The FSA has not yet lost patience with some SIPP providers’ addiction to Unregulated Collective Investment Schemes (UCIS). But it has revealed the latest piece of a puzzle which, once complete, will reveal a blueprint to solving many of the SIPP industry’s issues.
The regulator’s announcement of CP12/19 ‘Restrictions on the retail distribution of unregulated collective investment schemes and close substitutes’ was timely. For those yet to read it, the consultation paper proposes that UCIS and other similar investments no longer be available for retail investors. CP12/19 is closely linked with the highly anticipated consultation paper on capital requirements for SIPP providers and it is worth exploring why.
The investments
The principal reason for a SIPP provider to hold capital is simply to provide a pool of money sufficient to allow an orderly wind-down of a failed business. That is straightforward enough and advisers will of course be familiar with the concept, with their own capital requirements being the subject of a similar ongoing consultation.
But not all SIPP firms are equal. They are set up in different ways, run under various regulatory regimes and hold a wide variety of investments with a broad spectrum of risk and liquidity. One size rarely fits all, yet, broadly speaking, the current rules for capital provision adopt exactly that approach.
The regulator wants to change that and has dropped several hints about linking capital requirements to investment risk. It believes that the more complicated an investment the longer it would take to wind it up, and that seems sensible.
So, for example, a SIPP provider whose business largely comprises equities and collectives would need to hold less capital then one whose book had more illiquid and complex investments, such as UCIS or property.
But why is the regulator going to act now, especially after it has taken steps to limit the availability of UCIS to new investors? After all, SIPP providers are not regularly closing down or going out of business. The answer is that some of the more risky unregulated assets, into which many scheme members are heavily invested, are not quite what they first appeared.
Meteoric growth
The SIPP market has grown rapidly, from nothing to more than a million investors in fewer than 25 years. That is the very definition of a growth market, and with it comes associated problems. Many new entrants joined during this period, their business models reliant on this strong growth, but when the growth dries up the books become harder to balance.
Growth is a difficult addiction to give up. It pays staff, pays dividends to shareholders and brings improvements to services for advisers and investors. One only has to look at the UK economy to see the consequences of negative growth (we cannot even bring ourselves not to say growth) on systems built on the foundations of indefinite positive growth.
In some sectors of the SIPP market growth has stalled. Investors have less money to invest or are unwilling to commit as much as before, and at the same time have experienced some of the biggest losses in a generation.
For some SIPP providers without the critical mass of business to ride out the economic turbulence – and let’s not forget the steadily increasing overhead of the newly introduced regulator – maintaining growth was the only option.
In times of investment instability the promise of lucrative returns can be alluring, especially for the unadvised. Some SIPP firms needed continued growth from somewhere, investments needed funding and investors wanted a positive return to correct their losses. Enter the unregulated investment market.
This has not turned out to be a marriage made in heaven – which is why the regulator continued to be vigilant and has now acted with CP12/19. The FSA repeatedly spoke of its concern with certain types of esoteric investments and has been busy taking action against some. It raised concerns about pension funds via SIPPs providing significant finance for these investments, in particular when they are the only asset into which the SIPP invested.
But the FSA’s unease is broader. It is not only concerned with these SIPP investors, but also with all the others. If sufficient SIPPs fail then a provider can easily lose sufficient revenue to threaten the whole business. That affects all investors no matter where their assets are invested or whether they are advised or unadvised.
Recent UCIS failures have shown that in some cases a single investment can form a significant proportion of a SIPP providers’ business, as much as 5 per cent in some cases. Often it is the only investment within the SIPP, so when the investment fails that revenue disappears. Take 5 per cent of revenue out of a business and it can be highly damaging – the troubles of eurozone countries such as Greece provide a chilling example of what can happen when growth falls by just a few per cent.
Cash is king
That is why the FSA wants SIPP providers to have more capital, to manage situations just like this. However, it does not want to damage the industry, leading it to attach the greatest capital requirements to the illiquid investments that pose the highest risks. SIPP providers that specialise in lower-risk, more liquid investments, such as collective-focused platform SIPPs, are likely to have less to fear from the regulator’s proposals.
It is not black and white though – how the regulator decides to best apportion capital requirements to risk will be a delicate balancing act. Parts of the bespoke, traditionally high-net-worth end of the market are alive and well, and the regulator needs them to play a vital role in the rehabilitation of the SIPP market.
No nasty surprises
The regulator has acted responsibly and sensibly to date. It made clear its thoughts as early as 2010, voicing concerns over loose controls on investment policy and mooting ideas on capital needs in the SIPP industry, and has continued to do so in public and behind closed doors.
For those following the SIPP market – all 120 or so providers – it cannot have escaped attention that change is happening. Larger, stronger providers are continuing to grow and expand their businesses and broaden their propositions. For the first time they are starting to take business from other SIPP providers, as well as their traditional domain of pension transfers and consolidation. One only needs to compare the last Money Management survey to this one to see the change.
The anticipated new capital regime will add a significant layer of cost, more for some than others, and this means market consolidation has never been closer. Some small deals have already taken place and larger ones will follow.
A series of events is being set in place that will pave the way for a – largely – orderly transformation of the SIPP industry. The next couple of years will finally see the true effect of regulation in the SIPP market. There will be fewer yet larger, better-positioned, better-capitalised, stronger SIPP providers and this will ultimately lead to better outcomes for both advisers and investors.
There really are SIPP providers of genuine quality in the market today, those that can service the needs of all an adviser’s clients and who are committed to the market and their customers for the longer term. They are also the ones most likely to play a role in saving investors from less secure parts of the market.
Advisers will need to be more careful than ever to make sure their due diligence is sufficiently robust to find them. Choosing a SIPP provider that is not reliant on a few unregulated investment providers to prop up their business would be an excellent place to start.
Greg Kingston is head of marketing at Suffolk Life
