My speech to the Scottish Financial Services Industry, 20 December 2006

  1. It is a pleasure to be here today to deliver the annual Smith Institute Finance Lecture. And let me start by thanking so many representatives from Scotland’s financial community for joining us here today. I welcome the opportunity to speak to you about the important challenges we are facing in ensuring the future success of our financial services sector – here in Scotland and across the UK – in the years to come.
  2. Financial services are critical to our future prosperity: the UK financial services sector generates about 8.5 per cent of UK GDP, rising to 12 per cent if we include professional services such as legal and accounting, and supports 1.1 million jobs across Britain. The UK has more foreign banks than any other financial centre and it is also the largest source of cross-border bank lending.
  3. And here in Scotland, Edinburgh and Glasgow represent the UK’s second largest financial centre after the City of London. Financial and related services now employ 9.3 per cent of Scotland’s workforce – over 113,000 directly employed and a further 90,000 in related industries. You are now a leading European centre for banking, life insurance, pensions and investment management.
  4. And you have been making great strides in recent years. Output in the sector has grown 36.5 per cent over the last five years outstripping financial services growth in the UK overall. And in the six years to 2004, the yearly average direct employment in financial services in Scotland rose by 31.5 per cent compared with 7.5 per cent for the economy as a whole.
  5. This success has been based on the growth of Scotland’s indigenous financial services companies. You have a number of global financial services companies headquartered here in Scotland including RBS, Standard Life and HBOS. And you have also benefited from substantial new investment into Scotland. Since the start of 2006 this is reflected in new jobs created by JP Morgan, Morgan Stanley Securities, Citigroup and BNP Paribas.
  6. So our task together is to build on this success. I am optimistic that the Scottish financial services sector can continue to expand and create even more jobs in the years to come as a result of the strong and growing relationship between our financial centres. And in my speech today, I would like to talk to you about two important challenges we must face together.
  7. First, I want to set out the steps we are taking to ensure that we strengthen our competitive advantage and bring more jobs and investment to Scotland and the rest of the UK. I want in particular to highlight the challenges we face in one area where competition is increasingly intense – the fund management sector.
  8. Second, I want to set out why we must ensure that the opportunities and benefits of a strong and successful financial sector are fairly shared and accessible to all.

High Level Group

  1. I believe that the UK is well-placed to rise to the challenge of globalisation and technological change. Some commentators and practitioners feared that new globalising forces – the emergence of new financial centres and technologies, the switch from physical to virtual trading platforms, and new regulatory challenges in the UK and Europe – would threaten the standing of the City and UK financial services. But you have confounded the pessimists and surpassed all expectations.
  2. Today it is our shared commitment to openness and internationalism, our proportionate and risk-based regulatory approach – combined with the great pool of talent gathered from across the world – that underpins the UK’s success as a global financial leader.
  3. Indeed the UK’s unified and statutory regulator, the Financial Services Authority, is regularly cited as one of our chief attractions – a huge competitive advantage. Our determination to act to safeguard our proportionate, risk based regulatory approach is reflected in the Investment Exchanges and Clearing Houses Bill which successfully passed in the House of Commons in November. The Bill is now before the House of Lords and we anticipate that it will receive Royal Assent shortly.
  4. We should all be proud of this success. But we must not become complacent. With globalisation and the rapid pace of change this could reverse quickly if we make mistakes in London or here in Scotland too. It is more important than ever before that we work even more closely together to entrench our success and sharpen our competitive edge.
  5. That is why in the Budget 2006 the Chancellor set up our High Level Group, bringing together Government and the UK financial community, to develop a coordinated strategy to help ensure the future success of our financial services industry and to extend our global reach even further.
  6. The High Level Group met for the first time in October and we agreed to take forward proposals to:
  • maintain cutting edge principles based regulation by taking further action against unnecessary gold-plating and by agreeing to examine, with the Financial Services Authority, whether we can go further in making our regulation proportionate, risk-based and lighter touch for services with lower consumer detriment or systemic risk;
  • modernise the wholesale insurance market. Lord Levene, Graham Millwater and Andrew Kendrick will work together to support the timely delivery of the reform strategy being set by the Market Reform Group and, in parallel, the Government will examine the business environment for the wholesale insurance sector;
  • boost professional financial skills; the Chancellor asked Teresa Sayers and the Financial Services Skills Council to undertake research on financial skills gaps. At the same time the Treasury, together with industry, will examine a proposal for a centre for regulatory expertise that would provide teaching and research;
  • and promote the UK based financial sector in overseas markets, bringing a more strategic approach and better coordination of the efforts of public and industry bodies. UK Trade and Investment is responsible for coordinating the strategy and they will allocate additional resources to the promotion of financial services, with dedicated diplomatic staff and tailored promotional strategies in key overseas markets, including China and India.
  1. Our work will also focus on: addressing business concerns on tax administration; facilitating innovation in Islamic finance; and maintaining the reputation of the City by establishing a new financial crime supervisors’ forum.
  2. Work is also being taken forward on a number of broader issues affecting the financial and business services sector, including migration, and the findings of the various reviews which were published with the PBR last week including those by Lord Davidson, Sir Rod Eddington, Sir David Varney, Sir Sandy Leitch, and Kate Barker.
  3. The next meeting of the High Level Group will be chaired by the Chancellor in May next year, where progress on these issues will be reviewed. And I am very pleased that the Secretary of State for Scotland has agreed to present a paper to this meeting on how, working together, we can do more to support financial services in Scotland and win new investment and jobs. Scottish Financial Enterprise will be fully involved in the preparation of all this work.
  4. Here in Scotland you are building on your record of innovation and excellence. Your Financial Services Advisory Board, set up in March 2005 and led by First Minister Jack McConnell, has set out your vision of an innovative, competitive, and thriving international financial services industry.
  5. In reading the Board’s 2006 annual report I was struck by how much your ambitions in education and skills and international promotion complement the aims of the Chancellor’s High Level Group. It is clear that we have much to gain by a deepening partnership.
  6. Because, while financial services are a great Scottish success story this success has not been achieved by Scots standing alone. In this area, as in so many other sectors, the ties that bind the United Kingdom together have been key to growth. The reality is that the Scottish financial services sector is very closely integrated with the rest of the UK. So not only do Scottish financial services depend on exports, with the domestic market accounting for only 20 per cent of financial services sales, but just 7 per cent of exports are to the world outside the UK. This trade is possible because we have a truly open single market in the UK and a successful single currency.
  7. And by working together, I am confident that we can expand financial services jobs in Scotland and the UK in the years to come.

Asset management

  1. One area where I am keen we work more closely together is asset management. This morning I attended a seminar with representatives of the asset management industry here in Edinburgh, hosted by Scottish Financial Enterprises.
  2. UK asset managers manage over £3 trillion in assets and account for at least 25,000 jobs. In terms of international business the UK is probably the world’s largest asset management centre.
  3. And Scotland is central to this success – now one of the world’s major fund management centres with over £530 billion under management. This success has been built on the foundation of a long and proud history in the business. Much of the early development of the investment trust industry took place in Scotland in the late nineteenth century with Scots pioneers like William Menzies and Robert Fleming leading the way. And today Scotland has built on those roots to establish an asset management sector which competes strongly in international markets with particular strengths in institutional investment management and in life insurance.
  4. During the summer we held a series of dialogues at the Treasury with stakeholders from the financial services industry to examine the factors behind the UK’s success and any potential threats. On asset management you told us that the pool of skilled labour, an internationalist bias, liquid and vibrant domestic capital markets and aspects of the legislative environment are all vital to your future success.
  5. Following those discussions, I committed recently to bring forward consultative proposals by March next year to allow paperless settlement of trades in fund units – a relatively small change in legislative terms, but indications from initial discussions with industry stakeholders are that this could deliver significant cost reductions. We are actively looking at other areas where worthwhile regulatory cost savings could be achieved.
  6. I was also encouraged by the European Commission’s recent white paper on investment funds. Working closely with the industry, the UK Government had established a clear outline of the reforms we thought were necessary to allow EU asset management to go from strength to strength – including delivering a harmonised regime for the private placement of institutional investment funds and making it easier for funds to passport into new markets. We were very pleased that the Commission pledged to make progress on these and each of the four priority areas for action the UK had identified. The challenge now is to get the implementation right.
  7. On tax, we announced at PBR that we would exempt foreign exchange-traded funds from stamp duty. I believe this will be helpful in allowing a new market to develop in the UK. Through the agenda set by the Varney review, Her Majesty’s Revenue and Customs will also improve the way it engages and consults with you in the industry.
  8. Of course there are continuing challenges to this success, from Luxembourg, Dublin, Dubai, where I visited recently, and Hong Kong.
  9. That is why modernising the regulatory and direct tax framework for asset management is one of the key areas for further work in the High Level Group.
  10. And I can announce today that we have set up a joint Investment Management Association, Treasury, and HMRC working group, to consider the findings of the recent KPMG report on taxation and its effect on the competitiveness of UK funds.
  11. The group will consider how to improve consultation and communication between HMRC and the investment management industry and address a number of complex technical issues, for example:
  • tax barriers for authorised investment funds which invest in property, a subject on which we have ongoing consultation;
  • the operation of the Stamp Duty Reserve Tax rules for UK funds; and
  • the trading/investment boundary as it applies to funds.
  1. As I say these are complex issues and while I can’t promise that we can deliver change on all these issues, we are taking the findings of the report extremely seriously, engaging with the industry, and I will report back on progress of discussions at the next meeting of the High Level Group in May 2007.
  2. We in Government have a duty to get the framework right to allow asset management to continue to flourish – but also to support long-term investment in our economy. Because asset management is important not just for jobs, but also for long-term investment in our economy.
  3. UK institutional investors manage about half of the £1,500 billion of UK equities. By investing a big chunk of the long-term wealth of British savers, they exercise indirect control and significant influence over much of British corporate activity. This control is channelled through an ‘investment chain’ of relationships, a web that connects millions of ultimate owners with their investment in companies. Because this chain ensures the efficient allocation of investment, it is of vital importance for productivity and long-term growth.
  4. And because of its importance to productivity, the Government has systematically investigated how we can improve the effectiveness of the investment chain mechanism. Key milestones have been the Myners, Sandler, Higgs and Morris reviews – and I would like to say a little more about the Myners review today.
  5. Paul Myners’ review identified a range of problems arising from the challenges facing part-time and generally unpaid pension trustees, with little in-house support. These included poor evaluation of advisers and their advice; a reliance by trustees on a small number of investment consultants, supplying actuarial and investment advice bundled together; insufficient resources devoted to the process of asset allocation; unclear contractual structures which can generate strong and unnecessary incentives for herding and short-termism in investment; and insufficient focus on the potential for adding value through active shareholder engagement.
  6. These have been tackled on a broad front, by the Government working closely with the investment industry. First, through the voluntary ‘comply-or-explain’ Myners principles which set out a framework for more effective trusteeship. And more recently:
  • the Institutional Shareholders Committee’s voluntary code for shareholder engagement and its action plan for improving the quality and scope of engagement;
  • the commitment of leading investment consultants to encourage trustees to consider whether to use engagement capability as a criterion for fund manager selection,
  • through the work of the Marathon Club of Institutional Investors, to develop guidance for long-term long-only investing; and through the FSA’s new rules and voluntary disclosure code to provide greater transparency of broking transaction costs.
  • and the enactment in the Companies Act of a power for the disclosure of voting by institutional investors. But rather than exercise this power now, the Government is looking forward to engaging with institutional investors to take forward the development of a flexible and voluntary disclosure regime.
  1. These are all having a significant impact. But it’s important that we don’t stop here. So I am pleased that the NAPF has agreed to undertake a thorough review of the Myners principles over the course of next year, which will be a great platform for debate on how the Government works with the industry to keep up the momentum.
  2. The NAPF will be able to look at all the outstanding issues which impact on the principles’ effectiveness, including the substantial changes to the regulatory and investment environment which have occurred. The NAPF’s process will also be able to take up the issues from our current consultation on potential revisions to the Myners principles. I believe these proposed revisions will be more effective if they are now considered in conjunction with all the other issues arising from the NAPF review. We look forward to working with the NAPF on this.
  3. We need to remember that a voluntary approach like Myners works on the basis of convincing people and spreading best practice, not through grudging ‘tick box’ compliance. So in the interim, it is important that the proposed revisions to the principles and their supporting arguments remain available to trustees as part of the body of best practice they should take into account when using the Myners framework. We expect that trustees will give appropriate consideration to this, where it is in the interests of their funds, without there being any formal compliance or reporting requirement.

Fairness

  1. As Minister for the City and UK financial services I have now met almost all of the leading retail and investment banks doing business in the UK. The agendas for our discussion have covered important issues critical to ensuring we can compete on the global stage. But they have also included financial capability, and financial inclusion. Because we also recognise that banks, pensions providers, and insurance companies all play an integral role in our society and in our lives. I know you recognise that you operate within society and have social obligations and responsibilities, and that we cannot have people or social groupings excluded from our financial life.
  2. We all recognise the costs that financial exclusion imposes on individuals and families. People without a bank account find it harder to get a job, and can pay more for their utilities. People without access to affordable credit often resort to high-cost alternatives, or worse still, illegal loan sharks, who prey on vulnerable deprived communities through intimidation and criminality.
  3. And it is because of this that we have a shared goal of halving the number of adults living in households without a bank account of any kind, a £120m fund to tackle financial exclusion, and an independent Taskforce to monitor progress in the priority areas of banking, affordable credit and free money advice.
  4. We have also taken action to tackle illegal money lending. That is why, for example, I recently announced continued funding for a project in Glasgow that is tackling the problem of illegal lending by working with communities to bring loan sharks to justice. And why the Government has also invested £36m in credit unions and Community Development Finance Institutions, to ensure that people living in deprived areas, including in Scotland, have access to safe, affordable alternatives to loan sharks and high-cost credit.
  5. And this week John McFall and I announced a significant agreement to provide over 600 new free cash machines in lower-income areas.
  6. The ATM Working Group, chaired by John McFall and consisting of banks, building societies, independent cash machine operators and consumer groups, has worked hard to deliver this agreement, based on a careful analysis of the evidence base on the location and growth of charging and free ATMs. I believe it is an excellent example of how we can work together in partnership.
  7. I welcome the commitment by banks and other cash machine operators, as part of this deal, to further invest in new free ATMs across the country, particularly in those low-income areas identified by the Working Group.
  8. In Scotland alone, areas in 22 local authorities and 43 parliamentary constituencies were identified as currently lacking a free ATM.
  9. John and I wrote to all MPs and relevant Local Authority leaders on Wednesday, to ask for their help in finding suitable sites for these new cash machines. I am also pleased that industry has agreed to offer an extra premium to cash machine operators who are willing to install and maintain free machines in lower-income areas which might not otherwise have a free ATM. Such a “financial inclusion premium”, built into the multilateral interchange fee regime of UK’s LINK network, will benefit operators of free machines in low-income areas and help maintain ‘the last free ATM in town.’
  10. I believe this is a solid example of what market-based initiatives can achieve.
  11. We must also do more to equip individuals with the capability to make financial decisions. By building up financial literacy and increasing financial capability, banks benefit too as consumers move up the value chain. This is an enabling action that helps society, and that helps business too – a win-win scenario.
  12. The FSA has led in raising levels of financial capability, through its work with schools, in the workplace, and with new parents and young people – and your industry is playing its part.
  13. Scotland’s approach, especially with young people, is impressive, with the Scottish Centre for Financial Education part of Learning and Teaching Scotland, raising the profile of financial education in schools and providing schools and local authorities with the assistance and resources they need to take capability forward. The Scottish Executive already supports a range of excellent projects, including the ‘Young Scot’ Infoline, a web and telephone-based service for young people.
  14. Now is the time for us to think about what more Government can bring to the table. And in the coming weeks we will publish a long-term financial capability strategy setting out our aspirations and discussing the way forward. Government can, and must, make more use of the levers we have: our many contacts with citizens throughout their lives.
  15. We need all our young people to leave school with the financial skills to manage their own money and to engage in employment and enterprise. And all households should have greater access to affordable, simple, generic advice that helps them to understand their financial needs and options.
  16. The importance of strong financial understanding is highlighted by the recent collapse of Farepak and the terrible distress this has caused.
  17. The DTI are currently carrying out a full investigation of Farepak and the wider European Home Retail group of companies. I won’t pre-empt the outcome of those enquiries, but I will just say this: whatever went wrong with Farepak, the incident has raised important wider issues about people’s awareness of savings options and the methods by which people may prefer to save. Because – while the features of savings clubs of this kind can be attractive to lower-income savers, offering ease of access through local agents, the ability to pay in small sums regularly, and pre-commitment of funds – customers of these schemes will not earn interest on their money and do not benefit from the wider protection of financial services regulation.
  18. I am determined that we learn the lessons Farepak teaches us for our wider savings policy, in particular as we take forward the Saving Gateway once we have had the full evaluation report on the current pilot scheme next year. That is why I have asked Brian Pomeroy – the Chair of the Financial Inclusion Taskforce – to look at the reasons why people opt to use hamper schemes and similar vehicles instead of mainstream financial services products and, in the light of this, to consider how the savings needs of this group of consumers might be better met – and to report back around the time of Budget 2007.

Conclusion: building on a strong foundation

  1. In conclusion, we can only succeed as the leading global financial centre – and deliver both rising prosperity and fairness for all – if we think globally, work together, and deepen the links we have now.
  2. We have made good progress in recent years. We can do more in the years to come to exploit the full potential of our financial services industry and expand jobs here in Scotland and across the UK.
  3. So let us agree today to work in a strengthened partnership to ensure that we grow together and achieve even greater prosperity in the years to come.
Posted November 26th, 2015 by admin