PensionsMar 25 2014

Regulation, regulation, regulation

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Following a relatively serene existence for their first 18 years, Sipps have been hit hard following regulation in April 2007. The impact appeared to be negligible at first, and as recently as 2012 the FSA described Sipp regulation as “a work in progress”. Today, a full seven years on from the first days of Sipp regulation, there seems little doubt that 2014 will go on record as the most significant year of regulatory change to date.

The perfect storm

It would be difficult to conceive a more challenging environment for Sipp operators. Alongside the increase in regulatory scrutiny has come an unprecedented volume of legislative change, all of which will be extremely familiar to advisers. Repeated changes to lifetime and annual allowances, unsecured income to drawdown, drawdown limits, reversing changes to drawdown limits and mandatory illustrations to name but a few, have piled on the pressure. A decade ago most Sipp operators would put few, if any, resources towards change but now it is probably one of the most important functions in any Sipp business.

If this wasn’t enough, the ruling on capital adequacy is just a few months away. In simple terms, if the rules are implemented as originally written, most if not all Sipp providers will need to reserve far greater capital than today. For some it will mean reserving millions, rather than thousands, of pounds and there will only be 12 months for them to secure the required funding.

Capital, capital, capital

It is worth remembering why the FCA is so keen to see Sipp businesses recapitalise, as well as how it intends the precise amounts to be calculated. Capital reserves are required in order to provide sufficient funding to wind down the business in the event of failure and, because of the complexity and diversity of assets held by many Sipp providers, the FCA believes more is required.

The FCA’s proposals link the required amount of capital to the complexity of the assets with more capital needed to cover ‘non-standard’ assets. Further definition is still needed but non-standard assets are those that are likely to pose greater risk to the provider and which are generally illiquid or not readily transferable.

The implication is that businesses with higher proportions of non-standard assets are riskier and would be more difficult and time-consuming to wind down and transfer assets elsewhere. Comprehensive market surveys, starting with Money Management’s own review in 2013, now ask providers to reveal the proportion of non-standard assets held. This helps advisers form a view on their chosen Sipp provider, and they are likely to want to ask more detailed questions of those who have more non-standard assets than others.

The need to raise significantly more capital is driving consolidation in the Sipp market, although activity has stalled as the regulator delayed its capital adequacy ruling. This is now due in the middle of 2014 and is expected to trigger another wave of acquisitions as some businesses decide to cease Sipp administration.

We have been here before. Ahead of regulation in 2006 it was widely predicted that a number of Sipp operators would exit the market as they would be unable to cope with both regulation and the new capital regime proposed at the time. Those predictions proved to be false, the Sipp market demonstrating early on its flexibility and resilience. This year may deliver a different outcome though, as there is a feeling that a greater number of Sipp providers haven’t grown much since the introduction of regulation, have poorly diversified businesses, weaker balance sheets and higher concentrations of non-standard assets, including Ucis.

Greater transparency

The pace and volume of change has undoubtedly hit service levels. However, it has also helped to raise awareness with advisers (and compliance officers) of some of the key issues facing Sipp providers. There is now greater understanding that it is not sufficient to recommend a Sipp provider on product features alone. Advisers are increasingly asking more detailed and searching questions on what may prove to be topics uncomfortable for some Sipp operators: how much capital do you hold, what is your complaints history, who owns you, what is the background and experience of senior management?

Advisers that do not ask these questions may need to answer some uncomfortable questions themselves in the future, as the latest data from the Financial Ombudsman Service (Fos) shows. The number of complaints about Sipps is on the rise.

Chart 1 features data obtained from Fos via a Freedom of Information request. It shows that Fos resolved a total of 625 Sipp-related complaints in 2013, with 267 coming between October and December alone.

Of those complaints, nearly a quarter relate to administrative failures. Approaching three quarters of all complaints relate to advice or the sales process, with misrepresentation and attitude to risk inconsistencies the key areas of concern. Advisers will not be surprised to learn of the latter: issues related to attitude to risk are frequently cited as causes of complaints. In this sample many are, of course, likely to relate to the investments recommended within the Sipp rather than the Sipp itself. Chart 2 shows the percentage of resolved Sipp complaints.

Whether or not a tougher regulatory environment will improve Sipp complaint numbers is open to debate. Three thematic reviews of Sipp operators in less than a decade suggest that the regulator still feels parts of the Sipp market pose unacceptable risks of consumer detriment. Complaints tend to be triggered by events, such as unexpected news or poor investment returns.

The outcome of enforcing stricter regulation may just be one of those events, actually resulting in an increased number of complaints in the short term. That should not necessarily be seen as a poor outcome - a successfully resolved complaint puts the investor back into the position where they expected to be.

The real benefit of tougher yet appropriate regulation for Sipps is that the Sipp operators who invest to improve and survive the change will emerge stronger and more capable of meeting the expectations of both consumers and advisers. Of course, there’s always the risk that the regulator will go too far, risking a stifling of innovation and reduced choice for consumers.

Whatever the outcomes of the current thematic review and subsequent final guidance on capital requirements, advisers should keep a watchful eye on the Sipp market in 2014. How Sipp operators react will guide them on where to place new clients and, such is the magnitude of change expected, will also prompt them to review all their existing clients too.

Greg Kingston, head of marketing and proposition at Suffolk Life