Q&A: Greg Kingston on SIPP due diligence

Suffolk Life’s head of marketing discusses with Retirement Planner the FSA’s focus on SIPP due diligence

The FSA has criticised many SIPP providers’ due diligence processes when it comes high-risk investments. What processes should providers put in place?

The first step should be having a clearly documented process. Without this, it would be impossible to operate defined controls. These higher risk investments are normally the esoteric ones, the traditional domain of bespoke SIPP providers. Their first check is likely to be whether the investment is permitted under HMRC rules, and then if they as a provider can accept it. Some providers have experience of a wide range of these types of investments.

They have already put their own restrictions in place to ensure certain investments that could pose a risk to their business or to the investor are not accepted.

These investments would be ones that may be classed as taxable property or are not sufficiently liquid to be realised to meet certain events, such as crystallisation or death. Not having these controls is what has attracted the attention of the FSA. Its subsequent investigations may have found that the failings of controls are not just related to the administration of unregulated collective investment schemes (UCIS).

What are the ramifications if sufficient guidelines are not put in place? Are we likely to see a large hike in capital adequacy requirements, for instance?

Quite what the future intention is regarding capital adequacy requirements for SIPP providers isn’t as clear as it once was. The FSA’s pensions manager Milton Cartwright has made it clear that six weeks is inadequate, but that a move to mirror DC occupational schemes, where the requirement was stated at 18 to 24 months is unlikely.

The regulator will make a decision during 2012 following consultation, and there’s little doubt that for some there will be some nervous months waiting. Margins at some providers are already thin.

What impact could a move towards higher capital adequacy requirements have on the SIPP market?

Before the conclusions of CP11/03 were delayed in favour of further consultation, one could point to the impact of the impending investment that many of the smaller SIPP providers would need to take. That action and the subsequent associated costs are still on the horizon. Introducing greater capital adequacy requirements could have precisely the same effect. A move from six weeks to 13 weeks was already planned by 2013, but does the regulator now have more in mind and sooner?

If so, there will be a requirement by some to raise capital and in this environment, that is neither easy nor cheap.

The fallout is likely to be an acceleration of the consolidation that started in 2011, and may well even result in some providers withdrawing from the market.

There has been a lot of talk of SIPP provider consolidation. But some sales have been put off due to high asking prices. Are we likely to see prices coming down as providers struggle to attract buyers?

It isn’t as simple as prices dropping. The SIPP market is still growing and there are several robust companies with healthy balance sheets or strong financial parents. Equally, there are smaller independent firms. There is no doubt now that some are interested in testing the market. The cost of operating SIPPs is increasing, the regulatory overhead is increasing and at the bespoke end, growth is stagnating.

Coupled with this are concerns over the additional capital likely to be required and the potentially significant unknown liabilities that may lie in the administration of UCIS and other investments.

There are several ways to calculate the value of a business. One simple method is the price that the buyer is prepared to pay. At the moment, that seems to be balanced relatively evenly with the value that the business appears to hold based on its balance sheet and the book of business is operates.

The growing unease over the liabilities that may lurk in some books, along with the recent FSA investigation seemingly finding that some books did not even know if investments existed or not, will inevitably tip the balance in favour of the buyers. That is, of course, if the buyers by that point have not been put off.

The past year has seen three relatively high-profile providers on the market for investment or for sale, and at the time of writing none of them completed. An adviser will always ask several questions when they choose a SIPP provider for their client. The question as to whether that SIPP provider has sufficient financial strength and the controls to match is increasingly likely to be the first in 2012.