EIOPA: The EU overseer where prudential regulation and sustainability are “two sides of the same coin”

This is the second in a series looking at the role of European supervisors in the EU Action Plan on Sustainable Finance. The first, on the European Banking Authority, is available here.

This year will see the sustainability work of Europe’s insurance and pension supervisor feed into the European Commission’s Action Plan on sustainable finance.

But a focus on sustainability is nothing new for the European Insurance and Occupational Pensions Authority (EIOPA), says its Head of Insurance Policy Unit, Justin Wray, who describes prudential regulation and sustainability as “two sides of the same coin”.

“If any supervisor is going to be interested in sustainability, which is a long-term issue,” he adds, “it is going to be us because the sectors we are responsible for have such long-time horizons.”

This year will see EIOPA deliver two pieces of advice to the Commission: one on sustainability risks for insurers and the other on short-termism in capital markets.

It will also provide an opinion on incorporating sustainability into the prudential treatment of assets and liabilities by insurers – the so called ‘green supporting factor’ – which is something that Europe’s banking regulator, the European Banking Authority (EBA) is also grappling with at the behest of the Commission.

An area that EIOPA has been independently working on and which dovetails with the Commission’s push on sustainability is stress testing.

EIOPA, Wray says, is currently working with Paris-based think tank the 2 Degrees Investing Initiative (2°ii) on the development of climate scenarios.

Each year EIOPA conducts stress tests, alternating between Europe’s insurance and pension sectors, to see how balance sheets hold up under different scenarios.

It is hoped that the scenarios it is creating with 2°ii, which Wray describes as “less granular than stress tests”, will eventually form the basis for future climate-based stress testing.

In principle, Wray tells RI, sustainability scenarios are good subjects for such tests and could be used to identify assets at risk from climate change and/or related regulatory shifts.

This year’s testing, which focuses on pension funds, will include ESG considerations for the first time. But Wray says that it would be considered only at a “high-level” as there isn’t the scope for more detailed analysis currently.

A spokesperson for EIOPA tells RI that the analysis, which will launch this month [April], will include a “qualitative element”, exploring the implementation, management, and risk assessment of ESG by Europe’s pension funds.

This, she adds, will be “complemented by a quantitative exercise” using data provided by the EU’s statistical office Eurostat on the ‘E’ of ESG – though she stresses that this is still a first step.

Wray adds that the 2018 stress test on the insurance industry included a scenario in respect of significant natural catastrophes.

One of the tasks EIOPA has been set by the Commission is on the prudential regulation of insurers as set out in Solvency II, the harmonised EU-wide insurance regulatory regime.The question put to EIOPA is the extent to which insurers should consider sustainability factors when factoring the amount of capital they should hold against investments and liabilities, which is discussed in the Action Plan under action eight.

EIOPA has until September to provide the Commission with an opinion on the issue.

Wray describes this work as “important” and stresses that “what matters most is that the amount of capital an insurer has to hold properly reflects the riskiness of their assets”.

“If it is genuinely the case that you can identify a set of assets where the risk profile is different from other assets in that class then there is a case for a green supporting factor, [but] you shouldn’t have a green supporting factor just because it is green, you should have it because the asset has a different risk factor from non-green assets.”

Matthies Verstegen, Senior Policy Advisor at PensionsEurope, the Brussels-based industry body, echoes this. He told RI: “We would want to see very strong evidence that [green] factors have a risk aspect before it was introduced.”

By the end of April, EIOPA will advise the Commission to “change legislation to require sustainability risks be taken into account [under Solvency II]”, Wray says.

EIOPA’s advice carries the weight of its 28 European member state supervisors.

EIOPA is also working on the Commission’s plans for a sustainability taxonomy as part of the Technical Expert Group (TEG).

Wray describes the taxonomy as the “software code for sustainability”, which will help define language around ESG and “provide some objective judgement” on whether a product is truly sustainable, or not.

EIOPA is also involved in overseeing the revision to the EU pension fund directive, known as Institutions for Occupational Retirement Provision II (IORP II), which now contains explicit sustainability provisions for the first time.

RI reported in January, however, that many major European member states had missed the deadline for transposing the directive into national legislation.

A spokesperson from EIOPA told RI at the time that it would be “conducting work together with the National Competent Authorities on the implementation of IORP II” following the transposition deadline, which it would publish later this year.

Additional proposals, however, to introduce enhanced regulations on ESG in IORP II, so called delegated acts, which would give the Commission power to direct how pension funds should implement rules directly rather than through member state’s own regulators, has been scrapped during the EU’s “trilogue” negotiation process, according to the office of Dutch MEP Paul Tang.

PensionsEurope’s Verstegen tells RI that they opposed the proposed introduction of delegated acts to IORP II, stating that this would lead to “too prescriptive rules that would not take account of the diversity of the European pensions landscape”.

He also said it would be better to first evaluate the effectiveness of the directive’s new ESG provisions before expanding the regulatory framework.