Planning for uncertainty

The current state of Brexit negotiations makes a general election a distinct possibility. What might the financial services industry expect in the aftermath?

Former Goldman alumnus and UK Conservative Minister, Lord Jim O’Neill, stated, in an article in the FT, that “the Labour party has stepped into the vacuum left by the government and appears to be offering the radical change that people seek.” Although most of his article was critical of the way Labour would achieve this, the reality is that we are closer to a radical Labour administration in the UK than ever before.

BREXIT is a mess and it is unclear how it can be resolved. The reality is that both parties are hopelessly split on the issue with the Conservatives tearing themselves apart on policy and Labour basking in the warm glow of six unreal tests and ambiguity about their real objective. There could be a solution that meets the conflicting economic and political red lines of the EU27 and the UK. There could be a new Conservative government led by one of their unashamedly arch Brexiteers. Or there could be fresh elections, a new referendum, a split in the major parties and several other scenarios.

Some believe that the most likely would seem to be an election. It should be noted that this could only come about in the event of total parliamentary gridlock on BREXIT which remains the most likely scenario.  This would change the face of the securities industry and the broader financial services industry were the Labour party to climb the mountain that would give them victory and a sufficient majority to enable parliamentary accord for their radical economic policies.

And they would be radical. They would change the economy. They would emasculate the City of London as a global centre. And they would move the UK from a free market structure to a centralised managed economy.

First of all, the UK stock market would reduce massively in size. The government securities market would balloon as the Government issued paper to cover the cost of their economic, social and nationalisation programme. It is not to be excluded that this could be accompanied by mandatory directed investment, especially from pension funds, and a return of quantitative easing. As the nationalisation programme could be at prices dictated by Parliament rather than the market place, we can paint two scenarios; namely effective partial expropriation or a flight from the impacted securities that makes such an action redundant.

A second policy of the Labour party is to require listed companies in the UK to distribute 10% of their share capital to their UK employees within 10 years at a rate of 1% per year. This has serious fiduciary impacts on all global businesses for several of the largest are UK-listed but have a small minority of employees based in the UK and a small percentage of revenues sourced from the UK. We can only assume that such companies would delist and move their head offices to other jurisdictions, thus reducing the capitalisation of the UK domestic market. And others could well go private as current plans exclude such companies from the requirement.

Second, the UK would cease to be a major trading market in securities. The UK would introduce a Tobin tax. Even if unsuccessful relative to current volumes, the tax should be a net revenue raiser from funds captive in the UK such as pension funds, local insurance companies and domestic based mutual funds. But the trading markets would migrate promptly to jurisdictions without the tax for it is inconceivable that Asia and the Americas would not provide welcoming tax efficient alternatives to such a scenario.

Third, the UK would move from being one of the most desirable markets for inbound investment to become a net dis-investment market. Irrespective of the inadequacies of the current corporate tax system and the need for global reform, the reality is that tax levels impact decisions on location as does individual taxation. Moving the UK from a low tax economy to a high tax economy, both in corporate taxation and higher rate personal taxes, will deter business and cause a flight of activity. Those who doubt this should refer to the quite recent experiences of France pre-Macron when they raised personal tax levels into the stratosphere.

Alongside the fiscal regime, there are issues around social policy. The gig economy has a flawed social structure but the resolution should be more in adapting the social framework to the needs of the new business environment rather than trying, as intimated by Labour, to fit the gig economy into traditional structures. But the Labour party social policy also includes serious government intervention into all aspects of corporate life. The transfer of an eventual 10% of each listed company to employees is a bit of a smoke screen as employees would only get dividend flows up to a maximum £500 per annum from this move. The underlying shares would be owned by state-controlled bureaucracies and all excess dividends, estimated at around £12 billion per annum by year 10, would go to the State. Thus, the State would be the largest shareholder in all listed major UK companies. Workers, through their unions, would also be able to claim 30% of board seats of all such companies, there would be strict limits on executive pay and some of the long-abandoned union rights would be re-established. Some of the measures are not revolutionary in global terms, but they change the UK from a low tax and flexible employment regime to a high tax, centrally controlled and union-dominated one.

Fourth, it is likely that capital controls will need to be introduced, albeit after the horse will have bolted. If, as we approach an election, there looks likely to be a change in government, then there will be a massive run on the pound. The Labour party have already recognised that they may have to establish capital controls and, as already noted above and given the likelihood of currency flight by individuals, such controls are inevitable alongside a serious fall in the currency with its likely inflationary pressures.

Some believe this scenario will not arise as the pound will come under massive pressure and the UK will need to go to the IMF for support. Others believe that the unrest in financial markets ahead of any election would change voters’ minds. That is possible but perhaps only probable if the current government extract a sane resolution for the BREXIT conundrum and tackle clearly some of the underlying causes of dissent in both the social and fiscal arena that drove the “no” vote in the first place.

In the meantime, global financial institutions, including those in the global custodian market, would be well advised to formulate plans to extract themselves, at least for their country-agnostic activities, from the UK to avoid them becoming embroiled in any such future control and tax environment. Whether they press the button and activate those plans can be a later decision, but experience from BREXIT shows that timely planning is imperative.