UK: Market Volatility, Tax And Regulation

Last Updated: 6 March 2008
Article by Neil Fung-on

Our 2007 annual survey reports on the views of the City's FSA-regulated businesses.

Our tenth annual survey of FSA-regulated businesses in the City of London took place in November and December 2007. We surveyed 71 senior individuals from a variety of backgrounds, including banking, investment management, corporate finance and brokering.

Unsurprisingly, given the wide-reaching effects of the credit crunch, some of the results contradict what we reported this time last year.

Concern for the future

Research among the City's investment management houses and other FSAregulated businesses reveals that confidence has fallen since last year. Although 27% 'strongly agree' that turnover for 2007 will be better than the previous year, this is sharply down on the figures for 2006 when over half (52%) of respondents 'strongly agreed' that turnover for the year would exceed that of 2005 (Figure 1).

"The autumn of 2007 marks a turning point in confidence among the City's financial services sector. Optimism has been growing in recent years, but the credit crunch has put an end to this upward trend and the outlook now seems fairly uncertain, with only 55% of respondents confident about the next 12 months," said Neil Fung-On, head of the Financial Services and Markets group at Smith & Williamson.

Fig 1: Our business will achieve higher turnover in the current financial year than the previous financial year

The research also shows that while a resounding 90% of respondents believe London has strengthened its position as a key financial centre over the last five years, there is concern for the future, primarily surrounding macroeconomic issues.

"Market volatility ranks as the area of greatest concern, both in terms of how it might affect respondents' own firms and the financial services sector as a whole. The strength of the global economy and that of the UK were considered the second and third most important issues respectively, while fears of an economic recession came fourth," continues Neil.

"London's position remains strong – at least for the time being – but if these issues deepen, the worldwide financial services industry could feel the chill of a downturn. And, of course, London is unlikely to be immune to such difficulties.

"Other issues of importance for individual firms are managing the strategic direction of the business and the retention of key individuals, while dealing with the volume of new regulation is a concern for the sector as a whole," said Neil.

Tax has a growing influence

Our survey reveals that tax is playing a significant and increasing role in firms' business decisions. Indeed, eight out of ten (82%) participants believe the current tax system acts as a disincentive to undertake certain business decisions. This is in contrast to last year, when less than six out of ten (56%) respondents felt this way.

Fig 2: Tax system acts as a disincentive

The research reveals that over 56% of the participating firms have restructured their business to take advantage of tax efficiencies, whereas in 2006, just 45% did this.

In addition, a third of those who took part in the survey agree that tax was a key factor in deciding whether to expand or maintain operations in the UK, whereas just a quarter felt it was a key factor in 2006.

The majority of firms continue to make use of potential tax savings when considering remuneration packages: 59% of firms claim to have done this in 2007; the equivalent figure for 2006 was 55%.

"The danger is that with changes to the tax position of non-domiciled people – many of whom work in the financial services industry and who are extremely mobile – they may now be less inclined to work in the UK.

"This could put a serious question mark against London's continued pre-eminence, as what may be seen as marginal changes to tax legislation can have far-reaching effects. We are already seeing signs of this occurring, with an increasing number of clients exploring the implications of changing the jurisdiction from which they operate.

"These tax changes, taken with worries of an economic downturn, suggest a more uncertain outlook for both the City of London and the broader financial services industry," comments Neil.

Participants slow to comply with new regulations

Although MiFID was introduced on 1 November 2007, at the time of our survey, one in five participating firms claim to be only partly prepared for the new rules. And while a third of respondents have documented or finalised their Internal Capital Adequacy Assessment Process (ICAAP), at the time of the survey almost half (46%) were still in the research stages. However, most firms (53%) do not anticipate having to increase their financial resources as a result of their ICAAP.

Fig 3: Stage in ICAAP process (survey undertaken November/December 2007)

"Many firms, particularly smaller businesses, have been struggling to keep up with the volume of regulatory change. Not only do they have to shoulder the cost of implementation, many appear to see little or no benefit in the short term from these changes. As a result, many businesses have been leaving preparations until the very last minute," observes Neil.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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