A year ago today, the SIPP industry mouthed a collective ‘wow’ as the FSA announced its radical proposals for increasing the amount of capital that a business should hold in its reserves if it wanted to offer a SIPP to consumers.
The announcement wasn’t unexpected – in fact it was a few months later than predicted – but the method of assessing how much capital was so far removed from the current system it left many in the industry scratching their heads and even reaching for their scientific calculators on a search for the square root button.
The current system:
6 or 13 weeks’ expenditure subject to a minimum of £5,000
The system proposed one year ago:
ICR = 20 x SqRoot (Assets Under Administration)
5 x p% x ICR
where p = percentage of SIPPs invested in non standard assets.
all subject to a minimum of £20,000
The FSA had probably spent around two years coming up with their proposals. The consultation process lasted three months. The industry association assisted by conducting its own consultation before submitting its formal response. The final policy statement is now overdue after nine months of gestation.
As chairman of the industry association, I was heavily involved with both our consultation process and collating the thoughts into the formal response to the FSA. There was no silver bullet identified in those three months that would achieve what the FSA wanted, but it was pretty clear that the proposed calculation had holes in it that once pointed out I would not expect would be palatable to the regulator: uncontrollable fluctuations in the calculation, too little capital when needed, potential for manipulation and, of course, inconsistent capital requirements for two companies that would ultimately need the same capital.
I have had three times as long to consider the best solution since submitting the industry response than I had before submitting it (three months of consultation followed by nine months of waiting). What is my view of the situation now?
1. It’s not right that a SIPP company can operate with only £5,000 in reserve should something go wrong. So an increase to the proposed £20,000 minimum requirement needs to happen without delay and with a short lead in time.
My view is that the FCA can achieve this my making a statement that the current rules require essentially a sense check that the calculated amount is reflective of the costs required to wind down the business, and it would be unlikely that this could be done for less than £20,000.
2. In truth, I would expect £50,000 to be a more suitable minimum buffer and so I would look to impose a minimum of £20,000 but increasing to £50,000 by the time you are responsible for 100 SIPP members. ie an extra £300 per SIPP for your first 100 customers.
3. Basing the core calculation on Assets Under Administration was inventive and very worthy of inspection. I’ve inspected it, and have concluded that it is flawed. Even though it might provide a good indicator of size of the SIPPs operation, there are better measures.
Number of SIPP members (colloquially, number of SIPPs) to my mind is a measure at least as good as AUA but without some of the unwelcome aspects. There need be no debate about valuations or market fluctuations. No concerns about a conflict between SIPP member (high valuations) and SIPP firm (low valuations). And no inconsistency between two similar SIPP companies where one has clients who are twice as rich as the other’s clients.
If you are wondering why a valuation might be high or low, just bear in mind that some assets might be commercial property and think about the difference that a buyer (or bank) might out on the property compared to the owner.
So I am a supporter of using number of SIPPs over AUA and using the square root function to account for economies of scale.
4. But does this mean that I am a supporter of a switch away from the current method which is based on operating expenses. I’ve been vocal about support for number of SIPPs but that is against the backdrop of ‘instead of AUA’. As I reflect, I cannot see how number of SIPPs or AUA can give a good indicator of costs of winding down a SIPP business.
If you want a fair estimate of the cost of running down a SIPP then I haven’t seen anything other than loose arguments to convince me why starting with operating expenses isn’t likely to give most suitable result.
Some loose arguments:
That method is being manipulated: well clarify the rules and impose them, or use a proxy for expenses such as turnover.
Operating expenses change when a company is winding down: yes, but that doesn’t make operating expenses an invalid starting point or a radical formula a better starting point. I suggest the minimum requirement mentioned above is the starting amount, on top of which thirteen weeks’ expenditure is added.
Some operators only have to hold six weeks’ worth whereas others have to hold thirteen: would it be that hard to change everyone to the same basis?
One issue with the industry response was that two alternatives suggested: one based on number of SIPPs and one based on expenditure/turnover.
This indecision was manifested as generally we thought that tweaking the proposals would be more palatable than rejecting them completely and just tweaking the existing model. But you can’t escape the distinct lack of evidence to justify moving so significantly away from the current method.
5. So a calculation based on a minimum of between £20,000 and £50,000, plus thirteen weeks’ expenditure. This rewards those companies that operate efficiently.
But what of the capital surcharge to reflect the extra costs of disposing of clients who have invested in non standard asset types such as commercial property?
I don’t think it is enough to say that the operating expenses will be higher for those companies anyway and so the extra cost is built in to the ‘thirteen weeks’ calculation. A premium is still needed.
Bear in mind that normal ongoing fees should continue to be due and will help contribute towards the wind down costs, so any extra time shouldn’t need to be fully accounted for in the premium. (Ongoing overheads mean there would still need to be something). Any normal costs of wind down – legals, redundancy etc – should already be accounted for in the main calculation.
There would need to be calibration but I do not think that any SIPP company should need to hold more than one year’s worth of expenditure as a reserve in case it needs to wind down. A year is ample to find an exit route and if one is not found within a year then that is an indication of bigger troubles that are unlikely to be sorted by having two years’ worth.
Targeting a maximum of one year would mean that the premium would be 39 weeks’ of expenditure, multiplied by the percentage of non standard assets. That percentage should be based on number of SIPPs that hold non standard assets, as per the FSA’s proposals.
6. Anything else? Increasing the capital requirement within reason is, by definition, reasonable. But getting SIPP providers to throw excessive money at the issue is not a great solution as it reduces the amount of money available for actually improving systems and the SIPP proposition.
So getting the balance right is crucial. The regulator can terraform the industry when they issue their proposals.
That’s a long blog. For those that made it this far, here’s the summary suggestion:
CAPITAL REQUIREMENT =
£20,000 plus £300 per SIPP (up to 100 SIPPs)
plus ICR = 13 weeks’ expenditure
plus 3 x p% x ICR
where p = percentage of SIPPs invested in non standard assets.