UK: Financial Services And Markets Group Bulletin - Weathering The Storm

Last Updated: 19 February 2009
Article by Giles Murphy


Natasha Lee explains the results of our latest survey of the financial services sector, which indicate a bleak outlook for businesses.

For the second year in a row, the Smith & Williamson annual survey of FSA-regulated businesses shows a decrease in business confidence. However, this decline has accelerated substantially, with 56% of respondents reporting a drop in profit margins. Even more unsettling is the news that 62% of participants believe that London's reputation as a financial centre has fallen since last year.

Business Confidence

Now in its 11th year, the survey collects the opinions and expectations of financial services businesses in the City of London. This year, 44% of respondents expressed that confidence in their business prospects had decreased or strongly decreased over the last year, which is in contrast to 2007, when 49% were reasonably confident and only 18% were not. Last year's survey showed the first decrease in business confidence in 5 years. While the latest survey does not compare like-for-like questions with the 2007 survey, it does illustrate that the confidence of the sector has plummeted over the past year.

Fig 1: Business Confidence

According to 62% of respondents, London's reputation as a major financial centre has decreased over the past 12 months. This shows a significant shift from 2007, when 88% of respondents agreed that London had strengthened its position as a key financial centre over the last five years. It is expected that New York or Dubai is more likely to take over the mantle as the world's financial centre.

While the results are more negative than in previous years, the respondents appear to believe that they can weather the current storm. When questioned more closely about their experiences in 2008 and what their expectations were for 2009, they revealed what appears to be a varied outlook. For example, 38% of respondents have seen the volume of their business decrease in the past year, while 56% of respondents report a stable or increased volume of business in the past 12 months.

Fig 2: Change In Business Volume Over The Past 12 Months

While 56% reported decreased profit margins and 38% a decrease in turnover, 39% of respondents are expecting stable turnover and 26% are expecting an increase in turnover in 2009. This shows a dramatic contrast to the 2007 survey results, where 54% expected turnover to increase and only 4% expected a decrease.

Fig 3: Turnover Expectations: Comparison Of 2007 And 2008 Results

Considering the results above, it is unsurprising that, generally, respondents are not expecting an increase in their headcount, with nearly a quarter forecasting redundancies. For some firms this will be a new experience that will give rise to tax and legal issues that will need to be addressed. The overall message from respondents in respect of headcount is consistent with a low level of anticipated growth.

In respect of capital expenditure, a decrease is expected by 43% of respondents, while 41% expect it to remain the same and 16% expect an increase over the next year. However, 95% of the respondents expect expenditure on regulatory compliance to remain the same or increase. This appears to reflect a lack of growth, making firms more conscious of their expenditure. As a result, only necessary expenditure will be made, rather than discretionary or investment expenditure.

With the expectations for financial services businesses appearing to remain on an even keel through 2009, it must be that businesses in the sector are planning on making cuts elsewhere. The survey shows that more than half of the respondents expect a cut in discretionary spending in 2009. Spending on 'optional' services is likely to be downsized over the next 12 months, and marketing budgets could well feel the pinch.

Tax Issues

The results from the survey in respect of tax are not very revealing, with a majority of responses suggesting that expected changes to UK tax laws will have little to no effect on businesses. For example, 63% of the respondents forecast that recent changes to the UK tax legislation will have a neutral impact on the growth of the financial services industry. 88% of respondents think that the changes to be made to the supply rules for VAT will have neither a positive nor negative financial impact on their firm's business. Furthermore, 82% of the respondents reported that the various changes to VAT have had a balanced effect on their business.

These responses indicate that tax legislation is the least of the industry's worries. Businesses are undoubtedly more concerned about getting through an increasingly challenging economic climate, both in terms of winning work and securing additional funding.

The survey asked the respondents to select the factors they believe will most affect business growth over the next 12 months and the top three responses were: further economic factors, consumer confidence and their ability to raise funds.

In short, the views expressed in our survey are consistent with those of economic analysts: 2009 will be a hard year across the economy, and the financial services industry will be no different.


Andy Pedrette reflects on the expected drivers of continued demand for mid-market M&As.

Despite the recession, mid-market mergers & acquisitions (M&As) are still being completed, just at a substantially lower level than the past few years.

Corporates vs Private Equity

One of the contributing factors to the level of activity over the past few years has been that private equity appetite has been voracious, largely fuelled by large debt packages available for private equity backed deals. Now, the reduction in debt financing should provide opportunities for cash-rich corporates to re-enter the market at more attractive prices.

Private equity houses still have significant funds, raised in prosperous times, to invest in good quality businesses. Some houses appear to have adjusted their models and deal structures to accept less debt, or temporarily even no bank debt at all, if this is what is required to complete an attractive deal. Some also appear to be focusing more on buy-and-build strategies based on their existing portfolios.

Price Expectations

The current economic climate may seem to be driving a 'buyers' market', but activity levels in this environment are largely driven by vendors' willingness to sell.

Both corporates and private equity buyers will be looking to pay prices which reflect the current economic environment and uncertainty. This may be unpalatable to vendors, but we believe that price expectations are necessarily being adjusted. Prices are likely to involve a greater degree of contingent consideration and vendor loans may also be necessary. For vendors with realistic expectations and who are prepared to share in the risk of the future, deals are still to be done.

Opportunities For Some

The current downturn is also expected to generate its own stream of M&A activity as corporates review whether to hold on to non-core assets.

Stronger companies, with better management, more flexibility and clearer insight, will see the opportunity to acquire weaker businesses with financial problems. Defensively, companies may seek partners to mitigate falling sales/margins and relatively fixed overhead cost bases.

The strength of the euro and dollar against sterling is reflected in the increasing trend toward international acquirers becoming active in mid-market transactions. Foreign buyers are actively looking for UK acquisitions and opportunities.

M&A Activity Has Not Ceased

Smith & Williamson's M&A team has completed eight sales and four acquisitions for clients since the beginning of our financial year on 1 May 2008.

Of these, six involved overseas parties and the majority of buyers were established corporates. The minority, which were private equity driven, were almost exclusively buy-and-build strategies. Four of these deals were opportunities arising from the economic downturn, acting for either buyer or seller of a distressed business. In the remaining eight deals, the vendors were seeking either a larger partner to grow the business or a normal exit to facilitate retirement or succession.

Looking Ahead

In 2009, the market for the mid-market M&A looks set to continue to show modest activity and it appears that a return to the levels of recent years is still some way off. However, quality businesses will continue to be sought after by trade, private equity and international buyers.


For those of you left feeling a little underwhelmed by the 2.5% reduction in VAT, we offer advice on further VAT reductions and refunds.

Most businesses in the financial sector can recover only part of the VAT on their costs, so the Chancellor's announcement of a 2.5% reduction in the standard rate will have been welcome - although perhaps scant consolation for the grim economic outlook. If the reduction left you feeling a little underwhelmed, you should consider whether there are other reductions or refunds you could claim from HM Revenue & Customs. We have set out some suggestions to get you started.

Review Your Partial Exemption Method

Take a fresh look at your partial exemption method. Is it producing a good result, or does it need an update? Would you benefit from splitting the recovery calculation between the different areas of your business?

Reclaim More Of Your Input VAT

You probably know that input VAT is recoverable where it relates to making taxable supplies. 'Taxable' includes zero-rated transactions (e.g. in respect of the commodities markets). You might also know that it is recoverable when you make supplies outside the UK, if they would have been taxable here.

Did you also know that you could recover VAT on the costs of making exempt supplies, when the transaction is regarded as taking place outside the European Union (EU)? If so, do you know all of the rules for determining which transactions are considered to be non-EU? The obvious example is where your client is outside the EU, so if all of your services happen to be supplied to a hedge fund in the Cayman Islands you can recover your input VAT in full. However, if that is only part of your business you need to ensure that your partial exemption method provides for some of the input tax to be allocated and recovered accordingly.

Many businesses forget that a transaction also counts as non-EU if you're an intermediary (e.g. a broker) acting for a UK/EU client who is selling to a non-EU buyer. If you haven't been counting such transactions in your partial exemption calculation you may be able to submit a backdated claim.

Dealing With Reverse Charges

All businesses need to monitor 'reverse charge' services that they receive from overseas suppliers – not least because that is one of the first things that the VAT officer will look for when he/she comes to visit. Most businesses make the effort to track them and account for VAT under the reverse charge rules, but many are actually paying too much. Not all services are liable to the reverse charge. Some are exempt; some might have been paid for by your UK office but not actually received in the UK; others might be reverse chargeable but directly attributable to a taxable (or non-EU) activity and so be fully recoverable; and quite a few, on closer examination, turn out to be movements of money between group members that have nothing to do with supplies of services.

If you're not sure you're paying and recovering the right amounts of VAT, get in touch with one of our VAT specialists. The Smith & Williamson VAT team are experts at reducing the cost of VAT to our clients' businesses, not by selling you 'schemes' but by knowing what can be done.


Following the insolvency of KCP, defaulting investors are rapidly becoming a matter of concern.

One of the victims of the administration of Kaupthing Singer & Friedlander Limited in the UK, and the failure of other members of the Kaupthing group in Iceland and across the globe, has been Kaupthing Capital Partners II (KCP). KCP was a private equity fund, whose investors were Kaupthing entities and employees and unrelated third parties.

As a capital fund, KCP had access to loan facilities within Kaupthing, enabling investment in advance of drawdowns from investors. While this afforded freedom and flexibility, the general failure of the Kaupthing group precipitated a demand for repayment on loan facilities, rendering KCP insolvent as it was unable to pay its debts as they fell due. Our appointment as administrator of KCP duly followed.

Very few private equity funds have such loan arrangements, and we are not aware of any other funds which have entered an insolvency process for similar reasons.

Investors' default is, however, becoming a matter of increasing concern for fund managers, and there is anecdotal evidence from the legal profession of defaults from investors and indications that they will not be able to make future drawdowns. Such defaults should not, however, lead to the insolvency of private equity or other investment fund values unless, like KCP, the fund itself has borrowed against future capital calls.

Insolvency practitioners are well versed in assisting and acting for entities in financial difficulty. Our appointment over KCP has presented a welcome change, bringing the opportunity to engage with investee companies which are not in financial distress and have good management and sound business plans. We have maintained continuity in the management of the investments and the future looks promising, despite the difficult economic climate that lies ahead.

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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