European regulators’ growing focus on fees paid by DC plans and participants could have the unintended effect of rewarding only the largest investment managers with the scale to drive down costs, industry sources said.
Following an opinion published by retirement watchdog European Insurance and Occupational Pensions Authority on Oct. 7, DC plan executives are set to face more scrutiny of their cost disclosures as EIOPA wants fees paid by DC plans, known in Europe as DC institutions for occupational retirement provisions, or IORPs, to be more transparent and comparable.
EIOPA said in its opinion that local regulators in Europe currently don’t have sufficient insight into the level of costs paid by IORPs based on their annual accounts because disclosures often don’t include external investment fund and manager fees or transaction costs.
Noting that fees of about 1% of assets could reduce defined contribution plan participants’ retirement income by more than 20% over 40 years, EIOPA said it wants to boost effective cost supervision across the European Union to ensure that plan participants get value for money investments and that IORPs are cost efficient and affordable to sponsors. Some 125,000 IORPs across Europe could be required to better break down investment costs, including fiduciary management fees, external manager fees, administration and transaction costs, as well as costs associated with plan participant communication, when the opinion is transposed to national legislation across Europe.
And while EIOPA’s motivation to improve costs transparency was welcomed by the retirement industry, sources are concerned about the effects of implementing the regulation.
“There is a risk that too much focus on costs and charges in the supervision may result in a race to the bottom, leaving customers exposed to passive investment strategies and in the hands of a few providers dominating the local markets,” said Stefan Lundbergh, Amsterdam-based director and head of DC design at consultant Cardano.
“Transparency is a good tool since it keeps shadowy practices at bay,” he added. “To achieve this, in a cost-efficient way, a standardized approach of reporting costs and charges are necessary for both DC (plan) providers and their underlying fund managers. The approach outlined in the recent EIOPA opinion document is a good step in that direction,” he added.
But sources agreed that the impact of the opinion could have a detrimental effect on some DC plans. That’s because many European regulators already examine costs locally based on their own specific retirement regulations.
Enhancing comparability of costs between IORPs of different sizes could leave some DC plans unable to diversify their asset allocations even if they can prove they are delivering value for money investments to their specific plan participants.
Mr. Lundbergh added that for some DC plans, “using cost data for supervisory purposes should be done with care.”
Meanwhile, DC plan providers with plans set up in Belgium are convinced that they are already subjected to sufficient cost controls by local supervisors that monitor their contracts with money managers.
“Even if there is a higher requirement for transparency and cost disclosure, we are quite compliant to that,” Thierry Verkest, chairman of the €1 billion ($1.2 billion) United Pensions, the cross-border pan-European multiemployer plan run by Aon, said in a telephone interview about EIOPA’s opinion.
However, Mr. Verkest added that United Pensions’ expenses are reported on a general level rather than per employer.
Mr. Verkest also noted that Belgium’s regulators have already been constraining access to certain asset classes through means other than excessive cost control such as examining diversification attempts by DC plans.
“The regulator is putting more pressure on the fit-and-proper requirement and expecting that board members have the knowledge of what they are investing so they are extremely sensitive” if plans should start investing in asset classes that they don’t necessarily control such as alternatives, he added.
In Germany, EIOPA’s opinion wasn’t very well-received.
Germany’s occupational pensions association for the public and private sector, aba, criticized EIOPA’s opinion for a lack of consultation and ignoring differences in European retirement systems when attempting to use costs to determine what constitutes value-for-money investments.
Klaus Stiefermann, secretary general of aba in Berlin, said that value-for-money investments for participants should be EIOPA’s main objective rather than pure cost transparency. “While transparency around cost is important … focusing on costs without assessing benefits will lead to a race to the bottom, which is unlikely to be in the best interest of members and beneficiaries,” he said, adding that if IORPs are forced to publish in-depth cost data on their websites, that would lead to requests to cut money manager fees.
“Depending on how the opinion is used by (the regulator), it will increase pressure on IORPs to focus on cost. They are likely to pass on some of this pressure to their service providers, calling on them to lower their prices. However, the opinion itself does not ensure that this pressure will lead to better value for money,” Mr. Stiefermann said.
“We do therefore not agree with EIOPA suggesting that national competent authorities should encourage IORPs to disclose reported costs and charges,” he said.
However, Tessa Kuijl, head of Nordics at Dutch consultant Ortec Finance Ltd. in Amsterdam, said that keeping the market efficient and transparent is always good.
“For DC plans, possibilities to invest are not endless with requirements that come with DC investment. Nevertheless, you can still compare to others and enable senior management to improve if there is any inefficiency in their choices or the strategy that they pursue,” she said.
But Ms. Kuijl added that the regulators may intend to keep an eye on active strategies as there are questions if more expensive active strategies provide better retirement outcomes.
“I can imagine there is some agenda to keep a keen eye on active management,” she said.
But Ms. Kuijl added that it remains to be seen what impact on asset allocations EIOPA’s opinion will have. While she is not expecting a strategic reevaluation of asset allocations by DC plans, she thinks that the opinion could lead to simplification of strategies used by DC plans.
Meanwhile in the U.K., which left the European Union at the end of last year, the government signaled on Oct. 27 that it is planning to remove the charge cap of 0.75% on funds under management and administration on DC investments. And while ending the cap can unlock DC investments in alternatives, U.K. sources said that the level of permitted charges hasn’t been proven on its own to shape better outcomes for plan participants.
Commenting on the move by the U.K. government, Sonia Kataora, head of DC investment at U.K. consultant Barnett Waddingham LLP, said: “Workplace pension scheme charges are generally well under the existing cap, and although adjusting the cap may assist with some investments, this doesn’t tend to be the deciding factor for trustees when deciding whether a strategy creates good value for members.”