Breakingviews - Guest view: The City of London requires a strategy
Yet output in financial services has declined since the millennium, particularly since Britain left the European Union, while other services sectors in the UK have powered ahead. Although not the implosion some predicted, the City of London has been suffering a slow puncture as business and jobs in wholesale finance gravitate to the EU and other global financial centres like Singapore, Dubai, and New York.
Brexit cost the City some 40,000 jobs according to former Lord Mayor Michael Mainelli, but that is only part of the story. One of the legacies of leaving the EU is that many of the new jobs in wholesale finance are now created in other capitals. One big U.S. investment bank expects the proportion of jobs based in London relative to EU financial centres to shift over time from 90% to more like 60%.
Mending the City's puncture demands a comprehensive top-down strategy based on both its strengths as well as the headwinds it faces. So far attempts to address the City's problems have been sticking plaster solutions, involving a half dozen uncoordinated reviews. Some, such as the UK Listings Review conducted by former EU commissioner Jonathan Hill, came up with sensible recommendations. But an overarching strategy has been sadly lacking. Reeves has the chance to change this when she unveils her plan for financial services on Tuesday.
There is much at stake. Financial and professional services account for more than 12% of total UK tax receipts – more than the whole education budget. There is also significant opportunity. Trust is a critical commodity that helped the City achieve its position as the leading global intermediary in wholesale finance, managing international capital flows, international investment, and dispensing advice. The uncertainty engendered both by U.S. President Donald Trump's administration and geopolitical tensions makes London's reputation more valuable.
However, the chancellor needs to tackle challenges and weaknesses. For starters, the regulatory burden on the City is unnecessarily high. Politicians and watchdogs need to draw a sharper distinction between safeguards for domestic consumers and rules governing wholesale and international activity. Anecdotal evidence suggests that the compliance burden in the UK is higher and more expensive than needed, and lead times for authorisation of new entrants unduly long.
The Financial Conduct Authority recognises this difficulty and is now on a mission, opens new tab to reduce regulatory complexity and the administrative burden in wholesale markets. It is also providing extra support for wholesale, payments and crypto assets firms seeking approval to set up in the UK.
Then there is the much-debated issue of how much society should be protected from financial failures. Reeves needs to set the tone by clarifying that the public should not expect 100% protection when things go wrong, and by providing unambiguous guidance to regulators about the degree of risk appetite acceptable in international and wholesale finance. There is no point blaming regulators for being too cautious when politicians' expectations and the legislation they have passed drives those bodies to be risk averse.
Britain also needs to encourage a move more towards a standards-based regulatory approach to international and wholesale finance, based on outputs rather than binary 'blackline' rules. Such regulations are necessary in areas such as authorisation and capital adequacy. But writing specific rules to cover new, complex, and fast-changing areas of financial activity can be both stultifying and inhibiting.
Standards of good practice developed by practitioners have proved an effective complement to FCA regulation in the fixed income markets through the work of the Financial Markets Standards Board, which was set up with official endorsement in the wake of the Libor and foreign exchange scandals. The Standards Board for Alternative Investments has also been effective at promoting good practice in the hedge fund industry.
Standards can also be much more effective in new areas such as artificial intelligence, green finance, and cryptocurrencies, where the required outputs can be defined but the means of delivery are fluid. Moving further in this direction should be part of the government's strategy.
The UK must also ensure it shows a welcoming face to the talented individuals required in a leading international financial centre, at a time when technology and AI are reaping huge changes. It is unfortunate that many highly paid, wealthy individuals have been leaving the UK, in part because of the abolition of tax breaks for 'non-domiciled' residents. It is welcome that the government appears to be reconsidering its decision to make these individuals' worldwide assets subject to inheritance tax.
Finally, there is the EU. With the relationship between the two undergoing a reset, the government should take a hard look at where they can benefit from working more closely together in financial services. Both sides want to strengthen their capital markets and encourage productive investment by life insurance companies and pension funds. As the governor of the Bank of England suggested recently there can be benefits to both sides in closer alignment in financial services.
Of course, any dynamic alignment with EU rules will provoke accusations of squandering the opportunities of Brexit. But Britain must face up to the inevitable tradeoffs. Would greater access to the EU financial services market in return for a degree of rule-taking be better than the position the UK is now in? The government has already accepted that dynamic alignment with EU standards on food safety and animal welfare will benefit farmers and the public.
So far, the government's main regulatory preoccupation has been to encourage more investment in infrastructure by pension funds. Whatever the merits of this idea, the emphasis should be on developing a strategy for the UK's entire wholesale financial activity. The City's great strength is as an international intermediary. The issues are complex, which is why they have not been tackled before. But there is too much at stake, both fiscally and in terms of influence, to miss this opportunity to preserve and strengthen the City's position.
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