Features
12 Jul 2013 08:59am

Right on the money

As the UK government looks to rebalance the economy to reduce the emphasis on financial services, Iwona Tokc-Wilde runs the figures to see exactly how the sector’s contribution stacks up

According to the Office for National Statistics (ONS), British service industries helped the UK avoid a triple-dip recession by growing 0.6% in the first quarter of the year. Of all the services, the financial and professional business sector increased by 0.2% – and by 1.6% since March 2012. This growth, together with sluggish investment, poor manufacturing and rising trade deficit, suggests that the Coalition’s strategy of rebalancing the economy away from financial services (and consumer spending) to manufacturing, investment and exports is not yet working.

“The real issue is not so much that the financial sector is too big, it’s more about what the rest of the economy has to do to grow,” says Iain Coke, ICAEW head of financial services. But what is the real value of financial services to the UK’s economy? Here we take a closer look at the sector’s performance in 2011 and 2012.

London is the place to be for foreign private wealth

According to the most recent data available from TheCityUK, financial and related professional services contributed £195bn to the UK economy in 2011, representing 14.5% of UK GDP. The financial sector’s 9.7% contribution to UK GDP was significantly smaller than in Luxembourg (23.5%), smaller than in Ireland (10.7%), but larger than in Cyprus (8.9%), France (4.7%) and Germany (4.4%.)

Financial services have long been a key source of UK tax revenue, too. According to a report from PwC/City of London Corporation, the £63bn tax the sector paid in the 2011/12 financial year accounted for 12% of total UK tax receipts, broadly in line with the previous four years. VAT and National Insurance contributions accounted for almost 60% of the taxes borne by firms in the sector, the bank levy raised £1.6bn and the corporation tax paid by City firms came to £5.4bn. Mark Boleat, chairman of City of London Policy and Resources Committee, says: “The sector remains a major contributor to the UK’s total tax take despite the eurozone crisis and regulatory reforms impacting on the profitability of banks.”

Although UK exports grew in 2012, imports rose even faster, pushing up the UK’s current account deficit to nearly £58bn. Yet the financial services sector made the largest single contribution of any sector to the country’s net exports. Its trade surplus for 2012 was £44.9bn, nearly the same as the combined surplus of all the other net exporting industries in the UK. In 2011, the sector’s trade surplus was £47.2bn, more than double that of the next largest trade surpluses recorded by the International Monetary Fund (IMF) for Luxembourg, Switzerland and the US.

According to TheCityUK report Key facts about UK financial and professional services, the UK’s major trading partners in financial services are the US, the EU and other advanced economies such as Switzerland, Japan, Australia and Canada. However, the real potential for growth lies in the emerging markets, including Brazil, Turkey, China and Russia. Deloitte’s Winning in growth markets report suggests Britain could become a world leader in knowledge- and technology-intensive services as the demand for more sophisticated, expertise-based goods and services rises in 20 growth markets identified by UK Trade & Investment. “The challenge for a service business is to develop a very tightly defined niche that will allow it to compete in those local markets and we’ll see more of this happening in financial services,” says Chris Gentle, head of Deloitte Insight and co-author of the report.

As at 31 March 2013, the London Stock Exchange had a domestic market capitalisation of $3.846trn. This means that, by this measure, it overtook Tokyo as the second-largest stock exchange in the world. According to TheCityUK, UK companies raised £286bn through share issue between 2006 and 2011, with £236bn raised on the London Stock Exchange and £50bn in private equity. The Confederation of British Industry (CBI)estimates that British-based private equity firms currently back around 3,800 companies, which employ over half a million people in the UK.

A total of 1,115 companies are quoted on the AIM market, the largest share market for small companies in Europe. “AIM has supported the growth of more than 3,370 companies since its inception in 1995 and enabled over £80bn of equity capital to be raised, with over £35bn raised by companies at the time of admission, followed by £45bn of further fundraising, demonstrating the important role of AIM in supporting growth after admission to market,” says Philip Secrett, partner at Grant Thornton UK.

“This has delivered major economic benefits to the UK economy in terms of a significant contribution to employment, tax revenues to the Exchequer and indirect GDP contribution.”

Supporting SME growth

Traditionally, unquoted companies looking to raise finance turned to banks. TheCityUK estimates that, in mid-2012, loans made available by major banks to UK businesses totalled £450bn, including £160bn lent to SMEs. Yet a report by market research firm BDRC Continental reveals that only 45% of SME applicants managed to secure a bank loan last year.

The Bank of England’s Financial Policy Committee has recently said banks will need to find a further £25bn to fill the capital hole by the end of the year, and this is likely to reduce lending further, at least in the short term. “Banking and other providers of credit are key to recovery,” says Iain Pickard, head of financial services at RSM Tenon. “In the absence of traditional sources of finance, the role of innovative new players, such as peer-to-peer lenders, will become increasingly important.” Peer-to-peer lending, which includes models such as social lending and crowdfunding, has already transformed how businesses are bankrolled. “Many of the P2P lenders are already advancing more than £1m per week,” says Richard Carter, CEO of financial consulting firm Nostrum Group.

Another form of alternative lending – pension-led funding – is also starting to make waves. Adam Tavener, chairman of Clifton Asset Management, says that 80% of UK companies “hold intellectual property which can be bought by the owner-director’s pension scheme.” Clifton has so far assisted more than 1,200 businesses, helping to secure 10,000 jobs in the process and influencing UK payroll and corporation taxes of £100m a year. “Given that 90% of the UK’s business economy is made up of SMEs and that £100bn is currently available in SME business owners’ pension pots, this could be the economic stimulus the government is searching for,” says Tavener.

Leading employer

The UK’s financial and related professional services employ more than 2 million people, accounting for 7% of total UK employment, according to the ONS Business Register and TheCityUK estimates. “And it’s not all

Financial services need to regain public trust, too, after the PPI mis-selling, rogue trading, Libor-fixing and all the other scandals of the past few years

 about London,” says Coke. More than two thirds are employed outside the capital, including 148,600 in Scotland, 61,200 in Wales and over 200,000 in both the north-west and south-east of England. The majority are employed in banking (451,100), management consultancy (361,900), insurance (318,200) and accountancy (285,800).

Nearly a million people have accountancy qualifications administered by the UK’s professional bodies, which is where many of its business leaders spring from. Currently, for example, 81% of FTSE 100 companies have at least one chartered accountant on their board, and 59% have a chartered accountant as chairman, CEO or CFO. “With the increasing focus on governance, audit committees and risk management in particular, financial regulators are looking at who’s on board and what they contribute. This creates a need for board members with accounting or finance experience,” says Coke.

London was ranked first in the March 2013 Global Financial Centres Index. “We are a world-leader because of the sheer concentration of professional skills and support services, the fact we are a relatively open market and we have a legal system people can trust,” says Coke. “The regulatory environment has come under pressure, but it’s probably still an advantage, too.”

According to TheCityUK, there are over 1,400 financial services firms in the UK that are majority foreign-owned, from around 80 countries. London has 251 foreign banks, more than its nearest rivals New York, Paris and Frankfurt, holding nearly half of the UK’s banking sector assets, while UK-owned banks have over half of their assets outside the country.

The UK is also one of the largest hedge fund markets (18% global market share in 2012), an important centre for global equity trading (7% share of the global equity market capitalisation), and a major centre for issuance and the trading of international bonds (16% of the global total and second only to the US).

London is the place to be for foreign private wealth, too. According to The Wealth Report 2013 from Knight Frank, Britain’s capital is the second-top city in the world by high-net-worth-individual population (6,015 of the world’s HNWIs lived there in 2012), after New York. This also boosts jobs in the sector. Martin Graham is chairman of the advisory board at Oracle Capital Group, looking after wealthy Eastern Europeans, overseeing a total client wealth of several billion pounds. “We help them with relocation to London and pre-immigration tax planning,” he says.

Regulation is an issue

The UK insurance industry is the largest in Europe and third largest in the world. The UK is the global market leader in marine insurance with a 21% market share in 2011. The London market is the world’s largest international insurance market, with gross premium income of £41.7bn in 2011. According to TheCityUK, it’s the only place where all of the world’s 20 largest international insurance and reinsurance companies are active. And let’s not forget brokers and industry support services: “The total contribution of the UK general insurance brokers to UK GDP is 1%, the same as the entire agricultural sector,” says Katie Small, director at RK Harrison Insurance Services.

Yet, despite the world-leading performance of the various sub-sectors, overall the financial services have contracted, with banking and insurance activity down 9% since 2007. “The weakness of the economy is a problem for the sector – ultimately, it does rise and fall with it,” says Coke. There are also several other challenges ahead, like the need to rebuild balance sheets, with many parts of the sector now facing tighter capital requirements.

Financial services need to regain public trust, too, after the PPI mis-selling, rogue trading, Libor-fixing and all the other scandals of the past few years. “There’s been too much focus on the short-term and the sales culture, and not enough on thinking about the client first,” says Coke. “We need to build a culture of professionalism, ethics and integrity. That is a challenge. It won’t be easy and it won’t happen overnight.”

Finally, there is the issue of over-regulation and what it entails. “It could be argued that the emerging threat to the City of London is not Paris or Frankfurt but Luxembourg, as the affordability of regulatory compliance rather than taxation is becoming an issue,” says Hugh Morris, vice president, business development banking, EMEA at Genpact. “Organisations are exploring regulatory arbitrage to minimise costs and this is likely to change the financial map, with the dilution of capital and expertise availability to other locations like Luxembourg, Singapore or Dubai.”

Iwona Tokc-Wilde

 

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