EU takes steps towards cross-border pensions

The European Commission is moving slowly but inexorably towards legislating for cross-border occupational pension schemes. A recent Communication document published by Mr Mario Monti, the former single market commissioner, set out the Commission's proposals to remove tax barriers and investment restrictions for cross-border pension schemes in Europe.

The Communication, a response to the 1997 green paper on supplementary pensions in Europe, was a welcome sign that the Commission has finally acknowledged the extent to which the diversity and complexity of private occupational schemes within the European Union impede the smooth functioning of the internal market. Given the pressures to reduce state pension commitments, the Commission also recognises that there will be considerable growth in private provision.

To achieve its goals the Commission instructed three departments to address the issues of taxation, regulation and employee mobility.

However, experts are concerned that the Commission may seek to accommodate too many diverse views and increase rather than reduce the layers of complexity.

Ms Joanne Hindle, pensions development director at NatWest Life, says: "Simplification of the complex rules for pension eligibility, portability and general administration would be a catalyst for both free trade and free movement of labour . . . Minimum standards are necessary to ensure public confidence. But regulation should allow for innovation and not be inflexible."

The pooling of pension funds on a pan-European basis would, employers argue, enable multinationals to achieve an optimum investment strategy and economies of scale which could reduce overheads dramatically and bring the schemes into line with the costs of running a big pension plan in the US.

In Europe the situation is currently very different. A large multinational might have a dozen or more different pension schemes, each with its own fund and administration system and subject to local restrictions on investment choice. Ford and BP, for example, estimate the cost of managing these schemes separately, compared with a unified US scheme, runs to an additional €40 million-plus (£31.5 million-plus) per annum.

Not every multinational faces the same problems. Those with one or two very large European operations usually find that the individual pension funds have the critical mass to achieve the desired economies of scale. Mr Nigel O'Sullivan, head of European pensions strategy at Goldman Sachs International, says: "It is the multinationals with many small schemes scattered across Europe that have the real problems. The opportunities for achieving an efficient, cost-effective investment strategy are very limited without the ability to pool assets in a central fund."

The relaxation of tax barriers would also permit free flow of labour. At present it is not possible for an employee on secondment to benefit from tax relief on contributions paid to the home country scheme. This is despite the fact that pensions are defined as deferred pay by the European Court of Justice (ECJ) and, therefore, should be as mobile as the employees themselves. Employers argue that the fact that they are not, and that expatriate employees within the EU can lose out on pension rights, acts as a deterrent to labour mobility.

Although it is sometimes technically possible for employers to retain seconded employees in the home country scheme, Mr Adam Lessing, executive director of Goldman Sachs Asset Management, warns: "The beneficial tax treatment of contributions of seconded employees to their home country scheme is not yet assured."

The Commission is currently planning to introduce a series of directives to reform tax restrictions on cross-border schemes.

Cross-border portability is also important in stakeholder type models which are often multi-employer or industry-wide. Provided the model can guarantee true portability of the underlying investments, they could offer the mobility individuals require on a cross-border basis, says Mr Lessing.

Just when the European Commission finally appears committed to cross-border pensions, its face is changing dramatically. With Mr Monti handing over his responsibilities to a new commissioner, Mr Frits Bolkestein, single market priorities could change. Even if they do not, the legal process may prove painfully slow.

As a result, pensions lawyers, consultants and practitioners have joined forces in an attempt to demolish the tax barriers more quickly by taking a test case to the European Court of Justice (ECJ). If an ECJ ruling were to declare pan-European pension funds legal, and outlaw tax discrimination at a local level, it would be binding on EU member states.

Once achieved, the knock-on effects of cross-border schemes could be very significant. One particularly controversial result of the availability of a tax-neutral regime is that companies - both local and multinational - might decide to arbitrage regulations.

Mr Robin Ellison, British national head of pensions at Eversheds, explains: "There would be nothing to stop a company from registering its pension scheme in a favourable location such as Dublin where the regime for contribution and benefit limits are more flexible than, say, in Britain."

This would represent a tremendous challenge to the UK, which boasts the most developed private pensions market in Europe but also imposes on employers one of the most complicated set of rule books in the world. The threat of an exodus of schemes to Dublin might be the spur needed to force through a much longed-for simplification of the fiscal, legal and regulatory regime.

It is not just tax barriers and local investment culture that prevent multinationals from adopting a more coherent approach to the pensions package. Ms Penny Frohling, head of global asset management practice at Gemini Consulting, says: "Pensions have become a pawn in the EU tax labyrinth. The challenge for asset managers is to understand which parts of a pensions business can be developed centrally in preparation for a more homogeneous Europe while accounting for unique tax, compliance and reporting regulations."

Mr O'Sullivan believes significant improvements can be achieved at local level by appointing specialist managers and ensuring cost-effective implementation.

Mr Simon Gilliat, a partner at Watson Wyatt, says: "Multinationals can achieve many savings without pan-European pensions. Local operations often work in isolation. Encouraging the pensions manager to adopt a formal process for manager selection, performance measurement, administration, and plan design can significantly improve costs and results. Remember, a 1 per cent increase in the return on assets in a multinational's European plans could equal or exceed the benefits of moving to a pan-European fund."

Longer term, as more countries adopt defined contribution plans, it will be possible to invest in common unitised funds. They may have a different legal structure and different contribution rates in the various locations but the asset management will be the same, says Mr Gilliat.

Mr Koen De Ryck, managing director of Brussels-based Pragma Consulting, adds: "The successful approach will be achieved through a framework of better risk management, common reporting and a better flow of information, without needless restrictions on subsidiaries. If these conditions can be met, the programme may be a win-win situation for all parties."