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Shortly after the millennium, the European Commission concluded that an EU framework for pension schemes was needed to complete the single market in financial services. Like other financial institutions, pension schemes were to be able to operate in other member states, provided that members were protected. Directive 2003/41/EC on the Activities and Supervision of Institutions for Occupational Retirement Provision - the IORP Directive - was enacted in June 2003.

A number of considerations had prompted the interest of European legislators. The most significant was changing demographics. In 1997, there were estimated to be four people of working age to support each EU pensioner; by 2040 there are likely to be two. Realising that state pension systems in some member countries might become unsustainable, the Commission was keen to encourage occupational schemes to take up the slack, particularly in those countries which had no tradition of employer sponsored arrangements. A further objective was the accumulation of large pools of liquid capital which would, it was thought, provide new opportunities to invest in and stimulate the European economy.

How could European business be encouraged to maintain and extend pension coverage, while still remaining competitive in the face of increasing global challenges from lower cost economies? The obvious answer was to make benefit provision easier and more efficient. Companies with businesses in more than one EU state would no longer have to provide pension schemes in each country and jump the hurdle of multiple regulatory systems. Instead, they could, if they wished, provide a single scheme for all group employees, which would simply need to be approved by one pensions regulatory body. There would be no need for the scheme to be approved in any of the other countries in which the scheme was made available to employees. To promote confidence in the robustness of member states' regulatory requirements, the Directive set out minimum standards for schemes' governance, administration and funding, and required schemes operating cross-border to ensure that the scheme was fully funded at all times.

The Directive should therefore have heralded a new dawn for occupational pensions, with workplace schemes meeting Europe wide minimum standards, member states deciding the precise way to achieve these standards and a system which would, at last, allow businesses to organise disparate local plans efficiently.

Of course, life has not turned out like this. The full funding requirement, together with concerns about respecting member states' social and labour laws, have discouraged cross-border schemes, particularly those structured on a final salary basis.

United in opposition

What then of the future? How have we arrived at the position where an alliance of all of those involved in UK pension provision - employers, trades unions, trade bodies and professionals - is united in its opposition to changes to the Directive? While the European Insurance and Occupational Pensions Authority (EIOPA) conducted a second round of consultation (which ended on 2 January 2012) before it made formal recommendations for change to the European Commission, the likely framework was predictable. The Commission has instructed EIOPA that its recommendations should "...be compatible with the approach and rules used for the supervision of life assurance undertakings subject to Directive 2009/138/EC (Solvency II)". Solvency II is a substantial overhaul of European insurance regulation, designed to produce a more resilient long term insurance industry. It introduces EU wide requirements on capital adequacy and risk management and greater regulatory supervision. The implications for final salary schemes are increased funding targets with deficits to be met over shorter periods.

Following criticism of the Commission's approach, both the Commission and EIOPA have been at pains to acknowledge that there are differences between insurance companies and occupational schemes. However, they clearly now believe that they have found a workable compromise between the demands of the insurance industry pushing for Solvency II to be applied to pension schemes - and the realities of company pension provision. A simplified version of the solvency measures which will apply to insurance companies is likely to be introduced. There may, for example be only one measure - Solvency Capital Requirement (SCR) - rather than the additional minimum standard (MCR) which applies to insurers.

Whatever the details, the direction of travel is likely to be a more rigid approach to the valuation of scheme liabilities, a material increase in scheme liabilities and less flexibility for employers in dealing with deficits. The assets needed to meet these liabilities would not necessarily need to be in cash: value would be attributed to all of the support available to the scheme - its trust assets, any contingent assets, the employer covenant and - possibly - the insurance protection provided by the Pension Protection Fund (PPF). This is the "holistic balance sheet".

Of course, the exact mechanism for a recovery plan designed to meet SCR is unclear at this stage, but practical difficulties are not hard to imagine. How exactly will the employer covenant be valued? If everything and the kitchen sink has been taken into account in the holistic balance sheet, and there is still a substantial solvency gap, where will the money come from to fill it? Is the implication that companies will have to make riskier and riskier strategic choices in the management of their core business? Or will they be frozen into immobility on the basis that Solvency II principles prevent the asset base being weakened when solvency margins need to be repaired? Might we reach the position where at all stages in a company's life the pension creditor must always be preferred over all other creditors and stakeholders, whatever the needs of the sponsor business? How are breaches to be policed and enforced? And given the likelihood of SCR deficits, what would this do to shareholder value?

It is possible that the changes may not go ahead as envisaged. But if they are anything like we expect, the proposals could fundamentally change the legal framework in which sponsors operate their businesses, as well as the management of their pension schemes.

Reconciling interests

Within the current UK regulatory environment, balance and judgment is still possible to reconcile the interests of pension members with the other interests and priorities that need to be given weight if a business is to succeed. The rigidity of insurance solvency requirements could, on the other hand, permanently skew an employer's objectives and operations. Company schemes are an important by-product of a company's activities, but not its main purpose. If a company is to be required to operate its pension scheme as a self-contained insurance company, resources may have to be diverted from other parts of its business operation which are necessary for future prosperity. Directors' duties owed to the company under which they have to balance the interests of various stakeholders may need to be examined, because more prescriptive and intrusive regulatory intervention could restrict other business choices. There could be much closer scrutiny and regulatory interference in matters which have previously been the province of trust law and the exercise by trustees of fiduciary principles, such as trustees' delegation to investment managers and administrators.

There will be other changes as well. Defined contribution schemes are likely to have to maintain reserves to meet "operational failures". And even parts of the consultation which seek to make things easier in relation to cross-border schemes have the potential to make things worse. As a result of mooted changes in the small print, schemes which have the benefit of an EU parent guarantee could find that, overnight, they become cross-border schemes and subject to the horror of immediate full funding.

Further away

The objective of the original Directive was to complete the single market and to encourage employers to maintain and extend pension provision. Regulating company schemes which do not in reality compete with insurance companies, in a way which is likely to undermine companies' ability to sustain those schemes, singularly fails to meet that objective. Cross-border schemes are not deterred by anything except bureaucratic complexity and the full funding requirements of the original Directive. And the hope that more pension provision will lead to the growth of investment capital available to a European economy in sore need of it is even further away. The new requirements are, on the contrary, likely to encourage pension schemes to move out of equities and riskier investments and into bonds.

The purpose of the original Directive seems very far off indeed.