FCA unyielding on SIPPs
When the FCA consulted on a new basis for calculating capital in a SIPP administration business, 55 out of 57 responses (including ours) faulted the regulator’s preference. But evidently the FCA can lose the argument and still win the day. Apart from minor changes it has stuck to its proposals to tie capital requirements to assets under administration instead of operating costs. When we wrote about this at the start of the consultation, we did so because of an important principle: when regulatory changes are expected (or even intended) radically to alter the competitive landscape, the burden of proof of a market failure should be set very high. It wasn’t. That’s why not yielding to the 55 is so significant.
This is not an article of much interest to end investors although they are the ones likely to pay a price in one way or another. The subject is arcane but, because of the FCA’s cavalier attitude, it has attracted quite a lot of attention in the industry as a whole. Financial journalists should most definitely not treat this is a small story: this is one of the regulator’s most inglorious hours.
Setting aside for a moment the logic of the FCA’s argument, in this case it was upfront in stating it expected the result to be consolidation of this fragmented industry and that it believed that was a good thing, on the basis that there were too many firms that were under-capitalised and so posed a risk to consumers. The SIPP industry hasn’t been high on anyone’s list of banana skins except the FCA, so they must know something the rest of us don’t. We know about the instances of firms failing, so their advantage over the rest of us is that they also know about any near misses. But they won’t tell us about those because it relates to specific firms (an exception for regulators under the Freedom of Information Act).
But we can at least look at what the FCA told us they think the risk of detriment is and therefore how any market failure might manifest itself. It’s not what you might think: errors, omissions or fraud in handling large amount of money. Perhaps that was left out because it’s the job of industry compensation schemes and professional indemnity insurance to act as the first line of defence, not capital. It ‘s also certainly true that behind the SIPP sit much bigger structures, common to most financial firms, for ensuring money is safe: the custody function and exchange-based dealing and settlement processes. What the FCA singled out, and which then determines much of the nature of its proposals, is what happens to clients’ assets when a SIPP administrator winds up its business. Though the FCA talks about involuntary wind-ups, the risk it describes is equally applicable to voluntary windups. So what exactly can go wrong that looks anything like a market failure?
It’s the possibility that assets cannot be re-registered with another SIPP administrator, and the consequences of that as either a delay or even a total barrier to transfer. Well, you would think that competitors would be pretty keen to scoop up those customers and their assets. And so, in general, before these changes, they have been. The problem relates only to assets that are illiquid and hard to value and which a new pension administrator might decide they do not want to be responsible for. These pose a compliance risk for pension administrators already, even without any additional capital consequences.
SIPPs hold more of these idiosyncratic assets (both financial instruments and property) than other pension funds because that was one of their key advantages when they were first introduced. But the industry has moved on and SIPPs are now mainstream pension wrappers for self-directed and advised clients holding perfectly liquid market-traded investments. They will be central to the Chancellor’s ‘democratisation of drawdown‘. So, to be clear, we are talking about a low-probability event with a possible impact on a small proportion of the stock of assets.
What are the consequences? Re-registering illiquid holdings can take time and so could extend the time it takes for a SIPP firm to complete a wind-up. (As to the logic of the FCA’s proposals, you might therefore deduce that a capital requirement based on time remaining in business, as well as exposure to illiquid assets, was actually most appropriate.) The main source of consumer ‘detriment’ the FCA held out was not delay but inability to re-register. But in such exceptional cases the holder can either buy the assets from the pension fund personally or the administrator could enforce distribution of the asset in specie in which case they would constitute an unauthorised pension payment and be subject to a tax charge of 55%.
In our response to the FCA we argued that this was not even a source of detriment. It is better seen as a risk willingly borne by any investor who elects to place illiquid and hard-to-transfer assets in their pension fund. It goes with the territory.
So the FCA failed miserably to demonstrate a market failure. This is so transparent that we were bound to ask whether the FCA’s motive is really completely different: it suits it to regulate a less-fragmented industry with a smaller number of larger funds. Never mind the competitive implications, it just makes their job easier.
Indeed, we note that the detail of the final rules for capital adequacy, even with some (illogical) softening to benefit the smallest firms, appear specifically designed to encourage that outcome. This is well argued by actuary and long-term SIPP player Hyman Wolanski in an open letter to the FCA. He knows how to do the maths.
Finally (because we don’t want to leave the FCA’s logic unchallenged), what about the obvious flaw that consolidation will trigger the otherwise low-probability wind downs whose consequences it fears? It’s answer: we would prefer to deal with the problem all at once.