Key advice from Europe's supervisory agency for pensions has relieved pension funds of the need to provide an expensive capital buffer under new 'Solvency II' regulations but left open the possibility of funds still needing to inject capital on a massive scale.

The final advice of the European Insurance and Occupational Pensions Authority (EIOPA) on the European Commission's Institutions for Occupational Retirement Provision (IORP) directive proposes the use of a 'holistic balance sheet' method for making pensions regulation comparable across Europe.

The EIOPA stated that it favours allowing sponsor covenants and Pension Protection Fund (PPF) guarantees to cover requirements in order to safeguard pension funds under the 'holistic balance sheet' approach.

A press release from the body noted that the holistic balance sheet will "enable IORPs to take into account the various adjustment mechanisms (conditional indexation, reduction of accrued rights) and security mechanisms (regulatory own funds, sponsor support, pension protection funds) in an explicit way."

Professor Paul Sweeting of JPMorgan Asset Management told Pension Funds Insider in January that accepting employer covenants and PPF guarantees (which currently cover 90% of all UK pension liabilities) could see Solvency II having no cost at all to British pension funds.

The holistic balance sheet approach averts a massive £1trn bill to the UK pensions industry that an alternative use of a capital buffer would have given.

The EIOPA's advice makes a number of negative points on the use of such a buffer (termed a Solvency Capital Requirement). It argues that if a capital buffer is adopted without serious efforts to mitigate its effect on pension schemes, "the additional cost could undermine the cost-efficiency of occupational retirement provision in the EU."

The British pensions industry, alongside other major continental pension funds, has been vocal in its opposition to the strictest form of new Solvency II requirements. In a joint letter with the Confederation of British Industry and Trade Union Congress, the National Association of Pension Funds (NAPF) this Monday warned of a "disastrous impact on the long term economic growth and employment rate in the EU" if the measures were adopted in full.

The full details regarding the likely 'holistic balance sheet' approach are still open to discussion at the European Commission though, meaning the threat of a serious financial impact has not yet been fully averted.

Nonetheless there will be some relief that the EIOPA's advice reflects the concerns of the UK pensions industry, albeit cautiously.

The EIOPA urged the Commission to conduct a thorough cost analysis of the holistic balance sheet approach and "the various policy options within that" before making any policy decision, saying that "without a quantitative impact study an assessment of the concrete impact will not be possible."

The Commission will aim to draw up policy on the directive this year before having it debated at the European Parliament.

Complaints from across the continent

Zoe Lynch, a partner of Sacker and Partners warned that the unclear nature of the EIOPA's advice document (which runs to over 500 pages) will fail to calm fears of Solvency II marking the end of defined benefit pensions.

Lynch said "from the information provided, it appears likely the introduction of the holistic balance sheet would signal the end of DB pension provision in the UK. The proposed introduction of the approach represents a real risk that employers will abandon the idea of funded schemes (both DB and DC) if the solvency or minimum capital requirements are applied."

Lynch also said she effectively worried about the EIOPA being outmanoeuvred by the European Commission in the policy process. Lynch claims that the EIOPA were given a narrow remit that could not allow them to question the logic of harmonising European pension regulations.

Joanne Segars, NAPF chief executive, said:"We are disappointed that Europe's pensions and insurance regulator is still proposing Solvency II-type rules for pension schemes, even though its own advice now acknowledges the damage that would be done to European pensions, jobs and the wider economy.

"The UK already has a strong system in place to protect its final salary pensions. It does not need additional protection from Europe. The European Commission and EIOPA should instead focus on where they can add real value. Their plans to improve defined contribution pensions and member communication are welcome, and we encourage the Commission to focus its attention on these areas."

German political opinion was also highly critical of the EIOPA advice, for failing to call conclusively against Solvency II.

A labour affairs spokesperson for Angela Merkel's CDU party, Peter Weiss, said the EU's plans to apply Solvency II to occupational pension schemes were "completely incomprehensible".

Weiss said: "Such expensive over-regulation will undermine the willingness of employers to support the tried and tested occupational pension system." He accused the latest concessionary signals from the Commission as "not being sufficient".

Weiss said: "We will campaign resolutely against this half-baked idea from the Commission with the full consensus from politicians, unions and employers behind us."

dbillingham@wilmington.co.uk