Impact of accounting and prudential regulation on pensions

"A long-term view involves short-term risk, whereas a short-sighted strategy involves increased risk over the long term."

EDHEC just released its impressive report Impact of Regulation on the ALM of European Pension Funds. Even though we disagree in some instances, we think this is mandatory reading for anyone in the pensions investment space because it highlights those areas of regulation which will be of increasing consequence for pension funds' investment strategies in the near future, as we have continued to stress over the recent past.

At the core of the report is the development of an asset allocation model in the presence of liability constraints. The solution involves the components cash, risky assets and the liability hedging portfolio. The state of the art model takes inflation and longevity risk management into account as well.

There is not enough space nor time for an in-depth review of this valuable piece. Nevertheless, I would like to mention two issues that have slightly moderated my enthusiasm for the report:

• There seem to be a few at least implicit factual inaccuracies in the parts describing the regulatory environment. The most glaring of which may be the assumption that the EU pensions directive is applicable in Switzerland - it is not.
• Accounting standards seem to be understood to effectively determine investment action. While it is not unheard of that managements structure transactions in such ways as to optimise their reporting, this clearly goes one step too far. We are well aware of the interdependence between perception (qua accounting standards) and (economic) reality, but at least in an academic report, the latter needs to retain some vestige of predominance over the former. Remember: pension funds' long-term time horizon, as accounting standards can and do change.

Asset pooling

epn has an interesting story�mostly about the competition between asset pooling locations in Ireland, the Netherlands and Luxemburg. The Belgian approach with its relaxed solvency regime gets bad marks, especially with regards to next year's Commission review of the Directive and its transposition.�

CFA Pension Code of Conduct

The CFA Institute Centre is asking for comments on its Code of Conduct for Members of a Pension Scheme Governing Body until 15 August. The draft has been prepared with the assistance of the OECD and major trade associations from the Hong Kong, the Netherlands, Switzerland, the UK and the USA.

Discriminatory dividend taxation

The EU Commission has sent letters of formal notice to Italy and Finland about their rules under which dividends paid to foreign pension funds may be taxed more heavily than dividends paid to domestic pension funds. Italy and Finland are asked to reply within two months. These letters constitute the first step of the infringement procedure of Article 226 of the EC Treaty. Similar letters have been sent to the Czech Republic, Denmark, Spain, Lithuania, the Netherlands, Poland, Portugal, Slovenia and Sweden on 7 May.

DNB on pensions

In a recent speech, the president of the Dutch central bank has presented a concise and well structured comparison between US and Dutch occupational pensions. He particularly focused on the benefits of a legal separation between sponsor and pension fund as well as on the advantages of professional asset management which is supported by the more collective approach in the Dutch system.

Commission addresses differential taxation of investment income

Following complaints by the EFRP, the Commission has initiated Treaty infringement proceedings against a number of member states which do not grant the same preferential tax treatment of investment income (interest, dividends) to pension funds resident abroad as domestic funds receive. Even though there is no direct reference to the Pensions Directive in the text, the relevance of this step to an efficient investment regime of cross-border pension funds is obvious. (FT)

Location competition starts to bite

Evidently, the cross border competition for locating IORPs starts having an impact - at least, that's the impression you get when reading this story about the Dutch central bank lambasting neighbouring Belgium's new (and competitive) pensions regulation. We wonder for how long the Commission will be able to uphold its politically highly sensitive stance of tolerance towards regulatory & supervisory shopping - which is conceptually at the core of the Pensions Directive.

P.S. Naturally, the Belgian response wouldn't be too far out.

2007 asset allocation survey

Mercer IC published its periodic asset allocation survey of European pension funds. Of the 651 funds surveyed, 75% still reside in the UK, thus the survey's cross country comparison may not be entirely reliable (via VF).