EU proposes mandatory integration of sustainability risks and member preferences into pension funds under IORP III

The European Commission’s recent proposal to update the IORP II Directive, often referred to as IORP III, contains important but somewhat understated sustainability elements that could profoundly reshape how pension funds operate within the EU. While much of the attention has focused on the headline measures, such as compelling pension funds to explain investment underperformance and proposals to boost supplementary pensions, the document also quietly introduces two critical sustainability-related changes that mark a substantial evolution in regulatory expectations.

First and foremost, the proposal mandates pension funds to integrate sustainability-related risks into their risk management frameworks. This represents a significant shift from the previous directive, which had merely allowed member states to permit pension funds to consider these risks voluntarily under the prudent person principle. Jorik van Zanden of Dutch consultancy AF Advisors describes the change as moving from a discretionary allowance to a full legal obligation. Under the proposed update, pension funds “shall” factor in sustainability risks, defined in alignment with the Sustainable Finance Disclosure Regulation (SFDR) as those risks that could materially and negatively impact the value of investments if they materialize.

Further emphasizing the long-term horizon, the directive stresses that investment strategies must consider the potential long-term effects on sustainability factors in a manner proportionate to the nature, scale, and complexity of the pension funds’ activities. This aligns with the European Insurance and Occupational Pensions Authority’s (EIOPA) earlier recommendations, which advocated for pension funds to embed the long-term impact of their investment decisions on environmental, social, and governance (ESG) factors. EIOPA’s influence signals a growing regulatory push across the EU for occupational pensions to adopt responsible investment strategies consistent with broader sustainability goals.

The second notable update introduces a new requirement for pension funds to account for the sustainability preferences of members and beneficiaries where those preferences can be gauged. This marks a regulatory effort to bridge the gap between members’ values and pension fund investment policies, echoing recent debates on fiduciary duty and responsible investing. The directive proposes that member states require pension funds to reflect these preferences in their investment decisions, provided they are consistent with prudent person principles. However, the document stops short of detailing specific mechanisms for gauging member preferences, leaving those practicalities to national lawmakers, who will tailor regulations according to domestic pension fund structures.

This member-centric approach is emblematic of an evolving supervisory stance, highlighted by initiatives like the Dutch fund Pensioenfonds Detailhandel, which educates members on sustainability issues and seeks their guidance on investment priorities. Laura van Geest, president of the Dutch financial regulator AFM, recently advocated that pension funds should actively consult members to align investment strategies with their sustainability priorities. The EU’s existing MiFID II rules, which require retail investors to disclose their environmental and social preferences, appear to provide a suitable precedent for such engagement.

The proposal further encourages that members be explicitly asked about the incorporation of three pivotal sustainability frameworks in their investments: the EU Taxonomy, the SFDR, and the Principle Adverse Impacts concept. Introducing these frameworks into the pension fund domain is a complex move, especially as it coincides with ongoing EU efforts to relax some sustainability regulations, including plans to remove Principle Adverse Impact requirements from SFDR and significantly narrow the scope of the Taxonomy Regulation under the EU’s Omnibus I initiative. At first glance, the simultaneous drive to strengthen sustainability integration within IORP III and deregulate sustainable finance through Omnibus may seem contradictory. Yet, experts like van Zanden suggest these initiatives are, in fact, complementary parts of the EU’s broader strategy to mobilize workplace savings into supporting its twin green and digital transitions by developing a unified internal capital market.

The regulatory journey of IORP III is far from complete. The EU Council was scheduled to begin negotiations in early December 2025, with trilogues between the European Parliament, the Council, and the Commission expected to start shortly after. As these discussions progress, the finer details, particularly how pension funds should gauge and implement member sustainability preferences, will crystallize against the backdrop of a shifting EU sustainability regulatory landscape.

In summary, the Commission’s proposal to update the IORP Directive signals a definitive step towards embedding sustainability into the heart of pension fund management across Europe. It transforms sustainability risk considerations from optional to obligatory and introduces a new, member-focused dynamic requiring pension funds to reflect their members’ environmental and social values. This evolution aligns with wider EU objectives of channeling capital into sustainable investments while navigating the complexities of regulatory adjustments in an evolving green finance ecosystem. The ultimate success of these reforms will depend on political negotiations and the practical measures adopted by member states to implement these ambitious directives.