In many ways the Sipp market has become a victim of its own success. Considered a niche market in 2007 when the FSA first regulated Sipps and opened up the doors for companies other than banks, building societies, unit trust and insurance companies to become Sipp providers, the market has since burgeoned with around 110 companies currently offering a Sipp facility of one kind or another.
Some critics say this rapid growth has caught the regulator on the hop as the FSA did not expect the upsurge in investor interest in Sipps as an alternative to the personal pensions offered by insurers. In truth, the growth in the number of Sipps sold on an annual basis has been impressive – from 37,000 in the year to March 2008 to over 188,000 in the year to March 2011, according to FSA product sales data. Sipp specialist Suffolk Life calculates that the total number of Sipps in existence in the UK is now close to one million. The market now encompasses everything from 'simple' or 'packaged' Sipps, developed as a low cost option offering a range of insured funds and quoted securities and usually running on a single platform, to 'full' Sipps, bespoke products that allow direct access to a wide range of investments including commercial property, unlisted shares, gold bullion, UCIS (unregulated collective investment schemes) and so on.
Significantly, FSA data at the end of 2011 showed that sales of Sipps outnumbered sales of personal pensions, clearly making Sipps a mainstream product. With such rapid growth in the number of providers and the take up of the products in such a relatively short space of time, the market has become highly competitive. This has resulted in lower margins for providers and tactics such as discounted pricing to boost assets under administration as well as Sipps accepting unregulated products that have subsequently failed, resulting in negative press for the market.
In consequence, not only has the FSA spotlight been turned on the Sipp market but there have also been calls from within the industry – such as from John Moret of MoretoSipps and A J Bell – for an overhaul of the market. Providers expect this increased scrutiny and regulatory pressure, combined with the changes arising from the implementation of the Retail Distribution Review (RDR), will see a major shake-up of the market over the next couple of years.
The primary driver of the expected shake-up is likely to be the FSA's concerns around the capital adequacy of Sipp providers. Currently, providers must hold sufficient money in the bank to meet at least six weeks of audited administration costs to keep running their Sipps in the event of the firm's failure. During that time it is expected that the firm will be run down and a new provider be found to administer the assets. However, the FSA has said that the inflow of unregulated and esoteric funds into Sipps (the FSA has suggested some 45 per cent of UCIS are sold via Sipps) as well as "evidence of poor systems and controls" in the selection of small Sipp providers it visited in 2011, will add to calls for increased capital adequacy requirements for Sipp providers, with a consultancy paper to be issued later in 2012.
Martin Tilley, director of Technical Services at Dentons, described the current situation as "the calm before the storm." He said: "The industry is holding its breath. We all know the market is going to change but what we don't know is exactly when the FSA consultation paper will be issued or when the rules arising from the paper will become effective."
FSA pensions and investment policy manager Milton Cartwright told delegates at the Henry Stewart Pensions conference in November 2011 that the nearest comparison it had found to Sipp providers was defined contribution occupational schemes, which have capital adequacy requirements of 18 months to two years. Mr Cartwright added that it was unlikely Sipp levels would be that high, nevertheless, for some providers any dramatic increase from current requirements could be business critical.
Mr Tilley believes the greater difficulties of winding up a firm with a high proportion of illiquid or unregulated investments – such as commercial property and UCIS - may see the FSA introduce tiered capital adequacy requirements. "If providers are accepting a greater number of esoteric assets in their Sipps we may see the FSA levy a higher capital adequacy requirement on those particular companies," he said. "But the FSA can't expect Sipp providers to jump from one level of requirement to another overnight, so it is likely to be a staged implementation."
Steve Latto, head of pensions at Alliance Trust Savings, agreed that any radical change would need to be phased in over a period of time. "Nevertheless, Sipp providers that know they cannot achieve the higher levels or are without sufficient critical mass in their business, may well be looking for an exit route as a result," he said. "It is clear that financial stability and the track record of the Sipp company is going to be crucial now for Financial Planners looking where to place their client's Sipp business," Mr Tilley added.
The issues around unregulated investments, brought into sharp relief by recent fund failures, will add further pressure on companies to review their position in the market. There have been several calls of late for the FSA to conduct investigations into providers' due diligence processes, not least because there is a grey area with regard to just where the responsibility lies in this respect. Sipp providers say the responsibility for ensuring the product is suitable for the client lies with the Financial Planner, since only they can say what is appropriate given the client's risk profile and total investments. The counter argument is that the Sipp provider should have responsibility for ensuring the product is a legitimate investment beyond what is allowable from an HMRC perspective. At the same time, the opportunity to take advantage of investments in alternative areas is one reason Financial Planners are turning to full Sipps in current markets.
Rowanmoor Pensions is a relative newcomer to the Sipp market, having launched its product in May 2009, and has pitched itself firmly in the bespoke Sipp space, which includes the use of unregulated and esoteric investments. A highly experienced SSAS provider, the group had been requested by its clients to launch a Sipp but a management buy-out at the company imposed a regulatory moratorium on the launch, explained head of pensions Robert Graves.
A full Sipp provider has to have rigorous due diligence processes in place, Mr Graves said. "We sit as co-trustee with Sipp clients, so for any asset coming on board we need to fully understand what it is, how it provides yields or how gains will be achieved, that we can get a good title to the asset, who are the auditors and fund managers, and so on.
"We look to ensure, through our research, that the investment is legitimate, and the Financial Planner will ensure it is suitable for the particular client. With these provisions in place there is no reason why these types of investments cannot be used safely in a Sipp."
A further concern of the FSA has been around the transparency of Sipps and, in particular, the disclosure of payments Sipp providers receive, including commissions and bank interest. In May 2012 the regulator issued revised proposals to force disclosure of all such payments received by Sipp operators, as well as for providers to publish more detailed information, including key features illustrations, tables showing the effect of charges, and reduction in yield information, so consumers can make more effective cost comparisons.
This could see companies that have been deriving a significant part of their revenue from a range of unpublished payments, placed at a disadvantage compared to providers that have transparent, straightforward, and more sustainable, revenue streams, suggested Mr Tilley. He said: "The FSA consultancy document was quite clear that Sipps should have clear and explicit fees and if there is any other remuneration it has to be highlighted, so that Financial Planners and their clients have the full facts and can make an informed choice."
He added: "We are a firm advocate of such transparent pricing and costs. And we believe just how Sipp providers derive their revenue is going to influence where Financial Planners place their business in future."
Mr Latto added that transparent, pricing would be essential for any provider that wanted to stay in the market but it also had to be sustainable. "We differentiate our proposition by having a dealing charge for both funds and shares. Whatever percentage rebate or commission is received from the fund manager is then paid into the client's Sipp. This fixed fee charge can be highly attractive particularly for high net worth clients who may be used to paying away a percentage of their assets each year. If, under RDR, the FSA bans rebates and introduces different levels of share class, the client will simply pay a lower AMC. The point is it makes no difference to us, as our business model is not reliant on rebates for its revenue."
Mr Tilley highlights another aspect to the transparency issue, namely providers that force Financial Planners to do business through a panel of third party suppliers. "For example, Financial Planners investing in commercial property can find they are forced to use solicitors, valuers, or insurance lenders from the Sipp provider's panel, because historically that is a way Sipp providers have made additional money off the product. "We believe the client should be able to choose who they want to use as professional advisers to the Sipp so they can negotiate their own deal with them."
Chris Jones, proposition and marketing director at Suffolk Life, is of the opinion that the regulatory and business pressures which are building will culminate in the long talked about consolidation in the Sipp market. He said: "There is a range of forces at work that we believe will mean the current number of providers will no longer be sustainable. The figures we have collated show that the bulk of new business over the past four years has been going into simple and mid range Sipps; growth in 'full' Sipps has been relatively slight. Most of the smaller players will be in that bespoke, full Sipp market. Likewise, pressure from increased due diligence and regulation around unregulated investments, as well as increased disclosure and forced changes to published information, is all adding cost into the business. The last straw for some sections of the market will be increased capital adequacy requirements."
Mr Latto concluded: "The regulatory burden, of which capital adequacy is a part, may be the trigger for consolidation. In particular, smaller players may decide it is not a market they can play in any more because they can't make the same return they have made historically because of the associated costs of doing business.
"Firms need to be one step ahead of the regulator if they want to stay in business. It will be the costs of undertaking the changes overall, rather than the individual changes themselves that will build pressure on firms to leave the market."
Clearly, Financial Planners are looking to align their business with Sipp players that are in the market for the long haul, but there are some telling questions to be asked both of their current and potentially future providers.
Chris Jones, proposition and marketing director at Suffolk Life, is of the opinion that the regulatory and business pressures which are building will culminate in the long talked about consolidation in the Sipp market. He said: "There is a range of forces at work that we believe will mean the current number of providers will no longer be sustainable. The figures we have collated show that the bulk of new business over the past four years has been going into simple and mid range Sipps; growth in 'full' Sipps has been relatively slight. Most of the smaller players will be in that bespoke, full Sipp market. Likewise, pressure from increased due diligence and regulation around unregulated investments, as well as increased disclosure and forced changes to published information, is all adding cost into the business. The last straw for some sections of the market will be increased capital adequacy requirements."
Mr Latto concluded: "The regulatory burden, of which capital adequacy is a part, may be the trigger for consolidation. In particular, smaller players may decide it is not a market they can play in any more because they can't make the same return they have made historically because of the associated costs of doing business.
"Firms need to be one step ahead of the regulator if they want to stay in business. It will be the costs of undertaking the changes overall, rather than the individual changes themselves that will build pressure on firms to leave the market."
Clearly, Financial Planners are looking to align their business with Sipp players that are in the market for the long haul, but there are some telling questions to be asked both of their current and potentially future providers.