By any measure, Europe is certainly keeping pace with the US in terms of regulation. Indeed, there is enough going on to write a book on it. Actually, we did write a book.
Last year, PERE’s parent company published a tome on the Alternative Investment Fund Managers directive and its profound effects on fund managers and their capital-raising activities. With a hint of honesty, our specialist book department could have added several more books on the other regulations, if it had the time. Therefore, it comes as something of a shock to see recent talk about yet another potential game-changing regulation that PERE has hitherto not reported upon.
By now, readers will be used to acronyms attached to these regulations, so I make no apology for introducing a new one: EIOPA. This one stands for the European Insurance and Occupational Pensions Authority, which in April 2011 was asked by the European Commission to advise it on EU-wide legislation – the Institutions for Occupational Retirement Provisions (IORP) directive – designed to improve the pension industry.
As global accountancy and advisory firm PwC points out in a recent paper on the subject, given that this industry body is responsible for insurers as well as pensions, it should come as little surprise that the proposed IORP directive bares remarkable resemblance to Solvency II. Indeed, it looks like a copy and paste job.
Alarm bells already should be ringing in the ears of readers because Solvency II has been one of the most controversial of the proposed regulations, with huge implications for real estate. This is because pension investment into real estate is much, much bigger than that of even insurers and involves many more individual plans – some 140,000 compared to just 4,753 insurance firms.
The issue for insurers – and it is a massive one – is how they will view property as an asset class once Solvency II is in place from 1 January 2014. In particular, what will be the impact given that insurers will be required to hold the capital equivalent to a write-down of 25 percent in the book value of their real estate investments?
It seems obvious that the tendency would be for an insurer to reduce its appetite for property. Not only that, but the notion that insurers could perhaps increase their participation in real estate lending received a blow because Solvency II seems to catch that with a nasty charge as well.
Now, switch the word ‘insurers’ with ‘pension plan’ in the earlier paragraph on Solvency II, and one can see why IORP is vexing those in the real estate industry. Given we now have IORP as well as Solvency II, we are talking about the long-term prospects of some €715 billion of real estate investments provided by insurers and pensions.
John Forbes, a partner in real estate investment management at PwC, told me recently that the main impact from IORP would be on defined benefit schemes, rather than defined contribution schemes and linked-insurance products. That is because the directive is focused on systemic risk of pension schemes that hold investments on their balance sheet rather than schemes where the risk lies with the individual investor.
Still, this is certainly a significant rump. Little wonder then that a group representing a host of real estate associations and bodies have penned a joint response to IORP. While the various trade groups may support efforts to stabilise financial markets and lower systemic risk, their response dated 31 July said the group was concerned about EIOPA’s proposals, not least because the 25 percent figure in Solvency II was based on flawed data. The group suggested 15 percent would be more appropriate.
In addition, the jointly-signed letter stated that the flaws that still remain in the current Solvency II draft directive have made their way into IORP, even though they easily could have been avoided. For example, the importance of inflation risk is underestimated in both initiatives, and the 25 percent standard solvency capital charge for property is adopted without any real discussion in the IORP directive put out for consultation.
Now, IORP does not have a fixed date for implementation, so one doesn’t need to press the panic button just yet. Indeed, as PwC’s Forbes suggested, there might even be something good in this directive for managers of opportunity funds – well, in theory anyway.
It is true that the IORP directive might discourage defined benefit pension schemes from investing in real estate because of the high capital relative to government bonds, but a more positive outcome would be that pensions and insurance companies might start to look more closely at the returns from their real estate. That might mean they manage them better and put capital into more actively managed funds in order to generate a better return to justify the capital cost.
If it panned it that way, that certainly could be a possible silver lining. Then again, it could just be wishful thinking. I am all for wishful thinking, as it happens, but my wishes tend not to come true more’s the pity.