BRUSSELS - The European Commission is challenging certain member states' investment restrictions affecting domestic pension funds.
EC Internal Markets Commissioner Mario Monti said the commission is writing to several countries, contesting their investment restrictions and other barriers to European integration. Mr. Monti declined to name the countries, but sources believe likely targets include Belgium and Finland.
If such countries fail to justify or remove the restrictions, the commission will file suit against them in the European Court of Justice, he said.
Mr. Monti's announcement signals a new, more aggressive approach for the commission, which had lain low since the June 1994 withdrawal of its draft pension fund directive.
Belgium and Finland are viewed as easy targets; attacking a country like Germany, a political heavyweight in the European Union, would be more difficult.
Belgian pension funds are required to invest 15% of assets in state government bonds, although government officials have said they plan to remove the restriction. Finland is a new member of the EU and has little political clout. It also plans to liberalize existing investment rules.
Mr. Monti told the European Federation for Retirement Provision conference in Brussels the investment constraints amount to a "hidden tax" on pension funds because they impair returns and ultimately increase contributions.
The commission's action follows a series of failed efforts to create an EU-wide investment standard for pension funds. An EC pension fund directive was withdrawn in June 1994 after several member states sought to impose a provision permitting countries to require pension funds to invest 80% of their assets in their home currency.
A subsequent EC communication expressing its views on pension fund restrictions was challenged in spring 1995 by France in the European Court of Justice. France argued the commission was trying to reiterate through the communication the position it was unable to implement through the directive. Spain since has joined France's challenge to the communication.
Since that time, the commission has remained relatively quiet.
Mr. Monti said freedom of investment is "a cornerstone of the Treaty of Rome," the 1957 treaty that established the European Economic Community, now know as the EU. Investment restrictions violate the treaty unless they are justified on "prudential" grounds, he said. The EC, however, never has defined what qualifies as a prudent investment.
Mr. Monti also broadened the debate on pension policy in the European Union. He has ordered staff to prepare a report for release this fall on an array of retirement-related issues, including: Whether pension funds should be subject to the same rules as insurance companies. This topic is hotly contested in continental European markets, where insurance companies have dominant lobbies.
The need to optimize investment strategies and create more efficient European capital markets.
How to provide pension coverage for workers who move permanently or temporarily cross-border within the EU. Tax and vesting rules often inhibit or make extremely expensive pension coverage for employees who move cross-border.
Removal of tax obstacles to creating pan-European pension funds.
The EC launched an initiative in April to coordinate tax policy in limited areas. A special task force, chaired by Mr. Monti, will seek to harmonize tax regimes, starting with a June 24 meeting. Mr. Monti said the commission gives the "highest priority" to pensions.
In an effort to give Mr. Monti ammunition to build his case, the EFRP unveiled a long-awaited study on European pension funds.
The study warns Europe must embark on a path of creating advance-funded pension funds now. If adopted, total EU pension assets by 2020 could expand ninefold to 10.2 billion European currency units ($12.7 billion), in today's terms, from 1.1 billion ECU ($1.4 billion) at the end of 1994.
In particular, the study calls for:
Creating a pan-European debt rating system that would encourage securitization in various asset classes, particularly real estate.
Developing Europewide markets for corporate debt, large-cap stocks, and smaller growth stocks.
Promoting investment in Europe by non-EU institutional investors, especially U.S. pension funds whose international exposure is expected to double to 20% by 2005.
Guaranteeing, through a commission directive, freedom of investment and removing barriers to worker mobility.
Now, EU pay-as-you-go pension systems provide 85.8% of benefits paid, while funded plans provide only 11%.
The report, authored by Koen de Ryck, the EFRP's permanent representative in Brussels and managing director of Pragma Consulting NV, reveals the pressure on pay-as-you-go state pension systems will be far worse in 2040 than previously projected.
While an earlier study by the Organization for Economic Cooperation and Development had estimated the ratio of retirees to active workers would double to 42.8% in 2040 from 21.4% in 1990, it has been widely acknowledged the study overestimated the size of the work force while underestimating the number of retirees.
The EFRP report said the ratio actually will soar to 59% in 2040 from 36.2% in 1990.
To relieve the pressure on state systems, the report urged adoption of voluntary private plans that would cover, on average, 60% of the private-sector workers and would provide 25% of pension payments by 2020. Nearly 11 billion ECUs would be required to fund that level of benefits, in today's terms, the study estimated.
While much of the study rehashes familiar arguments on why funded systems need to be developed, it provides new insight on how poor investment practices have drastically limited returns and increased pension costs.
Looking at data from 1984 through 1993, the study cited a wide disparity in real returns, ranging from 10.2% a year in Ireland to 4.4% in Switzerland.
Danish pension funds, limited to 20% investment in foreign stocks, gained only 6.71% annually from Danish equities but 11.17% from foreign equities. German pension funds won their best returns from German stocks, at 12.45% a year, but their allocation to stocks was very small.
However, freedom of investment did not guarantee good returns: Dutch pension funds, which are governed by a prudent investor rule, obtained virtually the same returns as in Germany. In hindsight, Dutch funds should have invested more in domestic and international stocks, the study said. Europeans' risk-averse investments also need changing, the study said.
On a risk-adjusted basis, however, the study had a number of striking conclusions for the 10-year time period surveyed:
Domestic bonds produced strong returns, except for Spain, Denmark and Switzerland. The ratios of returns to risk were generally high - and highest in Great Britain, whose funds typically maintain a low bond allocation.
International bonds were far more volatile than domestic bonds, although they produced better returns. Still, the study concluded it was not worth diversifying into foreign bonds, except for U.S. and Swedish pension funds, which enjoyed high return/risk ratios for the asset class.
Domestic equities proved to be much more volatile than international stocks (except in Britain and the United States), although they provided better returns than foreign stocks.
International equities offered risk reduction because of their greater diversification - a point generally misunderstood by regulators, the study said.
The study also revealed the average asset allocation by European pension funds as an aggregate was not that different from the typical U.S. pension fund's. However, when U.K. pension funds - which provided 60% of EU pension assets - are taken out, European funds are weighted much more heavily toward bonds.
