Threat of costs spikes and custodian exits hang over London as election looms

The past year has proved that there are no guarantees when it comes to political outcomes, John Gubert discusses the possibility of multi-billion costs and custodians exiting London should the unexpected happen again.
I have been involved in discussions around action that could be needed in the event of a Labour or Labour-supported coalition in the UK, following the General Election. I have already blogged about the consequences of a Financial Transaction Tax. However, with the narrowing of opinion polls, formerly theoretical discussions have moved to the planning horizon.

The challenge for financial firms in the City of London is currently threefold. First, Brexit impacts their business model. Second, structural changes advocated in the Labour Party manifesto would necessitate relocation of some core business lines. And finally, at a personal and corporate level, taxation could make the UK unattractive.

In the case of Brexit, the core challenges are employment, access and regulation. The employment angle is the only one where I would be optimistic of a reasonable solution, as the inbound personnel are skilled, well-paid and no real drain on services. The access issue, primarily retail distribution into the EU from the UK, is perhaps less dramatic than portrayed and will result in the shift of certain business lines to EU locations, but I suspect the staff number movement will be less than initially feared.

The much-debated clearing issue is more dangerous as I suspect EU banks will be under serious pressure from their central banks to relocate to within the EU. Tangentially I also suspect that Brexit, and perhaps other developments, will be used as an excuse to repatriate business to the US especially, as, with round the clock coverage models operating in most major global players, geographical location becomes more an issue of preference than necessity.

The structural changes advocated by the Labour Party in their manifesto and in other debates would be cataclysmic for the future of London as a financial centre and the UK tax take in particular. The City contributes around £70 billion of tax revenues per annum. The Labour party aim to increase this by the unilateral introduction of a financial transaction tax on most instruments, including derivatives. It also plans to abolish the market maker exemption enjoyed by trading desks and some hedge funds.

It is assumed that the 8% corporation tax premium paid by UK banks will be maintained and thus corporation tax on banks will increase to 33%. There will be higher rates of personal tax and high earner levies on high paying institutions. And, although not mentioned in the manifesto, the bank levy, which was to be eased back and to exclude global, as distinct from UK, assets, may well be increased and its scope returned to cover all assets of the global banks.

The consequences of such policies are glaringly obvious. Trading desks and hedge funds will be obliged to re-domicile for tax purposes. The global banks will relocate given they were willing to do that on the issue of the original global bank levy alone, before the current government eased back their plans. The UK will not be an attractive place for foreign personnel, who are often employed on a net home country income basis and thus need to be compensated for any adverse tax movements as well as likely adverse variation in the sterling exchange rate. Shifting revenues from the UK and re-domiciling for tax purposes is simple. It is now a tried and tested exercise and would happen quickly.

The support infrastructure, which is a cost base, is more challenging to move. This can easily happen over time but leaving costs, and a very limited number of high paid employees in the UK, is not a problem for most companies as long as they comply with the rules on cross border transfer payments. So what is the impact likely to be? I would expect some global businesses, especially in the banking sector, to re-domicile. One only has to look at the US to see how fiscal naivety can lead to corporate tax loss. I would expect banks to move their dealing activities to other locations, with New York and Asia seeing the biggest inflows. But the EU would also benefit, and there are signs of a willingness to agree friendly fiscal deals from some of their jurisdictions, and the migration of trading desks will remove one of the barriers to clearing and other functions moving alongside. Some companies, primarily those with UK-based client bases, will remain in the UK and we can expect a radical change in their client cost structures for the new taxes will not only come out of the bottom lines of the directly impacted entities.

Our best estimate was that, within two years of Election Day, assuming the tax proposals go ahead, around £30 billion per annum less tax would be levied from the City as high margin business migrates and leaves cost, both marginal and fixed, as a deductibility for the residual activities of the departing tax payers.

£30 billion pounds can be met by raising the tax rate on high earners, under Labour proposals those with incomes above £80,000 per annum, by 30 percentage points to 70-80%. That is not viable. But to put the loss of revenue into perspective again, it is equivalent to a 6 percentage point rise in all income tax rates.

FTT can work if it is global. The bank levy can work if it is sensible. The abolition of market maker exemptions needs also to be global. And domestic personal and corporate tax has to be competitive. Financial services are global and want to be profitable. Its financial contribution has grown exponentially over the last decade. That could all be reversed. And, as one who has been involved in multiple corporate restructurings and business re-engineerings, it is not very difficult technically to do.

The human cost of any rapid change that cannot be met by natural wastage is horrific. The financial costs of penal tax on global business in one location would require immediate action to be taken, compounding, in the UK, the human cost with the disastrous impact it would have on government tax revenues.

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