The European Commission last month published its proposal for the regulation on a pan-European personal pension product.
We believe a PEPP would simultaneously begin to address the estimated €2 trillion ($2.334 trillion) "pension gap" in the 28 European Union member states and the fact that 41% of household wealth in the eurozone is languishing in bank accounts paying little or no interest, a total of €7.6 trillion. In doing so, it would contribute to putting the pension systems on a more sustainable path and strengthen the future adequacy of retirement incomes.
Supporters of the PEPP are, naturally, very pleased the European Commission is running with the ball on this particular issue. However, their hope is tinged with apprehension. We do not know yet the final shape of the regulation as the European Parliament and European Council will need to discuss the commission's proposal and agree on possible amendments. Still, we are hopeful they will be supportive of the ambitious vision EFAMA has for the PEPP.
This vision is rooted in the background problems for which the PEPP can be a solution.
Look at the numbers
There is no better place to begin than with the figure of 36%. That is the average proportion of a retiring employee's final salary that will be covered by public pension provision in the current 28 EU member states by 2060.
That leads to the two equally startling figures already mentioned: the €2 trillion pension gap and the €7.6 trillion in bank accounts.
Increased pension saving would seem to be a winning proposition in light of what can only be described as a looming crisis for household financial assets, in both the present, with very poor returns on cash in the bank, and with regard to the future security of retirees.
But the personal pensions industry in Europe is, for structural reasons, seriously inhibited in terms of delivering the sort of products that would bring this winning proposition fully to life. Individual national markets are fragmented, with the result that competition and choice are more limited than they ought to be and costs are commensurately higher.
This is where the PEPP can play a vital role: a standardized product that can be sold across national borders, breaking down barriers between different markets and, as a result, reducing costs and increasing competition. If it is to fulfill its role — and in doing so make retirement systems in the EU more resilient and more sustainable — the PEPP must meet three fundamental criteria.
It has to be cost-effective, it must be truly portable among the member states, and perhaps above all, it must be a trusted product, both safe and simple to use. This last feature would require a high degree of standardization, such as the information that must be supplied to would-be investors and the investment options PEPP providers should offer to savers.
But matters such as the retirement age should be left to the member states, as should the tax treatment of the PEPP, provided member states give PEPPs the most favorable tax treatment available to their personal pension products.
What it can achieve
Should it meet all of these criteria, what would we expect the effect of the PEPP to be?
First, people would save more and this would complement the savings in the occupational pension schemes and help to bridge the pension gap in Europe.
Second, it would play a big part in getting people to shift some of their savings out of bank accounts and into a product that will be higher yielding as a result of competition, lower costs and economies of scale.
Third, the overall effect of this would be to greatly improve the sustainability of the pension system, not least through the encouragement it would give to Europe's young people to start saving as early as possible. By doing so, they will harness the power of compounding, which, over a period of 30 to 40 years, is considerable.
Fourth, a burgeoning savings scene can help provide the funds needed to finance economic growth in Europe. In this way, the PEPP would strengthen the Capital Markets Union, the flagship commission project to develop a more diversified financial system complementing bank financing with deep and developed capital markets.
The legislative proposal for the PEPP confirms the commission shares our vision. This is why EFAMA and the investment management industry broadly support the regulatory framework put forward by the commission.
We are still analyzing the proposal in detail, and we will make suggestions on specific points. In the meantime, I can say that there is an important element of the PEPP proposal that will need to be clarified if the PEPP is to deliver its full beneficial impact: the default option.We agree the default option should aim at providing the PEPP saver with a high level of capital protection, using risk-mitigation techniques that result in a safe investment strategy. This does not mean, however, that all providers should be required to offer a default option with a minimum return or capital guarantee. Indeed, mandating these sorts of guarantees would restrict the access of the PEPP market to insurers and therefore severely limit the positive impact of the PEPP on competition among providers, on product choice and on cost. In addition, the obligation to provide a financial guarantee would force investment into low-yield traditional assets, such as government bonds and bank deposits. This, in turn, would lead to low returns.
In seeking to assist countries to strengthen retirement income adequacy in a defined contribution environment, the OECD Working Party on Private Pensions has identified elements of good design and public policy. In this context, the working party concluded life-cycle investment strategies are well-suited for default options. Such strategies offer long-term investment market exposure and risk diversification throughout the accumulation phase, while reducing the impact of market risk as the beneficiary approaches retirement.
The potential for PEPPs to contribute to capital market development and the goal of securing an adequate retirement income will strongly depend on whether providers have sufficient flexibility to diversify their PEPP portfolios into long-term asset classes.
It is our hope that a diversity of providers — insurers, banks, asset managers and others — will supply the PEPP, and it should be up to the PEPP providers to decide whether they want to offer life-cycle investment strategies or strategies with minimum return guarantees as a default option.
It is vital the PEPP be designed right. It must be highly standardized, but within that framework choice and competition should be the order of the day.
So much hangs on this, not least the encouragement of savings habits among the young, the financial security of European households and, above all, the sustainability of pension systems.
Peter de Proft is director general of the European Fund and Asset Management Association, based in Brussels. This article represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.