When the original consultation paper on capital adequacy for Sipp operators was published by the FSA in November 2012, responses were requested by 22 February 2013 with a view to a final policy statement being published in the second half of 2013.
Given the extended timetable in producing the policy statement and that the FCA, which has taken over from the FSA, has a requirement to promote market competition, a fairly radical alteration to the original proposals was anticipated.
While there have been some welcome changes to the original proposals, including the extended time limit for compliance from one to two years, Policy Statement 14/12, published by the FCA on 4 August, does not, in my opinion, provide a sensible framework for the future capital requirements of Sipp operators.
Wind-down
Before discussing the new proposals and changes from the original ones, I find the concept of “an orderly wind-down of a Sipp operator business” difficult to comprehend. The majority of Sipp operators are well-run, profitable businesses providing a reliable service.
As Sipp assets are held in trust, they are secure from creditors. If a Sipp operator wishes to exit the market, it would put its business up for sale. The only other reason for exiting the market is if FCA permissions are removed because of shortcomings in a firm’s management or corporate governance.
It seems unreasonable that the whole market is expected to hold hugely significant amounts of capital to cover a circumstance that is highly unlikely to affect them. It is also true to say that in the event of any wind-down of a business, fees will continue to be generated from the administration of the pension arrangements still under the control of the operator, providing funds to enable the management of the portfolio to continue.
The starting point for the calculation of capital adequacy is the initial capital requirement. This is a multiple of the square root of the assets under administration. From a freedom of information request by the Association of Member-directed Pension Schemes, it was apparent that 55 of the 57 responses to the FSA did not believe that AUA was a sensible approach for determining the amount of capital an operator should hold.
Despite this, the FCA has retained this basis with some benefit to smaller companies, in that the multiple of the square root of AUA has been reduced from 20 to 10 for companies holding less than £100m of AUA, and 15 where AUA is between £100m and £200m.
It remains at 20, where AUA exceeds £200m. The difficulty for smaller firms is if a sudden increase in AUA exceeds one of these benchmark figures. For example, a company with AUA of £190m and no non-standard investments, would have a capital adequacy requirement of around £207,000. If AUA increased to just over £200m through stockmarket fluctuations or new business, the initial capital requirement would increase to £283,000. For a small firm, this is substantial.
Most respondents to the original consultative document suggested that the number of Sipps was a more appropriate measure of determining capital adequacy. Why should it take longer to wind down a firm that holds assets of greater value in the same number of arrangements.
For example, if a company operates 2,000 Sipps with an average fund value of just over £200,000, its initial capital requirement will be £400,000. Another firm, with same number of Sipps and an average fund value of £100,000, has an initial capital requirement of £283,000. The funds under administration are not owned by the Sipp operator, but to the clients. Why should one operator have to hold significantly more capital because the average size of their clients’ funds is greater?
The other important feature of the capital adequacy requirement is the capital surcharge. This is a sum that is added to the initial capital requirement, based on the proportion of an operator’s Sipps holding non-standard assets.
Assets
It is positive that the definition of standard assets now includes UK commercial property. But this is subject to a requirement that title can be transferred within a 30-day period. It will be interesting to know exactly how the FCA intends to check on this. The new requirement will mean operators will wish to facilitate timely property transfers. However, as it is difficult to know in advance exactly how long it will take. I anticipate problems, particularly where the member is joint owner of a property.
The calculation of the capital surcharge has been changed so that it is 2.5 times the square root of the fraction of Sipps containing non-standard investments. It is evident there is a mismatch between the calculation of initial capital requirement and capital surcharge, in that one depends on the value of the investments, whereas the other depends upon the number of Sipps. A client with £1m in a Sipp, which includes a £50,000 investment in unquoted shares, adds to the proportion of Sipps holding non-standard assets, even though it is only a very small proportion of the fund value. I fail to see why this should be so.
The combination of the initial capital requirement and capital surcharge also makes the acquisition of new business costly. If we take a company with an AUA of just over £200m and 50 per cent of its Sipps holding non-standard investments, its capital adequacy requirement is around £780,000. If the firm adds 100 new Sipps to its portfolio, with an average fund size of £100,000 and 50 per cent of those new Sipps hold non-standard investments, its capital adequacy requirement will increase by £20,000 to £802,000.
If we assume the fee income in the first year for each new Sipp is £800, the firm will increase its fee income by £80,000 but will have to put £20,000 of it (25 per cent) aside to add to its capital adequacy. This makes the cost of acquiring new business excessive; as it is worse for smaller Sipp operators, it cannot be a sensible way for the FCA to promote market competition.
Capital
Finally, there is the requirement that capital held against the capital surcharge is in sufficiently liquid form, so that it can be available within 30 days. This means it has to be cash on deposit. These proposals will result in huge sums of money being held in bank accounts, yielding virtually nothing, which cannot be used for business development by the Sipp operators. This is not a sensible use of capital.
Over the past 12 months, the FCA has had time and opportunity to re-think the proposals on capital adequacy. It has failed to do so, making minor adjustments that do not resolve the inherent problem of the small number of Sipp operators who have poor corporate governance and are clearly under-funded for developing and supporting a complex pensions portfolio.
While I would not go so far as to say the FCA is seeking battle with many Sipp operators, it does seem a strange coincidence that the capital adequacy policy statement was issued on the 100th anniversary of the commencement of World War I.
Ian Hammond is managing director of Rowanmoor
Key Points
Policy Statement 14/12, published by the FCA on 4 August, does not provide a sensible framework for the future capital requirements of Sipp operators
Why should it take longer to wind down a company which holds assets of greater value in the same number of arrangements?
The majority of respondents to the original consultative document suggested that the number of Sipps was a more appropriate measure to determine capital adequacy
