John Moret discusses how differing compensation arrangements could affect the SIPP market
Like so many other parts of the financial services industry the SIPP marketplace is likely to be changed permanently as a result of the aftermath of the extraordinary events of the last few months. For advisers and their clients the regulatory framework and compensation arrangements governing their SIPP portfolios has suddenly become a key consideration - and I would argue not before time.
Until 2007 the regulatory framework governing SIPPs was a hotchpotch of various legal structures and differing interpretations of the impact of FSA regulation on these legal structures. This was a consequence of the way the SIPP market had evolved since it was conceived in 1989.
Many SIPPs had emerged from consultancies and practices that dealt with SSASs that were invariably trust based - albeit that there were differing approaches to trusteeship. The provider of these SIPPs was often a tame bank or building society as prior to 2007 there were a limited number of organisations that could act as provider. Some SIPPs emerged from the life company stable in which case even if the scheme were trust based the life company was likely to act as provider.
However, even in this situation there was scope for different legal structures with some SIPPs established as life company contracts - often referred to as 'private funds' - whereas other life company SIPPs were established under trust.
Level playing field
Following the introduction of the regulation of the establishment and operation of personal pension schemes - including SIPPs - in April 2007 there has been an assumption that there has been a level playing field as far as regulation of SIPPs and investor protection is concerned. This is incorrect.
Insurance based specialist SIPP operators are likely to have a much greater financial resources requirement - partly as a result of the FSA's individual capital adequacy provisions - as compared with trust based SIPP operators. For the latter the capital requirement will usually be 13 weeks expenditure although it is possible to reduce this to six weeks expenditure on agreement with the FSA that the operator is not holding client money. Consequently there are different tiers of capital adequacy depending upon the legal and regulatory framework adopted by the SIPP operator.
However, not only will the solvency levels be different but more importantly, life assurance based SIPPs will usually offer a higher level of investor protection. The compensation arrangements for life assurance investment contracts under the Financial Services Compensation Scheme will usually provide protection of at least 90% of the fund value with no upper limit whereas for trust based schemes any compensation will be limited to a maximum of £48,000.
This is a simplification however as the above interpretation applies where the provider or operator fails. However, SIPPs invariably use a default bank for operational reasons. Were a bank or investment provider to fail then the starting point for compensation arrangements is the regulatory arrangements that govern that bank or investment provider. This is the situation that has arisen with some SIPPs that held offshore bank or investment accounts. In some situations - which recent developments have shown may not be as extreme as was thought - the failure of a bank or investment provider could lead to the provider, operator or trustee failing in which case the regulatory framework governing that organisation will influence the compensation arrangements that apply.
This is an extraordinarily complex area for advisers. At Suffolk Life we operate both 'private fund' SIPPs and trust based SIPPs. Partly as a result of this we took the step of getting advice on the compensation arrangements that would apply to our schemes. A summary of our understanding from this was put up on our website www.suffolklife.co.uk early in October to help and provide some explanation of this issue to advisers who had clients invested in one of our SIPPs. Advisers with clients with other SIPP providers might wish to consider asking those SIPP providers for a similar interpretation.
In responding to the DWP consultation paper on self investment of protected rights we said that we felt it was entirely reasonable to require a higher level of investor protection for protected rights given that the source of those rights is either partially or totally a rebate as a result of contracting out of the State Second Pension. We went on to say that we believed it was also reasonable for any SIPP operator prepared to accept protected rights funds to be required to have a capital requirement in respect of those funds at the same level as that expected of life assurers and to pay comparable fees to the FSA. That suggestion was ignored.
The lack of a level playing field for SIPP operators is an issue that often escapes advisers and which is of growing importance as compensation arrangements come under increasing scrutiny. Linked to this point is the approach that the operator takes to cash and investment reconciliations. This is a potential regulatory minefield with complex regulations which are also affected by the regulatory framework adopted by the SIPP operator. The detail is outside the scope of this article but in the current climate reliance on third parties such as investment managers for accounting and reporting on investments introduces an added degree of risk for the SIPP operator, the significance of which will grow as business volumes grow.
More often than not it is the lack of reconciled cash and investments that lead to the very unsatisfactory delays in processing transfer requests between SIPP providers - particularly where the transfer is in-specie. Our experience shows that the average time for completing such a transfer is around 200 working days which surely falls some way short of meeting several of the FSA's six consumer TCF outcomes. I suspect we'll hear more about this in due course.
Finally a closing thought. Suppose that a SIPP provider or operator decides at some point in the future that they wish to or are forced to withdraw from the market because, for example, of administrative shortcomings. Most SIPP scheme rules will allow the SIPP provider or operator to enforce a block transfer in such circumstances. However, what happens if there is no provider willing to take on that book of business? As we know SIPPs are long term investments - but only if there is a provider to back them and a scheme administrator to operate them. Food for thought!
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