City of London Economic Research

Trends and growth in UK financial services trade

 

By Saif Ullah, Researcher in the City of London Research Team 

 

The Government’s recent publication of its Brexit White Paper (02/2017) confirmed their intentions to withdraw the UK from the EU’s Single Market and seek a new customs arrangement and free trade agreement with the trading bloc. While much uncertainty resides over how long it will take to negotiate a trade deal with the EU once Article 50 is triggered (let alone how similar any trade deal will be to the current terms enjoyed within the Single Market), the Government has also made clear its ambitions to create a ‘Global Britain’, creating new free trade arrangements with countries around the world.

 

Over the last few days, I’ve been interested in understanding what this vision for a global Britain might mean for the UK’s financial services and insurance (FS) trade, one of the economy’s most important exports. In particular, what do historical patterns of trade in FS say about potential opportunity markets for the UK? Has there been significant growth in particular markets for financial services exports outside of the EU?

 

The Office for National Statistics (ONS) Pink Book provides a good level of detail on sector trade. Usefully, ONS has recently published a short time series of data looking at the types of services exported by the UK to trading partners between 2007-15.  

The first chart below highlights the growth of FS trade more generally over the period, as well as FS trade surplus. In absolute terms, FS exports have increased by £6.8bn (12%) over the period, although they peaked in 2013, reaching nearly £70bn.

 

 

Similarly, looking at the trade surpluses generated by financial services since 2007 (i.e. the difference between the value of FS exports and imports), the FS trade surplus has increased by £9.4bn over the period (21% growth), with the surplus peaking in 2012.

 

The next chart shows what the UK’s major markets for FS exports outside of the EU have been between 2007-15. I’ve chosen three years across the period to illustrate the change in FS exports: 2007, 2011 and 2015. The United States has been by far the UK’s biggest FS export destination, reaching £17.2bn in 2011.

 

 

Other markets have been become major recipients of the UK’s FS trade. Japan is now the second largest recipient of UK financial services outside the EU, importing nearly £3.5bn worth of services in 2015. Switzerland (£1.8bn in 2015) and Russia (£1.1bn) have both also become valuable markets. FS exports to Canada have declined in recent years – having peaked at around £2.3bn in 2012, they have since fallen to around £670m in 2015. Elsewhere, Asian economies such as China (£262m in 2015), Hong Kong (£506m), Singapore (£420m) and South Korea (£204m) have become increasingly important markets, while FS exports to Taiwan (£156m) have grown over the last two years.

 

The final chart below shows the countries where there has been the biggest percentage increase in growth across two periods, 2007-2015 and 2011-15, alongside the level of UK’s FS exports to major markets in 2015. This helps provide some direction of travel in terms of growth of FS exports to particular markets across the period, against the absolute amounts exported to those countries.

 

 

The chart shows that Japan has been the biggest market for expansion of FS exports, both across the whole period (2007-15) and over the last five years (2011-15). FS exports to Japan tripled between 2007-2015 and doubled between 2011-15. Other markets where the UK was able to expand its FS exports over the period were Russia (24% growth 2007-15), China (30%) and South Korea (63%). Across the whole period, FS exports to the United States expanded by 16% but declined by 6% between 2011-15 (despite remaining the UK’s biggest FS export market by a significant amount in 2015), while FS trade with Canada has fallen by 55% since 2007.

 

Overall, the data highlights the importance of UK financial services trade, which generates a huge surplus for the economy, and the growing value of trade with nations outside of the EU. The charts show that, while countries such as the United States and Canada remain major recipients of the UK’s FS exports, other economies such as Japan, China, Russia and South Korea are becoming increasingly important growth markets. In the coming years, with Brexit looming and uncertainty over the level of access UK-based financial services companies will have with major European markets, such economies may offer increased export potential for UK financial services given the already developing market.

 

 

Looking back - the work of the Economic Development Research Team over the past year

Dr Laura Davison, Head of Research

Compiling our annual Research Review gives us the opportunity to look back over the previous year’s commissioned research, and reflect on our priorities for the year ahead. Our programme has a very wide remit, spanning local, national, and international economies. This was reflected in 2015’s topics, which ranged from poverty and healthcare in London, through to the ways in which EU financial services support the wider economy, and global currency usage.

A key on-going theme for us is how to ensure that London continues to function effectively as a world-leading business and financial centre over the long term. This includes looking at the physical and social infrastructure that enables the City to operate as the densest concentration of business and employees in London, with a workday population of 415,000 within one square mile - equivalent to bringing in all of the residents of Brighton and Oxford every workday. Nearly a third of our workforce travels from outside of London, meaning that developments that bring new connections and capacity are critical, for example Crossrail, bringing in 1.5million more people within a 45 minute commute of central London.

It is also crucial to understand how the world of work in the City is changing. In 2015, we worked with the largest companies in the City – who while small in number (225 firms), account for around half of the City’s workforce. The research emphasised the rise in mobile working and a more flexible workforce – with consequent demands on the City’s communications connectivity, for adaptable and well-designed workspace, and a public realm that supports the use of third spaces – such as cafes – to work in. This programme of work continues into this year, looking at the changing needs of the SME firms (employing <250 people) – who make up 98.6% of the business population in the Square Mile.

Financial services continues to be a key industry for London – and the UK more widely, and our annual Total Tax research showed that the tax generated by financial services has continued to rise – now standing at around £66.5bn, equivalent to well over half the annual NHS budget. Across Europe, our research showed financial services accounting for nearly 6% of the EU’s total economic output, with the potential for stable growth of 1.9% per annum to generate an additional 11 million new jobs by 2030 spread across sectors including construction, manufacturing and services.

Looking at global finance, we had the particularly exciting opportunity in 2015 to work with SWIFT to make public new data on the changing use of currencies globally, drawing on their global payments infrastructure linking more than 200 countries and territories worldwide. This emphasised the key role that the UK plays as an intermediary in financial flows, as well as the rapid growth of currencies such as the Chinese renminbi.

For a fuller overview of these and other pieces from 2015, please do download our Research Review – and look out for forthcoming work, as we continue to develop these themes. 

 

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.

Internal characteristics and external factors of IPO activities in Central & Eastern Europe

This paper is a study of IPO activities in the region of Central and Eastern Europe (CEE). The study uses original evidence from a dataset of 94 IPOs in the period 2000–2009 on the stock exchanges of Bucharest, Budapest, Bulgaria, Ljubljana, Prague, Vienna and Warsaw. Results are compared with empirical evidence for developed EU capital markets.

Download "Characteristics and factors affecting IPOS in Central and Eastern Europe from the City of London Programme's Fellowship Programme webpage.

By Polona Peterle

Polona Peterle attended the City of London Programme in 2007. She is now Assistant to the President of the Management Board for Risk Management at Triglav .

The City in Europe Debate

Ahead of a potential referendum on the UK’s membership of the European Union, politicians and business leaders gathered in Guildhall this month to debate whether a UK exit would be beneficial or damaging for the City. Despite some claims that the UK’s EU membership is of little interest to the majority of voters, almost a thousand Londoners listened and contributed to the discussion, which considered an issue crucial to the UK’s economic and political future. A link to the full debate is available at the bottom of this post.

UK access to the Single Market was identified by the Lord Mayor as an important advantage for UK financial and professional services, and remained a key theme of the debate, with Vince Cable and Sir Martin Sorrell highlighting EU membership as a key determinant of the UK’s position as the third largest inward investment recipient, and 60% of senior decision-makers locating here to access this important market. The Japanese government’s submission to the UK’s Balance of Competences review made it clear that leaving the EU would put the 130,000 UK jobs created through Japanese FDI at risk.

Our EU membership also facilitates UK trade internationally; free trade agreements with over 37 countries, including important emerging markets like Mexico and South Korea, have reduced global barriers to trade, and the current negotiation of a US-EU trade deal could boost the UK economy by £10bn.

Of course there are two sides to every debate, and supporters of EU exit Jesse Norman MP and entrepreneur Luke Johnson argued London’s development as an international financial centre, attributed to factors like its time zone, talented labour pool and stable legal framework, has not been dependent on EU membership. Norway and Switzerland were cited as examples of countries which have prospered outside of the EU, although as our research into Switzerland’s engagement with the EU showed, the country achieves access to the Single Market through a complex set of bi-lateral trade agreements and significant financial contribution.

EU-level regulation does present challenges for the UK’s financial services industry and the wider economy, particularly bonus cap regulation and the financial transaction tax, with our latest research estimating the tax would increase the cost of finance for UK businesses, and create an additional cost on UK government borrowing of almost £4bn. Despite not signing up to the tax, non-participating Member States are likely to suffer higher costs than those 11 Member States who have signed up, and the legality of the tax’s extra-territorial impacts is currently being challenged by EU lawyers. We’re also looking at how the tax will affect households and consumers across the EU in upcoming research.

However as Vicky Pryce argued, in order to maintain the competitiveness of the financial services industry and its key contribution to the UK economy (valued at over £132bn or 9.8% of total GDP by our latest figures), it’s important the City and the UK continues to engage in EU policy-making, rather than seeking to withdraw altogether. Closing the debate, the Chairman of Policy and Resources Mark Boleat, reflected on the government’s continued success in seeking UK-appropriate implementation of EU directives, and this week the Treasury announced that it would challenge EU bonus caps in view of stringent pay rules already imposed by the Prudential Regulation Authority and the Financial Conduct Authority.

As a key voice in the debate around the UK’s engagement with the EU, the City of London plays an important role through working in partnership with organisations like the Evening Standard and Centre for London, and acting as a host for informed discussion on issues affecting the City and the UK’s financial and professional services.

We also commission independent research to inform and support our work on the EU and financial services regulation, as part of our wider research programme. If you’re interested in finding out more please visit the City of London's economic research page.

To watch the debate in full visit the ‘The City in Europe’ page.

The proposed EU financial transactions tax and the cost of government borrowing

Based on the recent report 'The impact of a financial transaction tax on corporate and sovereign debt'  Shaan Devnani, of London Economics writes about the impact of the proposed FTT.

By Shaan Devnani, Senior Economic Consultant, London Economics

If in place today, the proposed EU financial transactions tax (FTT) could increase the cost of new UK government borrowing by close to £4bn this year.^[[i]] This is despite the UK having chosen not to support the tax and it only being implemented elsewhere in the EU. Why is this?

Under normal circumstances, a saver may be willing to provide the government with £100 for a 5% (or, £5) return per year by saving through a UK government bond. The saver may sell the bond at the end of the year. And, future investors may do the same. 

	Year 1	Year 2	Year 3	Year 4
	Saver 1	Saver 2	Saver 3	Saver 4
Return	£5	£5	£5	£5
Year 1: Bond value = £100

If the tax is brought in, buying from or selling to a saver from a Member State that has implemented the tax would carry a cost of 0.1% (or, 10 pence) per saver involved in the trade, so 20 pence in total.

Let's say savers 2, 3 and 4 from our example are from the Member States implementing the tax. The total cost of the tax would be 60 pence and Saver 1 would only be willing to provide the government with £99.40 for the 5% return when he used to be willing to provide £100.

Put another way, the cost of government borrowing would rise.

	Year 1	Year 2	Year 3	Year 4
	Saver 1	Saver 2	Saver 3	Saver 4
Return	£5	£5	£5	£5
FTT cost	£0.10	£0.20	£0.20	£0.10
Cumulative FTT cost	£0.60
Coupon minus FTT cost	£4.40
Year 1: Bond value ~ £99.40

Is this is a big deal? Despite the proposed EU transactions tax being quoted as being 0.2% on bonds, the effective tax would actually be quite a bit more.

At present, if you want to trade a bond, rather than buying from or selling to a saver directly as above (that is, the bond changes hands once), the process may look something like this:

 The bond we are interested in actually changes hands three times and the financial intermediary needs to carry out two additional transactions to hedge the associated risk.^[[ii]] The effective tax rate is therefore five times higher (1%) than the quoted tax rate (0.2%) every time we undertake to trade.

Take into account the fact that bonds are traded a number of times prior to maturing and we estimate the cost of new UK government borrowing under the proposed EU transactions tax to be close to £4bn.^[[iii]]

This would ultimately require either greater taxation or lower government spending at a time of already-fragile economic circumstances. In a similar way, the cost of borrowing for firms would also go up and be reflected in lower investment rates.

In other words, the effects of the tax on the real economy could be large.

So what should be next for the proposed EU financial transaction tax? So far, there has been a focus on the impact of the tax on the financial sector. Should it be subject to the tax? Would the sector pass-on the tax if it is implemented? Instead, we require a detailed analysis of the expected impacts of the tax on the real economy.

About Shaan Devnani

Shaan is Senior Economic Consultant at London Economics.

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[[i]] Among other things, this is more than taxpayer costs for London transport in 2011/12 (Source: 'A snapshot of the UK economy in 2011/12' http://visual.ly/snapshot-uk-economy-billion-here-billion-there)

[[ii]]  Source: Association for Financial Markets in Europe (AFME)

[[iii]] The study 'The impact of a financial transaction tax on corporate and sovereign debt' showed that the UK's planned borrowing through non-index-linked gilts for 2013 would cost close to £4bn more if the tax were in place than otherwise.