29 April 2016

Harmonised capital requirements for European pension funds remain off the agenda - for now

Pension funds remain the largest single source for European venture capital and private equity funds, contributing nearly one-third of the total raised in 2014, and – although most of that comes from US pension plans – European pension funds are significant investors too. As highlighted in a previous edition of Private Equity Comment, potential regulation of European occupational pension schemes has given rise to a concern that they could be tempted to look at more liquid, short term investments, turning away from longer term investing. It was therefore welcome when the European Commission shelved plans to introduce EU-wide capital requirements for pension funds (similar to the Solvency II rules which apply to insurance companies) in 2014, but the European Insurance and Occupational Pensions Authority (EIOPA) has continued to ponder the way forward since then.

Invest Europe and the BVCA are among those who have expressed concern that Solvency II-type rules could require pension funds to reserve greater amounts of capital when making private equity and venture capital investments, and this would run counter to various EU initiatives which are seeking to promote venture capital as a way to fuel growth in the European economy. It is therefore good news that earlier this month, EIOPA issued an opinion on "a common framework for risk assessment and transparency for Institutions for Occupational Retirement Provision" and advised that a framework based on common valuation rules and standardised risk assessments should be introduced, while refraining from capital or funding requirements at this point in time. While "at this point in time" could leave the door open for capital requirements at some point in the future, given that this announcement is consistent with the previous announcements from European bodies, a U-turn seems unlikely in the foreseeable future. The opinion was issued by EIOPA at its own initiative and it is now up to the European Commission to decide whether to act on the recommendations it contains.

EIOPA recommends some changes for pension funds, although only for those occupational pension schemes (IORPs) where the risk is shared by the sponsor, pension plan members and the institution itself. Defined contribution schemes, where the risks fall purely on the pension plan members, would not be covered by the suggested framework. EIOPA thinks that IORPs should be required to draw up market-consistent balance sheets and conduct standardised risk assessments using a set of pre-defined stress scenarios, with the main elements of the balance sheet and the outcome of the risk assessment to be disclosed publicly. The principle of proportionality, a notoriously difficult concept to apply in other areas, could also be adopted: with a possible exemption for very small IORPs with less than 100 members, and others being able to use simplified methods in proportion to their scale and complexity.

While these recommendations would, if adopted, obviously add to certain pensions funds' compliance functions, and indeed costs, it is a much more favourable position than applying arbitrary capital requirements. The reaction in the pensions industry has been generally positive, as many have been campaigning for several years to avoid these types of rules, and private equity and venture capital fundraisers will also be relieved.

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