A quick look at my dictionary for a definition of esoteric confirms it means “intended for or likely to be understood by only a small number of people with a specialised knowledge or interest”.
So, if this particular group of investments is only intended for a few people with a particular understanding or interest in them, why are they attracting so much attention?
The principal reason is the FSA’s concern at the proliferation of esoteric investments in the books of some SIPP providers. This was sparked by the failure of a couple of providers where holdings of esoteric investments were reported to have contributed to the problems at both firms.
As a result of these problems, the concern is that the holding of a significant number of esoteric investments within a SIPP book increases the risk of the provider facing difficulties. It also potentially increase the time needed to resolve client problems if a provider fails.
So how might the FSA deal with esoteric investments?
At a recent industry conference, Milton Cartwright of the FSA was quoted as saying that one option under consideration is an increase in the regulatory capital requirement of SIPP providers.
SIPP providers must hold a minimum of 6 weeks of expenditure as regulatory capital. This capital is seen as the buffer which should be sufficient to allow a regulated firm to go through an orderly wind up process. The problem is that this capital adequacy requirement may not prove to be sufficient where a firm holds a significant book of esoteric investments. History has shown that a significant issue in the wind up process is likely where other SIPP operators are not willing to take on the administration of SIPPs containing investments where problems have already arisen.
A capital adequacy requirement of up to 2 years’ expenditure has been suggested as a possibility. At that level, the capital requirement is likely to help smooth out the wind up process. However it will also act as a major disincentive to SIPP operators from holding any investment which might be classed as an esoteric investment. It may also cause some of the SIPP operators with a significant number of esoteric investments to question whether they can remain in the market. We may eventually be left between a rock and a hard place, where assets cannot be transferred to a new SIPP operator because none are willing to accept them, but also cannot be liquidated.
So, are there other options?
Those of you who were advising on SIPPs before 2006 will remember the various incarnations of the SIPP permitted and prohibited investment lists managed by HMRC.
From A-Day, HMRC chose to scrap the lists. HMRC instead decided to restrict investment by introducing the concept of “taxable property”. This enabled HMRC to manage the investment of pension schemes in particular areas, by imposing penal tax charges for holding particular investment classes.
The highest profile victim of this legislation was residential property. In the run-up to A-Day the press was awash with “put your home in your SIPP” articles. The Government saw problems with this and acted to make it unfeasible to hold residential property in a pension in all bar very limited circumstances. Other investments - works of art, antiques etc - were effectively banned at the same time by the imposition of tax charges on tangible moveable property.
The Government put these bans in place as it was concerned that individuals would look to exploit the tax reliefs available from the post A-Day pension framework to shelter valuable assets from tax.
Considering the Government was keen to ban certain investments to protect itself from loss of tax revenue, it is disappointing that there is such reluctance to take a similar approach to protect SIPP clients from the risks associated with holding some esoteric investments.
The question “What do you ban?” is not an easy one to answer. However a similar question will need to be asked if capital adequacy is used to discourage SIPP operators from allowing esoteric investments i.e. what investments will lead to an increase in capital requirements?
Restricting the investments which SIPPs can hold may not be popular with all across the industry but it will be easy to implement and will have the desired effect. If it protects investors from losses resulting from esoteric investments, and reduces the problems which increased capital adequacy will create for some SIPP operators then it must be considered as a positive for consumers and the market.
Gareth James
Technical Marketing Manager
A J Bell