UK as a Financial Services Hub

Robert Neill Excerpts

Wednesday 6th February 2019 Westminster Hall

[Bim Afolami]

I thank my hon. Friend; I will address that aspect directly in my remarks.

Before I come to that, I think it is worth defining, for people who might read or watch the debate, what financial services actually do. To many, it looks like it is just about shuffling paper around or playing with spreadsheets. Put simply, financial services are partners of business. In 2017, UK banks lent £14 billion per quarter. Almost 1,500 equity finance deals, with an investment value of almost £6 billion, helped smaller businesses grow in 2017.

Another thing to assess and to remember is that financial services create business demand for other goods and services. The financial services industry is the largest buyer of tech services in the UK, for example. A business contributing to what we might call “the real economy” needs financial services to be available, cheap and effective. In Britain, companies from around the world have access to those services through our financial services sector.

What impact do financial services have on the Treasury’s balance sheet? The Minister will be keenly aware of this—I know that the Chancellor is. The financial services sector contributed over £72 billion in taxes last year. To give people a sense of scale, that is half of the NHS budget and about 11% of total UK Government revenue. In addition, the sector provides 1.1 million jobs to the UK-wide workforce. If one includes related professional services in an advisory capacity, such as accounting or legal services, that number rises to 2 million.

We are global leaders. The UK is the leading destination country for foreign direct investment projects in financial services from the United States, Sweden and China. The UK attracts 15% of the US’s global projects of that nature, 47% of Sweden’s and 15% of China’s. I come back to the point made by my hon. Friend the Member for North Warwickshire (Craig Tracey); those who believe that financial services affect the City of London only should think again. Two-thirds of financial services jobs in the UK are based outside London. In fact, with regards to the foreign direct investment that I just described, between 2013 and 2017, regions outside London accounted for 49% of the jobs created, 48% of the gross value added in financial services, 36% of the estimated capital investment in the UK and 37% of the total number of jobs. All that went to regions outside London.

Highly paid bankers and insurance brokers or traders who earn millions of pounds do not reflect the reality of 99% of financial services. A major reason that they matter is the cluster effect of the jobs that major financial institutions create around them. Let us take self-employed freelance workers, who often work as consultants for major firms in the industry. The number of self-employed workers in the UK has gone up by roughly 50% since 2001. According to statistics from IPSE, the Association of Independent Professionals and the Self-Employed—I refer the House to my entry in the Register of Members’ Financial Interests—22% of the self-employed work in financial services, and 40% of those freelancers had at least one project based in the EU in the past 12 months. A good Brexit deal really matters to them, and those statistics show the ancillary losses that a poor deal for financial services will bring.

Numerous challenges and changes are on the horizon, which will require our Government to change and develop their approach to the sector. I will focus on three principal areas: first, the digitisation of the economy and the rise of FinTech; secondly, the challenges and tough choices we face as we leave the European Union; and thirdly, the need to increase the penetration of financial services into our most deprived areas. That will deepen and improve the relationship between the financial services sector and our most deprived people, to ensure that everyone benefits from the sector, not just the affluent.

On digitisation, we are in a new economy: the internet and social media, as all Members of Parliament know, have completely changed not only how politics operates but how goods and services are produced and sold throughout the world. Anyone who has read Stian Westlake and Jonathan Haskel’s book, “Capitalism without Capital: The Rise of the Intangible Economy”, will be in no doubt about the profound economic change that we are seeing. These days, anyone can produce almost anything anywhere using 3D printing; anyone can advertise a product worldwide at the click of a mouse; and, as I saw last week, a film producer based in Hitchin in my constituency can work with clients in China in minutes.

Such changes are exciting from a technological perspective, but present a real challenge to the way in which we do things. For the past 15 years or so, companies have invested more in intangibles, such as branding, design and technology, than they have in machinery, hardware or property. Businesses such as Uber do not own cars; they own software and data. Coffee bars and gyms rely on branding to help them stand out from the crowd, and they often lease their premises and physical goods, rather than owning them. That is capitalism without capital.

What does that mean for financial services and, in particular, for banking? The normal model for bank lending is this: when lending to a business, the assessment of the company’s balance sheet—the assets and liabilities—is a critical aspect of assessing credit-worthiness. In the new economy, banks struggle to understand how to value and monitor intangible property. In the old days, if a company went bust, a bank could recover its money by selling physical assets—it would have a mortgage over the buildings and could sell capital assets such as machinery. If a company with intangible assets folds, those assets cannot be sold off easily—in effect, their value will have sunk with the company.

A lot of smaller businesses in the new economy therefore do not have the same access to bank loans. They are much more reliant on venture capital and angel investors, and that is a very different model of financing from traditional bank lending. My first question to the Minister is this: how will our regulatory system have to change in order to catch up with the new economy, which is changing at both a domestic and a global level? Without changing the rules on bank lending, we will be unable to finance small entrepreneurial businesses properly over the longer term.

FinTech is another success story for Britain in financial services. Indeed, we are the world’s FinTech hub. Of the European Union’s $26 billion of FinTech investment, the UK attracted $16 billion, which is a huge chunk of that European market. In the first half of 2018, that helped the UK to overtake US FinTech investment for the first time. If we consider the size of the United Kingdom, for us to overtake the US in terms of total investment is really something.

Those numbers look impressive, and they are, but there are clouds ahead. I suggest that the money is still being raised easily because the successful companies that attract a lot of the equity investment are based in Britain—they were set up here. However, there is much evidence across the FinTech sector that new start-ups increasingly are created in competitor countries, in cities such as Berlin and Paris. Much of the money raised by companies—the money I was just describing—still comes to Britain, but it is spent abroad. The companies are expanding their footprints elsewhere due to worries about the short and medium-term outlook for FinTech in Britain. We need to face up to that.

The fundamental point that we need to be honest about is that Brexit has put huge uncertainty at the centre of Britain’s short and medium-term economic outlook, which affects financial services and FinTech in particular. There are many reasons for the success of FinTech over the past few years, but the key factor is that London has become the principal magnet for the best software engineers, the best inventors, and the best and most successful investors from all over the world. How will we maintain that while dealing with the challenge of Brexit?

I suggest a twofold approach. First, we need to ensure that we remain one of the best places to raise equity finance, and enable the employees of FinTech start-ups to take equity in the businesses in which they work. Will the Minister undertake to ensure that the Treasury will not seek to change the enterprise investment scheme or entrepreneurs’ relief? Will he also consider eliminating stamp duty on shares? That idea was floated recently by Xavier Rolet, the former head of the London stock exchange. Oxera Consulting calculates that the abolition of stamp duty on shares would cut the cost of raising capital for small and medium-sized enterprises by between 7% and 8.5%. KMPG estimates that that could rise to 13% for some technology companies. Cutting the cost of capital for SMEs would lead to increased growth, profitability and employment, and higher salaries for workers, all of which make revenue for Her Majesty’s Treasury while creating a more dynamic business environment.

The second approach is simple: it is about people. In recent conversations—some took place earlier this week—with major FinTech investors, they were extremely clear that the ability to hire high-quality people, and to keep them in this country away from the clutches of Paris or Berlin, is very important. The £30,000 earnings threshold proposed in the immigration White Paper should not be a huge problem for the sector, because the vast majority of the people brought in by our FinTech companies earn more than that. One consideration, however, might not have been fully appreciated: 42% of our founders in FinTech are from abroad, and when they start their business, they often do not earn much, because they are ploughing what they earn back into their businesses, so they might fall beneath the £30,000 cap.

What are the Government’s plans to ensure that founders—the talented people who are the brains behind FinTech businesses—can move easily to the UK to start their firms? If they cannot, they will go somewhere else, and that innovation and wealth, and those jobs, will go to other countries.

[Robert Neill (Bromley and Chislehurst) (Con)]

My hon. Friend is making a most powerful speech, and I agree with everything that he is saying. Does he agree that it is important to look at the means of retaining those bright graduates who come here and train? They are precisely the people who might wish to start their businesses in the UK. We need a scheme that makes it possible for them to remain in the UK, without having to leave and come back, so that they can move from graduate employment into the sector, using their skills. We would then get the brightest and best from day one.

[Bim Afolami]

I completely agree that we need to make it easier for graduates to stay. My understanding is that the Home Secretary has extended the time in which graduates may search for a job in Britain—I think up to 12 months. I would like to see that go up further, and I think the Home Secretary is quite amenable to that. We have to be honest: if we are thinking about immigration caps and the like, we should not turn away graduates, who will often be the brains of new businesses. We should help as many of them as possible to stay here; I agree with my hon. Friend on that point.

Brexit obviously dominates Parliament and Whitehall at the moment. We are in fast-moving times, so I will offer no predictions, largely because by the time anyone sees this debate, they would be completely out of date. As things stand, the political declaration that sits alongside the withdrawal agreement explains that the UK will have access to the EU market, and vice versa, under an equivalence regime. That means that the usual equivalence assessment will need to be undertaken for UK firms in the EU market, and the UK will have a similar equivalence process for the EU. Let me explain the notion of equivalence for those who are not familiar with it, with reference to the European Union. Essentially, the EU may look at a set of regulations that govern a certain area of financial services, such as bank lending, and deem another country’s regulations equivalent to its own, thereby allowing firms based in that other country to sell products to customers—individuals and firms—in the European Union.

Our reliance on an equivalence regime leaves me with three questions. First, to what extent do the Government wish to align themselves with EU regulations at a time when the European Union is pushing ahead in a much more restrictive and onerous direction, in regulatory terms? In recent years we have seen the alternative investment fund managers directive, the cap on bankers’ bonuses, MiFID II and other regulations, which were often well intentioned but have tended to increase costs, reduce Europe’s competitiveness and increase complexity. That has made accessing financial services more expensive, more complicated and not necessarily any safer for the consumer. I believe that onslaught of complicated regulation has led in part to the poor productivity of financial services since 2008. Productivity has slowed by just over 2% in the past 10 years.

--- Later in debate ---

[Robert Neill (Bromley and Chislehurst) (Con)]

It is a pleasure to serve under your chairmanship, Mr Stringer, and I warmly congratulate my hon. Friend the Member for Hitchin and Harpenden (Bim Afolami) on securing this debate on an important topic. I am sorry that more hon. Members are not present, but I hope that the quality makes up for the quantity.

I am particularly keen to speak in this debate because I have a personal and constituency interest in this matter, and because it is critical to our country. About 36% of the working population of my constituency is employed in the financial or professional services sector, and that is about the 15th highest proportion in the country. Most of those people commute to London, although the European headquarters of Direct Line insurance—one of our principal insurance companies—is based in Bromley, and is the largest private sector employer in the borough. This issue matters for the prosperity of my communities, as well as impacting on the national picture.

This debate is important, but perhaps the reason why there are not more people here is that we have come to take it for granted that we are world leaders in financial services and the allied professional services that underpin them—of which more shortly. We take it for granted that the City will always be all right. I use the City as a shorthand for the broader financial services sector because, as my hon. Friend pointed out, only about half that sector’s output is generated in London, and many of the jobs are in fact based outside.

The idea that “the City will be okay” is something that we have to challenge a little. It will be okay, provided that it continues to have the right regulatory tax, fiscal and political environment to support it. It will be okay if we leave the European Union on sensible terms with a deal that protects the interests of our market access, but it will not necessarily be okay in the event of a catastrophic exit from the EU. Although larger firms will be able to manage come what may, smaller firms, which are often the innovators in this sector, will be more at risk. That makes it all the more important that we get it right for the City and the financial services sector as we leave the EU.

My hon. Friend properly referred to the contribution made by the financial services sector to the UK economy, and it is worth mentioning the report “Total tax contribution of UK financial services”, which was issued by the City of London Corporation, to which I pay the highest respect for its work to promote the sector nationally and internationally. The report, which was published in December 2018, highlighted the fact that the industry’s contribution to the Exchequer increased over the past year to £75 billion. That is 10.9%—nearly 11%—of the Government’s total tax receipts from all sources. It is 6.6% of the UK’s economic output. The number of jobs has already been referred to. This is a critical national economic and strategic asset, and Government policy must treat it as such.

It is worth saying that access to the European markets remains important, as it should do. My hon. Friend the Member for Hitchin and Harpenden is right to recognise that there are opportunities to be had from growing our contacts and trade with emerging economies. I was in Hong Kong in September at a legal conference looking at the opportunities for British law firms and their financial services clients, in relation to the belt and road initiative. No doubt there is much that can be done there, but at the moment, often, trade with China—particularly in the service sector—comes with strings attached, and perhaps a lack of transparency about access to the relevant sectors that would frankly not be acceptable in UK terms. The same applies with India, where there are great opportunities, but where there has so far been a marked reluctance about liberalisation in the service sector. As to my profession, as a lawyer, there is marked difficulty with India in getting liberalisation in the legal services sector. I hope that the Government will give more attention to that.

I was the sort of lawyer who became involved in the matters in question if regulatory procedures had not always been properly followed, whereas my hon. Friend was someone who made sure they were. What I have pointed out makes good, robust and internationally recognised regulatory frameworks all the more important. I previously had a spell working for Scottish Widows insurance, and as a trainee jobber, when such things existed, with Ackroyd and Smithers, who were then the leading gilts jobbers. It is an area of law in which I have always taken an interest, aside from its constituency importance for me.

The benign regulatory environment is something we need to watch, as we leave the EU. My hon. Friend is right to say that sometimes EU regulators have been difficult to deal with, from our perspective. Equally, however, dealing outside the EU, with a proper free trade agreement with third countries, to include financial services, will not be without challenges. I am secretary of the all-party parliamentary group on financial markets and services and have just come from a breakfast meeting with the group to discuss the prospects of a free trade agreement in services with the United States. There are real regulatory obstacles—not least having to deal with not one regulator but, in relation to the insurance sector, for example, 50 state insurance regulators as well as a national regulator. With banks, would one be dealing with the federal regulator, the regulator in New York or the state regulator in Chicago?

There is a multiplicity of issues to be addressed, which is why it is critical that we leave the EU with a deal, and with a transition period in which we could maintain all the good aspects of market access to the EU and have time to sort out arrangements and opportunities with non-EU countries. Let us be honest and not kid ourselves—those complexities will not be sorted out overnight. It will take time, and to benefit we must be patient about how we go about things.

[Craig Tracey]

My hon. Friend is right that we need to get regulation that works, but an issue put to me by the insurance industry is that a Norway-plus model would not work for the insurance market as a whole, as we would not all be working to the same rules. The insurance rules are set at EU level, rather than on a global scale, so we need to look at the different facets of financial services, to ensure that they work for the whole market.

[Robert Neill]

That is perfectly true, and the need for the deal and for a time to thrash out our future relationships is all the more important because of it. There is not a simple scenario in which the sector works on a one-size-fits-all basis. The same thing applies to the legal services sector, which is a critical underpinning. It is worth remembering that with respect to financial flows, EU financial services trade with the UK between 2016-17 and the current time increased from £29 billion to £33 billion. That dwarfs the figure for trade with our next largest partner, the United States; it is only half, at £16 billion. The seven largest financial services markets added together—the US, Japan, Switzerland, Canada, China, India and Australia—come to only £26 billion, which is less than our financial services trade with the EU. That is why, at the same time as we look at the opportunities for opening out elsewhere, it is critical to maintain EU access, which has also been important to foreign inward investment into UK financial services as a gateway into EU markets.

It is worth bearing in mind that across measures of competitiveness London ranks as the top city and has the highest volume of financial services foreign direct investment globally. However, that is because of our current advantageous position, which we need to maintain. An important part of that advantageous position is the underpinning that legal services and the legal system give to the financial sector. I am concerned that although the Government have uttered warm words and issued advice to practitioners in the sector, real uncertainties would remain, should we leave the EU without a proper deal.

Some of the areas in question are similar to areas of concern in direct financial services, such as the loss of passporting rights, and the need to operate with a form of equivalence. However, the situation for legal services is even more stark, in some respects, because the establishment directive would go, as would mutual recognition of professional qualifications. That would not enable us to use the fly in, fly out arrangements that are so critical to enabling international law firms to advise their clients in real time while deals are going through. That needs to be dealt with, which is why, again, a transitional arrangement is critical.

The other critical point in that context is that unless we have a deal—if we leave without one—we will lose the existing arrangements for the mutual recognition and enforcement of UK court judgments in EU countries and vice versa. That is vital for contractual certainty and continuity. A contract is worthless if it cannot be enforced, and if it cannot be enforced through the judgment of a court there are no other means to do so. It is vital to find means to maintain that. TheCityUK has pointed out that losing it would mean profound difficulties in relation, for example, to insurance contracts—which would not be of value if we were to leave without the ability to enforce them in the event of default—and, significantly, uncleared derivatives. The derivatives market is particularly important to the UK. It is an area of expertise where, as my hon. Friend the Member for Hitchin and Harpenden said, financial services are not just about figures, but are relevant to real business. Most business work is now underpinned in one way or another by a form of financial instrument being traded, particularly in any significant commercial deal. That has been described as the plumbing of the business system, so anything that threatens the derivatives trade operating out of the City, and what relies on it, would be extremely dangerous.

There have been some areas of progress. I was pleased when the European Securities and Markets Authority agreed a memorandum of understanding with the Bank of England in relation to central counterparties and the central securities depository, which enables that issue of central clearing to continue. However, that is one part of a much more complex structure. There are other areas on which I hope for assurances that the Government are determined to see the issue as central to our negotiations. Those things are largely part of the future state negotiations, but we have to have a deal to get into those future state negotiations to begin with. That cannot be emphasised too strongly.

I also want to emphasise the fact that financial services and many aspects of legal services depend on the free flow of data to underpin them. At the moment that is available to us, in relation to our EU counterparties. However, unless—at least until a future state agreement is achieved—there is regulatory alignment on data sharing, we risk disruption to those data flows. That will severely disrupt the circumstances in which we could guarantee that trades could be carried out and completed. Again, insurance and uncleared derivatives are particularly vulnerable to disruption of data flows.

The City believes that an EU-level solution is the optimal one, and I hope the Government will reassure us that it is their intention to press for that, for the same reason as we spoke of before—the complexities of dealing with the 27 on bilateral agreements would be daunting to say the least, and would cause more delay, which would deter people from writing contracts while that period of uncertainty persisted. I know that a temporary solution to protect data flows is currently under discussion, relating to a non-enforcement period between regulators under what is known as a “safe harbour” precedent, but that is not guaranteed. I hope the Minister will be able to update us on progress and assure us that this, too, remains a very high priority for the UK Government.

Getting global regulation right and making it business-friendly, as my hon. Friend the Member for Hitchin and Harpenden said, is critical. Of course, the City of London Corporation provides the secretariat for the International Regulatory Strategy Group, which is a practitioner-led body comprising the leading UK financial and professional services figures. The key test of global regulation is not necessarily its quantity, but its quality and effectiveness. Thus far, the UK has been a world leader in that, and it is important that we continue to make that central to our policy.

My hon. Friend mentioned FinTech, and I am very pleased that he did, because I have constituents, including one of my councillors, working in the FinTech sector and there are real opportunities there. The ability to retain young talent in the UK is critical here; that applies also to young lawyers and to young professionals right across the board, so it is vital that we have a regime for immigration that not only does that in practice, but sets the right tone.

That is why I am pleased that we have scrapped the £65 fee for the settled status scheme; I rather regret that we ever had it to start with. I have in my constituency many EU-national professionals, working in the City of London, the west end and other sectors. They have been settled with their families in places such as Chislehurst and Bromley—commuter land—for many years, and the suggestion that they were going to have to pay to remain somewhere where they had already put down their roots and that they regarded as home sent the wrong signals. I am pleased that the Government thought twice about that, and I hope that can be reflected in the tone of our approach to our EU friends and neighbours hereafter.

However, we must bear in mind that it goes beyond that. International workers make up 40% of the City’s workforce and 35% of London’s finance and insurance jobs. Many of those are EU nationals; others will come from elsewhere, but having that welcoming and open approach is critical. Successful market economies are only successful if they have that open and broadminded approach, and it is important that we as the UK Parliament recognise and articulate that as strongly as we can.

Finally, sometimes people think that financial services are purely about profit; they see the City purely in terms of big financial institutions. The City of London does a great deal to encourage responsible business practice as well, and the two do not need to be separate. The financial services sector is one of the most active and engaged in corporate community investment across the country, as I see in some of the firms based in my constituency or where constituents of mine work.

New research that the City of London Corporation has published indicates that financial and professional services firms gave £535 million in cash and in-kind donations to various forms of community investment in 2017. It is worth saying that although a flourishing financial services sector is important to the economy, its leaders and the practitioners I know from my constituency also want to ensure that they pay their fair share not only to the Exchequer, but in kind to the communities that they serve. That is not separate from the day-to-day workings of our economy and our lives, but central to it, and I hope that this debate helps to bring that home.

[Graham Stringer (in the Chair)]

Just before I call Lee Rowley, I will say that I intend to call the Scottish National party spokesperson at 10.30 am.