Are the FCA’s capital proposals ‘adequate’?

Almost a year since the regulator published its proposals for a huge shake-up to operators’ cash reserves, the industry still lacks answers as the FCA continues to mull over the feedback to its proposals. Final rules were initially expected in September but were delayed; November is the latest official estimate, although industry sources expect it instead to be towards the end of the year.

Few in the industry disagree with the principle of increased capitalisation for Sipp operators. Under current rules, an individual needs only a few thousand in the bank to be able to set up a Sipp firm. However, some of the finer points of the consultation have led to contention across providers, with many hopeful that the FCA’s continued delay means it is looking a little deeper.

Starting line

The regulator proposed a big change to how capital adequacy is calculated. Firstly, it proposed raising the absolute minimum capital reserves from £5,000 to £20,000.

In addition, it proposed that an operator’s total requirement should be made up of two elements: an initial capital requirement based on the assets under administration and a surcharge based on the percentage of underlying schemes that contain non-standard asset types.

Andrew Roberts, partner at Barnett Waddingham, says the calculation is reasonable but should not be based on assets under administration.

“There is a really strong argument for taking the approach the FCA has set out but using number of Sipps, not value of Sipps,” he says.

Mr Roberts argues that the value of assets will fluctuate, making it hard to pin down a number. Moreover, he says, an investment with no or little value would require no capital to be held under the current plans, despite still incurring costs if a provider were to wind down.

“Most of the issues going on in the Sipp market are due to investment that have failed for some reason. Those that have failed have low to no value and no contribution to asset values in the asset calculation model.”

Martin Tilley, director of technical services at Dentons, agrees that number of investments rather than value would work better. He explains that one large fixed-term deposit may equal the value of 10 off-plan hotel rooms, but the former carries significantly less risk and is less complex in a wind-down situation.

Beyond the calculation methodology, some of the assets deemed to be non-standard by the FCA in its draft have also caused controversy, particularly commercial property.

Although the asset is likely to be burdensome if a Sipp operator closed down, some argue that as most providers accept commercial property - a fact that in itself challenges its categorisation as ‘non-standard’ - it would not be difficult to enact a transfer if necessary.

Mr Tilley says there could be a midway point for assets that are not fully ‘non-standard’, suggesting a “halfway house” for assets that are not “as standard as some” but also “not as non-standard as others”.

Small providers

One of the key concerns following the paper was the potential impact on smaller providers. The paper said it would expect 14 to 18 per cent of market players to disappear if the proposals came in as detailed. This could either be due to not having the capital required, or the cost of doing business becoming so much greater that the company is unsustainable.

Neil MacGillivray, head of technical support at James Hay and recently-elected chairman of trade body the Association of Member-directed Pension Schemes, is concerned about such predictions.

“Obviously it is easier to deal with a few large providers than a multitude of smaller providers,” he says. “The paper gave the impression that they were happy for a large chunk of smaller providers to leave the market.”

The regulator focuses on consumer detriment, he adds, which is the basis behind increasing capitalisation. But, he points out, restricting the number of providers is limiting consumer choice and the impact of operators leaving the market could be significant.

“You are left with a big issue: what happens to those Sipp providers? Who takes over the running and administration of those Sipps in the meantime? Are you then putting the consumer at detriment because they are having to sell assets and might not be able to make contributions to their schemes?”

There is no guarantee that larger providers would want to take on business from Sipp providers unable to stay in business as depending on the assets involved takeovers could pollute a provider’s book and raise the total capital needed significantly. The FCA may need to support or incentivise providers to take on orphan Sipps, but it is unclear how this would work in practice.

At present, a 12-month timescale is proposed for moving over to new capital adequacy requirements or exiting the Sipp business. Providers have called for longer to ensure a proper changeover.

“A longer period than 12 months needs to be given,” says Mr MacGillivray. “We will need to have some sort of information about arrangements so the consumer does not lose out.”

Business impact

Although there have been a number of acquisitions over the past year, for many providers it is a waiting game.

“We are in limbo at the moment, which isn’t a great thing,” says Dentons’ Mr Tilley. “We don’t know what proportion of our profits we can reinvest because we need to know how much we have to hold back to meet next year’s capital adequacy rules.”

Mr Tilly also points out that the FCA’s latest thematic review includes a look at capital requirements and wonders whether the final paper will be delayed as a result.

Nobody knows whether the regulator will stick to its original plans or enact a complete overhaul, but most providers are optimistic about the paper’s prospects.

“The formula that they provided had a big impact on small providers,” says Mr MacGillivray. “But one thing the FCA did make clear is that this was their proposal and they were happy to look at alternatives.”

Amps in particular supplied an alternative formula to the regulator with changes to the calculation methodology.

Mr Tilley pins his hopes on the regulator wanting to get it right. “I think that the FCA as the new regulator is looking to distance itself from the old regulator and they will want to make this very much their own,” he says.

“I am hoping that they may well come up with some new ideas.”