Child Trust Funds and Sandler Products Revisited

Many or most people find that looking after capital is at best a nuisance. I agree with the FSA that:

"The subject can be complex and people can find thinking about their long-term financial security dispiriting or even distressing." ^x

Looking after long-term financial security should be done collectively as far as possible. In my submission to the Treasury Committee, ^x I suggested that CTFs should be managed by an institution set up for this purpose rather than requiring everyone to negotiate separately with the financial industry.

CTFs will soon be followed by Sandler products which according to the Sandler Review are based on CAT standards (5.56) and will be "simple and good value" (38), "simple and comprehensible" (128), "simple, cheap and easy to understand" (52). But ISA CAT standards have flopped. Only a small proportion of ISAs are CAT ISAs.

In addition to the capped ^x explicit charges there will be hidden charges. An additional 1% of capital per annum is sometimes suggested. They will be a gamble largely determined by portfolio turnover, which varies by a factor of 18,617 to 1 from 0.1 % to 1861.7 % in the Fitzrovia report. ^x

Mindful of the trouble the Conservative Party got into over personal pensions and the self-regulation of the financial industry, New Labour should be very cautious before it does anything about this industry. It is instead introducing personal pension look-alikes starting with stakeholder pensions, and has extended self-regulation with the creation of the FSA.

This website was set up some weeks before stakeholder pensions were launched, predicting they would flop. I also predict that CTFs and Sandler products will not stand the test of time. They are like building houses on sand. The green paper Simplicity, security and choice: Working and saving for retirement (2002) ^x mentions the world "build" or "building" 75 times, such as "build on our track-record in kitemarking financial products" or "rebuild" such as "rebuild trust in the financial services industry". Much of this building and rebuilding is taking place without solid foundations. For example:

"The Sandler review's proposal for stakeholder products builds on the ideas behind the stakeholder pension." (page 85)

Cracks are appearing. For example the cap on explicit charges for Sandler products has been raised from 1% of capital per annum to 1.5% for the first 10 years. This is described in the press as a hugely embarrassing government U-turn. ^x Is there certainty that the 1.5% will reduce to 1% after 10 years? Perhaps a future government could change the rules, in the same way that the incoming Conservative government took away the cap on charges for unit trusts in 1979.

Financial companies are complaining that the cap will cause a loss of jobs. ^x This is the problem of instability in the financial industry in general, which affects both investors and the employees of the industry.

We now have an Act for CTFs ^x and 36 pages of regulations ^x. Only two companies are currently (June 2004) planning to offer CTFs. ^x

We also have draft regulations for Sandler products. ^x The complexity of these regulations makes them rather tiresome. The government has created a business model which encourages stealing and instead of changing the model, to discourage stealing it produces all sorts of regulations relating for example to charge caps, and price and performance transparency.

Stakeholder pensions, CTFs and Sandler products are collectively called "Stakeholder products".

"The stakeholder pension will be the pension product of the new suite of stakeholder products."

The term "Sandler products" is not used in the draft regulations, but this seems useful terminology to distinguish them from stakeholder pensions and CTFs. According to the draft regulations (Sections 6-8) Sandler products are then: 1) a deposit account, 2) units of a "relevant collective investment scheme" - which includes unit trusts and OEICS, 3) "smoothed linked long-term contracts".

The permitted investments of CTFs are more general than 2) and include company shares. Another difference between the regulations for CTFs and Sandler products is that all CTFs have accounts. The contents of account statements is given in the CTF regulations but not in the draft regulations for 2).

1. CTF accounts

Both the CTF and Sandler product regulations define "deductions". Deductions from what? In CTF regulations they are from the account:

9 (4) Statements shall include the following information

"(k) the total amount of deductions (including management charges) made during the period in sub-paragraph (i)"

3 (1) Deductions from a stakeholder account

"the values of those rights may be reduced by the making of deductions"

Making deductions from accounts is surely better than just making deductions from rights, since then the deductions can be seen on account statements.

What are the "deductions" additional to management charges in the CTF regulations? "Deductions" are defined in the case of stakeholder CTFs, in the Schedule Section 3. They include dealing charges, which are excluded from the cap on charges:

"(5) The following charges and expenses may be deducted in full from the account and are not subject to and do not count towards the limit provided for in sub-paragraph (2) -

(a) any stamp duty, stamp duty reserve tax or other charges incurred by the account provider directly or indirectly in the sale or purchase of investments held under the account" (Schedule 3 (5) (a))

Tax should surely not be combined with management charges in account statements. On the other hand what are people to make of stamp duty and stamp duty reserve tax (SDRT). They are likely to cause confusion.

"Incurred by the account provider" in the CTF regulations is "incurred by the manager" in the draft regulations for Sandler products Section 9 (9) (a).

Suppose a stakeholder CTF account is invested in a unit trust. The management charge and expenses of the unit trust will hopefully be included in the cap on charges. That is charges "incurred by the manager" will hopefully be included in the cap on charges even though in the regulations it says "incurred by the provider".

I have sometimes seen the SDRT in the accounts of unit trusts, but do not recall seeing stamp duty. As I understand it SDRT is paid on the units of unit trusts (when units are cashed in), and stamp duty is also paid on the underlying shares (on purchases). It seems that giving details of SDRT and stamp duty paid in the accounts of unit trusts, is not a legal requirement from the FSA's Collective Investment Schemes sourcebook, Chapter 10. ^x

It seems problematic putting the SDRT and stamp duty paid by unit trusts in CTF account statements, if they are not also in unit trust accounts.

The income from investments, dividends or interest is not included in the list of the contents of CTF account statements, in Section 10 (4) of the CTF regulations under the heading "Statement for the Account". Accumulation units should arguably not be permitted. Investors should be able to see the income from investments.

CTF account statements will contain:

"(m) The number or amount, description and market value of each of the investments under the account at the statement date."

Under Section 12 "Qualifying investments for the account", there are some sophisticated investments. In addition to shares, bonds, unit trusts, oeics, life assurance policies there are for example:

(g) units in, or shares of, a securities scheme, warrant scheme or fund of funds scheme;

(h) units in, or shares of, a money market scheme;

"The number or amount, description and market value of each of the investments" in the account statements suggests substantial capital whereas initial Government contributions may be only £265. There seems to be a contrast between the possible complexity of the account statements and the small amount of capital in most accounts. It seems that for there to be no hidden charges the CTF account statements will need to be excessively complicated.

2. The cap on explicit charges

In this area there is often a good news-bad news situation. The good news is, explicit charges for CTFs will be capped. This was widely reported in the press following the publication of the Treasury's Detailed proposals for the Child Trust Fund (2003). ^x In Box 1.1 on page 4 it says "The Government will set out later this year the level of charge cap to be applied to Child Trust Funds." The Treasury Committee in its report on CTFs ^x discusses "the price cap" (58).

Which price cap? The bad news is that there will probably not be a cap for most CTFs. Reading further in the Treasury report paragraph 4.2 says: "(including specifying whether the charge cap will apply to non-stakeholder accounts)". It was not yet decided whether the cap will apply to all CTFs. Now the regulations state that the cap only applies to stakeholder CTFs. Probably only a small proportion of CTFs will be stakeholder CTFs, in the same way that only a small proportion of ISAs have CAT standards. The cap for stakeholder CTFs has been raised from an initial proposed annual 1% to 1.5%, and now the cap will also be raised to 1.5% for Sandler products, for the first 10 years. ^x

This progression from good news to bad news, happens not infrequently in this area. In the early days of the proposals for stakeholder pension schemes I recall that they were all going to have trustees and "a collective structure like occupational pensions". Now the large majority do not have trustees, or a collective structure since almost anyone can join any scheme.

Stamp duty and SDRT are not included in the cap on charges for stakeholder CTFs. But under Section 38 of the CAT standards for ISAs, SDRT is included in the charge cap:

"Where dilution levy or stamp duty on dealings in units or shares is charged, the annual charge must cover these additional cost(s). The saver must pay nothing extra."

Stamp duty on the underlying investments is not included in the ISA cap on charges.

One of the four "key objectives" of CTFs is to "build on financial education". ^x The FSA's report Building financial capability in the UK ^x says:

"We share a vision of better informed, educated and more confident citizens, able to take greater responsibility for their financial affairs and play a more active role in the market for financial services."

This is claiming the moral high ground. But the FSA clearly intends that financial education should not include the importance of hidden charges, since as discussed on this website it wants them to remain hidden. The FSA is continually claiming the moral high ground whilst at the same time it is quietly helping the industry steal ("gain insidiously or artfully") our savings.

Another example is its change in the regulations to allow charges to be made out of capital rather than income. ^x This increases the yield at the expense of capital, contrary to its public statement:

"Reaching for high yield products can be a dangerous strategy, which could put consumers’ capital at risk." ^x

The retail market for savings "products" is composed of professionals and organisations doing business with members of the public. It is therefore very one-sided. This reality will not change however much people are educated. Nor will it be changed by: awareness, choice, clarity, competition, confidence, disclosure, flexibility, information, simplicity, standards, transparency etc.

Investors who have done best have invested in property, managed their own investments, or been members of large occupational pension schemes. Experience has proved that in the case of long-term saving the less people are consumers of financial services the better.

4. Sandler products

The Sandler Review refers to "substituting product regulation for the current regulation of advice" (10.13). The Review does not have a glossary of terms. "Product regulation" is apparently an extension of CAT standards (5.56).

"The over-riding aim of the CAT regime is to define straightforward, clear, easy to understand and fair products that offer good value. The intention is that consumers should be able to buy CAT products with little or no advice."

If "little or no advice" is needed for the new Sandler products, how will advisers be able to earn their sales commission? Ron Sandler seeks to:

"transferring the burden of regulation onto the product, as opposed to the sales process, and therefore making the whole thing much cheaper, providing protection built into the product, rather than policing the sales process." (Treasury Select Committee 22nd January 2004)

But "transferring the burden of regulation onto the product" refers only to the new Sandler products. This idea could be extended to existing products such as mortage endowments where the promise to repay the mortgage should arguably be transferred from the point of sale to the policy. At present the industry offers faulty "products" which are then verbally enhanced by financial advisers in order to make a sale.

5. A wrong emphasis

People buy the savings "products" of the financial industry because they do not want to invest in the stock market. But this is largely self-defeating because one market - the market in shares, is replaced by another market - the market in "products".

The Government is seeking to encourage this market in "products" in various ways. There is the introduction of stakeholder pensions, CTFs "to encourage parents and children to develop the savings habit and engage with financial institutions" and Sandler products. There is the promotion of "informed choice" "to empower individuals to make real and informed choices on working and saving for retirement". ^x

The green paper mentioned above ^x is largely concerned with encouraging people to buy, and helping them choose between, savings "products"; such as "Chapter 3: Informed choice in pensions - choices for individuals" which starts "There are a range of barriers to pension saving which need to be addressed." and "Chapter 5: Financial services - building trust and improving understanding".

But saving towards a pension on an individual basis is expensive because of charges and has other disadvantages in particular greater cost of life insurance or survivor benefits, possible mis-selling, no trustees. The green paper should therefore not be neutral and should instead favour group schemes. It has arguably a wrong emphasis.