PensionsSep 26 2014

Evaluating risk

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Self-invested personal pensions (Sipps) should give investors control – the first clue is in the name. Further weight is added in that these schemes are now more properly known as Member Directed Pension Schemes. It was certainly the intention of Nigel Lawson when he announced the introduction of Sipps in 1989 that the member should have more control over the investment of their retirement funds. A permitted investment list accompanied their introduction which covered a wide range of defined investment opportunities and clarity existed in the market.

However, the permitted investment list fell by the wayside in 2006 and in theory the gates were opened for a registered pension scheme to accept any investment asset, with some attracting immediate and penal tax consequences. As a result, Sipp operators chose to decline any such assets, which included any interest in residential property and taxable movable property such as works of art, cars and other chattels.

Regulation, regulation, regulation

This was very much the extent of the Sipp operator’s remit until Sipps fell under the regulation of, firstly, the Financial Services Authority (FSA) in 2007 and more latterly the Financial Conduct Authority (FCA). It is now clear that while the member can propose investments for inclusion in their Sipp, the acceptance of them is now firmly in the hands of the Sipp operator.

By 2009, the regulator registered concern, possibly triggered by the accelerated growth in the Sipp market fuelled partly by a widening range of more exotic investments, and in its first thematic review it outlined requirements that Sipp operators should review the sources of business they were accepting. By 2012, a further review identified “inadequate controls over the investments held within some Sipps” and required Sipp operators to review their business in light of this review’s findings. If ever there was a regulatory shot across the bows, this was it. However, following a third review this year the FCA found it necessary to write to CEOs of Sipp operators on 21 July requiring them to review their business again and specifically to ensure:

– ‘When the firm undertakes non-standard investment business it has adequate procedures in place to assess them and...

– ‘The capital position within your firm is being accurately reported.’

The latter will require a Sipp operator to make a judgement call on whether an asset is standard or non-standard. To help in this regard, the regulator has published a list of standard and non-standard investments with a caveat that if the operator has any reason to believe that a standard asset could not be realised or transferred within 30 days then it should be treated as non-standard.

This has particular relevance since the holding of non-standard assets, in addition to the risk analysis cost, has direct impact on the level of capital reserves required to be held to maintain authorisation to operate Sipps.

More so than ever, Sipp operators will need to undertake a detailed risk evaluation process on all assets held, but in particular non-standard assets which will entail a process to identify, collect, assess and evidence their decision to accept any individual asset and whether it should be treated as a standard or non-standard asset for the purposes of capital adequacy calculation.

So, far from the original remit of not accepting taxable assets, a Sipp operator will need to have a process of risk analysis. The words of the regulator can be seen in Box 1.

What remains key, and is evidenced by its absence from the regulator’s requirements, is that the Sipp operator is not expected to hold a view on the potential return generated by the investment nor on the appropriateness of an asset for a given individual. This remains the remit of the financial adviser.

The regulator’s requirement for risk analysis is of course for the ultimate benefit and comfort of the end client but in addition, the Sipp operator will want to review each asset based on its own risk management criteria for its own business purposes. The operator’s risk is not confined to the failure of the investment and potential action from the affected member but could also include risk of unforeseen administrative complications in holding, valuing or disposing of assets resulting in higher than anticipated administration costs which might not be recoverable from the member.

Different Sipp operators may interpret risk in different ways and indeed some may hold greater experience and/or expertise than others. For this reason, there will continue to be a variation in the permitted assets between operators, and advisers will need to be aware of this when placing Sipp clients.

There are many tools available to Sipp operators including the outsourcing of some investigative work to third parties but the overall responsibility of asset acceptance will lie with the Sipp operator.

Risk evaluation/analysis will vary between asset classes but taking commercial property as an example, a Sipp operator will need to collect the details as shown in Box 2.

In principle

With all details seen in the box, a decision in principle can usually be made, but the acceptance will still be subject to the ongoing review of anything identified in solicitors’ searches or other items that may come to light during the process.

While UK-based commercial bricks and mortar property has been categorised as a standard asset, the Sipp operator will need to identify at outset whether any factors relating to the property might lead it to assess that it cannot be disposed of within a 30-day period should the need arise.

Such factors might be the approval of a superior landlord on disposal for a leasehold property, whether legal charges attach as would be the case if borrowing could not be discharged, or whether the property might be owned through syndication where other parties’ involvement may delay a sale or transfer.

While the heightened capital adequacy requirements do not come into effect until September 2016, the nature of commercial property investment is long term and thus it would be expected that property acquisitions are still likely to be held at this date.

Other assets requiring detailed information collection and examination include unquoted equity, unconnected loans, unregulated collective investments (Ucis), intellectual property, overseas commercial property or any contractual interest in future property ownership.

At this time, with the regulator’s requirements recently published, all Sipp operators will be considering their future business strategy, their ongoing Sipp proposition and resourcing requirements, the latter of which might feed through in the pricing structure of their product. What is certain is that revised propositions and charges will filter into the marketplace over the coming months.

Martin Tilley is director of technical services at Dentons Pension Management