The global risk index is rising rapidly, driven by increased geopolitical tensions, threats of trade wars and the high-risk strategies adopted by some world leaders. But UK political risk has also escalated to such an extent that it could undermine the status of London and the UK as the world’s premier financial centre.
What are the threats to the UK and how could it impact securities services? The threats include the UK relationship with the EU, the demographic shift across developed markets and elsewhere, market footprint, political risk and skill risks.
It is difficult to gauge clearly what will happen post the election of a new prime minister in the UK. The policy, irrespective of who wins the contest next week, will be to exit the EU with the replacement of the Irish “backstop” as the key driver. This will be accompanied by heightened “no deal” planning and also the threat of a €40 billion or so financial battle between the UK and the EU on the exit fee. Meanwhile, the newly appointed president of the European Commission, Ursula von der Leyen, has said she is open to the idea of extending the deadline beyond October 31st. If Parliament votes against “no deal” the UK will be in constitutional crisis and will most likely be faced with an election as the time to completion of the alternative option of a referendum is surely too long to be viable.
An election would bring to the fore the major political risks facing the UK. Current public opinion polls point to a hung parliament in a country unused to multi party government. It also comes at a time when parties are phenomenally polarised around fundamental principles. The Conservatives yearn for Brexit above all. Labour, at least in the guise of their parliamentary leadership and the bulk of their membership, long for a full bloodied Marxist style socialism albeit with close, if ill defined, ties to the EU. The Liberal Democrat party long to remain in Europe. The Scottish Nationalists desire independence. The different Irish parties, with their religious as well as emotive drivers, still hover around the potential to return to the bloody days of the 1970’s. If Labour were to take power, we could see major moves for the State to acquire industries at below market values (although once the prices were announced one would expect any gap to narrow sharply), the State requiring public companies to effectively hand over up to 10 per cent of their equity to it, sharp rises in higher rate and corporate taxation as well as anti-wealth measures in inheritance and similar taxes. We would see banks subjected to extra levies, most likely on their global liabilities, and the State assuming powers to ensure that companies followed central directives on a range of social, compensation, equality and climate considerations amongst others.
The demographic shift is happening irrespective of the political forces but it will impact the funds flows across the world. With the ageing of the population, savings ratios will inevitably decline. Millennials may currently be attracted to socially acceptable ESG style investments, but history of other trends tell us that will only be for as long as they appreciate. Millennials are not imbued with the mandatory savings culture of their predecessor generation simply because saving for retirement has lost appeal with the abandonment, outside the public sector (and that will be a huge financial burden in the future) of the final salary pension schemes. Their successors, the capped pension allowance or the ISA in the UK, are a shadow of the perceived employee value of the former index linked, salary related pensions. A popular replacement, in an age where employment is likely to move to a fifty year plus cycle and jobs for life are a nonsensical concept in a fast changing environment, is not on the horizon.
Capital markets are already seeing the stresses of being global. Although it is lunacy not to heed the warnings around climate change, the need to adjust for the digital economy or the social impacts of the growth in quasi self-employment, governments need to look for flexibility and appreciation of the challenges before formulating new policies. Emotionally many of us follow the aims of Extinction Rebellion; at least till we are told to switch off the lights every evening! Industry will arbitrage between markets according to their policies on all these issues as it struggles to manage increased costs and potentially low growth in demand. And it also would be ridiculous to think that companies would remain based in the UK, if it meant paying premium taxes, accepting onerous labour laws and granting ownership rights to a country where they may have a small amount of their business activity. Why would Shell, BP, Unilever, HSBC or others retain headquarters or fiscal residence in the UK in that environment? And would that not be another catalyst for a major shift in trading activity in the underlying shares, not only due to the equivalence debate but also due to funds flows shifting around the world.
And if we are to enter a period of a weak and volatile pound with fund flows coming more from outside the UK and the EU, and if the UK is no longer the gateway to Europe and becomes a high political risk area, what value is the UK financial sector? An independent Scotland will reduce the attractiveness of the UK market as a whole for its financial sector could be decimated if independence means it loses its core export and fund source market place of the rest of the UK. Edinburgh surely would not flourish in that environment as several parts of its major financial services companies would be forced, by capital demands and oversight requirements alone from the UK, to move activity south of the border. A UK without the EU link loses a meaningful flow of activity and would not much of the balance of international business also migrate from it? Modern technology means money activity is global and ever more driven by automation. The next generation of AI could well lead to a truncation of the skill base needed in much financial sector management and thus the mobility of that activity would increase.
The securities services business is not an automatic UK activity. Much of it is based in US and EU institutions. London is an important branch office. But, if the business gets caught up in a politically inspired fiscal and labour environment and if costs rise, despite the net benefit of a weak pound on dollar or Euro sourced revenues, then the consolidation of much processing into the other major activity hubs of the world appears likely. Political risk is always hard to assess, but the clouds on the horizon are getting closer and more ominous. Financial services contributes over 10% of UK fiscal revenues; some believe that is too great a risk. The biggest risk, though, is the likelihood that London becomes just another local market and that 10% needs to be sourced from elsewhere.