The FCA has consulted on imposing two new requirements on providers of non-workplace pension schemes:

• the requirement to offer a "default" investment option to new non-advised customers; and
• a requirement to issue warnings to members holding more than 25% of their fund in cash for a sustained period, warning the member of the risk of the value of the fund being eroded by inflation.

Default investment option for new non-advised customers: more detail

The FCA's data suggests that an increasing proportion of new non-workplace pension (NWP) business is non-advised.  The FCA is concerned that many non-advised customers are at risk of poor outcomes because they lack the skills to choose appropriate pension investments.  This may lead to them choosing investments that are not appropriately diversified, inappropriately high risk, or low risk but with low potential for growth.  The FCA notes that in the workplace pension market, these risks are mitigated by having a default arrangement. 

Default investment strategy: the key proposal 

The FCA is proposing to require firms to offer non-advised customers a default investment strategy.  This would be similar to the requirement for automatic enrolment schemes to have a default investment option.  However, a key difference is that NWP members would not be defaulted into the default investment option if they make no choice, but only if they accept the offer of the default option, either at the point of joining the scheme or in subsequent decisions about their investment.  Firms would be required to present the default option "in an appropriately prominent way" when the member first joins the NWP scheme and at other times when the member is choosing investments.  Unlike with drawdown investment pathways, there would have to be a single default option compatible with the needs of the firm's typical non-advised consumer who might choose that option.

Scope of default investment strategy requirement/Bespoke SIPP exemption

There will be no need for firms to contact existing non-advised customers.  However, they would have to offer the default option in menus of investments shown to such customers.  The FCA will not immediately impose the default option requirement on firms with only legacy NWP business, but intends to come back to this issue once it has assessed the effectiveness of its intervention for new non-advised business.

If a scheme includes both workplace and NWP arrangements, the default option requirement will only apply to the NWP arrangements within the scheme.

The FCA proposes that the requirement to offer a default option will only apply to firms that "offer investments".  It uses the term "offer investments" to refer to the activities of offering, distributing or promoting investments for inclusion in the SIPP, or promoting platform services that distribute such investments. This will effectively exempt some "bespoke SIPPs" that do not offer any kind of menu of investments and simply rely on members to specify how their funds should be invested (eg in commercial property).  However, firms will be required to offer a default option if they accept business from other persons that both arrange the NWP and offer investments for it.

If a member of a workplace personal pension scheme is reclassified as a NWP member on leaving employment, this will not trigger a requirement to offer a default option as long as the provider does not offer the member additional investments outside the range of those available within the workplace pension arrangement.

Presenting the default option to members

Where there is a delay between a member setting up a scheme and funding it, the FCA will require firms to offer the default option at the point where the member funds the scheme.

The FCA says that where a member is able to navigate a menu to select investments, the member must be offered the default option as part of that process, with the default option presented with at least equal prominence to other investments.  The FCA also says that the default option should be presented alongside decision trees or tools at point of entry.

The FCA proposes that the default option should be labelled as the "standardised investment strategy" rather than "default option" to avoid implying that members' funds will be automatically invested in the default option if the member makes no choice.  Firms will be required to give warnings that the default option is not tailored to the member's individual circumstances.

Design of default option

The FCA says that when designing the default option, firms should have in mind the "average non-advised consumer in their target market".  Firms are expected to consider "an appropriate and diversified allocation of assets, to manage risks while seeking investment growth".  Firms should take account of the likely need for future changes to a default option and should not seek to depend on seeking consent from members in order to make such changes.  Members should not be "locked in" to the default option.

An individual must not be offered more than one default option or a default option that depends on answers to a decision tree or tool.  However, where a firm operates different businesses for different target markets, it may offer different default options to each.

The FCA expects firms to use "lifestyling" for the default option unless the needs, objectives and characteristics of the relevant members are incompatible with lifestyling (which the FCA considers unlikely).  A default option can be designed as a "to and through" solution into decumulation, with de-risking as appropriate.  The FCA's proposed rules will allow the use of "target date funds" for different age groups.  The FCA says that firms should assume pension access at state pension age unless an individual has stated otherwise.

Firms may use default options "manufactured" by other firms.  The FCA proposes that the manufacturer of the default option should review its performance and suitability at least every three years, as should the distributor (if different from the manufacturer).

Other points relating to default option

The FCA plans to impose various specific record-keeping requirements relating to the default option.  The FCA does not currently plan to extend the remit of independent governance committees (IGCs) to cover overseeing the value of NWP default options. Nor does it plan to impose a charge cap on default options.

Timescale for introduction of default option

The FCA plans to give providers 12 months to implement the default option proposals, starting from the date the FCA publishes its final rules and guidance.  The FCA expects this to be in 2022.

Cash warnings: more detail

The FCA's proposals relating to cash warnings stem from data showing that some scheme members hold a substantial proportion of their pension fund as cash for sustained periods, running the risk that the member misses out on opportunities for investment growth and that the value of the fund is eroded by inflation.  The FCA plans to require firms to send a "cash warning" to members with a significant and sustained proportion of their NWP assets held in cash.  Annual cash warnings will be required thereafter.  The proposals include assets defined as "near cash" in the FCA Handbook.

The FCA says that where appropriate it has sought to align its proposals with the existing cash warning requirements applicable to non-advised members entering or transferring into a drawdown fund.

Broadly, the requirement for a cash warning is triggered where a member has more than 25% of his/her NWP assets held as cash for more than 6 months and the value of cash held is at least £1000.

Unlike the default option requirements, the cash warning requirements will apply to members regardless of whether or not they are advised, and there will be no exemption for "bespoke SIPP" operators.  Where a scheme applies to both workplace and NWP arrangements, the cash warning requirements will only apply to the NWP arrangements.  The requirement will not apply to assets under management by a discretionary investment manager.

Content of cash warning

The FCA proposes that the cash warning must:

• inform members that more than a quarter of their NWP assets is invested in cash or investments that are similar to cash;
• say that their NWP is at risk of being eroded by inflation;
• include a generic illustration that clearly shows how erosion by inflation would affect a £10,000 pot over 10 years, assuming 0% interest and using the Consumer Prices Index; and
• inform members that they should consider whether their current investments are likely to grow sufficiently to meet their objectives.

Assessment of need for cash warning

Providers will be required to assess at least every 3 months the proportion of a member's fund held as cash.  To determine whether the cash holding has been "sustained", the provider must consider all assessments conducted over the preceding 6 months.  If, in addition to the current assessment, more than 25% was invested in cash in each of the previous assessments, the requirement to notify the member would be triggered. If the requirement for a cash warning is triggered, the FCA will require this to be sent within an "appropriate timeframe", normally 3 months.  Once one cash warning has been sent, one year gaps can be left between further cash warnings.  

There will be specific record-keeping requirements relating to cash warnings.

Timescale for implementation of cash warning requirements

The FCA proposes that providers will have 12 months to implement its cash warning requirements from the date that it publishes its final rules and guidance, expected to be in 2022.

Our thoughts

The proposals contained in these requirements will impose significant new obligations on SIPP providers.  Although we won't know the deadline for compliance until the FCA publishes its final rules, SIPP providers should ensure they plan to be able to meet the new requirements.