In response to findings that large life offices refuse to reveal rule change readiness, Suffolk Life’s Greg Kingston reveals that the situation for many could be far worse should the FCA decide to adopt a more practical solution later this year
The FCA’s capital adequacy paper, CP12/33, proposed that Sipp operators dramatically increase their capital reserves to ensure greater consumer safety should their business fail. Their reasoning and formula to calculate capital levels was based upon ‘non-standard assets’ – the riskier and more illiquid asset types – presenting a greater risk to both business and consumer.
That view is correct however, the method of calculating capital requirements is flawed and may not provide sufficient as the regulator originally intended. That’s because the calculation is based upon the value of the assets rather than the number of the assets, and there’s a significant difference in the outcome.
As an example, Firm A has a single £1m non-standard asset and reserves capital based on this value. Should Firm A fail, there’s hopefully enough capital to ensure that the asset is transferred over to another provider.
Firm B also has £1m of non-standard assets, but this total is in fact made up of 20 x £50,000 assets. Although Firm B also has to reserve exactly the same amount of capital as Firm A, they need to conduct 19 additional transfers in order to wind down the business. That’s a significant increase in the amount of work and resources required, and it is questionable whether there would be sufficient capital.
The FCA believes that some parts of the Sipp market have taken on high levels of relatively low value Sipps, often invested largely in esoteric (and therefore non-standard) assets. The most recent Money Management survey supports this view, with a number of surprisingly low average fund sizes in some Sipp operators. At the point of writing the FCA has delivered a telling example of this – their action taken against 1 Stop Financial Services shows an average Sipp investment size of just over £50,000 per investor.
The FCA proposal as originally written solves the problem for Firm A. But clearly that isn’t representative of the problem part of the market that they’re trying to fix. That part of the market is far closer to Firm B, with higher numbers of smaller value assets.
The possible outcome from this is that the better firms increase their capital reserves as required, an action that has been recognised as likely to lead to increased costs over time. However, the firms with high volumes of smaller non-standard assets, should they also manage to increase their capital, may still have insufficient reserves should they fail.
Capital reserves are not an exercise in flag waving or demonstrating how deep a business’ pockets may be. They’re there to ensure an orderly wind down of the business and to safeguard the transfer of consumers’ assets to another provider. Unfortunately it is expected that the new capital regime will be tested in the future, and for consumers’ sake it must not be found wanting.
