By Catherine McBride – 9 minute read
Financial, Insurance and Pensions, and Other Business services are the UK’s largest export industries, but they are threatened by high corporate taxes and low productivity – caused by overly prescriptive regulations, listing requirements not followed by other countries and disproportionate ESG reporting rules – all coupled with very expensive electricity. Together these threats make the UK less competitive with its rival financial centres and could destroy this thriving sector of the UK economy.
THE UK’S SERVICE EXPORTS now make up 48% of the UK’s total exports. The UK’s three largest service exports – Financial services, Insurance and Pensions, and Other Business Services – account for over 60% of total UK service exports. These three service sectors have been growing steadily since 2016 with Financial Service exports up 24%, Insurance and Pensions up 50% and Other Business Services up 72%.
Other Business Services are now not only the UK’s largest service export sector, but they are also larger than any goods export sector. In 2022 the UK exported £124.4 billion of SITC 7 Machinery and transport equipment, our largest goods export sector, but a massive £149.2 billion in Other Business Services.
While The City’s service exports are worth celebrating, the UK cannot be complacent that these businesses will remain in the UK indefinitely. Service businesses are generally multinationals, with little plant or equipment tying them to the UK. It would be very easy for these companies to move their revenue centres to other parts of the world. If the UK is to remain a global financial centre, then it needs to be competitive with its rivals: New York, Singapore, Hong Kong, San Franciso, Los Angeles, Shanghai, Washington DC, Chicago and Geneva.
Some of the issues that could drive service businesses out of the UK are:
The massive growth in service exports happened when UK corporate taxes were 19%. In April this year corporate taxes were increased to 25% for companies who make more than £250,000 in profits. And although the Government now allows full expensing of plant and equipment, most service industries don’t have large amounts of plant and equipment.
Meanwhile in other financial centres that rival the UK: headline US Federal Corporate Tax is only 21% with a corporate minimum tax of 15%. Individual US states can also add corporate taxes: New York, headquarters of JPMorgan Chase the largest bank in the US, has a corporate tax rate of 7.25%, while North Carolina, headquarters of Bank of America, the 2nd largest bank in the US, has corporate taxes of only 2.5%. But there are several US states that have no corporate taxes: Texas, Washington, Wyoming, Ohio, Nevada and South Dakota.
Taxes are even lower in Singapore where corporate taxes are 17%, the UAE where corporate taxes are only 9% and in Switzerland where the federal corporate tax rate are only 8.5% although some Swiss Cantons add additional corporate taxes making the effective combined tax rate 12% to 22% – both still lower than London.
Booking profits elsewhere is easy to do, as we have seen with US tech firms who run their profits through Ireland whose corporate taxes are presently 12.5% but will increase to 15% in 2024. In 2021 Ireland’s largest corporate taxpayers were all companies normally thought of as US multinationals: Apple, Microsoft, Google, Pfizer, Merck Sharpe & Dohme, Johnson & Johnson, Facebook, Intel, Medtronic and Coca-Cola. So the UK Government shouldn’t imagine that legal profit diversion couldn’t also happen from the UK if our corporate taxes are higher than other countries.
2. Revising regulations inherited from the EU
It is also important to note that much of the growth in these service exports has been to non-EU destinations. The US is by far the UK’s largest trading partner for financial exports which are as large, or in the case of Insurance and pensions twice as large, as export to all twenty-seven EU countries combined.
But other non-EU markets for service exports are also growing. Since 2016 Financial Service exports to China are up by 53%, to India by 62%, to Singapore by 100% and to Hong Kong by 127%. Total Financial Service exports increased by only 8% to EU destinations between 2016 and 2022 but increased by 33% to non-EU countries and are now worth more than double the value of financial service exports to EU countries. The UK’s Insurance and Pension exports have always been predominantly to non-EU countries which make up 84% of the UK’s exports in this sector.
While Other Business Services grew by 72% between 2016 and 2022, and again the US is the UK’s largest export market with exports worth £52 billion in 2022, an increase of 136% since 2016. However, Other Business Service exports also increased between 2016 and 2022 to China by 77%, to India by 106% and to Canada by 166%. Total Other Business services exports to Non-EU markets are worth 70% more than exports to EU markets.
But despite most of our Financial, Insurance and pensions and Other Business service exports going to non-EU countries, the UK is still laden with many EU regulations such as MiFID II, CRD IV, Solvency II etc. Unfortunately this is being changed very slowly.
However the UK’s Financial Conduct Authority (FCA) can change regulations very quickly when they want to. As they did for the ridiculous EU Double Volume Caps that hit UK equity trading more than any other EU market, for the MiFID II ‘Best Execution’ regulations (RTS 27 and 28) that made no difference to transactions, and for the requirement to pay for research on companies with market capitalisations below £200 million or on fixed income, currency and commodity instruments.
But other reforms such as changes to short selling regulations or unbundled research on larger companies have been much slower, even though unbundled research payments have put UK asset managers at a disadvantage relative to US and other non-EU managers who do not have to pay for research. While short sellers keep market valuations realistic and as the world enters a period of lower growth, may be more profitable than being long.
The UK Treasury is proposing to remove restrictions on uncovered short selling of Sovereign Debt and Credit Default Swaps (CDS), the requirement to report short positions to the FCA and to amend the market maker and authorised primary dealer exemptions. This is a welcome change as other rival financial service jurisdictions, such as the US and Singapore, do not have restrictions on short selling sovereign debt and CDS. The Treasury is also planning to replace the public disclosure of the short equity positions of individual investors with an aggregate short position for each issuer.
But The Treasury’s timing grid from its July 2023 publication Building a smarter financial service regulatory framework shows the Statutory Instrument making changes to Short Selling Regulations won’t be tabled before parliament until 2024 – four years after the UK left the EU.
3. Service Industry Productivity
While low productivity in goods production is generally blamed on the use of labour rather than machinery, low service industry productivity is due to too many compliance cost-centres. By trying to make investing ‘risk-free’ and protect people, banks and companies from bad decisions, the government has also greatly increased the number of compliance and risk staff employed in most financial service industries. It is difficult for a service industry to improve its productivity if a large proportion of its staff are not growing the business but are employed to complete mandatory regulatory compliance.
The best way to protect companies and investors is to make them aware that no one will save them from their own mistakes. Companies need to take responsibility for monitoring and limiting their own risks and have reserves if or when things go wrong. Private investors need to revert to buyer beware attitudes – if something sounds too good to be true, or even if it sounds like a sensible investment, they should still research the risks and returns. Financial education in schools would be more useful than forcing everyone to study maths.
4. Meritocracy in staff and management selection
The most important element of any successful service industry is its staff so it is vital that firms can hire the best person for the job, based on performance, experience and skills and not be coerced into employing staff or board members for their immutable characteristics.
Yet the UK’s FCA now requires 40% of a listed company’s board members to be women with at least one woman in a senior board position (Chair, CEO, CFO or Senior Independent Director) and at least one non-white ethnic minority board member. This must be included in their annual financial reports (on a comply or explain basis) as well as a numerical table of the gender and ethnic diversity of their board and executive management.
But amongst the UK’s rival financial service centres:
- The New York Stock Exchange has no such DEI board requirements for listed companies.
- Nasdaq listing rules only require 2 diverse company directors: one woman and one from an ethnic or LGBTQ+ minority group. While foreign issuers on Nasdaq and SMEs are not required to have an ethnic minority board member and companies with five or fewer directors only need to have one diverse director. Nasdaq also requires companies to publish a Board Diversity table, by gender and ethnicity.
- Hong Kong has mandated that all listed company boards must have at least one woman director by 31 December 2024. Hong Kong will be the first exchange to make this mandatory, rather than simply use ‘comply or explain’ rules.
- The National Stock Exchange of India requires its top 100 companies to have one ‘independent’ female board member. Independent as in not related by birth or marriage to any senior executive in the company.
- The listing requirements of Nasdaq Dubai do not mention diversity and inclusion.
- While interestingly the Singapore Exchange requires listed companies to maintain a board diversity policy based on gender, skills and experience and to explain how their board’s skills, experience and diversity serves the needs of the company. This seems to be a much more sensible idea and would prevent box ticking appointments.
The UK’s DEI listing requirements put the UK at a disadvantage when trying to attract new listings. Besides, the UK’s financial, insurance and business services have very ethnically diverse staff due to the many different markets they serve. While as female students are now the majority in both undergraduate and master’s programs in UK universities, they are also likely to make up the majority of candidates applying for City jobs that require these degrees.
For the FCA to require City firms to employ staff for any reason other than merit, is an anathema. Investors are interested in reliable advice, investment returns and custodian services regardless of the ethnicity or gender of a firm’s staff. The fastest growing companies in the world in the last decade have been: Facebook (Meta), Amazon, Tesla, Apple, Netflix and Google (Alphabet). But none of them have a female founder nor do they now have female CEOs, although Tesla has a female Chairwoman, Robin Denholm, and Google and Meta have female CFOs, Ruth Porat and Susan Li. But I very much doubt that Denholm, Porat or Li were promoted to their positions to meet an exchange listing requirement. I doubt FCA level, 40% female Board quotas would have made these companies more profitable or more interesting to investors.
5. De-banking their most important input – electricity
Despite evidence to the contrary, the de-banking of individuals for their political views is against FCA Regulation 18 of the Payment Accounts Regulations 2019 which forbids all types of discrimination by credit institutions against customers. But the UK economy has an even greater problem as many banks, asset managers and insurance companies are de-banking our vital energy industry in order to meet their Environment, Social and Governance (ESG) targets. Ironically, banks, fund managers, insurance companies and consulting firms rely on electricity to run their dealing rooms, financial records and data storage servers. The UK Energy Research Centre, estimates that running the 80,000 data centres in the UK used over 11% of the UK’s total electricity generated in 2016.
But the UK used gas and coal to produce 37% of its electricity in the last 12 months, renewables only supplied 36%, nuclear supplied 20% and transfers made up the balance. Whenever the wind drops, the UK’s gas and coal fired generators step in to keep our electric grid at 50hz, and whenever the wind is so strong that wind turbines must be turned off, again gas and coal fired turbines step in. And when the wind is not too weak or too strong, we turn down the gas generator, but we never turn them off.
The UK had the third highest priced electricity including taxes and levies in the 26 developed countries measured by the International Energy Agency in 2022. While the UK’s main financial centre rival, the US, had the cheapest industrial electricity, less than half the price of the UK’s, while in Switzerland, another financial service rival, electricity is roughly three quarters of the UK price.
If the UK wants to remain a competitive place for financial services, then not financing new UK gas developments but instead relying on imported Liquid Natural Gas from the US and Qatar, will not help. While black-outs or rolling brown-outs would drive Financial, Insurance, Pension and Other Business services out of the UK completely.
6. Climate related risk reporting requirements are beyond the life span of most companies
All UK listed companies, banking and insurance companies, and registered companies with more than 500 staff are required to disclose extensive information about their governance arrangements for assessing and managing climate-related risks and opportunities. The UK was the first country to make compliance with the Task Force on Climate-related Financial Disclosures (TCFD) mandatory for all UK large companies in April 2022. As at Oct 2023 TCFD disclosures have also been made mandatory in Brazil, Egypt, New Zealand, Singapore and Switzerland. None of these countries are known for being industrial powerhouses.
The international TCFD are designed to allow investors to understand how risks and opportunities relating to climate change are identified, considered, and managed and how they could affect the business. The Government also requires the assessment of the appropriate time periods over which climate risks and opportunities are expected to affect the business.
However, according to Companies House, the average UK company lifespan is just 8.5 years. Even in the US, the average corporate lifespan of an S&P500 company is only 21 years. So why is the government asking companies to spend time worrying about how climate change will affect their businesses in the future rather than ensuring their core businesses are successful and endure for more than 8.5 years? After all, according to NASA global sea levels have only increased by 8 inches during the last 130 years while the average temperature increased by 1.3Caccording to the IPCC. A lot of UK companies went out of business during the last 130 years, but none because of climate change.
Financial, Insurance and Pensions and Other Business Services are now the UK’s largest export industry and could have a great future, but our regulators need to allow companies to concentrate on their core business, assess their own risks and employ the staff they believe are most suited to their requirements especially as service exports grow to countries with different customs, concerns and priorities.
Catherine McBride is an economist and the author of Brexit and UK trade – What has changed? a paper analysing UK trade performance by sector since Brexit. She is a member of the Government’s Trade and Agriculture Commission.
Panorama of City of London by moofushi via Adobe Stock