So the FCA has issued the final rules for SIPP capital adequacy, PS14/12. With some serious watering down of the formula, SIPP providers may well be a lot happier than they were at the end of 2012.
The formula is still based around a key metric of Assets Under Administration (“how much all of your customer’s pension pots are worth”) which was an odd (or genius?) choice of metric when first announced.
I started this blog with a list I had curated of odd features of using AUA as the key metric as part of a job in putting together the AMPS industry response. Here I list them again (in order of click throughs to my blog), with a comment against each to see how the issue has been dealt with under the final rules. In total, I have scored the revised rules 5 out of 12 when it comes to addressing these unintended consequences.
PLEASE NOTE THAT THESE COMMENTS ARE MY OWN, AND NOT LINKED TO AMPS COMMITTEE, AND THIS IS COMMENTARY ON USE OF AUA IN ISOLATION NOT THE TOTAL PACKAGE OF RULES.
#4 The cost of transferring or selling an asset is not linked to the value of an asset
The FCA have made it clearer that the do not consider AUA as an accurate way of determining cost of wind-up, but simply a proxy that enables a best attempt at getting to the right sort of value without being too complex.
In other words, if you look at it logically asset by asset it might not work, but if you look at the big picture then they think it does. So in theory it will be way out for an operator holding only cash, but in practice that doesn’t happen. You could argue that using number of SIPPs introduces related issues (transferring a pooled cash account is not linked to number of SIPPs etc).
#1 Capital is not there just when it is needed
This issue is dealt with in part by using an average of the AUA over the last four quarters. This simply delays the effect though and I doubt a year is enough time for all skeletons to come out of the closet. In other words, if there is a failure of an investment which is held by a high number of SIPP investors at one SIPP provider, the capital requirement will fall away within 12 months and I suspect if the SIPP provider is to fail, it will do so later than that.
#5 Divergence from cost of wind-down as regime beds in
I had to remind myself about this one! Which perhaps also explains why it looks to have been ignored. The point is that if FCA have got the final rules right, in that the capital requirement is in the right ballpark of wind-down costs for any given SIPP provider, then roll it forward ten years and costs may have gone up with inflation, but the capital requirement by some other amount linked to market returns. So the capital requirement will drift away from the ball park as the two sides of the equation (wind up costs v capital requirement) are based on different amounts.
Another way of thinking about it, if you are scientific, is that the unit of the left side of the equation (wind up costs) is Pound Sterling, whereas the unit of the right hand side of the equation (capital requirement expressed as ICR + CS) has square root of Pound Sterling. Which to me is still a worrying sign. It’s like saying 1 metre plus 2 metres = 1.5 metres squared. It doesn’t make sense.
#3 Uncontrollable calls for capital lead to non-robust business models
This is dealt with by using an averaging approach to working out AUA – something AMPS suggested in the early stages of the consultation process. Averaging deals with this issue slightly (and the potential cliff edge situation that the final rules introduce, when you breach £100m in AUA and then £200m in AUA). But averaging also is a bit more of a pain to deal with. In reality, a prudent business would plan for such fluctuations.
#2 Release of capital to SIPP operator despite no change in risk of consumer harm
This unintended consequence is essentially the same effect as the above, but from consumer’s point of view. Averaging deals with this sufficiently well and I am sure FCA would not look that favourably if the capital requirement is operated like a bank account with money going in and out.
#11 Selecting the valuation date for AUA
The FCA response suggests, in para 2.15, that most recent valuations should be used and for assets not valued very often, such as commercial property, the value should be updated by a relevant index. So this practical issue has been addressed, albeit not very elegantly. Personally I think agreeing an average value per SIPP every year and then working out AUA by multiplying that average by in force SIPPs gets you to the same ballpark a lot more elegantly.
#6 Large number of small plans vs small number of large plans
The FCA highlight in para 2.15 that “there are currently firms administering a similar level of pension assets, with one firm reporting a capital requirement ten times smaller than a comparable firm”. This head scratcher was designed to illustrate that firms with similar levels of AUA may indeed face different running costs, though I assume the example given by FCA is an exceptional case which is designed to lend support to the AUA model as it would bring the two firms closer in their capital requirement.
So this oddity remains, with the FCA suggesting that this is intentional. Perhaps, being fair, in reality firms are not that divergent in make up and so you won’t get the extremes possibly when looking at it academically.
#10 The simple formula may not be so simple to verify
This remains an issue and I did not see that it was commented upon – how easy will it be for FCA to verify that AUA has been declared correctly? I suppose they are satisfied that returns from different firms will better reflect what they expect than under the current system.
#12 Monitoring assets held within portfolios
This also remains an issue, though FCA have commented on it. FCA have confirmed that SIPP providers will have to “look through” DFMs to see what is held in the underlying portfolio and if there are any Non Standard Assets held within a DFM portfolio for a SIPP plan, then that SIPP plan will be flagged up as a SIPP with NSA. The slight easement is that this check for any NSA doesn’t have to be done continuously, but just at every quarter-end. This is quite an admin burden, and will probably lead to more of the remaining SIPP providers looking for DFMs to sign up to “global” terms and provide data feeds.
#7 Misalignment of interests between SIPP operators and consumers regarding asset valuations
The FCA sent a clear message that they would be “concerned if operators were to take different valuations for the purposes of capital requirements and scheme members.” That’s fine, but doesn’t really address the issue that, for example, there could be a range of valuations for a commercial property but I suppose, if the valuation is only being used for capital requirements and benefit statements, rather than payment of benefits, then the issue can be swept away.
#9 Capital Requirement will be lower at times where there is a higher risk of consumer harm
This issue remains: when markets are down, AUA will be lower. At at really troublesome times, such as when there was the credit crunch, valuations could be severely down and there is greater risk that firms will need to access their capital rather than leave it as a margin for when (if) AUA come back to originally levels. This would not be an issue if the metric was number of SIPPs.
#8 Misalignment with SIPP operator charging structures
This doesn’t seem to be a concern to the FCA. Although there is a misalignment, in reality I doubt charging structures will change substantially given the watering down of the rules. Had Commercial Property remained a Non Standard Asset, I could see fee structure changing.