The Pan-European Pension Product Regulation – Towards Luxembourg as Europe’s Pension Hub

It is a key part of the European Commission’s work to create a pan-European personal pension product (“PEPP”) framework in the EU. For that purpose, Regulation (EU) 2019/1238 (“PEPPR”) was adopted in 2019 and is applicable since 22 March 2022. This contribution provides an overview of the key aspects of the PEPPR and concludes that Luxembourg might play a future role as Europe’s “Pension Hub”.

1.    Background

Currently, there is a dynamic and ongoing improvement in life expectancies that is not accounted for in pension systems designed to provide financial security in retirement. As a result of that, there are currently employment-based (2nd pillar) pension funds and first pillar pay-as-you-go (PAYG) state pensions systems all over Europe facing huge funding deficits. The introduction of the PEPP, a “European 401(k) account”, that may be provided by, amongst others, banks, fund managers, and insurance companies, could potentially be a solution to mitigate the growing challenge of this so-called “pension gap”. This contribution discusses the huge opportunity that the introduction of a PEPPR offers to the Luxembourg fund industry. Before doing that, this contribution first provides an overview of the PEPP (as a “wrapper (fund) product”) and its key provisions.

2.    The PEPP as a “Wrapper (Fund) Product”

PEPPs are (eligible) third-pillar retirement products that intercede between PEPP savers and the “markets” through a process of packaging or wrapping together investment, insurance, and saving products or a combination thereof to create different exposures, provide different product features, or achieve different cost structures. Such “packaging” or “wrapping” of investment, insurance and saving products in a “PEPP” allows PEPP savers to (1) make easier investment decisions, (2) (indirectly) invest in products that would otherwise be inaccessible or impractical and (3) to make easy comparisons between different PEPPs.

The PEPPR defines a “PEPP” as:

“a long-term savings personal pension product, which is provided by a financial undertaking eligible according to Article 6(1) PEPPR under a PEPP contract, and subscribed to by a PEPP saver, or by an independent PEPP savers association on behalf of its members, in view of retirement, and which has no or strictly limited possibility for early redemption and is registered in accordance with the PEPPR (underlined added by author).”

Furthermore, a Personal Pension Product (“PPP”) is defined as a product which:

• is based on a contract between an individual saver and an entity on a voluntary basis and is complementary to any statutory or occupational pension product;
• provides for long-term capital accumulation with the explicit objective of providing income on retirement and with limited possibilities for early withdrawal before that time; and
• is neither a statutory nor an occupational pension product.

PEPPs are thus under the PEPPR (1) eligible third-pillar retirement products (that under the PEPPR qualify as “PPPs”) that are wrapped by sharing (2) general “PEPP” features and (3) comply with PEPP product regulation that consists of “standard” and “flexible elements”. These three elements of the PEPP definition will now be discussed in more detail.

2.1.  Eligible Third-Pillar Retirement Products

Given the limited investment choices that a PEPP provider may provide for a PEPP, all PEPP investment choices involve investment vehicles allowed under the PEPPR under which PEPP savers are not allowed to make an individual selection of assets. These are under the sectoral restrictions of the scope of authorization of PEPP providers under the PEPPR: undertakings for collective investment in transferable securities (“UCITS”), alternative investment funds (“AIFs”), institutions for occupational retirement provision (“IORPs”) resembling investment funds, such as pension savings companies with variable capital (“SEPCAVs”), unit-linked insurances and voluntary pension funds under national law.

2.2.  Common Features

Only eligible third-pillar retirement products that are “wrapped” by sharing various “common features” are eligible for a PEPP under the PEPPR. A PEPP:

• must be based upon a contract between an individual PEPP saver (any natural person) and an entity, i.e. “authorized PEPP provider” or distributor, on a voluntary and complementary basis (third-pillar nature);
• must be “funded”, i.e. financed by contributions paid by individuals and/or third parties, such as employers, on behalf of individuals;
• needs to have an “explicit objective of providing income on retirement”;
• has restrictions on early withdrawals as to ensure that accumulated capital is only paid out upon retirement or, for PEPPs for which the “biometric risk” option has been exercised, on the occurrence of a biometric risk.

2.3.  Product Regulation

PEPPs have to comply with “standard” or “mandatory” features and may use certain “flexible” or “optional” elements.

a)    Standardized or “Mandatory” Features

PEPP providers should provide PEPP savers with up to six investment options to help PEPP savers in their choice. To that end, PEPP providers and distributors have to offer a “Basic PEPP” and may offer “alternative investment options” bearing in mind that all investment choices involve product types in which PEPP holders are not allowed to make an individual selection of assets.

These investment options have to be designed by PEPP providers on the basis of a guarantee or risk-mitigation technique that seeks to ensure sufficient protection for PEPP savers. The applicable risk-mitigation techniques may, inter alia, include life-cycling strategies, appropriate guarantees to protect against investment losses or reserves from contributions or investment returns.

The Basic PEPP is designed to be a “safe product” and acts under the PEPPR as a default investment option. The Basic PEPP can take the form of either a risk-mitigation technique consistent with the objective of allowing the PEPP saver to recoup the capital, or a guarantee on the capital invested. Furthermore, its overall costs and fees shall not exceed 1% of the accumulated capital per annum. The “cost-cap” and the restriction to the use of risk-mitigation techniques that allow the PEPP saver to recoup the contributed capital are not applicable to “alternative investment options”.

b)   Flexible or “Optional” Features

PEPP providers may complement a PEPP with financial guarantees to protect against investment losses. In addition, PEPP providers may offer PEPPs with a supplementary option that covers biometric risks, i.e. risks linked to longevity, disability and death, provided that either they are allowed under sectoral legislation to offer such an option or they enter into a contract with an insurance undertaking under Directive 2009/138/EC, as amended (“Solvency II”).

3.    The PEPP (Product) Passport under the PEPPR

PEPPs that are authorized and supervised by the PEPP provider’s “home Member State” benefit from a “product passport” under which they may be marketed throughout the EU without any additional conditions to be imposed by “host Member States”.

4.    PEPP – Governance: Intermediary, Product & Sales Regulation

PEPP providers willing to make use of the PEPP (product) passport, their distributors and depositaries will need to comply with certain PEPPR governance provisions that consists of intermediary, product and sales regulation.

4.1.  Intermediary Regulation

The PEPPR differentiates between requirements targeting the manufacturing of PEPPs by PEPP providers and the distribution of PEPPs by PEPP providers and distributors. For that purpose, the PEPPR focuses on regulating the PEPP provider and distributor as “intermediaries”. Apart from this, the PEPPR also regulates depositaries.

a)    PEPP Provider

Only regulated financial undertakings authorized under EU law to manage collective or individual investments or savings and eligible under the PEPPR may act as a PEPP provider, i.e. “manufacture” and “distribute” PEPPs. The PEPPR allows only a number or predetermined financial undertakings to act as PEPP providers. These include, amongst others, credit institutions, investment firms authorized for portfolio management, UCITS management companies (“UCITS ManCos”) and alternative investment fund managers (“AIFMs”).

For the provision of a PEPP, PEPP providers may only offer those PEPPs that contain an underlying eligible third-pillar retirement product for which they are authorized under EU sectoral legislation. Consequently, the authorization of a PEPP provider limits the range of PEPPs that may be offered to PEPP savers in the accumulation phase, as well as the payout solution in the decumulation phase.

b)   The PEPPR Distribution Regime: PEPP Providers & Distributors

PEPPs may be distributed by PEPP providers under the sectoral rules applicable to them, as well as, by distributors. In this regard, the PEPPR only allows insurance intermediaries registered under Directive (EU) 2016/97, as amended (“IDD”) and investment firms authorized for investment advice under Directive 2014/65/EC, as amended (“MiFID II”) to distribute PEPPs manufactured by third parties. To that end, insurance intermediaries are largely subject to the IDD and investment advisors to MiFID II. PEPP providers are, in addition to the sectoral legal framework applicable them, also subject to several MiFID II and PEPPR distribution provisions.

c)    Depositary

The PEPPR depositary regime consists of a “sectoral-based” and a “lex specialis” regime that is based upon the depositary regime under the UCITS directive. The type of PEPP provider and the “collective investment undertaking” (as part of the PPP) under which a PEPP is provided determines whether a depositary needs to be appointed under the “sectoral-based” or the “lex specialis regime”. PEPP providers that are IORPs, UCITS ManCos or AIFMs are required to “appoint one or more depositaries for the safekeeping of assets in relation to the PEPP provision business and oversight duties”. All other PEPP providers are only required under the PEPPR to appoint a depositary if this is required under the sectoral EU legislation that is applicable to them. Furthermore, a depositary requirement might also apply under sectoral/national law if the PEPP managed by an “another PEPP provider” is, for example, an IORP, AIF or UCITS.

4.2.  Sales Regulation/Disclosure

a)    Pre-contractual Information

Pre-contractual information must help PEPP savers in understanding the features of individual PEPPs and to compare PEPPs. For this reason, PEPP providers and distributors are required to provide a PEPP Key Information Document (“KID”) for all PEPPs that is adjusted to the needs of PEPP consumers.

Prior to entering into a PEPP-related contract, PEPP providers and distributors should give PEPP savers all the necessary information to make an informed choice through the provision of advice assessing their saving demands and needs (“the demands and needs test”). In addition, advice given should take into account the PEPP saver’s financial situation, investment objectives and also his or her knowledge and experience with investing (“the suitability test”).

b)   Ongoing or Accumulation Phase

The objective of information during the accumulation phase is to inform the PEPP saver of the current status of the PEPP investments in retirement that takes into account costs, projected performance in the future and whether product features have changed. For that purpose, a PEPP benefit statement modelled after IORPD II as additional appropriate annual information has to be given to PEPP savers. This annual statement contains, amongst others, information related to risks and returns, costs, investment choices and decumulation.

c)    Retirement planning and advice on out-payments

For the Basic PEPP, at the start of the decumulation phase, the PEPP provider shall offer the PEPP saver personal retirement planning on the sustainable use of the capital accumulated in the PEPP sub-accounts, taking into account some factors that concern the specific circumstances of the PEPP savers. Furthermore, the retirement planning shall include a personal recommendation to the PEPP saver on his or her optimal form of out-payments, including, amongst others, annuities, lump sums, drawdown payments or a combination thereof, unless only one form of out-payments is provided.

d)   Pre-retirement information and Payout Phase

Disclosure requirements in the pre-retirement phase differ substantially from the requirements in the pre-contractual and accumulation stages. Essentially, PEPP savers would need to be informed about the start of the decumulation phase and what payout options can be chosen in both phases.

5.    Conclusion: A Huge Opportunity for the Luxembourg Fund Industry

The PEPPR unleashes a true revolution in Europe and offers a huge opportunity for the Luxembourg investment fund industry. All PEPPs have mandatory investment options and the costs for the “Basic PEPP” are capped to 1%. From a cost perspective, only AIFs, UCITS and unit-linked insurances will be commercially viable eligible retirement products under the PEPPR. Such a development could imply that Luxembourg would not only be Europe’s largest investment fund domicile but could also become Europe’s “pension hub”.