As a financial centre, London has long had an ‘offshore’ feel about it. Post Brexit, those offshore characteristics are likely to strengthen, with implications for the UK’s regulation, taxes and infrastructure.
London’s offer as a financial services hub has always had a strong element of the ‘offshore’ – a sense of detachment from the EU mainland, a focus on the sophisticated wholesale markets and a transatlantic orientation. Over the last couple of decades, more and more global businesses have sought to use London as their European onshore hub. But with Brexit in the offing, it seems likely that the offshore nature of financial services in London will increase again due to three core drivers.
The first driver is regulation. The terms of the final Brexit deal are as yet unknown. It may be that efforts to maintain trading rights will limit the UK’s regulatory drift away from EU equivalence. The London market and regulators may, at least initially, aim to keep UK financial services regulation fully in step with EU directives. However, in due course there will also be voices for change, arguing that some of the EU’s regulatory structures are unhelpful. Both the Markets in Financial Instruments Directive (MiFID II) and Solvency II, have arguably been over-engineered, in some cases imposing unnecessary operational and capital costs. In an environment where capital becomes pricier, pressure to lighten the burden of these directives may grow. This may well be accentuated if it becomes clear that the frictional costs of maintaining an onshore presence in the Eurozone are less than market participants feared. Regulation may only change direction slowly, but over time, across all levels of regulation, the UK and EU regulatory super tankers will start diverging.
Brand is the second driver for a more ‘offshore’ London environment – and just as important, if not more so, than regulation. Some non-EU locations, such as Bermuda or Singapore, have an undeniably offshore nature. Their brand is clear. Luxembourg, although ‘onshore’ in the sense of being within the EU and Eurozone, also has a distinctly offshore feel – a dominant wholesale asset management market. So how might London’s brand evolve after Brexit? I believe that irrespective of the details of an exit deal it will increasingly be seen as ‘offshore’, with a much greater sense of London’s physical and psychological detachment from mainland Europe. Even if EU trading rights are maintained in a deal, London will increasingly be viewed as more of an offshore location, which will influence and affect the type of investors who choose to come to London.
The third driver will be entrepreneurialism. Some financial services companies will relocate some operations to EU jurisdictions such as Luxembourg, Dublin, Brussels, Amsterdam, Frankfurt, Malta or Paris. However, the great majority of players will at least initially aim to keep their main operations in London. This trend will be accentuated by the fact that no one Eurozone location has been notably more successful at luring London assets away (as of yet), so no one single challenger is emerging. The more entrepreneurial London players will start looking for opportunities made possible by Brexit. In my own field of reinsurance and wholesale insurance, this has already started with some players setting up fronting businesses in the Eurozone for use by clients. But it may go further. Trading deals struck with the US or Australia, for example, may well include financial services liberalisation measures. As expansion onshore in the Eurozone becomes frictionally more expensive for London businesses, wider overseas expansion or the development of new products to sell to a more global client base will be pursued. Given London’s non-EU status, much of this entrepreneurialism is likely to be of an ‘offshore’ nature.
If this argument is correct and London does become more ‘offshore’ in style and substance, this in itself has repercussions for regulation, tax and infrastructure.
We could see a shift in UK regulatory focus. Although prudential regulation is doubtless considered important, European financial services and insurance regulation have historically tended to prioritise the regulation of conduct. In offshore locations such as Bermuda and Singapore, regulation has a much more prudential emphasis. London is a very different market from Bermuda or Singapore, and conduct will remain important for UK regulators. Nevertheless, in the increasingly important areas of activity such as reinsurance and wholesale investment management, where transactions take place between sophisticated participants, regulators may well come under political pressure to lessen their emphasis on conduct and concentrate more on prudential matters.
We could also see a shift in regulators’ perspective in relation to welcoming market entrants. Most offshore regulators tend to prioritise simple and rapid authorisation processes. They often have a statutory duty to encourage market entrants and are highly proactive in their support for potential new players. This is very visible if you work in Singapore, as I did for the last two years. In future, both the UK’s Financial Conduct Authority (FCA) and the Prudential Regulation Authority could be expected to put more resources into emphasising the attractiveness of London as a financial services hub. Some evidence of this can already be seen in the new UK tax, legal and regulatory structure regarding insurance transformation.
A New Tax Regime?
From a tax perspective, offshore locations generally have lower corporate and personal tax rates than onshore competitors. They tend to avoid complex taxes focused at specific sectors, and their tax regimes tend to be relatively simple. How does this compare with the UK? Although the UK has been reducing its corporate tax rates, marginal personal tax rates (as well as indirect tax rates) are relatively high by comparison with leading offshore locations. The UK also has a range of financial services taxes (such as the bank levy and insurance premium tax) and an overall tax regime that no-one would describe as simple. Therefore, if momentum builds behind London being seen as a more offshore-style location and London needs to start competing with other offshore locations, future British governments could come under pressure to lower these tax rates, remove some specific taxes and move towards a simpler regime.
A Hard or Soft Brexit?
Given these anticipated drivers of a more offshore-style financial services hub in London, whether the UK has a hard or soft Brexit may become less important in determining London’s longer-term future. Either transitional or longer-term membership of the European Economic Area would slow down any regulatory drift away from the EU, but the essential nature of London’s financial services offering will still probably change. London’s offshore brand will re-develop and its entrepreneurial spirit will inspire changing and new business activities.
The London financial services may well become smaller and, as is the case with other offshore centres, it is likely to be focused on higher value products. As this evolutionary process gets under way, the UK government and regulators will need to assess what necessary steps should be taken to maintain London’s world-leading financial services centre – albeit in a new, offshore form.