Xavier Rolet (Non Executive Chairman, Shore Capital Markets), Matthew Elliott (Senior Political Adviser) & Dr Clive Black (Head of Research)
With the exit of the United Kingdom (UK) from the European Union (EU), and the additional tension emanating from the Covid ‘vaccine wars’, the mood music between the two parties is distinctly tetchy. The EU appears aggrieved but is also – wholly understandably – looking to serve its own interests. For anybody in the UK not to anticipate such an approach is naïve.
Predictably, the issue of equivalence in financial services is being leveraged aggressively by the EU, leading the Governor of the Bank of England to recently outline some realistic facts of life through his digital Mansion House speech (10th February 2021). Whilst certain sectors like asset management are less likely to be deeply impacted, that is not the case for financial infrastructure services, capital formation and advisory & risk management activities.
Politics is not always rational, and the absence of financial services from the EU-UK trade agreement predates the current Prime Minister, so the UK now needs to step back and think about the tangible benefits that Brexit can provide to its important financial services industry. The UK now has a unique opportunity to take stock and work out the best policy context for the City of London and our wider financial services sector to thrive, remain the largest tax contributor to the Exchequer and serve the wider UK and global economy. But whilst the question is quite straightforward, the answer is a good deal more involved, multi-faceted, multi-agency and multi-lateral.
What is clear though is that if the UK’s financial services industry is not only to limit the damage from trade flows lost to EU centres, but also to press on and positively flourish post-Brexit, London must maintain its innovative global approach to financial markets, with all that involves in terms of the unique links between finance, economics, and politics.
In our view, the policy environment needs to focus on three interconnected broad areas, within which there are many moving parts, challenges, and opportunities. These areas are:
- Maintaining London’s global reach
- Full review of financial services regulations
- Promoting innovation and long-term patient capital
1. Maintaining London’s global reach
The City of London has traditionally been perceived as blessed by its location, timeframe, and language. A less obvious trait, but more significant in terms of the commercial effectiveness of the City, is its scale: it is a true agglomeration of all the professional services across the classes and activities of financial markets. Such scale is not just bond, currency, and equity trading, but major activities such as asset management, derivatives, commercial and investment banking, insurance, and legal services. This nexus allows London to both raise and move capital efficiently.
London is also a convenient location for many global participants to operate for all sorts of other reasons, not least the relative political stability of the UK, the rule of law and the security of property rights. It is also blessed by having substantial fin-tech and financial services resources located in the same ‘town’. The UK’s world-class universities and the excellent cultural scene are also important. Hence, in not being under the jurisdiction of, say, US or Chinese doctrines, London’s independence and flexibility are quite attractive to those that hold and wish to invest capital across the globe.
Whilst this is all so, London must remain relevant and competitive to American and Chinese investors and all their intermediaries in particular if it is to remain relevant as a global centre. In this respect – noting that the UK is chairing the G7 in CY2021 – London must be seen by the G20 to be central to global capital formation – a key requirement for world development, especially with the major challenges of climate change, biosecurity, the effective allocation of scarce resources, the application of technology and the management of inequality.
Looking at the centres of world economic activity, with the USA and China accounting for roughly 75 per cent of global financial asset ownership and almost half of world gross domestic product (GDP), London, therefore, must create the products and services that are relevant to these two competing nations. According to Lombard, China is forecast to overtake the US in headline GDP by CY2028, so the City of London and the UK Government need to create the conditions that work for both US and Chinese financiers, politicians, and regulators.
In addition to global capital formation, risk management, balance sheet products and professional advice will all sit high on the agendas of key players, in a world of greater technological speed, capability and, of course, compliance. In these respects, it is important for London to remain relevant in key components of the world’s financial infrastructure, such as over-the-counter (OTC) derivatives, repos and foreign exchange (FX) trading and clearing, all areas where there are other international centres keen to take a greater share of trade.
In order to offer global balance sheet compression and capital formation efficiencies, the connection with the EU is particularly important in terms of OTC derivatives and FX trading and clearing, where the Bank of England (BoE) needs to have workable agreements with the European Securities and Markets Authority (ESMA) as it does with the US Commodity Futures Trading Commission (CFTC).
One idea that has been mooted for the industry to explore is for the London Stock Exchange (LSE) and the Financial Conduct Authority (FCA) to consider setting up a new segment for international companies listed on recognised exchanges around the world and allow them by virtue of their listing on their home market to simply trade on this new segment in London. Such a development, it is suggested, could in time encourage more companies to come to London to raise capital, so helping to secure London’s role as the global exchange.
Whilst conceptually interesting, expediting such a vision is fraught with political and regulatory challenges, noting as we do the functioning London-Shanghai (LSE-SSE) Stock Connect, which still needs to be fully activated by means of political support on both sides. In this respect, the UK being at odds with China is not an option for ‘Global Britain’ and the UK should also focus on its relationship with the US and promote an equivalent Stock Connect with the New York Stock Exchange (NYSE).
Another idea in the more novel product arena could be to revisit the rules around special purpose acquisition companies (SPACs), which have gained such rapid and considerable traction in the USA (143 SPACs have raised c$43bn in the USA in 2021 YTD according to Refinitiv). The UK needs to promptly consider the SPAC revolution. Whilst there are significant differences between our markets and those in the US, the appetite for permanent listed capital on the part of ambitious UK and European entrepreneurs and innovators is no less than that of their American counterparts: ask the management teams at Spotify or Markit. SPACs represent a financial instrument that should not be overlooked and where agility could realise considerable benefits to credible British and European entrepreneurs and dealmakers.
In this respect, we see Jonathan Hill’s current comprehensive review of all the listing and SPAC rules as a golden opportunity, which could also include permitting the disclosure of forward statements as part of private investments in public equity (PIPE), a move that could also draw a lot of business to the UK, so allowing London to grab some of the trade that has gone to New York and Amsterdam.
The opportunity of the Hill and Ron Kalifa reviews (the latter being the UK Fintech Strategic Review) was commendably commented upon by the editor of the Financial Times, George Parker (18th February 2021), when he stated:
‘Sunak has set up a number of regulatory reviews to shore up the City of London’s global appeal. The Kalifa and Hill reviews of fintech and listings are examining lower free float requirements and whether to allow dual class share structures on the premium segment of the main exchange to attract entrepreneurs who want to keep control of their businesses. A review of the Solvency II insurance regime will ease capital requirements, with the aim of releasing more money for investment in expanding new sectors of the economy.’
We shall touch upon Solvency II below, but it is clear to us that broader international collaboration to keep London’s place as a locus of financial transactions and capital flows is also essential. Not only should the City have a strong commercial relationship with the EU, but it should also have a coordinated and well-thought-out approach to Switzerland, sovereign wealth funds, key family offices, the techno-genius of Israel (where London should be a line to capital) and the financial capital of the UAE and Singapore. In all these areas, the UK Government and associated public bodies need to be credible sponsors and enabling forces for the British financial services industry, whilst reiterating the central importance of the USA and China to financial asset ownership.
2. Full review of financial services regulations
At times it is easy to be a little ‘tabloid’ when it comes to the regulation of financial services and the opportunity for the UK to seemingly break free from the bureaucratic-heavy Bruxelles. It is also an uncomfortable truth though that much of the drafting of ESMA regulations was heavily coloured and determined by its most highly influential Board members: London-based regulators. The rapid burning of the journals may not be as advantageous or clever as some may think.
That said, the EU is also ponderous when it comes to evolving policy and the UK can now be quick – a speedboat to the EU’s super tanker, to use President Ursula von der Leyen’s phrase. Realignment for the sake of it is not clever, but within the context set out, of needing to have global reach and capability, London and its regulators have the option to be capable and agile to beneficial effect. Where this newfound political independence could be especially important and beneficial is the scope to align regulatory control with the key capital markets of the USA, China, and the EU.
The rightly maligned MiFID merits a serious reconsideration, with the core priority of making London faster, leaner, cheaper, and better for global asset owners. To cite one small but telling example: it is ridiculous that financial services companies seeking to put on a conference face a nightmare of sorting ‘paid for’ versus ‘nonpaid for’ invitees. If we are seeking to attract new investment into the UK, should we not be making it as easy as possible for companies to attract new investors?
Another area to revisit is the aforementioned Solvency II provisions that act as a barrier to equity investment, forcing major asset holders such as insurance companies and pension funds to ‘short’ the real economy. The National Association of Pension Funds’ (NAPF) members average portfolio equity allocation in 2009 was North of 60 per cent. As a result of Solvency II and wider regulatory and risk considerations, it is presently under 20 per cent. The consequent illiquidity of equity markets and the higher cost of listed equity capital is the price the economy pays for allowing policymakers to force insurance companies and pension funds to buy ultra-low yield long-term government debt at the expense of stocks, albeit the UK Debt Management Office (DMO) will be needing low gilt yields for the foreseeable future, post the Covid-19 pandemic, and for pension funds and life assurance companies to buy such issues. We sincerely hope that the combined work of Parliament on the Pension Bill and the Bank of England provide a golden opportunity for beneficial reform.
Crypto-currency is not going away and whilst self-serving entrepreneurs like Elon Musk are reverse broking the instrument, the fact is that important institutions of the state (e.g., China) and commerce (e.g., Mastercard and BNY Mellon) are now embracing crypto-currency. This is a good example of where London self-evidently cannot act in isolation, but it can seek to act as a conveyor, working in connection with the world’s leading agencies to be at the heart of what will eventually be a regulated and very large component of financial markets.
All the relevant UK Government agencies should be resourced to thoroughly understand crypto currencies, attract the best brains from across the world to advise and manage policy, and so place London and the UK at the centre of a reputable and safe financial market. Doing so will not be easy, none of this stuff is, but it is essential to be well positioned, otherwise the crypto-currency market will pass the UK by. It is a good example of a policy area where independence allows us to be more agile, providing UK regulators actively construct and bring about a shared global regulatory framework, in conjunction with the world’s leading Central Banks. In this respect, agile financial services regulation needs to combine well with a functioning new immigration platform to attract and keep the best global talent in the UK.
3. Promoting innovation and long-term patient capital
The UK has so much going for it to make a meaningful contribution to the future knowledge economy. Thankfully, our universities and institutes still stand their ground across so many spheres from agri-tech to zoonosis, and the new Turing Scheme should enable the UK to attract young talent from around the world, from Monash to Tohoku, to help us solve the future challenges and seize the next opportunities.
Indeed, the Covid-19 pandemic has underlined the strategic importance of well-funded medicine and life sciences, and hopefully the UK Government is reflecting upon the success of genome testing and vaccine development and how these need to be resourced in the future. Which brings us on to the long-standing debate about patient capital in the high-risk, high-failure-rate, high-return world of medicine and life sciences, where the UK has world-leading innovation and capabilities but a poor track record in seeing through the idea generation to sector and wider economic effect. Comparing London to the US in healthcare and life sciences equity capital markets highlights a disappointing performance that needs to be analysed and changed for the better.
A similar tale should not be allowed to be the case of green technology where, again, the UK is no slouch in terms of global innovation and thinking. The UK Government and the financial services industry – the major holders of capital – need to be mobilised to capitalise upon the ground-breaking ideas that our institutions and entrepreneurs are developing to contribute to solving the climate change challenge. Such a policy context needs ambition, vision, clarity of thought and the multi-faceted combination of linking universities and centres of innovation to equity capital markets. In this respect, the appropriate reform of Solvency II could help enable insurance companies and pension funds to allocate material capital to the green revolution.
Additionally, we also need the tax structures and support to allow entrepreneurs and investors to be patient, to move away from the current situation where a plethora of small enterprises emerge and are taken out as toddlers, but instead create an ecosystem where many unicorns emerge. This would generate the wealth, employment and tax revenues to fuel a virtuous and exciting economic cycle, where the City of London is a key enabling force, but it is predicated upon enlightened policymaking by the UK Government and the other financial agencies. Would it not be exciting to hear the UK State speak to such a script at its International Green Investment Conference in London in October 2021, ahead of the COP26 in Glasgow the following month?
In short, the UK needs a regulatory and fiscal recalibration to compete with the USA. If such recalibration rested alongside the provision of substantial scale-up equity capital, then the potential outcome for the UK economy, the City of London and HM Customs & Excise would be material and truly exciting.
Central to substantial scale-up equity capital are the knowledgeable technology investors that the country needs to nurture and train. Such excitement also needs the appropriate funding for universities and institutes, a more credible long-term education strategy centred upon digitisation, and borders that welcome the best talent the world has to offer to come to work, live and bring up children in the UK.
Robert Colvile put all this succinctly in his Sunday Times column (14th February 2021): ‘If we do lose access to European markets, then we do need to come up with new and irresistibly better answers to the question: “So why should we base ourselves here?”’
That is the question, with all the many moving parts touched upon above, that the Prime Minister, his Chancellor, the Governor of the Bank of England, the leaders of the financial regulatory authorities, the Board of the London Stock Exchange and all other participants now have a unique opportunity to answer.