City of London Economic Research

Improving International Access to Credit Markets

By report author Iain Clacher, Associate Professor in Accounting and Finance, Deputy Director of the Centre for Advanced Studies in Finance (CASIF) at Leeds University Business School and Associate at Research Republic.

 

Our latest study, published by the City of London Corporation, ‘Improving International Access to Credit Markets’, shows the increasingly important role that credit markets and innovations in credit markets have played since the financial crisis of 2008. This has been driven by two key factors. The first is the squeeze of bank lending resulting from the demands of recapitalisation and new regulations. The second, as the figure below shows, is an increasing demand for credit in emerging economies.

Emerging Market Corporate Bond Composition

Source: IMF FSR 2015

As part of our analysis, we developed the Credit Market Assessment Framework, which allowed us to undertake a detailed examination of credit markets in 59 countries. These countries account for 91% of global corporate bond issuance and 87% of global GDP. The results show clear trends in the growth and development of well-functioning credit markets and highlight key areas that need to be addressed for each country. Countries with credit markets at the earliest stage of development need more robust legal systems, better bankruptcy and insolvency processes, and a broader investor base. In addition, for some of the most developed markets there are clear agglomeration effects, and this scale is a significant source of competitive advantage.  

Moreover, the analysis shows those countries that have the highest capacity to grow their credit markets and increase the use of debt finance to support economic growth.

In addition to the development of the Credit Market Assessment Framework, we also conducted in-depth case studies across 11 countries: China, Germany, India, Japan, Mexico, Nigeria, Norway, Singapore, the UK, the US, and Vietnam. These cases look at specific credit instruments in each country and highlight the key challenges and opportunities for each market. 

While many of the developed countries in our sample are in a process of deleveraging, it is in these markets that we are also seeing significant amounts of innovation. From our analysis, there are at least three significant areas of innovation:

1. The first is the implementation of the Capital Markets Union. The potential of a pan-European private placement debt market could result in a much more efficient allocation of capital across Europe. This development would allow much of the long term capital that is desperately seeking yield at a time of ultra-low interest rates to find investments that meet this need. At the same, it would allow firms in search of finance access to pools of capital at a time when bank finance is harder to obtain.

2. The second is the development of peer-to-peer lending. As a result of the financial crisis, many firms have struggled to find the finance that they need, while at the same time, investors have struggled to find yield. Consequently, in the UK for example, peer to peer lending tripled between 2013 and 2015 and consumer and business lending was approximately £3bn in 2015. While this is nowhere close to the value of lending that occurs in mainstream credit markets, this is nevertheless a growing area of importance and is likely to see significant growth in the coming years.

3. The third is green bonds. As the global shift towards a low-carbon economy continues, investors are increasingly looking for sustainable forms of investment. Green bond issuance is an important and growing feature of this new landscape. In 2014, it stood at $37bn - up from around $1bn in 2007. Moreover, this demand is not just occurring in developed markets. The developing Asian markets are a major source of demand for green finance. 

As the City looks towards the future, it should seek to develop and grow these areas in order to maintain the UK’s competitive standing as a global, diverse, and innovative credit market.

 

 

To download a free copy of the report, click here.

 

‘Evidence-based policy making’ - oxymoron, fable or feasible?

This blog post is co-authored by Sabrina Basran, a former Research Officer at the City of London Corporation, and Gareth Reilly, who has recently joined the City of London Corporation as a graduate trainee.

Gareth Reilly:

The case for using well informed and well-rounded data within the policy process is, arguably, one of common sense, yet at times common sense doesn’t prevail. On many occasions data is used in the wrong way or insufficiently; not enough is taken into consideration for a proper informed policy to be formed.

Using data within policymaking can contribute to its efficacy in several ways: accurate information can help define the issue which the policy is trying to resolve and it allows the scope to be narrowed to focus on specific areas, which in turn allows targeted options to be formed on how best to take the policy forward. Robust and informed data is always likely to help policymakers make accurate predictions about what impact the changes will have once implemented as well as acting as a point of referral for future work, in order to evaluate a policy’s success or failure.

Accurate data can also help increase the longevity of a policy. Whilst numbers and statistics are constantly changing, research can, if well thought-out, be used to shape policy in such a way that it is effectual in the longer term. One prime example of this is the work which was carried out on Growing the Social Investment Market. Not only did the research assess the existing market, but it also carried out an economic impact assessment for the first time providing new, detailed baseline information on the market which has since helped act as guideline for policy considerations as well as contributing to the formation of the Social Investment Research Council.

As a recent graduate trainee joining the Economic Development Office I hope to be able to make a worthwhile contribution to the research process and potentially the policy making process. As such, it is paramount that I practice what I preach and ensure that the data I use is of the best quality and the most relevant to the topic at hand. 

Sabrina Basran:

It’s always exciting to have somebody new in a team, and to hear a fresh perspective on how research can be used, to help ensure that the Corporation’s programme remains relevant. It’s my personal view that it is essential for any practical initiative or public policy to be evidence-based, in order to be effective. Gareth’s comments echo this, though he also raises the important point that there needs to be careful consideration from the research side, to ensure the right data is used. 

The Corporation plays a key role in supporting and promoting London as a leading international financial and business centre and the encompassing aspects of this – from helping local communities to improving the City and London’s attractiveness to businesses and visitors, to enhancing the capital’s position as a cultural hub. It is paramount then for the Corporation to use a well-researched, factual and evidence-based approach to dealing with key policy decisions in order to best serve not only the City, but London more widely and the UK as a whole.

To enable us to do so, our economic research programme spans a variety and range of topics – competitiveness, the UK economy, the EU and regulation, infrastructure, corporate social responsibility (CSR) and London communities to name a few  – with each topic underpinning and helping to inform the Corporation’s policy priorities and strategic areas of focus.

There are a number of examples where we have used research to achieve policy objectives:

• A paper exploring the threats facing London’s trees in the form of new and emerging pests and diseases – this helped to secure £1.5 million in Government funding for a project to fight oak processionary moth.
• Identifying and assessing good practice examples of employee health and well-being programmes amongst large firms based in the Square Mile to act as a benchmark for companies looking to support their employees and be used as a basis for engagement with firms starting on their employee health journey, as reflected at the report’s launch at the ‘Business Healthy’ conference.
• Presenting a rationale and justification for a tax relief for investors in social enterprises – this report, co-commissioned with Big Society Capital, informed Chancellor George Osborne’s announcement of a social investment tax relief in the 2013 Budget.

While by no means perfect, these examples help to demonstrate the value that can be achieved, when we get the right information to the right people in the right way. If there’s one thing I hope to take away from my time at the Corporation, it is this.

What does London contribute to the UK economy?

By Charles Davis, Director, Cebr

Understanding the budget deficit across the UK

It’s the burning question as we hit the six months to the UK general election: how will the budget deficit be reduced? While we don’t have the answers to this – that’s up to the politicians – we have assessed which parts of the UK contribute what to the public finances. The team I have led at the Centre for Economics and Business Research (Cebr) have crunched the numbers to understand how the changing shape of the economy affects the contribution of London, its boroughs and the rest of the regions and countries of the UK to generating taxes for the government as well as how much is spent in each respective area.

London leads UK economic bounce back

The results are fascinating: despite the financial crisis hitting the City hard, London has shown a remarkable ability to reinvent itself and a resilience to bounce back from a challenging economic environment and lead the UK economic recovery. Our research shows that London will be the fastest growing regional economy across the UK in 2014, driven by a fast-growing IT & communications sector and the UK capital’s strength in professional and business services, with a depth of expertise that few other cities around the world can come close to rivalling. The dynamic boroughs of Westminster and City of London generate almost £100 billion in economic output between them while the fastest growing boroughs over the last ten years have been Tower Hamlets, Islington and Southwark. While London is the fastest growing regional economy, the rest of the UK has also returned to economic health in 2014 and this has seen unemployment drop to its lowest level since before the financial crisis. What does this mean for the UK public finances across the UK?

Introducing a new approach to understanding public finances across the regions

Working this out is no easy task; while we (mostly!) have relatively clear information from HM Treasury on where public money is spent and on what around the country, for many elements of government revenue – which is mainly taxation – it is much harder to understand where the money comes from. Attacking this problem, the analysis we have produced is unique in that it allocates tax revenues according to our best estimate of where the respective economic activity takes place. Many previous studies have tended to look separately at approaches that are so-called ‘workplace-based’ i.e. allocating tax to where people work and ‘residence-based’ i.e. where they live. Neither of these is completely satisfactory. Our analysis attempts to allocate, line by line for each tax revenue, where the economic activity that generates the tax takes place.

London economy makes a £34 billion net positive contribution to UK public finances

The results are fascinating – especially in the context of further promises of devolution in Scotland and indeed around the rest of the UK – London is found to be making a major £34 billion positive net contribution to the UK public finances. The South East also makes a positive contribution – a £22 billion surplus – and the East of England is very slightly in positive territory at £181 million, but the rest of the UK’s 12 constituent countries and regions are in deficit. The largest estimated deficits are in the North West, Yorkshire and the Humber and Scotland. However, this is distorted by the size of the population; in relative terms the largest deficits are in Northern Ireland, Wales and the North East.

Looking forward, we expect London is expected to continue growing at a faster rate than the rest of the UK due to its dynamism and status as major global trading hub and financial centre. This is expected to see it make a major contribution to reducing the UK’s budget deficit over the coming years as it continues to generate tax revenues that support public spending right across the UK. You can explore in more detail by reading the report, London's Finances and Revenues. 

The impact of the proposed financial transaction tax on European households’ savings

By Shaan Devnani, Senior Economist, London Economics

The revised EC proposal for a financial transactions tax (FTT) landed on the desks of policymakers a year ago this month. However, the potential introduction of the tax in 11 Member States is a subject that is keenly debated today because, among other reasons, its effects are still not very well understood. To add to our understanding of the effects of the tax, we, London Economics, recently researched what its expected effects would be on household financial savings.

Financial assets are an important instrument for saving for European households, providing them with access to emergency funds and allowing them to build future retirement income.

Households save through various types of financial assets. In the UK for instance, life insurance and pension funds are important instruments for savings, making up over half of financial savings. Meanwhile, in Italy, 40% of household savings is invested directly in financial markets. 

The EU proposal for a FTT covers secondary market transactions in a broad range of financial instruments. If introduced, the tax would affect the returns to financial savings households could achieve to the extent that the financial assets they trade (or are traded on their behalf by insurers or pension fund managers) attract the tax.

Specifically, we study the 'instantaneous price adjustment' of financial assets resulting from the tax: Part of the value of financial assets arises due to low transaction costs. With the introduction of a tax on transactions, this aspect of the value of financial assets would fall and be reflected in the price of financial assets. There exists a significant body of empirical evidence supporting the existence of instantaneous price adjustments. ^[1,2,3,4,5] 

We capture the size of the instantaneous price adjustment on equity and debt securities by calculating the tax incidence on household portfolios of financial savings given current trading patterns. This is achieved by identifying the assets held in household portfolios using Eurostat and IMF data; and trading data from, among others, the Federation of European Securities Exchanges (FESE).

The results of the analysis show that the impact of the FTT on household savings is expected to be large in some Member States. In countries that plan to introduce the tax for example, among the countries studied, the impact is in the order of €80bn (Spain) to €200bn (Italy), representing a loss of as much as 15% of the value of the assets being taxed.

This is a multiple of annual household savings in some Member States. If the tax were introduced in Spain for example, households would have to save for an entire year in order to restore the value of their savings to their level prior to the introduction of the tax; in Italy, they would have to save for eighteen months.

The key results from our research are shown in table below for a selection of EU Member States. ^[6]

Total impact of the FTT on household savings in equity and debt holdings
	Reduction in the value of equity and debt holdings
	€bn	Percentage of equity and debt holdings	Percentage of GDP1
Participating Member States
Germany	-150.6	-14.1%	-5.8%
Italy	-204.9	-12.3%	-13.0%
Spain	-79.6	-16.0%	-7.6%
Slovakia	-0.1	-2.3%	-0.1%
Non-participating Member States
United Kingdom	-4.4	-0.6%	-0.2%
Luxembourg	-0.4	-2.2%	-0.9%

 It is important to observe that this study considers the immediate effect of the introduction of the tax on savings. In the long-term, or, on an ongoing basis, savings may also be affected through other channels; for example, due to the effect the tax is expected to have on the cost of capital and in turn GDP, as discussed in previous research. ^[7]

The research is available to download for free from the City of London's research website.

^[1] Jackson, P.D. and O’Donnell, A.T. (1985). The effects of stamp duty on equity transactions and prices in the UK stock exchange, Bank of England Discussion Paper, No. 25.

^[2] Umlauf, S. (1993). Transaction taxes and the behaviour of the Swedish stock market, Journal of Financial Economics, 33, pp. 227-40.

^[3] Saporta, V. and Kan, K. (1997). The effects of stamp duty on the level of volatility of UK equity prices, Bank of England Working Paper No. 74.

^[4] Oxera (2007) Stamp duty: its impact and the benefits of its abolition, Report prepared for the ABI, City of London Corporation, IMA and London Stock Exchange, May.

^[5] Best, M.C. and Kleven, H.J. (2013) Housing market responses to transaction taxes: evidence from notches and stimulus in the UK. Mimeo.

^[6] Six Member States were chosen to reflect those intending to participate in the tax and those not intending to participate and to reflect a mix of sizes and geographies.

^[7] 'The impact of a financial transaction tax on corporate and sovereign debt', City of London

Implications of a financial transaction tax for the European regulatory reform agenda

By Martin Walker, Head of Securities Tax & Kai Kohlberger, EMEA Centre for Regulatory Strategy, Senior Manager at Deloitte

The proposed financial transaction tax (FTT) would not improve financial stability with its impact on stability likely to be negative or, at best, neutral – this is the overall finding of the Research Paper published today by the International Regulatory Strategy Group, City of London and TheCityUK which is authored by Deloitte.

The FTT is a proposal to tax certain financial transactions (broadly, secondary trading of shares, bonds and derivatives) where there is a “connection” to at least one of the EU Member States implementing the tax (currently 11 Member States are in ongoing discussions).

Some of the key findings of the Research Paper are as follows:

Implications for European regulatory reform agenda

• There is a direct conflict between the FTT and the general regulatory objective of banks strengthening their balance sheets, to the extent that banks bear the significant costs of FTT.
• The FTT risks counteracting the European Central Bank’s post crisis efforts to wean Eurozone banks off ECB liquidity and into secured funding markets, as the FTT taxes secured funding.
• The FTT could undermine the objectives of the Recovery and Resolution regulations designed to deal with distressed financial services groups (“living wills”) by adding complexity to the process.
• There will be market fragmentation of the EU between Member States participating and not participating in the FTT. This would have adverse consequences in many areas, but most notably for EU collective investment schemes (UCITS) – so far, UCITS funds have been one of the biggest success stories in harmonisation and integration in the market for financial services in the EU. Consequences of the FTT for UCITS funds could be reduced returns for investors and business models becoming unviable.

Implications for the wider economy

• The FTT, if implemented, will increase the costs of trading activities and, in effect, the cost of capital, not just for the financial sector but for the wider economy and could negatively impact the collateralisation of debt. This will have a “dampening effect” on the EU economy, i.e. a negative impact on GDP and economic growth, including the cost of the FTT being passed onto end consumers.
• The FTT could provide an incentive for companies looking for finance to choose sources of funding such as bank loans which are not subject to the FTT, affecting the supply of corporate bank loans.

A copy of the Research Paper is available on the City of London website.

The Research Paper is co-authored by Martin Walker, Head of Securities Tax in the Deloitte Financial Services Tax Group, and Kai Kohlberger, is a Senior Manager in the Deloitte EMEA Centre for Regulatory Strategy.

http://www.deloitte.co.uk/financialtransactiontax

Deloitte LLP is the United Kingdom member firm of Deloitte Touche Tohmatsu Limited (“DTTL”), a UK private company limited by guarantee, whose member firms are legally separate and independent entities. Please see http://www.deloitte.com/uk/about for a detailed description of the legal structure of DTTL and its member firms.

Total Tax Contribution of UK Financial Services

By Janet Kerr, senior manager in the Total Tax Contribution team

The contribution of the UK financial services sector to the public finances

£65bn.  That’s the estimated amount paid by the UK financial services sector (banks, insurance companies, and other financial companies) into the public finances in the year to March 2013.  The total is made up of twenty different taxes borne and collected by these companies.  Corporation tax, the tax that is often front of mind when thinking about the contribution of large corporates is £6.5bn, 10% of the total.

These are some of the findings in a report released today by the City of London on the Total Tax Contribution of the UK financial services sector.  

The largest taxes borne and collected by the sector are employment taxes (income tax and national insurance).   For anyone with children reaching the end of formal education, you’ll know, like me, that the job market in the current environment is tough.  This sector employs 1.1 million people and estimated employment taxes are £28.4bn, that’s 12% of Government receipts from employment tax in the UK. 

Corporation tax borne, which is often the subject of media debate and public scrutiny, is the third largest tax borne on average for the study participants, after employers national insurance and value added tax which is a cost to the business.

The study findings highlight the importance of looking at the Total Tax Contribution to understand the contribution in taxes borne and collected of the UK financial services sector.  

Janet Kerr, is a senior manager in the Total Tax Contribution team and co-author of the study report.

The full research report can be downloaded from the City of London Website.