The Pan European Pension Product (PEPP), expected to launch in 2020, is intended to make a large-scale, portable, and cost-efficient retirement savings product available throughout the EU. The PEPP forms a critical sub-set of the Capital Markets Union (CMU) which is the principal policy initiative aimed at enhancing the efficiency and effectiveness of Europe’s markets.
It’s been over a year since we last wrote about PEPPs, and at that time, industry sentiment was cautiously optimistic. Most of the industry saw the PEPP as a promising idea, but with an overly inflexible framework. Initial market reaction was that the PEPP needed some key alterations if it was going to be a success. A year on and after a flurry of debate, disagreement, and advocacy (as is standard in EU rulemaking,) it looks like adequate compromise has been advanced in critical areas with the redraft of some targeted practical revisions which make the PEPP a more desirable addition to the toolkit of asset managers operating in Europe.
Whilst policymakers took much of the industry’s feedback into account, there are still some items to sort out before the PEPP can truly help with the EU’s pension puzzle. Let’s look at five key issues:
- Default Investment Options
One area of welcome concession is the recognition of two acceptable default options: life cycle funds with robust disclosure and risk mitigation techniques required, and capital guaranteed funds. The prior position was an insistence that all products must have a capital guarantee.
Whilst the revised default options are preferable to asset managers over mandated capital guarantee funds, there are several life-cycling and mandatory risk mitigation techniques, the details of which are not fully clear. These must be flexible and proportionate to make PEPP provisions commercially viable also.
The other great hope is that if a fund meets the criteria of a “basic PEPP,” then mandatory advice is not required and PEPPs may be sold on an execution-only basis on retail platforms. This would be a huge positive for the distribution of this product across the EU.
- Proposal for Fee Caps
The current PEPP proposals include a fee cap of 1%, however many in the industry disagree. The most obvious reason is that the PEPP is brand new and therefor there’s no certainty around what its cost base will be. Caps also tend to result in “herding” around the maximum regardless of what provision of the product costs. The industry feels that a competitive market should be allowed to set appropriate fee levels and that the rules should focus on fee transparency and comparability rather than caps.
Another open element is what makes up the 1%. For example, the proposal doesn’t specify if transaction costs are part of or excluded from the 1% cost. As the industry witnessed recently within MIFID 2 and PRIIPs, the calculation and disclosure of costs is both critical and difficult – often creating confusion for both investors and asset managers alike.
- Decumulation Parameters
Decumulation is the process of withdrawing retirement investment capital to fund the costs of living comfortably without a salary. Simply, it’s the act of putting one’s retirement assets to use after years of saving. Decumulation is not a concept that is normally found in mutual funds where liquidity is generally on demand. This is really where the pension world and traditional mutual fund spaces collide. It is also critical if PEPPs are to compete on a level playing field with other pension and insurance financial products.
Freedom of choice and flexibility regarding payouts within the decumulation phase is key. Regulators worry about people spending too much of their fund if they are given free reign, whilst savers want to make sure they have access to the nest egg they saved all their working lives to build.
Both the capital guarantee and life cycle products specify decumulation phases and allowable drawdown amounts. The rules try to acknowledge investors’ desire to access savings periodically, whilst honouring the fact that PEPPs are designed to specifically fund retirement horizons. The rules also set out a mechanism for investors to choose their preferred type of pay-out five years before decumulation phase. In decumulation phase, PEPPs may provide a limited pay-out to investors in year one and thereafter there may annuity, drawdown payments, or a mixture of the two.
- Regulatory Oversight
Pension products in Europe are regulated by the European Insurance and Occupational Pensions Authority (EOIPA). Funds and asset managers are regulated by the European Securities and Markets Authority (ESMA). So, the boundary lines of who should regulate what aspects of PEPP production, trading, and distribution have also been the source of much debate. For example, PEPPs will be subject to PRIIPs regulation, even though the risk/return methodology doesn’t align. As such, it will be necessary for EIOPA to discuss with the other European Supervisory Authorities (ESAs) to publicly consult on this and other disclosure elements to ensure investor clarity.
When authorised, all PEPPs will be registered in a central public register maintained by EIOPA. However, there is still much debate about the allocation of responsibilities between EIOPA and national authorities. This debate around centralized ESA control or empowerment of national regulators also continues to play out across Europe in relation to asset management delegation.
- Tax Treatment
In some quarters there have been suggestion of a specific pan-European tax treatment regime for PEPP to aid its success by reducing national tax arbitrage and increasing certainty and portability across EU borders. However, tax harmonization remains beyond the ambit of CMU generally. As such, it remains up to each individual member state to apply identical fiscal incentives to a PEPP as they do their own national pension products. This is not likely to change as most believe it won’t impact the success of the product on a cross-border basis.
The EU Parliament and Council have both concluded their initial review of the PEPP ruleset and there is a universal desire to implement pension before the European parliamentary elections in May 2019. We expect PEPPs to enter the market mid-2020, but this depends on the EU Trialogue process.
So, the PEPP debate remains open and whilst trending in a positive direction for asset managers, it is critical that the industry continues to remain actively engaged throughout the rule making phase to influence a final ruleset.