Sarah Hall looks at how the new Chancellor has approached the financial services industry so far and sets out what the implications of a more deregulatory agenda in this area might be.
The early signs of Kwasi Kwarteng’s tenure as Chancellor of the Exchequer point to a marked change in the government’s relationship with financial services. The sector was comparatively neglected during the Brexit trade negotiations, losing its automatic access to the single market under passporting arrangements.
Since then, with little progress being made on alternative forms of market access, the UK government has focused on making regulatory changes with the aim of improving the international competitiveness of the sector. Kwarteng seems intent on taking this deregulatory agenda a stage further as part of his ‘Growth Plan’ but this is not without risks.
The current proposed regulatory changes developed during Rishi Sunak’s time as Chancellor of the Exchequer are set out most comprehensively in the Financial Services and Markets Bill (FSMB) – currently at the Committee Stage in the House of Commons.
The Bill makes a number of important changes aimed at tailoring EU regulation that was onshored when the UK left the EU to the specificities of the UK’s financial services sector. For example, the Bill sets out plans for UK regulators to focus more on competitiveness and growth (the Bank of England, the Prudential Regulation Authority and the Financial Conduct Authority). It also aims to make it cheaper and quicker for companies to raise money on stock markets as well as making changes to insurance regulation.
However, in his Growth Plan 2022 Speech, Kwasi Kwarteng indicated that the new government intends to implement a more deregulatory agenda than currently set out in the FSMB.
He outlined one such change: the ending of the cap on bankers’ bonuses in the UK.
The cap, introduced in 2014 by the EU, limits bonuses to twice a banker’s basic salary, with shareholder approval. It was introduced with the aim of limiting excessive risk taking following the global financial crisis.
Its ability to meet this aim has been debated, with critics, including Kwarteng, arguing that total remuneration packages have remained unchanged with a greater proportion of pay being derived through salaries rather than bonuses. Kwarteng also argues that it acted as a driver for firms to relocate outside the EU although this is not corroborated by research. The planned ending of the cap is politically sensitive in the UK during a cost-of-living crisis. These political risks explain why previous Chancellors opted not to diverge with the EU on banker pay post-Brexit.
The economic impacts of the cap’s removal are also unclear. Without the cap, it should be easier for large US institutions to make their remuneration packages in the UK more attractive and its removal will allow UK domiciled banks to offer more attractive pay in competitive international markets such as New York.
However, because it is a form of regulatory divergence between the UK and the EU, it may make the prospects of closer dialogue and market access with the EU less likely. The EU has been clear that greater single market access for UK financial services will not be possible with significant divergence.
Whilst Kwarteng has stated that he will bring forward further proposals for financial services regulatory reform, the details of these are currently unknown. However, Kwarteng’s predecessor Nadim Zahawi noted that the FSMB does not set out mechanisms permitting ministers to ‘call in’ regulatory decisions made by the Bank of England. Such a power would allow ministers to challenge and potentially override regulatory decisions if it was felt they were too cautious and not in the public interest. Zahawi stressed in his Mansion House speech that such a change should be considered by his successor.
There is a risk that should ministers be permitted to ‘call in’ regulatory decisions made by the Bank of England, the position of the Bank as an arm’s length regulator would be undermined. This move risks repoliticising regulation which, in turn, could undermine the attractiveness of the UK as a location for financial services.
There has also been speculation in the media that Kwarteng and Truss may seek a more radical change to financial services regulation. This could involve merging the Financial Conduct Authority, the Prudential Regulation Authority and the Payment Systems Regulator as part of a wider review of the objectives of each regulator to more closely align them with a focus on economic growth. The existing regulatory structure was introduced following the 2007 financial crisis and critics have argued that the suggested changes could make it harder to protect the systemic stability of the financial services sector and would fail to implement the lessons learnt from the financial crisis.
Whilst the financial services sector will welcome the closer attention Kwarteng is paying to the City compared to his predecessor, his emphasis on growth and further deregulatory reform creates uncertainty. Firms have already absorbed costs of implementing EU regulation and further change would inevitably incur additional costs. Indeed, the perceived high and predictable regulatory standards in the UK are frequently identified by market participants as one of the strengths of London as an internationally competitive financial centre.
As a result, the risks, both economic and political, of regulatory change need to be considered carefully alongside potential opportunities for growth.
By Sarah Hall, Senior Fellow at UK in a Changing Europe and Professor of Economic Geography at the University of Nottingham.