How The Regulator Is Restricting Choice

How The Regulator Is Restricting Choice
Palau by Julian Cohen. Why?

For a few years, the Financial Services Authority had been rather concerned with the number of SIPP operator failures

Whilst the industry has boomed, with around £100 billion currently invested, the capital adequacy rules for SIPP operators haven’t changed. 

Capital adequacy in this context is the amount of money a SIPP operator must hold to ensure there is sufficient money available to allow an orderly wind-down of its business.  So if a SIPP operator gets into difficulty, the capital will enable SIPP administration to continue while a buyer is sought and the business is transferred.

While the law requires SIPP investments to be ring-fenced, the regulator is concerned that SIPP operators without a robust capital base won’t be able to transfer assets to another provider without cost to their members if they have to wind down.

Worried that too many SIPP operators have been trading on very thin margins, putting investors at risk, the former City regulator, the Financial Services Authority, commissioned a consultation.  The results have been published in Consultation Paper CP12/33, A New Capital Regime for Self-Invested Personal Pension Operators.

The new capital adequacy rules are likely to be very stringent

At present, SIPP operators are required to hold an amount of capital, which is the higher of £5,000, six weeks of expenditure or 13 weeks of expenditure if they hold client money.

The new regulator, the Financial Conduct Authority, is proposing to increase the fixed minimum capital requirement from £5,000 to £20,000. In fact, it believes £30,000 is more appropriate.

Furthermore, those SIPP operators whose investors only hold non-stockmarket investments, or which are more exposed to non-standard assets, will have to put aside a “capital surcharge” that will reflect the increased cost of winding down these investments.

Controversially, the regulator is also proposing that commercial property, a very popular SIPP investment, should be classified as “non-standard” because it is relatively illiquid.

Incredibly, it’s been calculated that some SIPP operators will need to hold between £700,000 and £2.5m in reserve

Not only is this a massive change from the current rules, there are very few businesses that have the ability to hold this kind of money in cash.

Not surprisingly, these proposed policy changes will result in a reduction in the number of SIPP operators in the market.  And that’s really bad for investors.  In its report, the regulator believes around 18 per cent will leave the market. 

Ahead of when the changes take effect, some operators have indeed already closed their doors to new business. Some mergers and takeovers have already occurred. But the biggest problem for investors is that some SIPP operators could go into administration, potentially affecting the assets as they are transferred.

The consumer financial media has been quick to highlight the new rules could force some SIPP operators to charge more. And indeed, some already have done so.  Some now charge a flat fee for non-stockmarket investments, no matter how many you hold. But others charge per investment, which could add significantly to the cost of running your SIPP.

However, the most worrying change is that several SIPP operators have decided to stop taking in new non-stockmarket investments. And some who used to allow such investments into their SIPPs are refusing to accept new money into those that were formerly ‘approved’.

Getting advice from your trusted adviser has also been affected

To help put their house in own order, there are now almost no SIPP operators that will allow investors to open up a SIPP without independent financial advice. If things go wrong, to protect their businesses, SIPP operators want the ability to point the finger at an independent financial adviser who confirmed the investment was a sound choice for the client.

Here's the problem. Independent advisers are regulated. But the products are not.  It means that if things go wrong (and both regulated and unregulated products do go wrong from time to time), advisers are likely to get into big trouble for advising on 'non-regulated' products. Furthermore, their professional indemnity insurers will simply walk away, leaving the advisers to pick up what could be a sizeable bill. And none of them want that!

It's therefore hardly surprising there are now almost no financial advisers willing to provide their normal service and give a positive recommendation, even when it's blindingly obvious it's the right advice.  Most will simply decline to comment. And those that do comment will almost certainly issue their clients with a recommendation not to proceed. If the client wants to go ahead, the adviser will require them to sign a letter, insisting they do so at their own risk.

Arguably, that's the point of 'self-invested personal pensions'.  It says 'self-invested' on the tin, so there's nothing wrong with educated clients, who've analysed the due diligence documents making their own decisions about their money. After all, almost every one of them has bought their own home, and that isn't regulated.  So regulation didn't stop them in one part of their financial life, so it shouldn't be a barrier when it comes to another part.

The problem is that changes in regulation have caused SIPP operators and advisers, the very people who can help clients improve their financial wealth, to be incredibly negative about the whole area in general, and about specific products in particular.  And that puts doubt in the minds of clients, when in many cases, it's entirely unfounded.

It's a classic case of the industry 'protecting its own back', irrespective of the needs of clients.  And that can't be right!

Ironically, in its attempt to protect investors, it appears the unintended ‘double whammy’ consequence of the regulator’s consultation is to significantly reduce the choice of non-stockmarket investments, whilst simultaneously increasing their cost!

That said, there are a few forward-thinking SIPP operators and independent financial advisers who understand that investors need more than just the choice of those investments that come under the remit of the regulator. Whilst the stockmarket remains a volatile and unpredictable place, investors also require access to other investments, including lower risk, property-backed solutions.

A quick review of stockmarket funds over the last five years puts this into context

The average Managed Fund has earned just over 5% per year.  The average Equity Fund has done not much better at 6.5% year. But best performing has been a fund with lower risk than these: the average Fixed Interest Fund, which has grown at 6.7% per year.

When you put this against a range of lower risk ‘corporate bond’ and ‘loan note’ investments, delivering returns of 10% or more, backed by the security of property, it’s clear there’s a big place for carefully selected non-stockmarket investments.

In an ideal world, all investments should be regulated

It’s bizarre that the biggest investment sector of them all, property, escapes regulation completely!

So whilst it’s entirely right and proper for SIPP operators to be required to hold more capital in their businesses to protect investors, the best way for the regulator to serve investors is to oversee all investments, including property. 

Until then, investors shouldn’t miss out on the considerable opportunities afforded by property-backed investments, like those featured on SIPPclub. Though, as with any investment, regulated or otherwise, you need to carry out thorough due diligence before you part with your money.

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