Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.
The last week has been an important one for the City and UK financial services.
First, the European Union extended its self-imposed limit on EU banks and other financial institutions being able to clear trades through the City, beyond next summer.
EU politicians had hoped to be able to force this business to move to the euro area. The fact that no further deadline has been set may reflect the EU’s hope that they can set one at a later date and force this business to move then, but I doubt they will be able to.
There may still be some uncertainty, but this action was significant. While the main reason cited was the need to safeguard financial stability, it also reflects London’s continued competitive advantage in this important area of clearing: an advantage it is likely to retain.
Second, the Treasury released its consultation document about the Government’s proposals to reform the City’s future financial regulatory framework. This was another important and welcome step in the right direction – although it is still an open question as to whether the current UK approach is ambitious and urgent enough to capitalise on the advantages that Brexit could bring to financial services.
Encouragingly, there has been a marked shift away from benign neglect towards the City in the wake of the 2016 referendum. The previous approach was that the City could look after itself and didn’t need government help.
This gave the wrong impression to the City and to international firms based here. In the face of aggressive regulators on the continent and intense global competition, it is important for the City and financial services to be seen to have full political support when needed.
Now, there is a proactive approach, which seems to be working and has been well received across the industry. There has already been much consultation, and the Treasury document is the start of the next stage. Significantly, in July, the Chancellor outlined four over-riding principles to drive the Government’s policy, which were that the industry should be open, innovative, globally competitive and sustainable. All of which make sense.
As the economy’s largest sector, the influence of the City stretches far beyond the Square Mile, and it has a fundamental role to play in both the green and levelling-up agendas through its provision of finance.
The City has weathered the pandemic well, and has witnessed continued growth since the EU referendum, despite misplaced fears that a vote to Leave would fatally wound it. Naturally, some firms have had to adjust, moving assets or people, given their business model, but overall the City has grown. The most recent survey of global financial centres showed London second to New York. Both have jostled for top spot over the years.
Five of the top ten centres are in Asia. It is from these, plus New York, that London faces its biggest competitive threat. They are gaining investment, and there is a shift in the balance of economic power to the Indo-Pacific region. But it is London that is often seen as having the biggest global reach. Nonetheless, Paris has shot up to tenth, a heady position it usually does not hold, and one it hopes to build upon.
While London’s competition is not with Europe, it cannot be complacent and rely exclusively on its inherent characteristics to prosper. Lord Hill’s Listings Review and the Kalifa Review of FinTech have identified areas were the UK needs to act.
Encouragingly, the Government’s consultation paper proposed regulators new secondary statutory objectives of international competitiveness and growth. This would help promote the City globally, as well as encourage economic growth at home. Perhaps, however, these should be primary objectives alongside financial stability, otherwise nothing may materially change. While recognising the need not to overburden regulators, the need for international competitiveness and stronger future growth should be paramount.
London’s status depends upon a combination of three key attributes: its inherent characteristics; the regulatory framework; and being a place where firms and people want to do business helped by the depth and breadth of its markets. One inherent advantage that we should leverage off more is English common law.
Given the digital and data revolution though, some of London’s other advantages, such as its time zone and English language may become less important – replaced instead by the greater need to keep investing in its digital and data infrastructure.
There are many new growth areas where the City is well positioned, such as FinTech, Green Finance, Islamic Finance and electronic and automated trading. A working group has already been established to look at digital currencies. Governments should not aim to micro-manage, but to help provide the incentives and to create the environment in which London and UK financial services will thrive. The importance of competitive taxes cannot be understated, as well as retaining high standards. The latter is not incompatible with growth.
Some may be disappointed that there will be no new Big Bang with large-scale deregulation. One understandable aspect of this is that firms have invested heavily in complying with regulations, and so do not want to see them radically changed. And some pieces of legislation were driven by the UK when in the EU.
However, this mindset needs to be challenged. Legislation such as Solvency 2 can evolve to suit domestic aims. Instead of only tinkering around the edges, more can be done to capitalise on the regulatory dividend.
This points to the need to diverge from the EU on financial services regulation when it suits, including making London the most attractive venue for parallel markets in euro-denominated instruments. Equivalence should not be driver of our approach – suggesting that we hug the EU in the mistaken hope that they may grant us this.
Earlier this year in a Policy Exchange report, I outlined the need to focus on strengthening the City’s underlying competitiveness and strengthening the link between financial services and the wider economy.
The latter still warrants further policy attention, even after last week’s review, and includes a range of areas, such as boosting bank lending to small and medium sized firms and onshoring back-office and other services from overseas to cities and centres across the UK.
Given the new direction, communicating a vision is important, both domestically and globally. The latter dimension still can be built upon, as there has not been enough rebuttal of an unnecessarily pessimistic view of the City’s future prospects. This is where the role of the Chancellor, Governor and the regulators are key.
Sensibly, the Government is retaining a targeted approach towards scrutiny. However, the door has been left open to Parliament to decide upon the future structure and remit of committees to act as a counter- weight to the regulators’ enhanced power. I would advocate the creation of a specialised committee of both Houses of Parliament to look at the specifics of financial services legislation.
The challenge with the new system is that regulators are being given more power. While recognising the need for their expertise, the concern here is with them exclusively setting the direction of travel and enforcing it. The worry is there may then be less desire by practitioners to push the boundaries and innovate.
There is much to be positive about when one looks at the City’s competitiveness and the role of financial services in the economy. But we must remain bold.