PensionsMar 23 2016

Understanding non-standard assets

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Understanding non-standard assets

One of the biggest regulatory upheavals for Sipp operators since the product became regulated in 2007 is the introduction of new capital adequacy requirements, which come into effect on 1 September 2016.

These new requirements may be a catalyst for a polarisation of the Sipp market between operators that will only allow investment into standard assets and those that will continue to offer the full freedom and flexibility to invest in both standard and non-standard assets, in line with the original principles of the Sipp.

The aim of the requirements, which in the main will require Sipp operators to hold substantially more capital than previously, is to provide greater protection for clients. This protection means that in the event of the operator closing down, the capital can be used to facilitate an orderly wind-down of the business and allow time for members and their advisers to seek alternative arrangements and avoid client detriment.

However, the new requirements may have further implications for advisers and their clients which, by having an understanding of the mechanics of the new capital adequacy calculations, could influence their selection of an appropriate Sipp operator.

The impact of non-standard assets

In a nutshell, the capital adequacy formula has three parts. Part one calculates an initial capital requirement based on the value of assets under administration; part two calculates a capital surcharge factor which is based on the proportion of Sipps that hold non-standard assets; and part three calculates the total capital required, by increasing the initial capital requirement in part one by the capital surcharge uplift factor in part two.

If on 1 September 2016, Firm A has no non-standard assets, then its capital requirement will just be its initial capital requirement. If it subsequently accepts non-standard assets – such that 15 per cent of its Sipps hold a non-standard asset – then its initial capital requirement will be uplifted by a factor of 1.97, or 97 per cent.

By contrast, if Firm B starts off on 1 September 2016 with 60 per cent of its Sipps holding a non-standard asset, its capital requirement will be its initial capital requirement uplifted by a factor of 2.94. If that firm subsequently accepts more non-standard assets such that it also increases the proportion of Sipps that hold non-standard assets by 15 per cent, then its initial capital requirement will be uplifted by a factor of 3.17, an increase of only 0.23 or 8 per cent.

But if both Firms A and B have the same value of assets under administration on 1 September, Firm B will have a much higher capital requirement at outset, but will be better placed to continue to accept non-standard assets due to the lower impact on its capital requirement.

A key message for advisers and clients is that if there is a possibility of investment diversification beyond standard assets, consideration needs to be given to selecting an operator that will allow investment in non-standard assets as determined by the FCA for capital adequacy requirements.

Are non-standard assets ‘bad’?

The FCA has set out a list of standard assets which includes deposits, shares in investment trusts, securities traded on a regulated stock exchange and units in regulated collective investment schemes, but they are all caveated by needing to be capable of being accurately and fairly valued on an ongoing basis and readily realisable within 30 days whenever required.

The rationale is that if assets are held that do not meet this criteria, in the event of a firm being wound down, it will take longer to deal with the non-standard element, hence the need to hold more capital.

Therefore although some firms may construe non-standard assets as being ‘bad’ for their capital adequacy requirements, from an adviser’s or client’s perspective, holding a fixed-term investment of greater than 30 days – or even investing in a Ucis – may be ‘good’ and quite ‘normal’, rather than non-standard, as part of a diversified and risk assessed portfolio.

Appropriately capitalised, established, bespoke Sipp operators offering both standard and non-standard assets, will continue to meet this demand.

Robert Graves is head of pensions technical services at Rowanmoor Group