Rapidly disappearing returns on cash could end up costing the Sipp industry hundreds of millions of pounds and see up to half of bespoke providers closing.
Firms are already under pressure from the new capital adequacy regime, falling new business, cuts to higher earners’ annual allowance and the possibility the tax relief system will be reformed, potentially slashing upfront relief.
Experts say falling bank rates will be “disastrous” for Sipp providers which are destined to raise customer fees, while many will be forced to close. There are also calls for the regulator to mandate “clean cash” and require firms to unbundle charges that can include margins on cash deposits.
So will cutting off providers’ flow of margins earned on clients’ cash condemn firms to the scrapheap or have they adapted in time? Did the regulator miss a trick by excluding cash from the move to unbundled charges as part of the RDR?
Cash cow runs dry
There is growing fear among providers that banks have begun to speed up how quickly they slash interest rates. While rates have been falling since the aftermath of the financial crisis, Basel III banking rules have accelerated the decline.
From 1 January 2016, banks have to hold 100 per cent of instant access cash and make it available within 30 days. Previously they could earn interest by lending out instant access cash held on behalf of Sipp firms.
A note sent by Royal Bank of Scotland to one provider, seen by Money Marketing, confirms the rate of interest it pays on Sipp cash accounts will be falling from 0.75 per cent to 0.4 per cent from February 2016. From March there will be no interest paid at all
RBS declined to comment on why it is slashing rates, while Cater Allen, Metro Bank and Bank of Scotland say they have no plans to change rates.
But Sipp providers say they have been told by banks rates will be cut over time.
Mattioli Woods operations director Mark Smith says: “Our main bank – Bank of Scotland – has been reducing the rates available for some time. They made it clear it was linked to the EU banking regulations.
“They’ve been telling us for probably over a year this was coming and they’ve started to move rates accordingly. Their view was if other banks weren’t moving yet, they would soon have to.”
Sipp consultancy MoretoSipps principal John Moret estimates if all banks operating in the Sipp market cut their rates to nothing, the impact would devastate the industry.
He predicts traditional non-platform providers – which have historically taken a margin or “turn” on cash – could lose around £80m a year.
He says: “If the removal of interest turn applies to the whole non-platform Sipp sector the total loss of interest turn would have a disastrous impact equivalent to a loss of about a quarter of their overall revenues.
“Coupled with the new capital requirements that apply from October 2016 this will be a hammer blow to the non-platform based Sipp sector and I would estimate it could lead to up to half the current non-platform based Sipp providers, that is bet-ween 30 and 40, disappearing either through consolidation or folding altogether.
“It will be difficult for them to raise charges because of the increasing competitiveness of platform-based Sipps.”
In the past providers have made a large proportion of their income from taking a margin – known as turn – on the cash held in Sipp cash accounts. These are used to hold short-term cash to pay income and fees, including to advisers.
Providers negotiate individually with banks on interest rates and are reluctant to reveal what interest they receive and how much of a cut they take.
Dentons director of technical services Martin Tilley says: “In the past taking a margin on cash made up quite a significant proportion of income for some providers and in some cases was essentially their profit. They were relying on it for basic running costs and administration. It wasn’t uncommon for the bank to pay 5 per cent, the provider would keep 2 per cent and pass on 3 per cent to the client.
“But falling interest rates have taken that away. Some providers are totally clean but a lot of them were passing on a lot less to clients than they were keeping. We take a margin but under no circumstances would we ever have more interest paid to us than to our clients.”
But even providers which do not take a margin on cash will suffer, says Liberty Sipp founding director John Fox.
“We don’t take turn but we promote our Sipp as one where you get a higher rate of interest, so it’s a bit of a kick in the teeth. We advertise that we pass on the whole 1 per cent we get from Metro, for instance, and that does actually get us work.”
Fox calls on the Prudential Regulation Authority to be clear on how it will be treating Sipp cash accounts.
He thinks banks’ current interpretation of Basel III rules is too conservative.
He says: “How can you plan when there’s still so much uncertainty about how you earn income?
“It’s not our business model but providers should be able to earn a margin if they want to.”
Suffolk Life head of communications and insight Greg Kingston warns falling rates are just one of a number of pressures weighing on firms.
He says: “There’s a combination of factors that all add up to a change in the business models Sipp providers used to operate.
“I don’t think you can underestimate the impact of the slowdown or decline in new business.
The majority of Sipp providers charge an establishment fee and the first year’s annual fee, all in advance, as well as any other related transaction activities when they set up a new Sipp.
“When you look at the annual cost of a Sipp, the income the providers get in year one is significantly higher than that. So any slowdown in new business is really felt quite severely.”
Earlier this year, Money Marketing revealed how leading Sipp providers are struggling to meet new capital adequacy requirements.
Under the rules, providers will be required to hold capital in reserve based on assets under administration, with an additional charge linked to the proportion of non-standard assets held.
In addition, Suffolk Life estimates total regulatory costs for operators could rise by 75 per cent this year compared with 2014, mainly because of rising FSCS levies.
Mattioli Woods’ Smith says providers will have to adapt quickly to imp-rove efficiency in other parts of the business.
This week, LV= began operating a new cash management programme provided by Cashfac. As part of the changes, around 41,000 of its client accounts will be transferred to just six real accounts and thousands of “client managed, virtual accounts”.
Smith says the company is looking at making a similar move in a bid to keep costs low.
He says: “We’ve been looking at this ourselves, it will really streamline the process in the background. We have around 100 client relationship managers who are effectively administrators and individually reconcile the accounts, but you could centralise that and probably have two or three people with this software.”
It is not only bespoke providers which are suffering. A year ago, platform Sipp provider AJ Bell said falling bank rates were “entirely” responsible for a 40 per cent fall in profits.
Earlier this month, Hargreaves Lansdown posted a 5 per cent fall in pre-tax profits, and said this was partly down to the £17m cost of lower margins on client cash.
Head of pensions research Tom McPhail says: “This is the inevitable consequence of monetary policy. Banks have no incentive to offer attractive rates on this money. It is very challenging for Sipp providers to offer meaningful interest rates on cash accounts.
“For us, the consequences have now played through. We adjusted to the low interest rate environment, so the impact of our balance sheets has already been felt and now we’re looking at areas like peer-to-peer lending.”
Aviva does not take a margin on cash accounts through either its advised or new direct platform. But head of financial research John Lawson says the FCA needs to take action to stop firms hiding what cut they take from cash.
He says: “This is something that was missed as part of the RDR. “Platform unbundling was one of the key topics. They used to bundle investment funds and platform charges together to get a combined charge, so you didn’t know how much of the charge was platform and how much was for the fund.
“That’s all transparent now but it seems a bit of an oversight that they didn’t specify what would happen to cash as part of the unbundling. I don’t have any problem with people who want to apply a charge to a cash deposit as long as it’s transparent.
“The FCA seems to have forgotten about this. We refer to clean pricing in the investment world – now what we need is clean cash.”
Independent pensions expert Alan Higham says: “Paying little to no interest on cash deposits in a Sipp has been an industry guilty secret for many a long year.
“Hiding uncompetitive charges is not customer-friendly and the regulator should take action.”
More pain for Sipp providers
The recent revelation that Royal bank of Scotland is to pay no interest on a Sipp linked cash account from March 2016 is no great surprise.
The main banks operating in the Sipp market have been warning for some time that interest rates will fall as a result of a combination of factors including the oversupply of liquidity, bank lending reducing and a number of regulatory impacts – especially EU capital rules.
The implications are huge for many Sipp providers who have relied on the margin derived from cash account pooling to prop up revenues from Sipp administration, which have come under increasing pressure as costs have spiralled.
Most Sipp providers will have negotiated their own “bulk” interest rate deal with one of the banks. The duration of these deals will vary so the impact of the renegotiated deals will be different and will be staggered.
What seems clear is that over the next 2 or 3 years many Sipp providers will experience a significant reduction in the income they derive through the interest rate margin they retain.
In my last analysis of the Sipp market based on a survey conducted in May this year I estimated the total value of Sipp assets was just over £150bn. Of this £80bn was with platform based Sipps and £70bn with non-platform based or bespoke Sipps.
The majority of Sipp providers take an interest margin.
Measuring the financial impact on individual Sipp providers is difficult. However in my experience around 15 per cent of Sipp assets will be held in cash on a day to day basis. For the non-platform Sipp market that’s about £10.5bn.
In the RBS example that has been quoted the ultimate reduction in interest payable to the Sipp provider is 75 basis points. Applying that to all non-platform based Sipps the overall loss of revenues to this sector would be in the region of £80m per annum. For the 315,000 Sipps in this sector I would estimate the annual revenues including interest would be £330m.
So if the removal of interest turn applies to the whole non-platform Sipp sector the total loss of interest turn would have a disastrous impact equivalent to a loss of about a quarter of their overall revenues. The impact on platform-based Sipp providers would be less severe but still significant.
John Moret is principal at MoretoSipps
Paul Stock, director, Dobson and Hodge Financial Services
I would question whether firms should be using the margins being made on cash holdings to subsidise their operating profits.
Steven Robinson, managing director, Clarke Robinson & Co
It is no surprise that market forces are reducing the number of Sipp providers. Lower interest rates and the capital adequacy requirements are just two of the factors at work in reducing their numbers. The strong and adaptable in any market survive and the others lose out to the competition and newcomers.