In search of a pithy title for an introductory article on international financial centres (IFCs) amid the undeniably challenging environment of 2008, one can do no better than turn to the title of musician David Sylvian’s most arresting work: ‘Flux and Mutability’. Not only because the global financial industry is experiencing unprecedented change and a somewhat inconsistent and fickle response from both regulators and participants, but also because the work has two subtitles: ‘A big, bright, colourful world’ and ‘A new beginning is in the offing’. Both can be considered true for those financial centres willing to exploit the opportunities that such turbulence will undoubtedly bring.
So what will the dynamic markets actually mean for IFCs? Opportunities and threats. Winners and losers.
First, there will undoubtedly be a greater intensity of competition for global and regional financial services business as those ‘new’ centres, which are well advanced in their jurisdictional development, begin to implement their plans for capturing market share. This includes powerful economic centres, such as Istanbul and Beijing, as well as more focused centres, such as Tel Aviv and established ‘tax neutral’ platforms, such as the Bahamas, seeking to refine their regulatory frameworks and services in response to market changes. In addition, we are already witnessing the self-(re)assessment of the competitiveness of leading financial centres, such as New York, London and Switzerland.
Second, public and political reaction to the recent credit crunch, bank failures and share price declines will (for good or bad reasons) strengthen the existing perception that regulation must be tightened. We can already see this in the UK with the Treasury Select Committee focus on offshore centres, following Northern Rock’s employment of structured securitisation vehicles. This will likely increase the pressure on offshore centres to be well regulated. But the arguments of what ‘well regulated’ means, who is well regulated and (perhaps most interestingly) who is in a position to opine, will be a very long and critical debate, with arguments logically flowing both ways. Suffice to say that ill-considered and inappropriate regulation will impose unnecessary costs and stifle innovation, so there will be a competitive advantage in getting regulation right and making it responsive to industry’s needs.
Old and new
From a product perspective, some activities will become less profitable – and therefore less attractive – as sectors on which to focus, both for existing and emerging IFCs. For example, securitisation markets in the US and western Europe (where they had been best established) are likely to remain weaker for a period. But the picture is complex and we see the same markets performing better in emerging markets, so this activity may well still be a valid focus for developing centres in those regions.
We might also note that private placement is still reasonably active, demonstrating further complexity and fragmentation of securitisations into sub-markets. Those centres willing to take a role in resuscitating and developing these markets may gain significant competitive advantage. But speed-to-market and responsiveness of an IFC wishing to capitalise on these opportunities will be important here as hard-pressed London and New York-based teams will be prepared to go further afield to capture business.
Furthermore, new-entrant IFCs may choose to focus on sectors that will be boosted in these refractory markets. For example, the demand for derivatives may be strengthened because the cost and difficulty in raising finance will make it harder for some businesses to ‘ride out’ mismatches in cashflows and the risks relating to them.
In addition, the current market flux is putting strains on governments’ finances, combined with more hostile public attitudes to tax planning by business and the wealthy, given squeezed personal incomes. This may create more pressure from ‘onshore’ regimes to combat and undermine the tax advantages of offshore centres. There are already concrete signs of this. This may force many jurisdictions to reconsider their approach of offering excessive tax breaks, perhaps concluding that a stable and competitive (i.e. not necessarily zero) tax environment may offer the prospect of a more secure long-term revenue base.
Finally, this strain on governments’ finances comes at a time when, to take advantage of the markets, there is a need for investment on the part of IFCs, to develop rapidly in order to capture value before it is lost to competitors or re-consolidated into existing major centres as markets re-stabilise. So, how can governments manage this?
Pursuit curve strategies
In the 1730s, the French mathematician Pierre Bouguer studied the paths an object takes when pursuing another moving object, such as a dog chasing a rabbit. Sometimes referred to as path minimisation, this can be considered the nature of the strategies successful financial centres will now need to employ in the near term.
One may ask, ‘why not anticipate ahead of the quarry to attempt an even shorter path?’ However, in such a hard-to-manage environment it may be unwise to anticipate too far ahead, and adopting a (let’s call it) ‘reactive strategy’ would seem preferable.
But, pursuit curves take real agility on the part of the pursuer and successful IFCs are likely to be those who can design-in flexibility and market responsiveness, balanced against the absolute need to maintain stability and insure against systemic risk.
So, how can an IFC design-in flexibility? After all, speediness is not something for which regulators and tax authorities are generally renowned. In particular, it may take a complete mindset change for some regulators, who will need to moderate their approach from ‘risk minimisation at all costs’ to ‘balancing risk and return appropriately and accepting a non-zero-failure regime’.
It is likely that flexibility will come from four main design principles:
- Highly effective two-way communications and consultation – between IFC bodies (such as regulators, tax authorities, lawyers, etc) and market participants (both new and potential).
- Reduced complexity of regulation and administration – realised through an optimised regulatory organisation structure and a pro-business culture.
- Improved clarity and certainty of the tax system – with an ability to deal swiftly with business needs and the changing commercial environment.
- Improved general ease of doing financial services business – ensuring red-tape is eliminated and (perhaps) formation of a dedicated unit to help firms enter the IFC.
Will this solve all? No, not entirely. For smaller IFCs that are already using their inherent nimbleness to good effect, they will also have to understand the sectoral (product) needs of global financial companies and build a regulatory, tax and legal environment that encourages growth in these products by meeting those needs.
Also, flexibility is not the only thing that determines where banks and insurers choose to undertake business. For example, even though some captive insurance jurisdictions may provide highly attractive and flexible environments for the establishment of a new captive (with, for example, an efficient and rapid establishment process, low levels and less onerous classes of capital, advantageous tax structures, etc) not all business will immediately flow to those centres.
This is because existing captive centres have established themselves as the natural choice for this class of business, having built the community, processes and brand. It is then difficult for new jurisdictions to usurp this position unless the established centres make mistakes or do not spot new developments in the market.
And for larger, well-established IFCs with large domestic/regional economic hinterlands, building-in flexibility should provide a more enabling environment within which financial services institutions will feel more able to compete for local, regional and international business, ultimately allowing the markets to choose which products will grow fastest in the fertile ground.
Learning From experience
Our recent experience is that the level of discussion, the awareness of the value created, and the appreciation of the global nature of competition between IFCs, continues to rise. Market flux and mutability are unlikely to diminish this. On the contrary, competition for the capture of ‘IFC market share’ is increasingly intense.
The long-term success of an individual financial centre then becomes highly dependent on getting the strategy right ‘today’, applying national assets efficiently to that strategy and making sure it is actually implemented – not just talked about.
Contactvcolvin@deloitte.co.ukjcullinane@deloitte.co.uk
