The FCA has published a very scary note intended for advisers recommending transfers from Defined Benefit schemes .
In its statement published on Tuesday, the FCA revealed further failings in the pension transfer advice market, the regulator said some advisors had not met its expectations over the “critical yield”, a test used by advisers to pinpoint the investment returns needed to match the benefits offered by the existing scheme.
The regulator said some advisers had been recommending pension transfers solely on whether or not the critical yield was below a certain rate set by the firm for assessing transfers generally.
“This does not meet our expectations, we would expect the firm to consider the likely expected returns of the assets in which the client’s funds will be invested relative to the critical yield.”
The Regulator goes on to demand that the receiving product is suitable to the investor.
This is scary stuff. It is only a short step away from making the advisor accountable for the outcome of the investment.
It becomes incumbent on any adviser to know the destination of the transfer payment.
It releases the trustee from the responsibility for ensuring the money is going to a sham investment where the investor will be scammed.
It effectively transfers the fiduciary responsibility for the transfer from the trustees to the adviser who- as I read things- has a stake in what happens next, if only on the liability side.
As my friend and fellow blogger Abraham is pointing out, managing drawdown to achieve a critical yield as low as some of the discount rates used for CETVs is no cinch http://tinyurl.com/zzvfdvp .
Whether you use a natural yield, total return or just rely on a 4% rule of thumb, any drawdown strategy is running the risk of what is called a black swan event. Take for example a cancellation of units at a point when the price swung against you for 500 bps for liquidity reasons or a trade executed at a point of market panic. It is not possible to predict or insure against such possibilities using unit-linked funds.
So advisers are going to be very wary about being accountable for the outcomes of the plans into which moneys are transferred.
They cannot – if they are referring to this FCA paper – simply ignore the destination, even if they are no party to it. They must do due diligence not just on the critical yield but the vehicle used to manage the investment. Cash is a no-no in terms of a critical yield, but so will many ultra safe bond strategies. Indeed the ruling suggests, what we already know, that to achieve the critical yield, the investor will have to take additional risk.
What is not clear is whether a declaration from the investor that he or she understands the risks of the drawdown product, is a proper protection for the adviser.
Linking the adviser’s reccomendation to the product used to manage the transfer is a scary thing for advisers. It may mean that the high cost wealth managment vehicles often employed are simply too “risky” in terms of yield drag, to be fit for purpose.
I suspect that IFAs will find it harder to reccomend transfers into vertically integrated SIPPS with proprietary investment strategies and easier to reccomend simple products with low transparent costs.
While the FCA paper has been taken as a means to protect transferees from scammers, I suspect it is as much a means to protect IFAs from an over-exuberant confidence in their financial invincibility.
I think, Henry, this is a misreading of yesterday’s FCA’s release which is intended to be a reminder of, not a change to, the existing COBS rules on transfers. It’s great to see how you foster cross-fertilisation of ideas between different fields in pensions so in that spirit may I try to clarify the position from the point of view of a firm that advises on transfers.
There has always been a requirement that the advice takes into account reasonable expectations of the returns and risks of the receiving scheme’s investment strategy. But bear in mind that the transfer adviser is not necessarily going to be the manager of the receiving scheme’s strategy and indeed the member may plan to self manage. There is even recognition in the case of a QROPS that the receiving scheme is foreign and therefore requires a local adviser to complement the UK transfer specialist. So there cannot be a requirement to take responsibility for the performance of the receiving scheme strategy (unless perhaps because the adviser and manager are the same). The key implication for compliance is that in every case the adviser must spell out the dependencies that affect outcomes, discuss the planned strategy and give clear warning if there are concerns about the risk of the new strategy being either too high for the client’s apparent risk tolerance (there is no relaxation of the KYC requirements) or too low to achieve the required returns that would rationalise the transfer. Similar requirements to take costs into account apply. The FCA says it has observed that these existing requirements in respect of the receiving scheme are not always being met.
My opinion is that the intentions of the rules in their entirety override the narrow (and outdated) requirement to calculate the critical yield, which only forms part of the content of a compliant report. It is always going to be impossible to justify a transfer close to retirement if the critical yield has to be exceeded as there is insufficient time for the risky returns to compound. Besides, it makes no sense in most cases to transfer if you plan to buy an annuity. The critical yield made sense only when there was a requirement to annuitise at 75. The fact is the COBS rules need to be altered to cater for drawdown and other aspects of pension freedoms. The FCA has conceded as much. It is already two years since pension freedoms served notice of the need for change. But this release is not the change.
Hi Henry
I agree with Stuart’s interpretation of the FCA newsletter, which to me clarified a lot of what was previously already in place. I found it a helpful article rather than one which drove fear into my heart. The critical yield is not the main driver in most transfers, as if an annuity is what they want then few clients other than specific cases would be advised to transfer away from defined benefits.
I had already decided that TVAS reports were flawed and compared against drawdown as well, then matched the required return against the investor’s risk experience and profile to judge whether the asset mix would deliver in normal conditions.
What this highlighted for me is the need to qualify the member’s understanding of risk, and judge whether they are likely to plead ignorance in the future. I deal a lot with investment directors and can trust them to manage the investments carefully, where a high Critical Yield was involved and I partially manage the investments I have insisted on being notified of all other investment decisions. Where there are substantial non pension assets as well I see little risk in this type of business.
Having had a long chat with the FCA previously I decided to apply my own commonsense rules rather than wait for guidance, At the end of the day as the PTS I am answerable directly to the Regulator so it is up to me to interpret COBS in a practical way.
The problem is now with the part of the market that thinks about these things, but the part that doesn’t! I suspect that the last people the FCA are worried about are Geoff, Brian and Stuart!
But we know that the market takes the critical yield as the hurdle, that there is very little prudence built into assumptions around the charges of the inheriting plans and – for those who are offsetting transfer fees by SIPP revenues, an obvious bias to talk up the product.
We see this in our correspondence and meetings with advisers and in the work that we do for trustees in ensuring that member’s interests are protected. We would argue that – in practice – this is not a clean market and that the FCA need to place a fiduciary obligation on advisers involved in managing the drawdown outcomes. As for those who simply execute advice – there is still an obligation to ensure that they are not just unlocking the door for rascals to scam.
Whether this is within the COBS handbook or whether the handbook needs to be rewritten, this is a shot across the bows and will be welcomed by trustees who see little accountability for what goes on after the money has left them.