Before explaining why, it is important to look at the events that have lead up to now. SIPPs have been endlessly discussed and it is easy to forget they only became regulated relatively recently in April 2007.
SIPP administration has long been a fragmented business, with a large number of small firms vying for business. Significant consolidation among SIPP providers was predicted in advance of regulation, recognising that, for many businesses, the overheads and costs of regulation would be prohibitive. Whil that consolidation has not yet happened to any significant extent, it is clear from the FSA’s thematic review that some SIPP operators have adopted a ‘light touch’ approach to regulation, perhaps not fully understanding all that they should be doing. So the FSA’s current focus on bringing all companies up to the same standard could prove challenging for some organisations.
Resting on their laurels
The astonishing growth in the SIPP market – generally estimated at around 30%pa since A-Day – has drawn in new providers and been a real impetus to innovation with new propositions from both existing and new providers. Technology played its part too, lowering costs and making SIPPs more affordable to a wider range of advisers and end investors. But the growth has been focused at the low-cost and streamlined parts of the market, tailing off for some of the smaller, traditional firms.
Not all new entrants were successful though. While some platforms have gained reasonable momentum, other newcomers have not. Included in the 100 or so smaller SIPP providers that cover less than 20% of the market there are fund managers, some advisers and other wealth managers who all thought that running their own SIPP would complement their businesses.
The end result is a collection of SIPP providers, for many of whom SIPPs are not central to their businesses, running a sparse number of SIPPs – a number that is static or slowly losing ground to the larger providers who have the critical mass of business necessary to survive. The FSA knows this and, from informal feedback, is concerned.
A worried regulator
The regulator is busy and it is of course also about to change responsibilities. It is estimated that there are more than 800,000 SIPPs in force today offered by 116 providers – a problematic number to regulate and supervise, especially when half of them have less than 2000 SIPPs on their books. And at the end of 2011 the regulator confirmed that they were indeed concerned about significant parts of the SIPP market.
In fairness to the regulator neither SIPP providers nor advisers should be surprised. The FSA’s manager of pensions investment policy Milton Cartwright has been taking a keen interest in the SIPP market since he first spoke at the Henry Stewart SIPP conference in July 2009. It was back then that he stated that the capital adequacy requirements of SIPP providers would need to be reviewed.
He used the same stage again in November last year to reinforce that message, and this time there was more than a hint of immediacy to his tone. Speaking on the back of recent investigations into several smaller SIPP providers amid concerns over use of high risk esoteric investments including UCIS, Cartwright was unusually forthcoming and direct and was reported as saying: “What we have found is; for those SIPP operators that come into difficulty it takes a long time to sort them out. At the moment it’s six weeks’ expenses. We have found that six weeks is inadequate when the schemes get into problems. Especially with UCIS or non mainstream investments.”
What is interesting is the regulator’s assumption that SIPP operators are already in difficulty. Those investigations took place in September following reports that initial questionnaires were sent out to 70 providers earlier in 2011, resulting in 33 telephone interviews and visits to eight providers. They uncovered signs of poor controls, record keeping and due diligence as Cartwright concluded, “We saw examples where it was not clear to see whether the investment existed at all. This was particularly the case with unlisted shares; one example had £10 million in unquoted shares and it was not clear where this was held. This gives us cause for concern. There are obvious repercussions for consumers, for retirement planning and even financial crime issues.”
These are strong words. During the same presentation Cartwright offered thoughts on what extent of capital reserves might be required to meet the challenges of winding up a SIPP firm: “We are actively considering raising capital requirements for SIPP operators. There will be a consultation next year. The one closest example is occupational DC schemes, which is 18 months to two years. I’m not saying it will be two years, there are bigger operation risks, but that gives you an idea. It enables a more consistent and orderly wind down.”
Separately, FSA head of investment policy Peter Smith suggested that capital adequacy could be linked to whether providers offer a full SIPP proposition. Those allowing more flexible investment could face higher capital adequacy requirements.
Let us be very clear, the FSA have this in their sights and will be watching very closely. They have said they will consult during 2012, but it seems likely that implementation will follow quickly.
Capital adequacy implications
So what changes might be made? A formulaic approach of requiring (say) 26 weeks’ or 52 weeks’ expenses would be relatively straightforward to design and implement, but could have a major impact on some providers, particularly those without a history of good cashflow and profitability.
The more sophisticated approach, as suggested by Peter Smith, of linking reserves to the individual risk profile of each firm is already up and running for insurers, banks and some other firms who have to complete an individual capital adequacy assessment (ICA). These involve detailed modelling of different categories of risk so that appropriate reserves can be calculated for each risk. Those individual (internal) assessments are then compared with a formulaic calculation and may be supplemented with a further capital assessment required by the FSA based on the risk characteristics of the firm.
This would be both costly and time consuming for each individual SIPP provider to analyse, document and model its own risk profile, but it would mean that providers would have to implement more systems and mechanisms to capture, analyse and evaluate their risks, which would certainly help to alleviate the FSA’s concerns about inadequate systems and controls.
Whichever approach is adopted, the implications for providers will be profound. And this is at a time when providers are contending with significant commercial and marketplace challenges alongside other regulatory demands emanating from both the FSA and HMRC
The commercial challenges are wide ranging, from the unexpected Financial Services Compensation Scheme (FSCS) levy a year ago, through to tough competition and erosion of the bespoke SIPP market by streamlined, lower cost products. Even the abolition of protected rights in April - which will simplify things long term - will create a lot of extra work in the short term with updating illustrations, forms, key feature documents, rules and other literature, as well as system changes. And for providers that hold protected rights in separate plans with separate fees, there will be pressure from clients to merge their plans, thereby reducing overall fees.
At the same time, there is a continuing flow of other mandatory changes, particularly impacting illustrations, arising from RDR, statutory money purchase illustration rules and unisex annuities and drawdown changes arising from the Test Achats European Court judgement.
Ringing in the changes
As this impending increased cost of regulation coupled with the sometimes murky view over what investments some SIPP providers hold becomes ever more clear, signs are emerging that SIPP providers may not find it as easy to raise funds or sell as they might have thought 12 months ago. SIPPs in 2011 will be remembered for many things, including the introduction of capped and flexible drawdown. It will also go down as a year when several SIPP providers of significant size failed to attract either a buyer or external investment in their business. The risks of operating a SIPP business have suddenly and measurably increased.
One group of people who will be paying particularly close attention will be the shareholders of SIPP firms facing the prospect of making further substantial investments into a firm operating in an increasingly difficult marketplace.
Another group will be the finance directors of those firms for whom SIPPs are not part of their core operations, particularly wealth management firms. If they can offload the administration and capital resources needed to run a small book yet keep the clients and assets with them then there are signs that they will look to do so.
In short, consolidation of providers seems inevitable – how many firms will have the resources to meet the new requirements? So while all of this will be painful for providers, it will result in a more manageable SIPP market with far fewer yet stronger, better capitalised SIPP providers representing a lower risk to the end investor.
It must sound like a broken record now – the due diligence that advisers need to do must be thorough and regular. It goes without saying that no adviser would want to recommended a SIPP for their clients that subsequently ceases to operate or is moved to or bought by another provider – the reputational damage would be great.
Clients could well be stuck in limbo during this process, with the adviser losing control over the situation. The adviser certainly will not want to expend valuable time dealing with something that they can neither exert significant influence over nor recoup any income for their time. A rearrangement of investments within a SIPP after this year may also result in trail commission ceasing.
To protect their pension business and that of their clients advisers need to make sure that the SIPP provider they recommend is everything they say they are, and everything they need to be to meet the new regulatory demands. They need to be sure for all new and current clients too – making the right decision now will make an immeasurable difference in the future.
Greg Kingston is head of marketing at Suffolk Life
