Articles - Unquoted Damage

The law of unintended consequences strikes. One of the most-talked-about changes to the SIPP industry for many years took effect on 1 September – the changes to the rules on capital reserves for SIPP operators.There has been a spate of takeovers since their announcement and at least two companies have gone into administration, although it is difficult to say to what extent the demand for higher reserves contributed to these situations.

 By Andy Leggett, Associate & Head of SIPP Business Development Barnett Waddingham
 We are fortunate to be backed by the financial strength of Barnett Waddingham, the UK’s largest independent firm of actuaries and consultants. However, there are some effects of this new regime which fall directly on SIPP members.
 The rules are not optional so if you are invested in unquoted shares, please do not bury your head in the sand.
 A quick reminder
 It is nearly four years since change was first mooted so here is a quick re-cap – in plain English rather than exhaustive (and exhausting) technical detail. The Financial Conduct Authority has introduced a new formula for calculating how much capital SIPP operators must keep in reserve. It is based on the value of assets the SIPP operator has under administration (AUA) and the number of SIPPs that are invested in any part in assets it classifies as ‘non-standard’.
 The formula includes a square root function which has the effect, other things being equal, of increasing reserve requirements more slowly than asset growth. The presence of non-standard assets in a SIPP demands significant extra capital. Before 1 September 2016, the calculation of the minimum capital needed was based on a SIPP operator’s expenses and was equivalent to either 6 or 13 weeks’ expenses. (We should also note that some providers were, and will continue to be, covered by a completely separate regime.)
 Collateral damage
 The use of the value of AUA was a ‘proxy’ in the regulator’s words. However, because the formula for determining the amount of capital reserves is based on AUA and is regularly updated, we are now told that all individual assets have to be valued at least once every year. That is inconsequential when dealing with listed investments (except in relatively rare instances such as, say, property funds being closed). However, it is a problem when dealing with investments such as commercial property and unquoted shares.
 It wasn’t a problem in the past. Generally, such assets only needed to be formally and independently re-valued at a critical juncture like taking benefits. At other times, such expense would generally have served little purpose for the member.
 At times when they are not being sold, the value of a commercial property or unquoted shares inevitably involves a degree of opinion. For property, desktop valuations and limited use of indexing are possible, reducing the impact (besides which, there are other reasons to update valuations periodically such as to make sure properties are adequately insured).
 But, in the case of unquoted shares, that opinion – in the form of an independent valuation – will inevitably be an expensive business, coming as a result of trained accountants pouring over accounts.
 In the case of unquoted shares, opinion – in the form of an independent valuation – will inevitably be an expensive business, coming as a result of trained accountants pouring over accounts.
 Ways out
 The rules are not optional so if you are invested in unquoted shares, please do not bury your head in the sand. By getting involved you can reduce expense significantly through simple, practical means.
 Investors can cut out the considerable expense associated with an outside accountant getting to ‘know’ the company by getting the valuation from the company’s auditors, who already know the company. They will be able to eliminate further costs associated with identifying an appropriate valuation basis as this will already be established.
 Given the increased cost of holding this asset class, it is worth asking yourself if you still want to hold the shares or whether this is a good point to sell. If you are still committed to the investment – or if you are left in two minds – another option is to buy it from your pension to avoid this cost in future years. You should note, however, that HMRC rules mean a current valuation is needed and that the tax treatment of the holding will change outside a pension. As ever, we would recommend speaking to your financial adviser.
 Our view
 We tried to explain the flaws we perceived in the new regime in response to the regulator’s consultation, both through our industry body (chaired by Barnett Waddingham partner Andrew Roberts at the time) and directly. In regard to unquoted shares, this measure surely fails any cost-benefit analysis: they make up a tiny percentage of AUA and then the capital adequacy formula square roots the valuation, rendering its accuracy all but invisible.
 Hand-wringing does not help here and now. While there is no Barnett Waddingham minimum investment, investors’ judgement of the implied minimum investment in unquoted shares, given the extra costs, has inevitably increased. A rare investment just became rarer still.

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