UK: Financial Services And Markets Group Bulletin - London’s Reputation Under Threat?

Last Updated: 6 November 2008
Article by Giles Murphy


Your participation will help to form a comprehensive overview of how the sector is reacting to the economic crisis.

The last 12 months have been a turbulent time for UK and global businesses, with the credit crunch bringing the collapse of some large, well-known firms.

As part of our continued commitment to the financial services industry, we are carrying out our 11th annual survey at an important time for the UK and global economies. It will be interesting to gauge how opinion has changed over the course of the year, and the feedback will provide an insight into how businesses are reacting to the current climate.

Last Year's Results

Results from our previous annual survey, which was undertaken in November and December 2007, had already started to indicate a fall in business sentiment as the effects of the credit crunch began to filter through. This led to businesses forecasting a downturn in projected turnover, with only 27% strongly agreeing that their turnover for 2007 would be better than the previous year. This was markedly down on 2006, when over half of respondents expressed the same belief.

Overall, market volatility was ranked as the area of greatest concern, in terms of how it might affect individual businesses, as well as the financial services sector as a whole. The survey also highlighted concerns over the strength of the UK and global economies, which were considered the second and third most important issues, respectively.

Another critical issue for businesses was the fear of an economic recession. This was unsurprising given the survey was conducted at a time when the Northern Rock debacle had started to unfold. Yet despite the impact of Northern Rock, 90% of respondents thought London had strengthened its reputation as a key financial centre. Other issues for individual firms included retention of key staff and coping with the volume of regulatory changes that were being implemented.

There was also growing disquiet surrounding changes being made to UK tax legislation, with eight out of ten respondents believing the then tax system acted as a disincentive to undertake certain business decisions. However, last year's survey also revealed that over half of respondents have structured their business in such a way as to take advantage of the tax efficiencies that do exist. The impact of continual changes to tax legislation will be interesting to assess in this year's survey, especially in the current economic climate.

Looking Ahead

In light of last year's survey results and the uncertainty surrounding the global economy, it will be important to assess confidence within the financial services industry. Will the sector face similar concerns to those in the wider economy? Has London's reputation as a financial centre potentially come under threat from regulatory failings, or has its ability to trade through this period demonstrated its strength and resilience as a financial centre? Similar thoughts also apply to the US, given the unfortunate events involving Lehman Brothers and AIG.

Our survey acts as a reliable source of information relevant to your sector and highlights key areas affecting your business and market. We would like to invite you to participate by completing the enclosed questionnaire. Individual responses will be treated as confidential.


Changes to the scope of UK VAT exemption for fund management came into force on 1 October 2008.

HM Revenue & Customs (HMRC) introduced changes to the scope of the UK VAT exemption for fund management following the European Court of Justice (ECJ) judgment in JPMorgan Fleming Claverhouse Investment Trust plc (JPMC). This article considers some of the implications for the industry.

Last year, the ECJ held that fund management services supplied to investment trust companies (ITCs) should be exempt from VAT. It ruled that the restrictive treatment applied by the UK was in breach of the principal of fiscal neutrality. From this it was clear that other similar forms of investment vehicle should also benefit from the VAT exemption.

To comply with the decision, the UK exemption for fund management has been amended by Statutory Instrument 2008/1892, which came into effect on 1 October 2008. The scope of the VAT exemption will now be extended to include the following.

  • Funds similar to open-ended investment companies (OEICS) and UK authorised unit trusts (AUTs).
  • Other collective investment undertakings – although, in order for the exemption to apply:

    • he sole object must be investment of capital, raised from the public, wholly or mainly in securities
    • assets must be managed on the principle of spreading investment risk
    • all ordinary shares (of each class if there is more than one) or equivalent units must be included in the official list maintained by the Financial Services Authority (FSA) pursuant to section 74(1) of the Financial Services and Markets Act 2000
    • all ordinary shares (of each class if there is more than one) or equivalent units must be admitted to trading on a regulated market situated or operating in the UK.

The exemption will also apply to foreign equivalents of the funds, such as Dublinbased OEICS and Luxembourg Société D'investissement À Capital Váriable (SICAVs) that are managed from the UK.

HMRC has issued Business Brief 48/08 to clarify the legislation. The key points to note are as follows:

  • HMRC has acknowledged that the sub-funds listed on the FSA register do not necessarily correspond to the sub-funds that are marketed in the UK. It has therefore provided a list of other factors (such as 'distributor status') that should be considered in deciding whether the management of a sub-fund falls within the exemption
  • there is now a de minimis provision which requires a fund (or sub-fund) falling within the new classification of those funds attracting VAT exemption, that is not 'for the time being' marketed to UK investors, to be treated as not within the VAT exemption categories, where either:

    • less than 5% of its shares or units are held overseas by UK investors, or
    • where that fund has never been marketed in the UK.

The expanded guidance note also provides more information on how the new legislation affects the recovery of input tax.

Impact Of The Changes

Retrospective claims

By now, most fund managers will have lodged retrospective claims with HMRC to recover overpaid output tax. But a number of issues have arisen with regard to the backdating of these claims. The recent Condé Nast case established that the UK law to cap claims by three years was defective when first introduced in 1997, as no adequate transition period was provided for. As a result, fund managers are now entitled to file claims dating back more than three years, although we understand that HMRC is taking a rather aggressive line.

First, HMRC needs to be satisfied that the fund managers will not be 'unjustly enriched'. They are unlikely to approve claims unless it can be demonstrated that monies will be passed to the original customer, which is not unreasonable.

HMRC also requires that the claims submitted by fund managers be reduced to allow for input tax recovered previously.

Again, this is not unreasonable, but HMRC has also insisted on a further reduction in input tax which the ITC may have already recovered.

However, HMRC has been accused of acting unlawfully in this regard, since this requires one taxpayer to reduce his/her claim to allow for VAT that HMRC is unable to recover from another taxpayer. This could result in further litigation action.

Input Tax Restriction

To date, fund managers have been entitled to recover input tax (and not charge output tax) in respect of funds located outside the UK. This is on the basis that providing fund management services to a similar fund in the UK would be taxable. The new rules mean that where a fund is covered by the VAT exemption, the VAT recovery on related costs will need to be restricted. This will impact on a fund manager's cost base as the irrecoverable VAT cost will increase.

From a VAT compliance perspective, many fund managers will become partially exempt for the first time and will therefore need to negotiate a partial exemption special method. As a result of the change in business status from taxable to partially exempt, HMRC may be slow in approving the new methods.

Umbrella Funds

With respect to 'umbrella funds' such as SICAVs established in Luxembourg, HMRC requires that the VAT exemption be applied at sub-fund level, i.e. it is not the management of the SICAV, but the management of the SICAV's 'recognised' sub-funds that are exempt. However, there are likely to be practical difficulties in establishing which sub-funds are affected.

Pension Fund Management

Finally, it should be noted that the VAT treatment of pension fund management is also under review. A new case yet to be heard by the Tribunal will test whether the principles of the JPMC decision can be used to bring pension funds within the definition of 'special investment funds', and thus within the VAT exemption. If successful, this case could also have a retrospective effect, creating more work but also significant opportunities for those involved in this sector.


The FSA has adopted a more principles-based approach to regulation, spearheaded by its TCF initiative. But how will businesses adopt this approach ahead of the December deadline?

The FSA believes that rather than implementing prescriptive rules and processes, a principles-based approach will give financial services firms greater flexibility to deliver fair treatment to their customers, in a way that best suits their individual business needs. There is little doubt that this model is already having a significant impact on all firms.

The FSA has identified four main stages in the implementation of the Treating Customers Fairly (TCF) initiative.

  1. Awareness
  2. Planning
  3. Implementing
  4. Embedding

As the momentum builds ahead of the December deadline when all firms are expected to demonstrate that they are treating their customers fairly, activity will continue to increase as firms attempt to embed this principles-based regulation into the way they conduct business.

Recent FSA figures reveal that only 13% of firms assessed had met their March deadline, suggesting many companies are a long way off the mark. This was particularly true in the case of smaller firms.

Yet despite the lack of take-up, many firms seem to agree with the concept of TCF and are aware of the potential benefits it can deliver, including:

  • improved customer loyalty
  • increased customer satisfaction
  • better customer trust and confidence
  • enhanced reputation.

As the year-end approaches we are likely to see a large wave of assessments hit the industry. The focus on TCF is likely to become even stronger as the FSA prepares to visit more firms in the next few years than ever before. Previously, only the top 5% of firms were visited, but now there will be 11,500 TCF visits over the next three years – a big shift.

Those firms that think they are below the regulatory radar may find that this is no longer the case. In fact, TCF could claim some high-profile scalps if firms fail to understand what the initiative really means for their business and, as a result, fail to get their house in order. Firms must look to interpret what TCF means for their clients and customers, and the industry as a whole needs to adapt its practices to ensure the FSA's guidelines are implemented. However, this may prove extremely challenging because it will require a sustainable behavioural change.

The FSA has made it clear that its intention is to "embed a change in behaviour" in the sector, and it is on this much deeper degree of change that the FSA is now focused; but it is also here that many firms will struggle to deliver.

This final stage is not simply about undertaking a gap analysis and establishing an action plan; it's about changing mindsets and behaviours so that the financial sector as a whole transforms the way it behaves and, subsequently, alters the way it is perceived by the public. It is also about delivering outcomes that benefit the customer.

No matter how large or small an organisation, it cannot afford to rest on its laurels. Those that do and fail to meet the December deadline can expect more regulatory intervention.

About TCC

The Consulting Consortium (TCC) is a renowned regulatory compliance consultancy that provides specialist regulatory consultancy, advice and guidance on any regulated activity. It has designed two innovative technology-based approaches to help firms introduce the TCF initiative – and get it right – preventing media-grabbing headlines, not to mention fines.

The first is an electronic simulation tool, which recreates realistic TCF situations. Applying technology from the gaming industry to the regulatory world, this package examines six consumer outcomes from a number of perspectives. With the FSA's emphasis on how a firm embeds the principles of regulation, this method of immersive learning can be particularly beneficial. TCC has received endorsements from industry leaders in respect of this product.

TCC has also developed a self-assessment tool which identifies, documents and demonstrates TCF progress. The TCF Frame-worker allows a firm to evidence TCF to the FSA through a simple checkpoint system, which analyses and assesses the progress made in each outcome, demonstrating how well TCF has been embedded into a firm. This enables companies to analyse the root cause of compliance problems, not just the symptoms. The product is scalable and can be used within business divisions, allowing progress to be viewed centrally and, therefore, making it easy for compliance professionals to validate remotely.

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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Giles Murphy
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