Financial Services

Lord Flight Excerpts

Thursday 20th June 2013 Grand Committee

[Lord Flight]

My Lords, first, I declare my interests as set out in the register, but which amount to 43 years in the investment management industry. Although I want to talk specifically about the initiatives in this year’s Finance Bill, I should say that when I started my career, I remember someone older than me asking, “Why on earth are you coming into this? London is too big and it only services the UK economy. It has lost all its international business”. He could not have been more wrong. One of the things that I am proud of over my career has been to see London return to being the major financial capital of the world, earning somewhere between £60 billion and £70 billion a year in invisibles that help to pay for so many of those cheap Chinese imports. Although the City is certainly subject to criticism, to regulation, and even to a Government policy that led to the banking crisis, it is an incredibly valuable asset to this country. For those who say that it is too big, I would just point to Hong Kong where the financial services industry is a far larger proportion of the economy, but because it got its financial regulation and economic policy right, it has never been a major problem. Rather than contract the City, let us expand other areas and get its regulation correct.

I want to speak about the initiative in this year’s Finance Bill which will set up the UK investment management strategy, a Treasury paper published back in March. I greatly welcome this. It is there to try to get more foreign fund management businesses to come to this country. That might obviously benefit those who work for them, as well as the lawyers, accountants, regulators and even HMRC because they would provide another source of income. By the way, I think that the total fund management industry represents around 1% of GDP, some £12 billion per annum, so as a sub-section it is pretty significant.

Thirty years ago, when my noble friend Lord Lamont was the Financial Secretary to the Treasury, I tried to persuade him to remove taxation on funds, then unit trusts, and put it firmly on individual investors in order to stop Luxembourg taking masses of new business which could rightly have come to London. The Revenue would not accept the argument, and so Luxembourg emerged with its huge industry of today, but at the time it did not exist. At last HMRC has got the message that this is an industry worth having in this country.

There is a level of serious commitment within the Government’s measures. First, there is the commitment to abolish the stamp duty reserve tax, of which there has been criticism for many years. Secondly, there is a commitment to make sure that the tax status of non UK-domiciled funds will not be affected if they are obliged to appoint a UK AIFM. I look forward to working with TheCityUK and the new Financial Services Trade and Investment Board to come up with an agenda of what I would call constructive proposals which might be politically possible, and I am glad to see that the IMA is coming up with good initiatives aimed at creating greater cost transparency in terms of the amounts charged by various funds.

There are obviously two key factors. One is tax; the other is regulation. The tax regime needs to be attractive for funds. It also needs to be attractive for the staff who might work for them; it needs to be competitive. Regulation needs to be, first and above all, good; and, secondly, it must not be too expensive or over-bureaucratic. Otherwise people will want to go to other places.

On the tax front, I remember some 12 years ago when I was seeking to drum up support for the Conservative Party in the City, one of the major world banks said to me, “We are totally happy as long as income tax remains at 40%, as introduced by Prime Minister Blair, and, secondly, as long as the pension plan arrangements aren’t interfered with”. Well, sadly, both of those have been lost. They were then boasting to me about the numbers of staff they transferred from Paris and Frankfurt to London. Do not forget that individual tax matters as well as the tax on the operations themselves.

I know that the Government are concerned because probably the largest fund management group in London has recently started shipping staff and a lot of its new business off to Luxembourg. I have explored that and it is really not about the taxation of funds; it is about the taxation of individuals. In particular, it is about what I think was a very unwise and aggressive taxation of non-doms relating to their property ownership, which for many will involve a 7% per annum mansion tax. For funds and the fund management business, broadly the tax regime over here is fine; and as corporation tax comes down to 20% for fund managers it becomes an attractive tax regime.

Again there is some very interesting data here in the Government’s paper. The volume of funds managed has risen from £2.7 to £5 trillion in the past six years. Where this paper is slightly mistaken is that while it initially focuses on the volume of funds managed in the UK, which is what matters, it also focuses on the domicile of funds. In fact, managing the funds—irrespective of where they are domiciled—is where employment and revenues come. It is much more important to keep the UK an attractive place to manage funds that are not actually domiciled here. There is a slight error there.

The second mistake is that the paper suggests that the new AIFMD regime may be good for the UK as it will encourage funds to be domiciled here. I think it is serious bad news for the UK and will lead to a significant loss of business. It is very expensive and very hasslesome. Anyone who is managing funds which are not to be marketed to the EEA and EU are going to move elsewhere and, indeed, are starting to move elsewhere—predominantly to Singapore and Hong Kong.

I am no great liker of hedge funds and have never invested a penny in one, but there is a great misconception in Europe that hedge funds caused the financial crisis, whereas it was money being easy for too long, bad regulation and so forth. It was really the banks and not the fund management industry that led to the trouble. In terms of regulations, the FSA as it was had become unnecessarily hostile to the fund management industry. Many reputable businesses said to me that they did not want to raise their criticisms of certain regulatory initiatives because they were frightened of retribution. There was a breakdown in communication. However, in Luxembourg, again, they virtually embrace you with both arms and offer you all manner of inducement and attraction if you will come and bring your business to them. I am pleased that the Treasury is “in discussions” with the FCA on that territory.

London obviously has a huge amount to offer: lots of people with high skills, a wonderful place to live, wonderfully international and so forth. However, I think that there is one danger of undermining all these attractions by an increasing nightmare of regulation. It is not just an AIFMD; the threat of the transaction tax would be a disaster for London and the trickle-down effect means often that it would turn out to be at least 1%. I hope that the Government will go to extreme measures to stop it happening—although I am hopeful that Merkel wants to give it up once the election is over We will now have to put up with EMIR. The Government have done quite well on MiFID II but are still somewhat protectionist towards third country suppliers. We have ESMA wanting to take over regulation in this country. Candidly, I have never known a more exhausting time of masses of excess and useless regulation, particularly the AIFM report. No one will read it—it is so voluminous and completely unnecessary.

Contrary to my noble friend Lord Dykes’s extolling of the situation, the main threat to the UK fund-management industry is the regulation coming from the EU. I end by saying that it was a great mistake of the previous Government to surrender sovereignty on financial regulation to the EU. We are inevitably vulnerable because some 70% of all financial transactions for the entire EU are done in London. I do not particularly blame Paris and Germany for thinking that they would like to have a bit of the cake and to encourage measures which might lead to that. As someone in the industry, I see that as the biggest threat.