PensionsOct 1 2015

The run up to September 2016

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The run up to September 2016

One of the most heated discussion points in recent history in the Sipp market has been that of capital adequacy. First announced by then regulator the FSA in its CP12/33 paper in November 2012, it was proposed that Sipp operators would be required to increase the amount of capital their business must hold in reserve. The changes proposed a formula that results in significant increases in capital requirements for Sipp operators whose assets contained the greatest proportions of non-standard assets.

The regulator defines non-standard assets as those which, in general, cannot be realised or transacted in less than 30 days. Included in this classification are unregulated investments about which the regulator has repeatedly raised concerns. The classifications are also behind the sharp increase in complaints the Sipp market has had, and have contributed significantly to a costly increase in the levy imposed on advisers and other parts of the Sipp market by the Financial Services Compensation Scheme (FSCS).

The reaction to the FSA’s initial proposals was met by large parts of the Sipp market with shock, disbelief and disagreement. Following the publication of the FCA’s amended proposals in PS14/12 (published in August 2014), this reaction threatened to turn hostile.

The board of the Association of Member-directed Pension Schemes (Amps) took the unprecedented step of starting proceedings for a judicial review on the basis that the FCA’s consultation process was “unlawful”, “unfair” and “inadequate”. This action – that took many Amps member firms by surprise – was ultimately refused by the courts in early 2015. The approach reflected the mood of a significant number of Sipp operators, and the manner in which it was conducted, highlighted the lack of agreement among them.

More recently, in June this year, the FCA provided further clarification – and what appeared to be a limited last opportunity – to provide feedback when it published CP15/19. With less than a year to go before the final capital rules are implemented in September 2016, the regulator has yet to publish a final position but the expectation is that there will be few changes from its current standing.

Throughout what has clearly been a difficult journey the response to the discussion from advisers has been ambivalent, despite embarking on changes to their own capital requirements. Now that the new rules appear to be set, advisers need to change their approach in the crucial period between now and implementation on 1 September 2016. So, what do you need to be aware of?

Why is this important?

With less than a year to go until the rules come into play, advisers now need to understand what Sipp providers need to be preparing for in the run up to September 2016. The failure of a Sipp operator is, fortunately, a rare occurrence. Nevertheless, this is not to say it has not happened, and could not happen in the future. A number of potential failures of Sipp operators have been averted in recent years, due to either a distressed acquisition or a more orderly and mutually agreed exercise in consolidation.

The Sipp market is likely to see further acquisitions of varying size over the next 12 months. However, an uncertain future waits for those firms who will be unable to meet the regulator’s requirements next year and who are unable to find a party willing to buy them who can.

Identifying which Sipp operators are prepared to meet the new requirements should now be the first due diligence question an adviser should ask. Such is the size of the capital increase that it is unsafe to assume that a Sipp operator in business today will be sufficiently capitalised to remain in business in 12 months’ time. Money Management’s survey asks providers what percentage of their business is covered in the run up to 1 September. What about those who cannot afford it?

Those who can’t

The FCA has not yet unveiled its plans for undercapitalised firms. With this in mind, let us think about consolidation. It has been one of the biggest topics of conversation in the Sipp industry surrounding whether there will be any mergers and acquisitions before the September deadline, especially as smaller companies struggle to raise funds. Should it indeed happen, it will within the next year.

In PS14/12, the FCA said that many respondents to its initial consultation expressed concerns regarding what would happen to the capital requirement if it acquired the pension book of another operator – and whether or not the acquiring firm would be able to afford it.

In response, it admitted it would result in an increase in the capital requirement and that administering a “significantly higher level” of business would be “desirable”. Interestingly, it also admits that if this were to be a “genuine” obstacle to the hypothetical acquisition, the FCA would expect the operator to approach them regularly to agree an “appropriate course of action.”

The FCA adds, “We would not expect a regulated firm to become highly leveraged when making an acquisition and would expect any necessary capitalisation to be reflected in the purchase price.”

This brings into question whether or not it would do the same for operators in September. This remains a grey area and at time of press, there is no official confirmation on this policy from the FCA. It should also be remembered that Sipp providers would have had more than two years to first calculate their capital adequacy requirements and subsequently raise sufficient funds.

Assuming a Sipp operator is prepared simply because it is authorised, regulated, and open for business is not a luxury afforded to the adviser who does not want to be caught out in the future.

What to look for

The majority of Sipp providers will – or should – operate with an excess of required capital. That prepares them for changing capital needs, taking into account fluctuations in asset values and increasing volumes of new business. How much this additional margin (or “buffer”) should be is down to the risk tolerance of each individual operator.

Again, Money Management’s survey looks more in depth at what percentage of an operator’s assets are in non-standard assets. The figure is used to help calculate a firm’s capital adequacy requirements.

Keep in mind that UK commercial property will not come under this requirement, unless it is not capable of being “readily realised” within 30 days. If it is not able to meet this, then the operator should classify it as a non-standard asset, and it should fall within its capital adequacy calculations. In CP15/19, it was classified that the 30-day point begins as soon as the land registry is formally notified.

How to calculate

The headline figure is £20,000 in reserve but there is more behind the figure than meets the eye. This amount will apply only to the smallest providers – and in reality is theoretical only – and the figures could reach the millions. The final number is calculated through three stages:

Stage one is calculated by finding the initial capital requirement (by multiplying the square root of a provider’s assets under administration and K1, a constant depending on the size of the firm – either 10,15 or 20).

Stage two involves calculating the capital surcharge. This may prove more difficult for some companies because the percentage of plans containing non-standard asset types must be measured. The square root of this figure is then multiplied by K2, a constant currently proposed at 2.5, and multiplied by the initial capital requirement found in the first stage.

Stage three is simply adding stage one to stage two to find the provider’s total capital requirement.

Remember, remember

The main clue is in the name “capital adequacy”. Providers only need to be adequate. It is important to remember that just because a company claims to have £5m banked when they only need to hold £1m does not equate to being five times better than another. It does not mean the operator is providing a good and stable service.

Capital adequacy should not be seen as a competition between providers, but an exercise of proof its assets are being held by a stable administrator.

Greg Kingston is head of communications and insight at Suffolk Life