An upcoming UK investment bonanza

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Peter is off this week so I’m making my newsletter debut as financial regulation editor. Predictably, the main piece is on the hunt for Brexit dividends in the finreg world. For those of you who aren’t fascinated by financial regulation (which I put at about 5 per cent of the FT’s readership) I’ve detoured into the latest UK cross-border trade for the second piece. Spoiler alert: tempted as I was to reprise my Ireland correspondent hat, the Northern Ireland protocol doesn’t get a look in. You can contact me at [email protected]

Brexit’s finreg dividend, much-hyped ahead of the UK’s grand departure from Europe’s single market, has mostly proved elusive in the country’s first two years outside the shackles of the EU’s regulatory machine.

Reforms to insurance regulation, reported by the Financial Times last week, offer the first sign of a big bang result in the policy space that could materially benefit both the UK’s economy and its financial services industry.

No formal announcement has been made, but people familiar with the situation say the Treasury and Bank of England have hammered out a reprieve of the EU’s Solvency II insurance rules which will free up tens of billions of insurers’ capital that can be invested in infrastructure projects. (If any detail-orientated readers would like to know more about the fine print, our friends over at Lex have penned this helpful note).

The upcoming investment bonanza is a big win for Prime Minister Boris Johnson’s beleaguered government, especially since much of the money is likely to go to politically popular projects that overlap with its “levelling up” agenda and greening the economy.

Insurers, who’d chafed against the rules since their 2016 inception, responded gleefully — particularly London’s Pension Insurance Corporation, which promised to invest as much as £20bn extra in infrastructure thanks to this “once in a lifetime opportunity”.

Michael McKee, lawyer at DLA Piper, said Solvency II was always the place where there was the most scope for a Brexit dividend in financial regulation, since the figures involved were so enormous. The Association of British Insurers has said as much as £95bn could be freed up for long-term investment if the mammoth Solvency II package were overhauled.

In the short to medium-term, the dividend will be enjoyed by the insurers already in Britain, who have more freedom to invest their policyholders’ cash for higher rewards, and infrastructure projects seeking funding.

Over the longer term, McKee said the changes would make the UK a more attractive venue for international insurers, though those who want to access the European market will still need a foothold in the EU for regulatory purposes.

The post-Brexit regulatory mood music is more mixed in other parts of the financial services industry.

McKee said he expected the UK to become more attractive in the funds market as well, where he says City regulators are already making it easier by introducing better processes, while the EU is “tightening up their regime”. The UK has already announced a post-Brexit overhaul of the way some private equity and infrastructure funds are taxed.

In the broader markets world, lobby group UK Finance said the industry was “encouraged” by the government’s efforts to reform wholesale capital markets. The biggest piece of work, the Wholesale Markets Review, is still ongoing, but the Financial Conduct Authority has already announced a sweeping overhaul of listing rules in an attempt to woo more fast-growing companies to London’s exchanges.

UK Finance is also encouraged by the Treasury’s November decision to give the UK’s top regulators a “secondary mandate” to promote growth and competitiveness, a measure that UK Finance believes can “balance enhancing the UK’s international competitiveness while ensuring we maintain high regulatory standards”.

Smaller banks are expected to be among the biggest beneficiaries of the UK’s refreshed approach to financial regulation. The Bank of England has spoken of its desire to be a “proportionate” regulator, code for applying different rules to a bank with a £10bn balance sheet and a bank with a £2tn one. More detail on that is likely in the coming months.

That could make the UK’s market more attractive to new entrants, though the potential to win inward investment is more limited than if there were to be a bonfire of the rule book for large and complex banks.

No one is expecting that. In fact, in the months since Brexit, the UK’s biggest lenders have grown steadily more pessimistic about their lot. The big game changer for them is the local application of the latest wave of global capital rules agreed by the Basel Committee for Banking Supervision.

The EU has already shown its hand, publishing a document in October which set out its proposals for implementing the rules and laid out a timetable.

The EU proposals include a number of bank-friendly deviations from the global deal. Some of them would even allow Europe’s banks to provide services into the UK at a lower cost than the UK’s own national champions, assuming the UK doesn’t offer the same reprieve to its lenders.

The UK’s banks are left guessing at what their regulators will propose, but are generally expecting them to stick close to the global deal, a stance that will disadvantage the City’s lenders relative to their EU rivals.

Meanwhile, this week ShareAction, a non-profit that advocates responsible investing, has been briefing UK policymakers on how a shrinking City could actually be a good thing.

“One of the consequences of Brexit is that the financial sector decreases in size, there is actually an opportunity here: to create a smaller, more robust, more purposeful financial sector that promotes sustainable and inclusive economic development across the rest of the economy,” says Rachel Haworth, policy manager at ShareAction.

The non-profit is urging the UK to take the EU’s work on ESG labelling and disclosure and “go beyond what the EU had proposed, showcasing its own innovative approach to sustainable finance and promoting it in the global marketplace”.

Do you work in an industry that has been affected by the UK’s departure from the EU single market and customs union? If so, how is the change hurting — or even benefiting — you and your business? Please keep your feedback coming to [email protected].

Brexit in numbers

Line chart showing that last year the UK imported more goods from non-EU countries for the first time on record

It’s official, the EU is no longer the biggest show in town for the UK’s importers. Data from the Office for National Statistics show that in 2021, for the first time since records began, the UK imported more from non EU countries than from the 27 of its closest neighbours who make up Europe’s single market.

“It was predictable — and predicted — that a major increase in trade barriers with the EU, combined with a modest reduction in the UK’s global tariff, would result in a reorientation of UK imports from the EU to the rest of the world,” says Jonathan Portes, professor of economics at King’s College London. “But this ‘trade diversion’ has been bigger and faster than most expected.”

Thomas Sampson, associate professor of economics at the London School of Economics, says the shift to non EU imports “suggests that new non-tariff barriers created by the TCA [Trade and Cooperation Agreement signed by the UK and EU] have increased import costs”. The UK and EU agreed not to impose tariffs on each others’ goods, imports and exports must go through customs checks and incur local charges for VAT and other duties.

Michael Gasiorek, professor of economics at the University of Sussex, says the fall in imports is “of course . . . due to higher barriers to trade, which is raising prices”.

“In part, the decline will be that the higher prices mean that consumers and firms are buying less,” he adds. “In part, it may be driven by EU firms simply deciding it is not worth the hassle of exporting to the UK, and if the UK only accounts for a small share of their sales it makes that decision easier. In any case this suggests less variety for UK consumers, and higher prices for consumer and firms buying intermediate input.”

At macro level, those higher costs are “likely to weigh on investment and productivity growth, though analysts have not yet been able to disentangle these effects from the impact of Covid-19,” Sampson says. He believes the swing away from EU imports is likely to become more pronounced in future years “particularly since many customs checks on imports were delayed until 2022”.

UK goods imports from non-EU countries are also boosted by the rise of China as a global supplier. At the start of the century, just 2 per cent of UK goods imports were from China, but the country became the largest source of UK imports last year, overtaking Germany for the first time on record.

The UK’s exporters are also struggling with the TCA. New research from the British Chambers of Commerce, published on Wednesday, says just 12 per cent of exporters believe the deal will help them, while 60 per cent of exporters say they are “facing difficulties adapting” to the new regime.

“Many of these companies have neither the time, staff or money to deal with the additional paperwork and rising costs involved with EU trade, nor can they afford to set up a new base in Europe or pay for intermediaries to represent them,” said William Bain, head of trade policy at the BCC, arguing for the UK and EU to reform the regime.

And, finally, three unmissable Brexit stories

Moderna, the US biotech company, is in talks with the British government about investing in UK research and manufacturing, as well as collaborating with the NHS on clinical trials. The Boston-based start-up — famous for its mRNA Covid-19 vaccine — is said to be considering sites in the so-called golden triangle of London, Oxford and Cambridge. One of those familiar with the matter told the FT the deal would be a “key element” of the UK’s post-Brexit strategy to become a global hub for the life sciences.

Big changes to alcohol taxation — set to come into effect next year — are causing concern across the wine industry. UK chancellor Rishi Sunak described the new rules as “the most radical simplification of alcohol duties for over 140 years,” enabled by Britain’s departure from the EU. But, as William Wallis reports, it seems that this so-called sunshine tax will worsen the already existing bureaucratic headaches importers are experiencing as a result of Brexit.

In this interesting opinion article, Paula Surridge, co-author of The British General Election of 2019, writes that focus groups of voters who turned away from Labour in “red wall” areas in the last election reveal that the Tories can’t count on continued support. “It is hard to find any sense that new bonds have been forged with the Conservative party,” she writes, and a feeling that votes were lent to the Tories, in order to “get Brexit done”. Now that has happened, could the shift be reversed?

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