Small Sipp providers have been handed a lifeline by the FCA after the regulator significantly watered down proposals to increase capital requirements across the sector.
The regulator has been talking tough on Sipps since it first proposed ramping up capital requirements in November 2012.
Despite this rhetoric and a number of high-profile investment failings linked to Sipps, the FCA has softened its stance on capital adequacy after concerns were raised about the impact the original proposals would have on small firms.
While experts say small Sipp operators could see their cap ad requirements slashed by hundreds of thousands of pounds as a result, new analysis reveals providers with significant commercial property exposure could still be hit.
Currently, Sipp firms are required to hold capital in reserve equal to six weeks of annual audited expenditure, subject to a minimum of £5,000.
In 2012, the regulator proposed creating a new regime where firms’ capital requirements would be based on a two-part equation.
The first part, labelled the “initial capital requirement”, links the amount of capital each firm has to hold to the value of assets under administration.
The approach originally put forward by the FCA was non-linear, meaning as a firm’s AUA rises, the corresponding cap ad increase levels off.
The method was criticised by many respondents who argued the impact on smaller companies would be disproportionate. As a result, the FCA has revised the calculation so Sipp operators with AUA of less than £200m have a lower ICR.
The second part of the equation links each firm’s capital requirement to the proportion of “non-standard” assets they administer. This should mean firms with riskier assets on their books have to hold more capital in reserve.
This part of the formula has also been changed to reduce the burden on Sipp firms. Also, the FCA has added physical gold bullion, National Savings & Investments products, bank account deposits, units in regulated collective investment schemes and, crucially, UK commercial property to its list of standard assets.
In addition, the FCA has handed the industry a generous two-year transition period, with the new rules due to be implemented on 1 September 2016.
Curtis Banks managing director Rupert Curtis says: “There were some decent small firms which would have been forced out of the market under the original proposals, although many will still see a significant rise compared with where they are now.
“The two-year implementation also makes the whole thing look a lot more stable.”
Cap ad slashed
According to calculations from Barnett Waddingham, a Sipp firm with £90m of AUA – where 35 per cent of clients have readily transferable UK commercial property and 5 per cent of funds are in less liquid assets – would have been required to hold £570,000 in reserve under the 2012 proposals. Under the final rules, the firm’s requirement drops to just £147,000.
Barnett Waddingham partner Andrew Roberts says: “The proposals are more watered down than most people were expecting and will drastically reduce the requirements for small Sipp operators.
“The regulator wants to reflect the costs of a Sipp operator winding down and it hasn’t changed its outlook on that. It has been collecting data over the past year and clearly has concluded the initial proposals were over-egging what was necessary.
“Ultimately, it seemed unrealistic that it would cost over half a million pounds to close down a relatively small Sipp provider.”
AJ Bell marketing director Billy Mackay says fears of a “disorderly wind-down” of small Sipp firms caused the FCA to rethink its original formula.
“The FCA has been subject to a hell of a lot of lobbying from the industry,” he says. “Ultimately, the aim of this is to provide extra protection to consumers and if the original proposals had meant a whole raft of Sipp providers were forced to exit, the people who would ultimately suffer in that scenario would be consumers.”
The FCA has revised down its estimate of how many Sipp operators are likely to leave the market as a result of the changes, from between 14 per cent and 18 per cent to “less than 10 per cent”.
Sting in the tail
While the revised formula will dramatically reduce capital requirements for some businesses, experts say the FCA’s apparent U-turn on UK commercial property may not be all it seems.
The regulator says commercial property can be counted as a standard asset – but only if it can be transferred to another Sipp within 30 days. Analysis from Suffolk Life reveals that of 350 in specie property transfers the administrator has completed in the past 18 months, none would have met the FCA’s threshold.
Suffolk Life head of marketing and proposition Greg Kingston says a variety of factors can result in a property transfer being delayed, including delays with the ceding scheme and issues with third-party interests.
“This reinforces our belief that Sipp providers will be unable to guarantee that a property can be easily transferred to another provider within 30 days,” he says. “Although UK commercial property could be defined as a standard asset under the FCA’s final rules, in the majority of cases it should be defined as non-standard.
“Advisers should treat with caution those Sipp providers who define property as standard assets because there’s an increased risk that their capital reserves will be insufficient in the event of failure.”
Curtis and Mackay suggest some form of guidance, from either the industry or the regulator, will be needed to ensure providers do not incorrectly label commercial property as a standard asset.
“It takes time to complete property transfers but I think it can be done within 30 days,” Curtis says.
“It is difficult to know exactly what the FCA expects from the industry at the moment so some additional guidance would be useful.”
Sipp cap ad in numbers
Estimated total cost to the industry of the FCA’s revised proposals
Transfer time limit for ‘standard’ UK commercial property
Number of in-specie property transfers completed in this time by Suffolk Life
Tom McPhail, head of pensions research, Hargreaves Lansdown
The FCA is clearly sympathetic to small Sipp operators and has reacted to lobbying. But I don’t think this will ease the long-term pressures on smaller firms and I still expect further consolidation.
Dennis Hall, managing director, Yellowtail Financial Planning
Sipp providers have never been the big problem; it is the underlying investments and the lack of due diligence. The FCA was right to row back on its original proposals, which would have severely restricted consumer choice.
After nearly two years of waiting the regulator has revealed the new capital adequacy rules Sipp providers will soon have to work from.
While Sipp operators continue to debate the new rules, I am interested in how they will affect investors. Will the “watered-down” rules expose investors to more risk? (At least one Sipp provider suggests this will not reduce their cap ad requirement.)
The FCA’s aim is to ensure that if a Sipp provider fails, an orderly takeover of the Sipp book can be achieved. The new rules probably fulfil this aim but not without some unintended consequences.
First, Sipp providers which continue to allow investments on the non-standard list will have to hold more capital in reserve. How will they meet this cost? One obvious way is to push up fees.
Second, we have already seen many Sipp providers move away from allowing riskier, non-standard investments. Indeed, we have seen loyal members have the rug pulled from under them, unable to top up or roll over existing investments. This trend is likely to continue.
This takes us back to fees. Fewer Sipp providers allowing access to non-standard investments will reduce competition, which normally drives cost up. So for the average Sipp investor the new rules will probably provide extra security. Having said that, I would suggest such a change is not a priority for most Sipp members.
But for those investors venturing onto the non-standard list, there is a risk of higher fees and reduced flexibility – although, with investment horror stories now a weekly occurrence, perhaps the investment itself poses a far greater risk than anything else right now.
Phillip Bray is marketing and relationship manager at Investment Sense