November 2022 • Topic: The politics of capital markets • by Maximilian Bierbaum and William Wright
For a few brief weeks, the UK government had a new tone towards financial services and a new sense of ambition, with a focus on ‘Big Bang 2.0’ and wanting to turn London into the ‘world’s leading financial centre’. While this reaffirmed commitment to the sector was welcome, this paper aimed to cut through some of the noise and provided a reality check on reforming UK banking and finance.
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It is not controversial to say that the Chancellor’s ‘mini budget’ and the market reaction to it made quite some noise. In this short paper, we are not trying to provide an economic or political assessment of those announcements. Instead, this paper aims to frame some of the new and not-so new announcements on reforming UK banking and finance in the context of recent events.
Our original thesis was that most of this new tone was a political rhetoric rather than substance. We argued that government was promising reforms in the name of ‘international competitiveness’ that most of the industry had not been asking for (such as scrapping the bonus cap) while not giving the industry what it would really like or what it thinks would really move the dial (such as changes to the taxation of banks).
Since we published the paper in October the government has descended into chaos: the Prime Minister and Chancellor of Exchequer have been replaced, and the government has rowed back on almost all of the pledges in the ‘mini budget’ except the bonus cap and the rise in national insurance.
There is no question that reform is needed to enable the industry to better support the UK economy and to strengthen London’s attractiveness as an international financial centre. At New Financial, we have long argued that post-Brexit the UK has both the opportunity and the imperative to adjust the framework for banking and finance that it had inherited from the EU. However, not all of the recent and expected announcements are quite what they seem, and many of them will be easier said than done. We hope this paper provides some helpful context for these reforms to ensure that the UK reforms the right things, in the right way, for the right reasons.
There are several recurring themes running through this paper:
• The UK economy needs all the help it can get in the wake of Brexit, Covid, and the war in Ukraine, and the banking and finance industry can play a vital role in supporting a recovery.
• In thinking about reforms, it is important to separate the domestic role of the City of London and its role as a host for international activity – and it is important to focus on outcomes for customers and the wider economy more than outcomes for the industry itself.
• Competitiveness should not become an end in itself, and competitiveness is not merely the mechanical output of reforms to tax and regulation.
• And, while many of the immediate solutions may seem obvious, many of the problems are far more ‘upstream’ in the economy and embedded by decades of well-intended regulatory reforms. Every change at one point in the chain of capital markets has a knock-on and often unintended consequence elsewhere in the chain.
Rebooting UK capital markets and rethinking the future of the City of London has been a big part of our work at New Financial over the past few years. We have published reports and hosted events on stock markets, the listing review, the secondary capital raising review, unlocking productive
investment, and Solvency II.
Here is a 10-point summary of this paper:
1) A reality check: this paper provides a reality check on reforming UK banking and finance. It frames the reforms that have already been announced and those which are expected in the next few weeks in the context of recent events, the challenges the UK is facing, and the different roles of the City of London to help ensure the UK reforms the right things, in the right way, for the right reasons.
2) The problem: the framework inherited from the EU was designed for 28 member states and is not tailored to the unique dynamic of UK markets and its role as a global financial centre. Brexit provides opportunity and imperative to rethink this framework, but there is no silver bullet to reinvigorate UK capital markets. Brexit has damaged parts of the City, and the UK needs to make up lost ground.
3) A new tone: in the first month since the new government has been in office, ushering in ‘Big Bang 2.0’ and wanting to make London the ‘world’s leading financial centre’ have been high on its agenda. This reaffirmed commitment is welcome, but many of the reforms will be far less headline-grabbing.
4) A ‘tale of two cities’: reforms that would help boost the ‘domestic’ role of the City – supporting the real economy – need to be clearly separated from reforms that would boost the (much bigger) ‘international’ role of the City as a host and venue for international activity. Bundling up or conflating the two would lead to fuzzy and less effective policies.
5) The work so far: over the past few years, the UK government and regulators have published more than 30 major reviews and consultations. There are currently more than 130 live regulatory briefs underway in the UK. With the next election due in the next few years and added pressures from external shocks, the government should move quickly to implement agreed proposals.
6) A political disconnect: the government seems to be running ahead of the industry politically. It is promising reforms in the name of ‘international competitiveness’ that the industry has not been asking for (such as scrapping the bonus cap) while not giving the industry what it would really like (such as changes to the taxation of banks). Over and above the reforms embedded in the Financial Services and Markets Bill, the list of what the industry did not get is longer than what it did.
7) Institutional strength matters: competitiveness is not merely the mechanical output of reforms to tax and regulation. The reaction in the past few weeks to the ‘mini budget’ shows how quickly reputation and trust can be damaged. In pushing through reforms, the government should be careful
not to undermine the credibility of the UK or of the City of London in areas such as financial discipline, political predictability and stability, and the independence of key institutions.
8) The EU angle: all regulation is political, and there are still many areas of friction between the UK and the EU. While the UK is now free to reform the framework it inherited from the EU, any reforms and any sense of ‘deregulation’ will likely be met by an equal and opposite response from the EU in areas such as clearing, delegation for asset management, or the recent desk-mapping exercise.
9) Part of the solution: the UK economy needs all the help it can get in the wake of Brexit, Covid, and the war in Ukraine. Banking and finance have a huge role to play in fuelling a recovery – but the industry needs to address its poor reputation, low levels of trust, and low levels of understanding. It
would help if the industry made a more constructive and tangible case for what it does.
10) Some more radical ideas: most of the ideas for reform have already been trailed but we think the government should consider five more radical ideas to help reinvigorate UK banking and finance:
i) abolishing the debt/equity tax differential, ii) creating a sovereign wealth fund, iii) exploring a hybrid market that would sit between private and public markets, iv) adopting a collective approach to DC pensions, and v) the introduction of financial health checks.