Risk aversion and its consequences
The financial crisis of 2008-09 was a watershed.
Before the collapse of Lehman Brothers, which was very nearly followed by the collapse of the Royal Bank of Scotland (RBS), the banks were growing their balance sheet like crazy. They were keen to invest in structured finance as exemplified by exotic instruments such as collateralised mortgage obligations (CMOs). That all ended in tears.
After the fall, the quid pro quo for the taxpayer having bailed out the banks – including the de facto nationalisation of RBS – was that the banks had submit to a much more restrictive regulatory regime. Consequently, a culture of risk aversion began to spread within the banking sector.
The Labour government under Gordon Brown and then the Coalition government under David Cameron went even further than the Europeans. The UK imposed special levies on the banks, meddled with their lending practices, and quite unnecessarily forced them at great expense to ring-fence their retail operations. Traditional relationship banking was superseded by the Know Your Customer (KYC) bureaucracy which largely consists of box-ticking. Unexplained Wealth Orders meant that all very wealthy customers became objects of suspicion. Lending officers became overshadowed in the corporate hierarchy by compliance officers and, increasingly, by the all-powerful HR department with its equality and diversity agenda. Senior bankers became personally liable for excessive risk-taking. Banks would have to keep higher capital and liquidity buffers. Bonuses were capped.
These trends were reinforced by the oversight of new bodies such as the Financial Conduct Authority (FCA) with a mission to “name and shame”. But some might point out that the slow creep of financial regulation began well before the financial crash. After Robert Maxwell’s body was found floating in the Atlantic in November 1991, it emerged that he had raided Mirror Group Newspapers’ pension fund in order to shore up his crumbling business empire. The Pension Insurance Corporation (PIC) was designed to ensure that such a thing never happened again. New accounting regulations forced companies to carry any corporate pension deficits on the liabilities side of their balance sheets.
That is all very well. But it is one thing to inhibit theft and another to oblige investors to take less risk. The fact is that the major UK pension funds increasingly allocated most of their portfolios to low-risk, low-return gilts – government bonds. They came greatly to disfavour equities – especially British equities. That is another reason why the London market has struggled to grow in the last decade, even as the New York market has soared. As a result, London listings look under-valued. And that is why so many UK-listed companies have fallen prey to foreign buyers. Even the 500-year old Royal Mail will soon have a foreign owner. And most of our privatised utilities are already in foreign hands.
Even retail investors are out of love with equities. Under Mrs Thatcher, who privatised the state-owned behemoths, the UK briefly became a property and share-owning democracy. That is no longer the case, as it still is in America. Only about 11 percent of the UK population own shares directly.
Britain has never recovered from the scarring wrought by the financial crisis. The UK economy is reckoned to be about 20 percent smaller than it would have been had its pre-crisis growth trajectory been maintained. The trend growth rate from the end of World War II to 2008 was about 2.8 percent. Since then, it has been 1.1 percent. The difference with the USA, which is where the crisis began, could hardly be greater. The US quickly clawed back the economic losses of the crisis and has similarly managed to recover from the coronavirus pandemic much faster than us.
If Brexit was supposed to liberate the City from overweening regulation imposed from Brussels – such as the EU-wide cap on bankers’ bonuses – the UK government has done precious little to ease the regulatory burden. And the City has lost much of its EU-based sources of revenue without replacing them with the much-promised opportunities available in the wider world. According to a 2019 study by the Centre for Policy Studies, there are about 90 “arms-length” regulatory bodies in the UK which collectively spend over £6 billion of public money every year.
Anecdotally, things are not what they used to be. Lord Spencer, who founded ICAP back at the time of Mrs Thatcher’s “Big Bang” recently told the Daily Telegraph: “I started ICAP in 1986 with £50,000 of my own money and 20 years later, it was a FTSE-100 company. I think it would be impossible to do that today.” He says that directors spend much of their board meetings discussing, not new business opportunities, but compliance and ESG issues. And compliance is an expensive overhead. The Institute of Economic Affairs (IEA) reckons that anti-money laundering regulations cost UK banks about £34 billion a year. That is more than the cost of the UK police force. And all of these costs reduce return on equity and therefore shareholder value.
There is very probably a correlation between the rise of risk-aversion in the banking industry and the fall in our productivity growth in the sixteen years or so since the financial crash. Without greater productivity, living standards cannot rise. In fact, the main source of economic growth in absolute terms in recent years has been large-scale immigration: but immigration does not translate into higher GDP per capita unless those immigrants are highly skilled – and clearly, many were not.
I had a personal insight into the new banking culture recently. I have been banking with HSBC both for personal accounts and numerous businesses in which I have been involved for over 20 years. A few months ago, I got a call from HSBC Premier Banking asking me to come in for “a chat”. I thought that they wanted to sell me some glossy new investment products, so I gladly agreed. In the event, I was ushered into a room where a twenties-something young banker sat at a desk peering into his laptop, and a fifties-something supervisor sat behind taking notes. They had no new products to sell me. It turned out it was an exercise in KYC. I was asked to explain my various sources of income. Not so much delight your customer as Big Brother is watching you!
Outlook for the London Stock Market
Even given recent record highs, the London market is barely larger than it was at the beginning of this century. Last week, London regained the crown as Europe’s largest stock market by market capitalisation – but only because the Paris Bourse was reeling from the political uncertainty prevailing in France.
A slow trickle of companies have de-listed in London and re-listed in New York over the last year. Just as foreign takeovers – partly driven by the fact that the London market is too cheap – reduce the total number of listings. In short, the London stock market is shrinking. The danger is that the loss of liquidity will be self-reinforcing.
Several companies have withdrawn from the UK stock market in recent months including CRH (owner of Tarmac), Flutter Entertainment (owner of Paddy Power) and plumbing group Ferguson. Meanwhile, cryptocurrency remains an entirely unregulated market – and is mainly favoured by young people who are unfamiliar with the equity markets.
It’s not all doom and gloom. A Boston Consulting Group (BCG) survey published in late April reported that London is still seen as one of the most desirable locations for international executives to work. The exodus from the City anticipated by the Remain camp in the Brexit referendum campaign never happened – although Paris has been stealthily eating London’s lunch. Goldman Sachs is one financial giant that has transferred about 500 deal-makers from London to Paris. JP Morgan moved an entire trading floor from London to Paris in 2021 – and President Macron was gracious enough to launch it, like an ocean liner. Overseas direct investment is bearing up in the UK, even if the French have overtaken us.
But the recent political turmoil in France offers the City an opportunity. The French hard-left proposes a menu of swingeing wealth taxes; the right-wing National Rally is unsympathetic to big finance. The prospective incoming Labour government is not generally enamoured of big finance either, but there are things they could do to help the City.
For a start, they could exempt banks and fund managers from the proposed new employment laws, just as Emmauel Macron did in France. Labour’s proposed employment laws are intended (if I understand correctly) to raise the condition of the low-paid; they should not be too worried about high-earners who will be paying more tax anyway.
It is of note that the financial markets appear to regard the prospect of a Labour super-majority with equanimity. In contrast, in France, government bond yields have spiked. The spread between the 10-year German Bund and the equivalent French Trésor is running at 74 basis points as I write. That is the highest spread since 2017. This reflects the dramatic divergence of debt-to-GDP ratios between Germany (64 percent and falling), and France (111 percent and rising).
The Paris Bourse has also lost more than five percent since President Macron announced legislative elections on 09 June. The financial markets have been expecting a Labour victory for some time; and a Labour majority government will prospectively be stable, even if inclined to a high-tax, high-spend agenda. In France, however, whatever government emerges after 07 July will be a minority one with an uncertain economic policy. President Macron even spoke this week about the danger of a civil war in France if the centre cannot hold – an utterance that further spooked the markets.
Just as a new government is poised to take power, the economic outlook in the UK is looking up. UK inflation is now below that of France and Germany. Britain has more “unicorns” (start-ups with an estimated valued in excess of $1 billion) than any other European country. (Although it is regrettable that some of our tech super-stars like Arm Holdings and DeepMind were sold off to foreign buyers too early in their lifecycle). That is partly because we have a thriving venture capital and private equity sector – on which Labour has threatened to impose new taxes.
Labour supposedly wants to stimulate wealth creation. “Financial services are one of Britain’s great success stores”, Labour now claim. But their instincts are towards risk-aversion, safety first and excessive regulation. The party’s 2024 manifesto mentions the word “regulation” 27 times. They even want to set up a Regulatory Innovation Office – surely an oxymoron, if ever I heard one. They have plans to introduce “binding regulation” on AI; a “tougher system of regulation” for energy providers; new powers to block bonuses for water utility executives, and to “strengthen regulation” of children’s social care. Even the beautiful game of football is going to have its own statutory regulator. So why not cricket too?
The attitudes of most mainstream politicians during the coronavirus pandemic were also telling. The Johnson-Sunak government locked us in our homes for months at a time. But the SNP government in Scotland and the Labour opposition in Westminster wanted to go even further and confine us indefinitely, even though the median age of Covid-19 morbidity was 82. Extreme risk-aversion ruled – with catastrophic economic consequences.
The City was once the British goose that laid golden eggs. That goose now looks sickly. Can Labour save the City? They do have friends there such as the ex-Governor of the Bank of England, Mark Carney. And they could hardly do a worse job than the Cameron-May-Johnson-Truss-Sunak cluster-disappointment.
Afterword: News from Scotland
I spent last week on the campaign trail in Scotland in the verdant, rolling Borders. Its pastel light, especially in mid-summer, is arresting.
In 2017, when I last campaigned there on behalf of John Lamont – who was elected for the first time, winning Berwickshire, Roxburgh and Selkirk from the SNP – the Tories won twelve Westminster seats in Scotland. One could have walked the incredible Southern Upland Way from Stranraer on the Irish Sea to just outside North Berwick on the North Sea and not have left a Tory constituency. And much of Aberdeenshire turned Blue too.
The general election of 2019 was not as felicitous for the Tories. Scepticism about Brexit had already set in, and no-nonsense Scots never took to Borisian buffoonery. But, as one who knows the Borders as an outsider, this is not just a wonderful region with abundant flora and fauna, but a telling bellwether of our national political mood. In Scotland, Labour is advancing as elsewhere, but in the Borders the main battle is between the Scottish Conservatives & Unionists and the SNP.
The Borders region is special. There are cricket clubs in every market town, even if Scotland does not have a national cricket team. But that does not make the Borders England, even if much of it was once a part of the ancient Anglo-Saxon Kingdom of Northumbria. True, one widely hears English accents. It is prosperous. People tend immaculate gardens, even if their houses are modest. There is little litter. The air is good. There are decent hostelries. I would gladly live there – and have long aspired to buy a bothy.
My overwhelming sense on the doorstep was that many former supporters have lost faith in the SNP who are widely perceived as incompetent and self-serving. At the same time, the Scottish Conservatives and Unionists are tarnished by the failed brand which they share with their confreres down south.
In Dumfries and Galloway, Alister Jack, who is still Secretary of State for Scotland as I write, is standing down. His successor, John Cooper – a trusted colleague – is defending a 2019 majority of just 1,805. The main challenger is Tracey Little of the SNP. The local complaint is that the SNP government in Edinburgh has neglected this corner of Scotland. Local farmers are sceptical about policies coming out of Holyrood (including Jamie Blackett, whom I have often cited in this column). The A75, running south, becomes the M6 at the border with England: yet it has never received funding from Edinburgh to be upgraded to a motorway. The Scottish Conservatives also have a decent chance of winning back Ayr, Carrick and Cumnock from the SNP, which lies just north of Dumfries and Galloway.
In Dumfriesshire, Clydesdale and Tweeddale, David Mundell is defending a majority of 3,781 against the SNP’s Kim Marshall. But, reportedly, Labour support has surged. So, this is now a three-horse race.
What has changed since my last stint campaigning in the Borders is that the Conservative boots on the ground are now extremely hi-tech. Each campaign team communicates through tightly administered WhatsApp groups. Canvassers are equipped with Google maps of where wavering (“knock-up”) voters live. Some can summon the electoral register on their devices. There are plenty of tireless volunteers and leafleteers on hand, who are competitive step-counters. The young female lawyer campaign manager in Roxburgh is formidable.
Do not write off the Tories in Scotland. In fact, the Scottish Tories will have a disproportionate influence in the reduced Westminster parliamentary Tory party, post-apocalypse. I foresee that the Borders will stay Blue – and that, further north, the SNP will get a hammering from Labour.
And, next time round, it is Labour that will be in the frame.
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Enjoy the week ahead. As the Chinese valediction goes: May you live in interesting times. I’ll have some preliminary thoughts about the outlook for the UK economy and investment scene by mid-morning next Friday.