City must forget about Brussels and look to New York
The US and UK are already closer in philosophical and regulatory approach than either is with the EU
It’s now been 14 years since the financial crisis. And yet there are few signs that politicians are prepared to let banks and bankers off the naughty step any time soon.
In a recent interview, the former prime minister Gordon Brown expressed his regret that some bankers hadn’t been jailed for their role in the credit crunch (although he failed to explain which laws he thought might have been broken). This followed an attack by the shadow chancellor Rachel Reeves on Rishi Sunak’s decision to cut the bank surcharge tax in the Budget last autumn.
The best that successive Conservative governments have been able to offer the City has been benign neglect. In the lead up to and immediate aftermath of the Brexit referendum, the concerns of the financial industry were repeatedly ignored.
Now, thankfully, we appear to have moved on from arguments about aligning the UK financial industry with EU rules in exchange for future access. The debate is effectively settled: it’s not going to happen. But the Government has yet to adopt a new approach.
It is true the banking surcharge rate levied on the profits will be reduced from 8pc to 3pc from April next year. But this is only because the headline rate of corporation tax is being increased from 19pc to 25pc. Without the reduction, banks would be facing an effective tax rate of 33pc.
This would obviously have damaged UK competitiveness – never a great idea but especially when financial services companies are thinking long and hard about where to base their operations following Brexit. As things stand, the effective tax rate of 27pc now, and 28pc from next April, is higher than in Frankfurt or New York. And the gap is forecast to grow, according to research by PWC.
The Government has launched more than 30 major reviews and consultations into various aspects of the City’s supervisory and regulatory frameworks. These include a review into the Solvency II rules for insurers, another into wholesale trading, the Khalifa review on fintech and several long, hard looks into listing rules, to name but a few.
Yet there has been very little in the way of substantive change. Six years on since the Brexit referendum, and two years since the UK formally left the European Union, the UK Government’s attitude to overhauling financial regulation has been, to coin a phrase, all jacket and no motorbike.
Recently, Sam Woods, a deputy governor at the Bank of England, tried to rev things up by floating the idea of a rethink about bank capital rules. The head of the Prudential Regulation Authority wasn’t arguing that the amount of capital banks must hold to absorb losses if things go awry in times of stress should necessarily be reduced. Rather, he was suggesting that the rules – which have developed in a hodge-podge manner – should be simplified. Since the financial crisis, a whole series of additional buffers have been added on top of minimum capital levels to address specific risks. There are worries that the resulting patchwork quilt of rules overlap in some places, leaves gaps in others and is, in short, highly inefficient.
Each of the different buffers rely on their own set of assumptions and models allowing banks to cherry pick their numbers and potentially game the system. The Bank recently fired a shot across the bows of UK lenders – and Barclays in particular – for making capital arbitrage transactions through their pension schemes that boosted their capital levels.
What’s more, it was clear through the economic downturn resulting from the Covid pandemic that regulators found it difficult to get banks to support businesses with more lending by lowering so-called “countercyclical” buffer requirements.
Woods prefers the idea of a simple common equity threshold that regulators could, if they saw fit, relax at times of stress to keep banks lending during a downturn in order to support the economy. By taking the decision out of the hands of management teams you would avoid the issue of banks all seeking to maintain higher capital levels than their rivals in order not to spook investors.
None of this will happen anytime soon. The Basel Committee’s capital reforms have not yet been fully implemented – even though we are now 14 years on from the financial crisis. Woods also made a point of saying the UK should not be going it alone and deviating from global rules on capital, but should be using its influence to reshape them.
Herein lies the crux. The UK should now be raising its sights above the EU by using its outsized financial clout to help ensure global rules are fit for purpose. And there is an obvious ally with whom to partner in this endeavour. As a recent report by the think tank New Financial points out, the US and the UK are already closer in philosophical and regulatory approach than either country is with the EU.
The think tank has identified 10 areas of financial activity – including, for example, foreign exchange and derivatives trading – where the two countries are home to the number one and two biggest markets in the world. By joining forces to write the rules, a NY-LON financial axis would be setting the de facto global standards.
Many people may not like it but the banking and finance sector is rather important to the UK economy. It employs about 3pc of the total workforce, accounts for 7pc of the country’s gross value added, generates more than 10pc of all the tax that flows into the Treasury and is responsible for a third of all foreign direct investment into the UK.
Boris Johnson is hoping to reboot his Government today with a series of post-brexit reforms designed to boost the economy. Politicians love banging on about new sectors like space, artificial intelligence, robotics and the biosciences. Of course we should be vying to compete in the industries of the future. However, none of that stuff happens unless it is funded by finance.
Similarly, this Government has talked a lot about nebulous concepts like boosting productivity and levelling up without clearly articulating how it will achieve those aims.
But the best way to generate the biggest boost is by making things easier for one of the few industries in which the UK is already world class.