PN Philip Bennett The EU Pension Funds Directive: The UK’s approach to implementation presented to a meeting of The Association of Dutch Pension Lawyers on 15 th March, 2005

PN Overview Part I: Introduction and Timing Part II: IORPs Covered in the UK Part III:Technical Provisions/Funding Part IV:Investment Rules and Restrictions Part V:Cross-Border Activities

PN Part I: Introduction and Timing “Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision” Note: referred to as an “IORP” Adopted: 3 June, 2003 Published in Official Journal: 23 September, 2003 In force: 23 September, 2005 Option to defer implementation for “regulatory own funds” (Article 17) until 23 September, 2010 Option to defer restriction on employer related investments to 23 September, 2010 (Article 18(1)(f))

PN Part I (cont’d): Introduction and Timing Ensure high level of protection for IORP members IORP in Member State A can cover employees and former employees in Member State B (in theory) IORP can follow investment strategy tailored to its liabilities subject to prudent person rule Respect Member States’ prerogatives in relation to social protection and pension systems

PN Process for Implementation in the UK Pensions Act 2004 approved by Parliament on 18 th November, 2004 Nearly all detail to be in Regulations (not yet available) But Consultation Paper issued by UK Government (October 2003) 1 UK Government Response to Consultation (June 2004) 2 1 Implementing the European Directive on the Activities and Supervision of Institutions for Occupational Retirement Provision: A Consultation Paper (October, 2003). 2 Implementing the European Directive on the Activities and Supervision of Institutions for Occupational Retirement Provision: Government Response to Consultation (June, 2004).

PN Part II: IORPs covered in the UK Typical structure in UK Employer enters into Trust Deed with Trustee under which >Trustee agrees to hold assets on trust for purpose of pension scheme >purpose of pension scheme: provide retirement benefits for members >members are employees and former employees of employer >benefits funded out of employer contributions, any member contributions and investment income and gains Remember an English trust does not have a separate legal personality

PN acts as trustee of Shareholders ABC Pension Trustee Limited Directors The Trustee Company The Employers 1.AAA PLC : Principal Employer 2.BBB Limited 3CCC Limited 4.DDD Limited 5.EEE Limited ABC UK Pension Scheme Memorandum & Articles of Association Definitive Trust Deed Deeds of Adherence

PN The Trustee Company The Scheme bank account The employees who are active members The Employers pay contributions regular AVC pay contributions invested

PN Part II (cont’d): IORPs Covered in the UK UK private sector funded tax approved occupational pension schemes set up under trust and qualify as IORPs but Directive does not apply to: Companies using book reserve schemes with a view to paying out retirement benefits to their employees (i.e. UURBS 3 and AURBS 4 ) 3 Unfunded Unapproved Retirement Benefits Schemes. 4 Authorised Unfunded Retirement Benefits Schemes.

PN Part II (cont’d): IORPs Covered in the UK Pension Act 2004 introduces new definition of occupational pension scheme to align with Directive definition of IORP 1 Personal pension schemes including group personal pension schemes and stakeholder pension schemes are not IORPs UK Government will not exercise option to extend Pension Funds Directive to the “pension business” of life insurance companies 1 Institution for Occupational Retirement Provision

PN Part II (cont’d): IORPs Covered in the UK Member States may choose to exclude from large parts of the Directive: An IORP with less than 100 members (those in receipt of survivors’ benefits only are not members) in total (but the freedoms on provision of custody services and investment management services to such small IORPs (Article 19) cannot be excluded) public sector occupational pension schemes set up by legislation and guaranteed by public authority (in practice only Article 18 (Investment) and Article 19 (Freedoms on investment management and custody services) must apply)

PN Part III: Technical Provisions/Funding IORP must establish at all times “adequate amount of liabilities corresponding to the financial commitments which arise out of their portfolios of existing pension contracts” Where IORP provides cover against “biometric risk” or guarantees investment performance or a given level of benefits, that sufficient technical provisions are established

PN Part III (cont’d): Technical Provisions/ Funding Minimum amount of technical provision must be calculated by sufficiently prudent actuarial valuation method taking account of all commitments for benefits and for contributions Minimum amount must be: >sufficient for both pensions and benefits already in payment to beneficiaries to continue to be paid, and >must reflect the commitments which arise out of members’ accrued pension rights

PN Part III (cont’d): Technical Provisions/ Funding Prudent rates of interest to be determined by taking into account: >yield on corresponding assets held by scheme and the future investment returns, and/or >the market yields of high quality or Government bonds

PN Part III (cont’d): Technical Provisions/ Funding Note: Commission must, every 2 years or on request of a Member State, propose necessary measures to prevent possible distortions caused by different levels of interest rate and to protect interest of beneficiaries and members of any scheme Comment: Will lead to harmonisation. But what if interest rates differ between those Member States inside Euro zone and those outside?

PN Part III (cont’d): Technical Provisions/ Funding IORP must have sufficient and appropriate assets to cover technical provisions Underfunding only allowed for “a limited period of time” relative to technical provision If underfunding occurs, IORP must adopt a concrete and realisable recovery plan to fully fund technical provision in due time Recovery plan available to members and/or subject to approval by competent authorities of home Member State

PN Part III (cont’d): Technical Provisions/ Funding UK will have a “scheme specific funding standard” Note: If the scheme operates cross-border, technical provisions must at all times be fully funded. If this condition is not met, scheme may no longer operate cross-border. Home Member State may require assets to be ring-fenced

PN Part IV: Investment Rules and Restrictions Prudent person rule applies with assets invested in the best interests of IORP’s members and beneficiaries Decision on investment must be made in sole interests of members and beneficiaries in cases of conflict of interest Assets must be invested to ensure security, quality, liquidity and profitability of portfolio as a whole! Assets held to cover technical provisions must be invested in a manner appropriate to nature and duration of expected future retirement benefits

PN Part IV (cont’d): Investment Rules and Restrictions Assets to be predominantly invested on regulated markets Investment in assets which are not admitted to trading on a regulated financial market must, in any event, be kept to prudent levels Comment 1: Consider direct investment in property Comment 2: Consider direct investment in private equity Comment 3: Consider 100% direct investment in unit linked life policies and other pooled vehicles which are not traded Comment 4:Consider life cover only IORP.

PN Part IV (cont’d): Investment Rules and Restrictions UK Government comment: “ 6.15The Government would like to confirm that we do not intend to prevent schemes from securing their pension liabilities through the purchase of long-term insurance contracts, such as unit-linked life policies. More generally, we believe that indirect investment via collective investment vehicles where underlying assets are traded in regulated markets should be treated as being equivalent to direct investment on regulated markets.” Note: See page 37 of UK Government’s response to consultation: June 2004

PN Part IV (cont’d): Investment Rules and Restrictions Assets must be properly diversified to avoid >excessive reliance on any particular: –asset, –issuer or group of undertakings, and >accumulation of risk in the portfolio as a whole Note: Member State may disapply restriction on diversification in relation to investment in Government bonds! Comment: Consider whether investing all assets in a single unit linked life policy or Open Ended Investment Company will be properly diversified (but see UK Government view expressed one slide earlier)

PN Part IV (cont’d): Investment Rules and Restrictions Investment in sponsoring undertaking must be no more than 5% of portfolio as a whole When sponsoring undertaking belongs to a group, investment in group undertakings must not exceed 10% of portfolio Comment: UK Government to defer implementation of this provision (Article 18(1)(f)) to 23 September, 2010

PN Part V: Cross-Border Activities May operate cross-border in EU subject to prior authorisation from home Member State “An institution wishing to accept sponsorship from a sponsoring undertaking located within the territory of another Member State shall be subject to a prior authorisation by the competent authorities of its home Member State, as referred to in Article 9(5). It shall notify its intention to accept sponsorship from a sponsoring undertaking locating within the territory of another Member State to the competent authorities of the home Member State where it is authorised.”

PN Part V (cont’d): Cross-Border Activities Importance of definition of “sponsoring undertaking” ““sponsoring undertaking” means any undertaking or other body, regardless of whether it includes or consists of one or more legal or natural persons, which acts as an employer or in a self-employed capacity or any combination thereof and which pays contributions into an institution for occupational retirement provision” See Article 6

PN Part V (cont’d): Cross-Border Activities Example 1: UK branch of Dutch company provides pensions for employees of UK branch in UK IORP Question 1: Is there any cross-border activity? ““sponsoring undertaking” means any undertaking or other body, regardless of whether it includes or consists of one or more legal or natural persons, which acts as an employer or in a self-employed capacity or any combination thereof and which pays contributions into an institution for occupational retirement provision”

PN Part V (cont’d): Cross-Border Activities Example 2: Employee of Dutch company is member of Dutch IORP and is transferred to work in UK branch of Dutch company but remains in Dutch IORP Question 2: Is there any cross-border activity? ““sponsoring undertaking” means any undertaking or other body, regardless of whether it includes or consists of one or more legal or natural persons, which acts as an employer or in a self-employed capacity or any combination thereof and which pays contributions into an institution for occupational retirement provision”

PN Part V (cont'd): Cross-Border Activities Consider relationship with Mobile Workers Directive Directive 98/49/EC of 29 th June, 1998 Definition of “posted worker” See Title II of Regulations (EEC) 1408/71 Contributions to supplementary pension schemes by or on behalf of posted workers Note: Wider than Pension Funds Directive definition of IORP

PN Part V (cont’d): Cross-Border Activities Are the cross-border provisions compatible with Articles 39 to 55 of the Treaty of Amsterdam? Note: Free movement of persons, services and capital. Do the cross-border provisions in Article 20 impose incompatible restrictions Consider Danner (ECJ Case C-136/00) and also Ramstedt (ECJ Case C-422/01) “restrictions on freedom to provide services within the Community shall be prohibited in respect of nationals of Member States who are established in a State of Community other than that of the person for whom the services are intended” (Article 49 of the Treaty of Amsterdam) Query: Compatibility with requirement to comply with host Member State's requirements of social and labour law relevant to the field of occupational pensions

PN Part V (cont’d): Cross-Border Activities Example 3: Dutch company makes available membership of Dutch IORP to employees of UK branch of Dutch company Note: contributions to Dutch IORP paid by Dutch company from Holland but cross-charge of contributions to Dutch IORP to UK branch Question 3: Is there any cross-border activity?

PN Part V (cont’d): Cross-Border Activities Example 3: Dutch company makes available membership of Dutch IORP to employees of UK branch of Dutch company (cont'd) ““sponsoring undertaking” means any undertaking or other body, regardless of whether it includes or consists of one or more legal or natural persons, which acts as an employer or in a self-employed capacity or any combination thereof and which pays contributions into an institution for occupational retirement provision”

PN Part V (cont’d): Cross-Border Activities Example 4: Dutch company makes available membership of Dutch IORP to employees of UK subsidiary company of Dutch company Note: contributions to Dutch IORP paid by Dutch company from Holland but service cross-charge of contributions to Dutch IORP to UK subsidiary of Dutch Company Question 4: Is there any cross-border activity?

PN Part V (cont’d): Cross-Border Activities Example 4: Dutch company makes available membership of Dutch IORP to employees of UK subsidiary company of Dutch company (cont'd) ““sponsoring undertaking” means any undertaking or other body, regardless of whether it includes or consists of one or more legal or natural persons, which acts as an employer or in a self-employed capacity or any combination thereof and which pays contributions into an institution for occupational retirement provision”

PN Part V (cont’d): Cross-Border Activities Example 5: Dutch company makes available membership of Dutch IORP to employees of UK subsidiary company of Dutch company Note: UK subsidiary pays contributions directly to Dutch IORP Question 5: Is there any cross-border activity?

PN Part V (cont’d): Cross-Border Activities Example 5: Dutch company makes available membership of Dutch IORP to employees of UK subsidiary company of Dutch company (cont'd) ““sponsoring undertaking” means any undertaking or other body, regardless of whether it includes or consists of one or more legal or natural persons, which acts as an employer or in a self-employed capacity or any combination thereof and which pays contributions into an institution for occupational retirement provision”