London’s offshore financial services future
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 USP as a financial services hub has always been a strong element of the ‘offshore’ – a sense of detachment from the European Union mainland, a focus on the sophisticated wholesale markets, and a transatlantic orientation. From an insurance perspective, this is reflected in the greater strength of the reinsurance market relative to the insurance market, and its stronger wholesale market as compared to retail. A similar offshore feel could be attributed to asset management and some areas of investment banking. Over the last couple of decades, more and more global businesses have sought to use London as their European onshore hub. However, 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.
Regulation
The first driver is regulation. While the terms of the final Brexit deal are obviously still unknown, it may be that efforts to maintain trading rights will limit the UK’s regulatory potential 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 strictures are unhelpful. Solvency II, for example, has perhaps been over-engineered, in some cases imposing unnecessary operational and capital cost on companies. In an environment where capital becomes less available, pressure to lighten the Solvency II burden may well grow. This may well be accentuated if it becomes clear that the frictional costs of maintaining an onshore presence are less than market participants initially feared. Regulation may only change direction slowly, but over time, across all levels of regulation, the UK and EU regulatory supertankers are likely to start diverging.
Brand
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 – and a dominant asset management market. So how might London’s brand evolve after Brexit? I believe it will increasingly be seen as ‘offshore’, with a greater sense of London’s physical and psychological detachment from mainland Europe. Even if EU trading rights are maintained, London will increasingly be viewed as more of an offshore location which will influence and affect the type of investors who choose to invest and operate in London.
Entrepreneurialism
The third driver will be entrepreneurialism. There’s no doubt that some financial services companies will relocate (at least some) operations to EU jurisdictions such as Luxembourg, Dublin, Brussels or Paris. However, the great majority of players, certainly in insurance and reinsurance, will keep their main operations in London. The more entrepreneurial ones will start looking for opportunities made possible by Brexit. Trading deals struck with the US or Australia, for example, may well include financial services liberalisation measures. As expansion onshore in the Eurozone becomes 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 post-Brexit 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.
Regulatory implications
Regulation could be affected in a number of ways. As previously noted, there could be a drift away from EU-inspired regulatory directives, although this will be opposed by those who see maintenance of EU trading rights as essential. One change could be a shift in regulatory focus. Although prudential regulation is now considered important, European financial services and insurance regulation has historically tended to prioritise the regulation of conduct. In offshore locations such as Bermuda, regulation has a much more prudential emphasis. London is a very different market from Bermuda and conduct will remain important for UK regulators. Nevertheless, in the increasingly important areas of activity such as reinsurance and wholesale, 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 proactive in their support for potential new players. This is very visible if you work in Singapore, as I have been doing for the last two years. In future, both the UK’s regulatory bodies could be expected to put more resource into emphasising the attractiveness of London as a financial services hub.
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 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 tax rates, remove some specific taxes and move towards a simpler regime.
Infrastructure needs
If London becomes more of an offshore-style centre, that could have implications for its infrastructure, both in a physical and non-physical sense. Physically, London needs to maintain its accessibility through maintaining its status as a global aviation hub. This is a strength that should be maintained as a priority in Brexit negotiations
In terms of non-physical infrastructure, safety and security are essential characteristics of successful offshore centres. London therefore needs to provide a safe work environment and pressure on the government to maintain this could increase. One current strength is the UK’s common law legal system. Some other offshore jurisdictions also have a common law system (such as Singapore and Bermuda), but not all.
Another strength that the UK and London will want to maintain is the existence of strong professional services to support financial services businesses. London currently benefits from the quality and number of its accountants, lawyers and other professionals, including experts in IT and risk management. Maintaining access to these communities will continue to give London an advantage when competing against other locations (offshore and onshore – there could well be a shortage of local lawyers as well as risk and compliance officers if many entities decide to set up operations in Luxembourg, for example). Pressure is growing for the UK government to ensure that financial services businesses (and other sectors) can access non-UK talent after Brexit. The depth and breadth of UK and international talent available has been a key factor in London’s appeal and it needs to be maintained. If barriers are raised further and the talent pool runs dry, the attractiveness of other offshore and onshore, EU locations will increase sharply. A tightening of Singapore’s immigration regime in the last five years has undoubtedly reduced its attractiveness to global business.
Hard or soft Brexit?
Given the anticipated drivers of a more offshore-style financial services hub in London, the issue of whether the UK has a hard or soft Brexit arguably becomes less important. Membership of the European Economic Area could 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 inspire changing and new business activities.
The London insurance and reinsurance market may well shrink but, 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.
How we can help
Moore helps clients thrive in a changing world. While no industry will avoid future being impacted by Brexit, it is safe to say the financial sector world will change more than most. Our team of insurance specialists have already helped clients plan for a post-Brexit future and mitigate risk posed and take advantage of opportunities created. For more detail on the issues contained in this article or to discuss how your business could be affected please contact us to discuss in more detail.