for
example in drawing up a White Paper on sustainable and
adequate pensions, are therefore more than welcome.
The Netherlands also attaches a great deal of importance
to a sustainable and adequate pension system that has
the capacity to deliver a decent income for pensioners
in the future (for which in the Netherlands they make
their contributions during their active working period).
In view of the demographic challenges and the current
upheaval in the financial markets, it will be necessary to
monitor the European pension systems closely.
Given the wide diversity of systems and unique national
regulations across Europe, it will remain a major
challenge to find common ground within Europe to deal
with these problems without infringing on existing
rights of current and future pensioners. In this respect it
can be considered a material and legally enshrined fact
that the principal authority to develop and formalise
pension systems rests with the member states and not
with the European Union.
We have noticed that the creation of large pan-European
financial institutions in the banking and the insurance
sector has caused major problems. Large banks need to be
rescued because their failure would jeopardise the proper
functioning of the economic system, as we have seen
during the current crisis. It is wise to exercise caution in
the process of aiming for large European pension funds,
large financial entities.
Nevertheless, it is useful to talk about common
baselines, such as linking the pension age to the life
expectancy rate, better access to second-pillar pensions
and better provision of information. Affordable and
adequate pensions are important for everyone. Secondpillar pensions can be of great value in this regard.
Consequently, promotion of these pensions should
not be hampered by disproportionally strict rules from
Europe. This could certainly be the case where pension
systems are already well developed. It is therefore of
vital importance that decisions on these systems remain
the domain of member states. This also ensures that
Pension Background September 2012 no 1
27
countries are and remain responsible for financial
problems within their own systems. The Dutch system
is a mixture of financial and social components, which
allocates responsibilities to the government, the social
partners and individual employers and employees.
Central to this system is the principle of solidarity.
Most proposals in the White Paper look appropriate at
first sight. It is wise to assess the sustainability of the
labour market and the pensions system given the major
demographic changes now taking place. The proposal to
preserve the entitlements of employees who have
worked in different countries for a number of years is
also prudent. These employees must be able to collect
their pensions in a straightforward manner by means
of a tracking service, and they must have access to good
information. Furthermore the waiting and vesting
periods must not be excessively long, precisely in order
to protect them. The intended exchange of best practices
between member states can also be extremely helpful,
and it is gratifying that the European Commission has
emphasised the importance of supplementary pensions
and the role of social partners and collective systems
Having said all this, there are some issues on which I
have a more critical stance . My view is that in order
to ensure that the unique aspects of pension funds are
protected, the subsidiarity and proportionality principles
as described in EU-law should be applied carefully. Let me
first explain these principles.
Subsidiarity and proportionality principles
The Lisbon Treaty and the options of the subsidiarity
and proportionality control mechanisms have placed
an important instrument in the hands of the national
parliaments to help them play their role in European
decision-making . The principle of subsidiarity ensures
that the European Union does not act in areas which
are better regulated at national level. Proportionality is
the principle that the form and content of the Union’s
actions should not exceed that which is necessary to
achieve the Union’s objectives. In a number of proposals
discussed in the White Paper on pensions, both elements
are manifestly at issue.
28
The subsidiarity check can be applied to all concrete
legislative proposals. This procedure can result in
a yellow card if one third of national parliaments
object to a proposal on the grounds of subsidiarity.
The European Commission will then reconsider its
proposal. The procedure can lead to an orange card if
half of the national parliaments judge that the proposal
conflicts with the principle of subsidiarity. If the Council
of Ministers or the European Parliament shares this
judgement of the national parliaments, then such a
proposal will definitely be scrapped.
The principles of subsidiarity and proportionality have
a very clear relevance here: the design of the national
pension system will be put in jeopardy, while it is in
employees’ interest that agreements, schemes and
supervision are as specific as possible. Harmonisation
is in any event nearly impossible due to the entirely
different tax systems and differing relationships between
first pillar and second-pillar pensions.
Pension funds are not insurance companies
In the White Paper, the European Commission has
announced a legislative proposal for the revision of
the IORP-Directive in order to improve cross-border
activities, modernise supervision and maintain a level
playing field between pension funds and insurance
companies, which are covered by the Solvency I­ IDirective. In my opinion there is no convincing case for
such a level playing field for social security schemes (not
products) with substantially different characteristics:
pension funds operate on a non-profit basis with a col­
lective sharing of risk, whereas for insurers the capital
adequacy of individual policies is primary. Consumer
protection is of paramount concern here. For pension
funds the primary issues alongside the protection of
the participants are fair allocation of risk and inter­
generational solidarity. As a consequence, insurance
products cannot be compared to supplementary
pensions.
The costs of pension schemes operated by pension
funds will not fall, but could rise explosively as a result
of demands in a revised IORP Directive for excessive
guarantees at the level of insurance companies. This
collides with the European Commission’s objective of
facilitating more cost-efficient second-pillar pensions.
The costs of strict and highly complex quantitative
regulations may well be disproportionate, and would
deny employees the opportunity to accrue an adequate
pension at the lowest possible costs.
Legislation setting down complex and detailed
prescriptions for the supervision on and setting up of
such systems will not contribute to the goal of improving
access to second pillar systems. The perverse effect may
in fact be a shift to pay-as-you-go (PAYG) schemes, which
are not regulated at all. Such a shift has unfortunately
already taken place in certain EU member states.
delegated to the supervisory authority. In addition, such a
supervisory authority would inevitably claim substantial
policy freedom with regard to all the national pension
systems existing in the EU. This is undesirable.
Portability Directive
The Commission has announced its intention to
put forward a proposal for a Portability Directive on
supple­mentary pensions, with the aim of removing
impediments to mobility of labour. This proposal will
aim at enabling employees to take their accrued pension
rights with them when moving from one country to
another.
‘It is gratifying that the European
Commission has emphasised the
importance of supplementary
pensions and the role of social
partners and collective systems.’
In these member states pension funds have been
nationalised and the national governments have taken
over future pension liabilities. This is not in the interest
of sustainable government finance in the long term.
Increasing European supervision may also result in
incremental increases in European responsibilities
and obligations. In my view, it is appropriate for the
countries themselves to be and to remain responsible
for their own pension systems. The question is whether
current national and European supervision is actually
falling short. Increased European supervision would also
mean that essential political choices about such matters
as the confidence level of pension benefits would be
The topic of portability was last on the agenda of the
Council for Employment and Social Policy on 9 June
2008. At that time, no agreement was reached on the
proposal and the subject has not come up for discussion
since. The Commission’s (revised) proposal aims to
promote mobility within national labour markets
and between member states. It includes the following
elements:
1. substantial measures relating to the acquisition
of pension rights (maximum waiting and vesting
periods and vesting age),
2. measures relating to their retention (adaptation
of sleepers’ entitlements in accordance with the
agreed pension is “fair”),
Pension Background September 2012 no 1
29
3. a right of information for active and sleeping
participants, and
4. an effective date of application two years after the
adoption of the directive, with a possibility of a
five-year postponement.
lower than those that a Spanish fund needs to
hold. But if this Latvian fund transfers the entire
reserved amount, the “receiving” Spanish fund
will still have far too little to satisfy the Spanish
accountancy rules because these are based on the
Spanish national life expectancy tables.
‘The Netherlands with its
pensions register provides
an excellent example which
can serve as a blueprint for a
European solution.’
Due to various technical issues, portability would under
this directive run into insurmountable problems:
a. Some countries levy tax on contributions, whereas
other countries levy tax on pension payments. In
order to take into account these differences in tax
treat­ment, a recalculation would be required in the
case of cross-border transfer of pension rights. An
additional complication in this respect could be
the possibility that a member state would need to
pay back tax already levied after an employee has
left this state.
b. Portability can only apply if the accrued pension
entitlements are fully funded. This is only the case
on a large scale in a few countries. Capital can
only be transferred from those countries. Pension
systems in EU member states vary from PAYG
systems via non-liquid funding to fully funded
systems.
c. The determination of the transfer value is
extremely problematic. For example, male life
expectancy in Latvia is 68 years, whereas in Spain
this is 78 years. The reserves which a Latvian
pension fund needs to maintain are considerably
30
supplementary pensions were to be dealt with in the
same way as private insurance policies, this would have
an enormous impact on solvency requirements for
supplementary pensions. This could entail significantly
larger buffers for pension funds, leading to far more
expensive pension schemes, and would have the perverse
effect that countries would further nationalise funded
systems. Extensive European regulation would also be
needed to protect customers from pension misselling
or excessive cost loading. Pension entitlements are an
element of the labour agreement, however. Harmonised
regulations at European level and European supervision
would be hopelessly complicated against the background
of 27 completely different national systems. Moreover,
such a move would go against the principle of
subsidiarity, enshrined in the EU treaty.
Pieter Omtzigt
Member of Dutch
Parliament
Dutch Parliament has harboured concerns about
the portability of pensions for some time now.
Implementation could be exceptionally complicated.
Besides, a good tracking service with proper provision
of information would be an obvious alternative, as
is identified by the European Commission itself. The
Netherlands with its pensions register provides an
excellent example which can serve as a blueprint for a
European solution. If such a register is accompanied by
limited threshold periods and by protection of deposit
funds, the same objective could be achieved more
efficiently.
Conclusion
The announced proposal relating to the portability of
supplementary pensions has
raised concerns in Dutch Parliament. The European
Commission has previously proposed legislation on this
issue, and this has been repeatedly rejected for various
technical and financial reasons.
To conclude, the proposed review of the IORP-Directive
could mean that pension funds will be treated as market
participants and not as part of a labour agreement. If
Pension Background September 2012 no 1
31
Both the Dutch and British pension sector face changes.
While both countries started out with similar systems,
they moved in different directions, but are now showing
signs of converging. What are the lessons the Dutch can
learn from the process that the British pension system
went through?
Knowing the past helps to understand the future
The Dutch and British
pension sector Converging towards a
steady state?
The Dutch and the British pension sector were similar up
to the 1980s. After that they began to diverge. It is use­
ful to consider two important differences between the
Netherlands and Britain that impacted the directions that
were taken: the legal framework and strength of labour
unions. The Netherlands, as most of continental Europe,
has a legal system based on the Napoleon code, or civil
law. Britain, on the other hand, has adapted the system
of common law with a stronger focus on individual
con­­­t­racts. In the Netherlands it is possible to change a
system by changing the legal code, whereas in Britain
the individual contract is considered to be almost holy.
The other difference is that the position of the labour
unions is more powerful in the Netherlands than in
Britain. It is also worth noting that within Britain there is
a significant difference in the quality of pension between
the unionised sectors and other sectors1.
The modern pension system began to develop after
World War II; a public PAYG scheme was introduced
to reduce immediate poverty for the elderly, while for
younger employees an additional final salary DB scheme
was introduced. The main difference between the count­
ries is that the Dutch system has always had a mix of
company pension funds and industry-wide pension
funds (the first industry-wide pension fund for the dairy
industry was founded in 1917)2, whereas the British
designed, demographic and career projections were
different from today. As is well-known by now, increased
longevity and demographic changes have a strong effect
on the sustainability of PAYG and DB schemes. When
DB and PAYG systems were designed, people on average
lived considerably shorter than they currently do and
they were expected to have more children earlier in life.
Besides that, it was not unusual in those days to have a
single employer during your entire career, as opposed to
the frequent job switching that is the norm nowadays3.
The DB schemes were attractive to employees, as DB
schemes are easy to understand and the employer
assumed the open-ended pension risks. This system
worked well until a combination of longevity,
demographics and adverse market conditions put a strain
on the system. These problems came to the fore when
new accounting standards made the risk associated with
the company pension fund explicit on the company’s
balance sheet. The volatility of the pension fund began to
interfere with the core business of listed companies. This
is where the Dutch and the British pension sector headed
into different directions, determined to a significant
extent by the unions and the legal framework.
system is dominated by company pension funds.
During the period in which this pension system was
Within the British market, we should distinguish
between public sector and private sector schemes.
In the British private sector, the CFOs wanted to get
the volatility of pension liabilities off the company’s
balance sheet, so they closed their DB funds and/or
1
3
2
Centre for Policy Studies (2011), Self-sufficiency is the key: addressing
For a thorough explanation, the authors refer to Pensions
the public sector pensions challenge.
Commissions (2004), Pensions: Challenges and Choices, the first
SER (2012), In heel Europe moet de arbeidsparticipatie omhoog.
report of the Pensions Commission.
Pension Background September 2012 no 1
33
went for a buy-out of the pension liabilities4. In their
place, individual DC schemes were offered to new
employees. By offering these DC solutions, the problem
for the employer was solved, as the risk is completely
transferred to the employees. The chosen solution is in
line with the concept of fairness based on common law:
the old contracts are kept intact and new employees get
another, much weaker contract. On the other hand, in
the British public sector, DB schemes were maintained,
and a discussion about the sustainability of the system
has only just begun. For most civil servants a DB scheme
is offered on the basis of the PAYG principles, while
local government employees save for their pension in a
funded DB scheme. Since the DB schemes in the public
sector are paid out of the government budget, the costs
same types of scheme are in place. However, it should be
noted that the risk that employers bear is limited. The
contributions into the pension scheme can vary, but they
are “capped”. This is not a hard cap, but since increasing
contributions only has a marginal effect on the financial
position of most funds, the current contribution rates
may be considered as capped. The different path taken by
the Netherlands can be explained by the Dutch concept of
fairness based on the civil law code, in combination with
strong unions. In the Dutch pension debate, employers
and unions were able to renegotiate the pension deal (i.e.
change the code) with support from the government.
That meant that both old and new employees got
the same deal, which prevented a full move towards
individual DC schemes for new employees.
‘The pension market lacks the
kind of competition on price and
quality that we see in normal
consumer product markets.’
were not as explicit as in the private sector, which is
why it took so long before the change debate started. The
difference between the public and the private sector can
be explained by the role of the unions. The unions in the
public sector are stronger and better in protecting their
members, making it harder for the employer to shift all
the pension risk to the employee.
The Netherlands took a different approach. Instead of
replacing the entire DB deal, the risks were partially
shifted towards the employee. A move from final salary
to average wage was a significant step in making the DB
schemes more sustainable. Furthermore, compensation
of inflation was made dependent on the financial health
of the fund. This system is usually called conditional
indexation. For both the public and the private sector, the
4
IPE (2009), 90% of UK DB Schemes now closed.
34
Recent developments
While DC is favourable for employers, who can shift
risk entirely to the employee, for British employees the
actual individual DC experience was disappointing.
Participation is as low as 50% in the private sector5,
contributions are low and costs are high. This
combination has severe implications for the pension
outcome. To counter some of the shortcomings of the
individual DC schemes offered, particularly the low
participation rate, the British government introduced
auto-enrolment. Auto-enrolment means that every
employee with insufficient pension accumulation
automatically participates in the pension scheme of
their employer. The employee can opt out if desired.
The employer is obliged to offer a pension scheme. This
5
Office for National Statistics (2011), Pension Trends, Chapter 7:
Pension Scheme Membership.
can either be the pension scheme of a provider, or the
National Employment Savings Trust (NEST), which was
initiated by the government. NEST is a straightforward
DC scheme that operates at arm’s length from the
government.
Figure 1
Employer liability
Traditional DB
Conditional indexation
Besides these changes, another important trend
in Britain is the proposed introduction of Defined
Ambition. Steve Webb, the minister of State for Pensions,
and his Department of Work and Pensions (DWP) are
contemplating whether a type of pension scheme that
is in between a traditional DB and individual DC should
be possible6. Such a scheme can probably offer a better
pension outcome for participants while it might not
burden the employer more than the current DC schemes
do. Introducing these Defined Ambition schemes is likely
to require legislative changes.
After the IT bubble, the Netherlands made the move from
final wage to average wage pension calculation. The DB
contract could be maintained by shifting some of the risk
to the participants. However, the interest rate sensitivity
of the liabilities, demographic changes and rising
longevity expectations have caused concerns on how
sustainable the system is in the long run. A renegotiation
of the pension deal between employers, employees
and the government was initiated, which looked into
options like increasing the retirement age and making
the retirement age and benefits more dependent on
longevity. While the exact outcome of the new Pension
Deal is still unclear at the moment of writing this paper,
it is expected to look more and more like a collective DC
scheme.
Learning from past experiences
What is interesting to see is that the Dutch and British
pension systems, coming from very different ends of
the spectrum, now seem to be converging towards
something in the middle. Figure 1 illustrates the changes
to the pension system in both countries. While both
started at traditional DB, the Dutch model, as explained
above, moved towards the model of conditional
indexation. The British private sector shifted into the
6
Steve Webb (2011), A new future for workplace pensions?,
Collective
Defined Ambition /
The new pension deal?
Individual
Individual DC
No employer liability
Individual DC market, while the British public sector
still has with the traditional DB model. Both countries
however are now searching for a new steady state, as the
chosen models have proved to be unsustainable.
So what can a steady state look like? Or more
importantly: what are the lessons learned from the
paths that the two countries took? We will draw some
conclusions that are relevant for designing new pension
contracts and products.
1. Absence of “The invisible hand”
In a traditional market, a buyer and a seller have
symmetric information. Services and goods change
hands after price negotiations. This process is repeated
many times in the marketplace and after a while a market
price is formed. Unfortunately the pension market does
not work that way.
In reality, pension products are sold and not bought.
There is a significant information asymmetry between
the service provider and the consumer. Financial
illiteracy is widespread and people are irrational when
it comes to making decisions regarding their pension.
Pension, after all, is a low-interest product and requires
the ability to think on a horizon of multiple decades. But
we only get one chance to get it right; once we are retired
it is too late to change our mind. It is well known from
academic literature that we as individuals have several
behavioural biases that commercial service providers
skilfully take advantage of. As a consequence, the pension
market lacks the kind of competition on price and quality
that we see in normal consumer product markets.
In Britain, the market solution experiment resulted in
The Telegraph (8 April 2011).
Pension Background September 2012 no 1
35
‘Changes are not implemented overnight
and the political decision-making
process in both countries only allows for
change one step at a time.’
individual pension products with high fees, low participation
and low contributions. For the Dutch debate, an important
lesson is that someone needs to defend the interests of the
individual, and therefore a strong involvement of the social
partner is crucial when moving towards Collective DC.
2. Fee level
One euro paid in fees is one euro less invested in
pension. It may sound trivial, but a lower annual fee is
the single most important step towards a good pension
in Britain. The compounding effect of costs in pension
provision (primarily asset management) is difficult to
understand for most individuals. A difference between
costs of 0.5% and 1.5% in annual fees might seem mar­
ginal but the effect over 40 years of pension savings can
easily amount to a gain in pension income of over 28%.
It is important that the cost of pension is kept to a minimum.
Mandatory participation in pension solutions is a great cost
saver since it completely eliminates marketing costs. A nonprofit pension fund eliminates the need to pay dividends to a
shareholder.
3. Participation ratio
The Dutch system and British system differ most
significantly in the area of participation. Over 90% of
Dutch employees save for their pension, as a result of
which old-age poverty in the Netherlands is among the
lowest in the world. The British sector, on the other
hand, had no strong participation incentives in place,
and participation among private sector workers in the
employers’ pension schemes has hovered around 50%.
Again, mandatory participation can explain this large
36
difference. The British government recently introduced
auto-enrolment. While the actual result of this policy
change needs to be seen, it is a good step in the direction
of increasing participation, especially among low-income
earners.
In the Dutch context it would be a great improvement if
specific groups that are currently outside the Dutch pension
fund system, such as the self-employed, could be covered by a
collective DC solution.
That said, since the British and Dutch pension sectors are
moving towards a similar system, both countries should
pay close attention to the transition on either side of the
North Sea.
It is our hope that the outcome of the pension deal
discussion in the Netherlands preserves the strengths
mentioned earlier, and that the people of the Netherlands
will continue to have access to an integrated pension
solution in which both the build-up phase and the payout phase proceed in a cost-efficient way.
Our predecessors did a great job designing the original
DB pension deal given the times they were in. We could
ask ourselves what they would have done if they were
living today and facing the current challenges. What
solution do you think they would have opted for?
Ruben Laros
Innovation Centre APG
4. Contribution level
While the contributions into DB schemes are comparable
between the two countries at a level around 20%, the
shift towards individual DC in Britain was accompanied
by much lower contribution rates. The legislation on
auto-enrolment and NEST implies that the contribution
will in future be at least 8%. In the past, the British
premiums into individual DC schemes were set based
on very optimistic return assumptions, leading to
low contribution rates. As history has shown, these
assumptions have not materialised, leaving many people
with inadequate savings for their retirement.
In the Dutch pension deal discussion, it is clear that the
contribution level should be kept at current levels if/when
moving towards a more explicit Collective DC solution.
Stefan Lundbergh
Innovation Centre APG
Towards a new steady state
The discussion on what the new steady state in both
countries should be ongoing and will remain so for
many years to come. Changes are not implemented
overnight and the political decision-making process in
both countries only allows for change one step at a time.
Pension Background September 2012 no 1
37
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