A ‘fake law’ is a document that looks like a real piece of legislation on the outside but on the inside its content does not have any legal force. This applies to the latest attempt by the European Commission to create a new pan-European pension product (COM(2017) 343 final) which is ultimately little more than an announcement policy full of promises. What the European Commission wants to achieve could be done under current market conditions. The reasons why this hasn’t happened up until now won’t change much in the future.
The main features of the initiative
First, a few introductory words before going into the details of the ‘Pan-European Personal Pension Product’ (PEPP).
As part of the legislative packet to complete the Capital Markets Union, the European Commission wants to deepen the individual, personal third pillar of pensions. However, in doing this, it neither wants to harmonise the products nor subject them to minimum standards. Instead, it wants to create an additional product as a kind of 29th regime (after Brexit it will be the 28th). It won’t replace the national systems but be additional to them. PEPPs will not be approved by the relevant authority in the country of origin but rather by the European Insurance and Occupational Pensions Authority (EIOPA). National authorities would then be only responsible for overseeing ongoing operations.
The European Commission has high expectations for the new product. It is hoped that it will pump money in eye-watering amounts into new markets. Personal pension product assets are expected to not only double from the current EUR 700 billion but even possibly triple, depending on what model assumptions are used. PEPPs are also expected to help close the pension gaps that are known to be opening up all over Europe as a result of past pension reforms. It is hoped that PEPPs will ultimately produce higher returns through economies of scale and long-term investments.
The characteristics of a PEPP
According to the proposed regulation, a PEPP product must have a number of standardised characteristics, including:
- Participation is voluntary.
- It follows the ‘prudent person’ rule.
- The product offers up to 5 investment options (risk categories) including a risk-free default option which guarantees investors recoup at least their capital invested.
- Fees and costs must be transparent, provided in a Key Information Document (KID) prior to a contract being signed.
- Further transparency must be ensured by providing annual benefit statements for the contract period of the product. These annual statements must include results, yields and risks.
- Providers can freely choose to either service the ‘accumulation phase’ only or to also offer pay-out options such as a lump sum, annuity or regular withdrawals.
- Savers are permitted to change PEPP product or provider every 5 years.
- Entitlements and actuarial capital must be portable. The product follows a mobile citizen or worker across all EU borders to the new Member State. Ideally, the saver receives a single pension at retirement. Incidentally, PEPPs differ from the pan-European RESAVER pension which was specifically created for researchers because entitlements and capital saved in a RESAVER pension remain in the country of origin; the member receives more ‘benefits’, even if from the same provider.
The Achilles heel: national compartments
Mobility, which is supposed to be PEPP’s trump card, is also its Achilles heel. Regulation of PEPP does not fall exclusively within European competence; on the contrary, national tax legislation continues to apply. In plain language: Once they have been approved, PEPPs can be freely sold throughout Europe. However, they wouldn’t necessarily enjoy the same tax ‘benefits’ of national products and thus would be virtually impossible to sell. The draft regulation addresses this by providing for the establishment of national compartments. These are designed to ensure that a PEPP product complies with the applicable regulations in the country in which it operates, including retirement age and pay-out methods (e.g. lump sum or annuities). In another document, the Commission recommends Member States to treat comparable PEPPs and national products equally for tax purposes; however, this does not change the condition of setting up national subdivisions for each product – up to a possible 27.
It is important to understand that the proposal does not foresee the creation of a new type of financial service provider but rather a new product, at least according to the Commission. A PEPP can be created and sold by existing approved financial service providers such as banks, insurance companies, state-based pension funds, occupational pension funds or investment fund companies.
What do stakeholders think?
Given the complexity of the proposed pan-European personal pension products, the European Representation of the German Social Insurance and the Federation of the Dutch Pension Funds (Pensioenfederatie) organised a workshop on October 19. This was attended by the main European umbrella associations for the finance and insurance sectors, the social partners and the European Social Insurance Platform (ESIP). When assessing the success prospects for the proposed new product, it was quickly agreed that the complex organisational structure in national compartments and the unknowns regarding tax treatment speak against PEPPs becoming a model of success. A lot of convincing has to be done to persuade people to sign a contract that locks up their savings for decades, especially with questionable interest rates from the saver’s point of view. Without tax incentives for pension products, which also fulfil their actual social purpose, it will be very difficult to channel private household assets into long-term capital investments, even though this is a prerequisite for higher returns.
There is a contradiction which threads its way through the entire project. Namely, the desire to promote investments that are only profitable in the very long-term and not the short-term is incompatible with the need to be able to liquidate a part of these investments at any given time in the interests of portability and competition.
The outlook: Is this just the start?
So, what will change in the real world if the proposed regulation is actually passed? Nothing really. The financial service providers mentioned above (banks, etc) are already able to offer products which are similar in content to the requirements stipulated in the proposal, and to offer these products across borders. The only unique characteristic of PEPPs is that they will no longer be approved by the relevant national authority but by the European Insurance and Occupational Pensions Authority (EIOPA). This might be advantageous for providers because EIOPA will certainly not be tempted to strictly interpret standards or impose additional conditions, but this is behaviour that is often labelled as ‘gold plating’ when the Member States do it.
However, if the project fails because of its complexity (national compartments, no harmonisation of tax rules, etc), the Commission will probably not hesitate to put it back on the table, but next time rather than just recommending PEPPs be given equal tax treatment with national products, the Commission will want this as a provision.