EUROWEEK UK CAPITAL MARKETS - SERVING UP ECONOMIC RECOVERY - LLOYDS BANK
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EUrOWEEK In association with:
UK Capital Markets
September 2013
Serving up economic recovery
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4 The UK economic revival: rhythm, or blues?
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57 Banks are not the only fruit: firms seek new funding tools
UK Capital Markets | September 2013 | EUROWEEK 1
Foreword by the Economic Secretary to the Treasury
UK: the economic plan is working
by Sajid Javid, MP, Economic Secretary to the Treasury
T
he UK government is dedicated to increas- ulation to ensure we
ing the nation’s competitiveness and have a safe and resil-
maintaining London’s position as a world ient financial sector
leader in the financial field. But we face that can compete sus-
serious challenges. The economy is recovering from tainably in the global
the most damaging financial crisis in generations. market; (ii) creating
UK output fell by 7.2% from peak to trough. That is the right environment
almost twice as deep as that experienced by the US for financial servic-
and three times as deep as Britain’s recession in the es firms to trade and
early 1990s. attract inward invest-
Debt was at unsustainable levels. In 2010, total pri- ments and supporting firms to pursue high value
vate sector debt had reached 470%. The government opportunities; and, (iii) incentivising banks to lend to
ran rising deficits even at the peak of the boom. The the real economy, supporting SMEs and employment.
UK entered the crisis with a structural deficit of more We are delivering necessary reforms to strength-
than 5% of GDP, the highest amongst the G7. Subse- en the City and make it more resilient. We are
quently the deficit soared and in 2010 the UK deficit implementing the recommendations of the Vick-
was forecast to be the highest of any major economy. ers review through the Banking Reform Bill and we
The historically high level of borrowing undermines have reformed the financial regulatory architecture
fairness, growth, and economic stability. in the UK through the Financial Services Act. We are
The UK government has implemented the econom- also working hard in Brussels to secure the best pos-
ic strategy necessary to rectify Britain’s perilous mac- sible outcomes on a range of financial services dossi-
roeconomic imbalances. The combination of fiscal ers, enhancing financial stability whilst protecting the
responsibility and monetary activism assists the rebal- competitiveness of the financial services industry.
ancing of the economy from debt-sustained activity In the Budget this year, the Government announced
towards investment and exports. Our fiscal credibility the creation of the Financial Services Trade and Invest-
has helped keep interest rates low and allowed the UK ment Board, which has been tasked to support the sec-
authorities to pursue a strategy of monetary activism. tor in gaining market share abroad and creating the
This includes measures such as the Funding for Lend- right environment to attract inward investments. The
ing Scheme that has supported a dramatic improve- Board is now up and running and will identify trade
ment in financial conditions. and investment priorities within the financial services
Our unwavering commitment to deliver a sustain- sector and provide senior level steers and directions for
able recovery is yielding results. The UK economy is joined up government and industry actions.
turning a corner. Recent evidence suggests tentative
signs of balanced, broad-based growth. The deficit A plan for sustainable growth
has been cut by a third as a percent of GDP and the A key element of our economic plan is an ambitious
structural deficit has been cut more than any major programme of growth-enhancing reforms to support a
advanced economy. Private sector debt has fallen by sustainable recovery. Our plan focuses on tax competi-
almost 40% of GDP since early 2010. For every pub- tiveness, business growth, workforce skills, and rebal-
lic sector job lost, 3.2 have been created in the private ancing towards investment and exports.
sector. Employment is at an all-time high. Finally, the Consistent with these aims, we are emphasising
average of independent forecasts for 2013 GDP growth long-term investment in infrastructure by committing
are now more than double the 0.6% official forecast to publicly fund a pipeline of specific projects worth
from March. Britain is on the mend. over £100 billion by 2020.
But the recovery is in its early stages, and we must We have brought forward the delivery of our com-
remain vigilant. While the extreme risks in the euro mitment that the first £10,000 of income is free from
area have been reduced, they do remain, and emerg- income tax. Increases already in place have saved a
ing market economies have slowed as capital flows basic rate taxpayer £600 a year, rising to £700 next
back to recovering advanced economies. We will not year. By April 2014, 2.7 million low income individuals
become complacent about implementing our plan to under 65 will have been lifted out of income tax alto-
repair and strengthen the UK economy. gether.
In addition, we are boosting investment and com-
Financial services: petitiveness through a major programme of corpo-
stability and competitiveness rate tax reform, including by reducing the main rate
The financial services sector in the UK accounts for of corporation tax from 28% to 20% between 2010 and
10% of our GDP, 12% of our tax revenue, half of our 2015. Companies that had left the UK are now bringing
trade surplus, and employs over 1 million people — investment back home.
two thirds of whom are outside of London. Financial So whether it’s helping keep interest rates low;
services have a critical role in the recovery as a pro- repairing our banks; dealing with the deficit, or last-
vider of credit and financial intermediary services to ing structural reforms to make Britain more competi-
businesses and consumers. We are taking ambitious tive — the government is backing British business and
actions along three strands to ensure that we have a creating lasting improvements in the living standards
financial sector which can make significant contribu- of families. The economic plan is working and we are
tion to sustainable growth: (i) reforming financial reg- committed to seeing it through. s
2 EUROWEEK | September 2013 | UK Capital Markets 2013
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7679912_EW Tombstone Ad_vAW.indd 1 18/09/2013 14:13
Macroeconomic Overview
The UK economic revival:
rhythm, or blues?
The UK economy seemed to shift into gear over the summer with improved data suggesting a
recovery is underway. But, as Philip Moore discovers, the path back to boom times may prove
anything but smooth.
The UK Chancellor of the recent Morgan Stanley analysis of
Exchequer may have turned down “I’m not aware of productivity in the UK. If the Mor-
an invitation to perform a duet anyone who gan Stanley prognosis is correct, it
with Jeffrey, the R&B-singer with foresaw the speed should have significant implications
whom he shares a surname, after with which the for the sustainability of the UK’s
President Obama got his Osbornes economy seems to equity market, given that will sup-
mixed up in June. But in the last be recovering” port rising corporate profits. Tell-
few weeks, George Osborne may ingly, Morgan Stanley has recent-
have been tempted to sing chirpily Jamie Dannhauser, ly lifted its year-end target for the
in his bath, as one of his predeces- Lombard Street FTSE 100 from 7,000 to 7,170 —
sors was famously reported to have Research suggesting there is scope for a rise
done following the UK’s exit from of almost 10% over the next three
the Exchange Rate Mechanism in months.
1992. has been the surprising strength
In an unguarded moment, Chan- of the incoming data,” says Mela- Productivity problem
cellor Osborne may even have been nie Baker, UK economist at Mor- Baker’s qualification about the pro-
tempted to echo the same predeces- gan Stanley. That data, she adds, ductivity outlook is an important
sor and point to the emergence of has recently led Morgan Stanley to point, because Bank of England gov-
some green shoots of recovery. He revise its forecast for GDP growth ernor, Mark Carney gave a muted
has, after all, had almost an embar- in 2014 from 1.4% to 2.4%, leapfrog- assessment of the outlook for pro-
rassment of good news to digest ging the CBI’s forecast for next year, ductivity growth in August, forecast-
recently, which began in June when which has recently been lifted from ing annual growth of 1.8% for the
the IMF revised its growth forecast 2.1% to 2.3%. next three years, which is still below
for 2013 from 0.7% to 0.9%. RBC is also forecasting growth its pre-crisis trend of 2.2%. “While
The flow of good news acceler- of 2.4% in 2014. “The economy has even that modest productivity is not
ated in August, when the Office turned the corner, and I expect the assured, it is hardly an aggressive
of National Statistics (ONS), recovery to be sustainable,” says forecast,” said Carney. “It implies
announced that second quarter Jens Larsen, chief European econo- that productivity reaches its 2008
growth came in at 0.7% rather than mist at RBC Capital Markets in Lon- level only in 2015. And it means that
the 0.6% it estimated in July. In the don. “But the growth rate will still productivity doesn’t catch up any of
same period, employment rose by not reach the levels we would have its current 15% shortfall relative to
80,000, with the private sector creat- regarded as sustainable before the its pre-crisis trend.”
ing three times as many jobs as were crisis, which would have been in the “Our outlook is certainly not with-
lost in the public sector, accord- range of 2.5%-3%.” out risks,” says Baker at Morgan
ing to the Confederation of British Stanley’s Baker foresees sustain- Stanley. “If we’re wrong on the pro-
Industry (CBI). Construction orders able growth underpinned by rising ductivity story, it changes the whole
jumped by 20% between April and productivity without stoking much complexion of the UK recovery.”
June. Activity and orders in the in the way of inflationary pressures. For the time being, however, the
manufacturing sector are rising at “We see a virtuous circle developing consensus among economists is
their fastest clip for 19 years. Retail in the economy with a simultaneous more upbeat than it has been for
sales are up. So are exports. pick-up in demand, supply and cred- many years. Indeed, the marked
It amounts to a cocktail of good it conditions,” she says, arguing that turnaround in the fortunes of the
news that seems to have caught as it is largely a cyclical rather than a UK economy has given the Bank of
most forecasters on the hop. “I’m structural phenomenon, productiv- England sufficient confidence to
not aware of anyone who foresaw ity growth should accelerate as the stick at £375bn of quantitative eas-
the speed with which the economy economic recovery gathers pace. ing (QE), rather than to twist for an
seems to be recovering,” says Jamie “This suggests that there is less additional £25bn.
Dannhauser, director in the research need to worry about the risks of The revival of the economy, how-
group at Lombard Street Research in underlying inflationary pressures ever, has also given rise to increas-
London. building in a recovery, compared ingly vocal misgivings about some
Others agree. “The main theme with our previous concerns,” says a of the policies that were originally
4 EUROWEEK | September 2013 | UK Capital Markets 2013
Macroeconomic Overview
scheme wouldn’t get them very the Funding for Lending scheme
“We see a virtuous far, given a median house price in (FLS) introduced in August 2012 to
circle developing in the borough of £965,000, accord- boost lending to households and
the economy with ing to the This is Money website. In companies, is mixed. According to
a simultaneous the northern towns of Burnley and the Bank of England’s latest num-
pick-up in demand, Stoke, by contrast, it is a little under bers on the FLS, in the second quar-
supply and credit £64,000. ter of this year 18 participants made
conditions” More broadly, however, the Help drawdowns of £2bn, bringing the
to Buy idea has been lambasted by total of outstanding drawdowns
Melanie Baker, those — even within the UK’s govern- under the scheme to £17.6bn from
Morgan Stanley ing coalition — who argue that it is 28 lenders. That is a far cry from the
likely to engender an unsustainable £70bn that was originally set as the
house price boom and even a minia- upper limit when the scheme was
designed for a patient in intensive ture US-style sub-prime crisis. announced, and perhaps explains
care. why the programme was modified to
Some of these stimulants, it is Housing help incentivise banks to increase their
argued, are looking less and less But Baker says that Morgan Stan- lending to SMEs.
appropriate now that the patient is ley is positive on the Help to Buy In its most recent update on FLS,
out of bed and threatening to start scheme. “We think there will be a the Bank reports that “there is evi-
cart-wheeling down the corridor. supply response that will be big- dence that the price and availabil-
The fiercest criticism has been ger than the market expects, and ity of lending to businesses has
reserved for the government’s Help we also believe it could ultimately improved since the scheme began
to Buy scheme announced in the act as a powerful macro-prudential and this trend has continued in
March 2013 budget. Designed to defence against future bubbles,” she recent months.” Lending still has
kick-start demand in the housing says. some way to go, however, before it
market, this three year scheme is Morgan Stanley has estimat- comes close to pre-crisis levels. Hav-
divided into two parts: an equity ed that, encouraged by the initia- ing risen by 16.8% in 2007 and 18%
loan component and a rather more tive, the UK could see a 30%-40% in 2008, lending to UK businesses
controversial initiative that will pro- increase in new housing starts by slipped back by 1.8% in 2009, 7.1% in
vide some £130bn of guarantees 2015 on 2012’s levels. 2010, 3.3% in 2011 and 3.1% in 2012.
for up to 15% of loans for purchas- Trevor Williams, chief economist, “Although there are tentative signs
es of homes worth a maximum of Lloyds Bank Commercial Bank- that the pace of bank balance sheet
£600,000. ing, is also relaxed about the impact restructuring may be lessening,
One of the reasons the scheme is that the scheme may have on house credit flows remain moribund,” Bar-
regarded by many as hare-brained prices. “House price inflation in real clays cautioned in a recent note.
is because it doesn’t appear to take terms is still significantly below its It may not have generated the
into account wild differences in peak, and in some parts of the coun- volumes that its most enthusias-
affordability across the UK’s wonky try it is even declining,” he says. tic advocates were hoping for at its
property market. Most residents in “The national average is distorted launch, but economists say the FLS
the posh parts of London like Kens- by the high prices in London, but has had a beneficial effect on credit
ington and Chelsea don’t need help the picture is more mixed than the conditions in Britain.
to buy property or anything else. headlines suggest.” “One of the reasons that bank
But if they did, the government’s Opinion about another stimulant, funding costs are so low is that they
have had access to FLS,” says Larsen
at RBC. “The reason banks are going
UK forecast summary through such an extensive peri-
2012 2013 2014 2015 od of balance sheet restructuring
(Estimated) (Estimated) (Estimated) is not shortage of liquidity. Capital
Real GDP (%Y) 0.2 1.4 2.4 2.1 requirements and pressures on prof-
Private consumption 1.1 1.5 1.6 1.8 itability have been the main con-
Government consumption 2.8 1.6 -0.6 -1.5 straints on bank lending.”
Gross fixed investment 0.5 -2.7 5.6 5 The recent rise in Gilt yields is a
Contribution to GDP (pp) reflection of a range of influences,
Final domestic demand 1.4 1 1.7 1.5
led by the global response to taper-
Net exports -0.6 0.8 0.4 0.5
ing in the US. But economists say
Inventories -0.6 -0.3 0.3 0
longer term rates in the UK may also
Unemployment rate (% labour force) 7.9 7.7 7.5 7.3
Current account (% GDP) -3.8 -2.7 -2.5 -1.9
reflect a view that monetary tighten-
CPI (%Y) 2.8 2.7 2.7 2.3 ing may be required sooner than had
Policy rate (eop, %) 0.5 0.5 0.5 1 been expected earlier this year.
General government balance (% GDP) 5.5 6.1 5.2 4.4 This is why some are even ques-
General government debt (% GDP) 90.1 93.5 96.2 97.8 tioning the suitability of the new
governor’s signature tune, forward
Source: ONS, Bank of England, Morgan Stanley research estimates guidance, given the apparent volte-
UK Capital Markets 2013 | September 2013 | EUROWEEK 5
Macroeconomic Overview
“The growth rate modest, it would mean that well make a recovery.”
will still not reach over 750,000 new jobs would need The strong performance of the
the levels we would to be created, with the responsibility last few months has only succeeded
have regarded as for doing so falling squarely on the in clawing back some of the losses
sustainable before shoulders of the private sector. That of recent years, making for unflat-
the crisis, which will be a tall order. tering comparisons between the UK
would have been The third, Carney warned, is that and its main trading partners. “Con-
2.5%-3%” a recovery in growth does not nec- struction activity is still 16% below
essarily filter through to faster job its pre-crisis peak and production
Jens Larsen, creation. That may be a legitimate is 10% below its peak, while ser-
RBC Capital caution. Witness concerns over what vices have just got back to where
Markets some have called the jobless recov- they were in 2008,” says Williams at
ery in the US. Lloyds Bank. “As for the economy as
face in the UK’s economic fortunes. Economists appear to agree with a whole, it is still about 3% below its
Forward guidance, or ‘conditional Carney that a rapid decline in unem- 2008 peak, compared with 5% above
commitment’, refers to the com- ployment towards the 7% level looks the 2008 level in the US and 4%
mitment of the Bank of England’s unlikely. “Unemployment has been higher in Germany.”
Monetary Policy Committee (MPC) roughly unchanged for the last four One explanation for the weakness
to holding policy rates at 0.5% until years now,” says Williams at Lloyds of the UK’s recovery, Williams adds,
GDP growth accelerates to the point Bank. “One of the reasons for believ- has been the deleveraging of house-
where it brings the UK unemploy- ing unemployment is unlikely to holds in recent years.
ment rate below 7%. fall to 7% is that one of the conse- “At its peak, UK household debt
quences of having stable or growing was approaching 180% of GDP,”
It’s a knockout employment at a time of falling or he says. “It has now come down
There are, however, three knockout stagnant output is that labour pro- to about 140%, which is a sharp-
clauses that would trigger a tighten- ductivity plummets. As output picks er fall than in any other industri-
ing in monetary policy before the up, firms will aim to generate more alised nation. There is now scope
7% target is reached. All bets would productivity from their existing staff for households to start spending
be off if the MPC reckons inflation before they start thinking about again, which is partly why recovery
looks like reaching 0.5% above tar- adding to their labour force.” is underway, although some would
get over a 10-24 month period, or if One extreme manifestation of argue that debt is still uncomfort-
medium term inflationary expecta- this pursuit of productivity gains ably high.”
tions become dislodged. from companies’ existing labour
Monetary tightening could also be resources has been the increase in
brought forward if the Bank of Eng- the number of employees working “The economy is still
land’s Financial Policy judges that on zero-hour contracts, which the 3% below its 2008
low rates pose a threat to financial Office of National Statistics (ONS) peak, compared
stability by fuelling asset bubbles or puts at 250,000. with 5% above the
excessive leverage. There are several reasons that 2008 level in the
For now, none of these knockouts Carney is right to be cautious US and 4% higher in
look imminent, but some say that about growth and employment, Germany”
the credibility of forward guidance say economists, particularly when
is already coming into question. it comes to the UK’s main trading Trevor Williams,
“Recently markets haven’t been buy- partners. Another dip in European Lloyds Bank
ing into the guidance story, which is economic performance could be
a worry,” says Dannhauser at Lom- especially damaging.
bard Street Research. “My hunch The weakness of the recovery to
is that over the next few months UK’s ‘lost year’ date comes in spite of the fact that
the MPC will try hard to talk down Another is that although the govern- government spending has risen,
rates and the pound and contain the ment has made considerable politi- meaning that the economy would
upward move in yields.” cal capital out of the recent encour- have been weaker without it. That
Certainly, in his first speech as aging data, the recovery is a fragile does not bode well for cuts set to
governor, delivered at the end of one which comes from a very low take effect in the near future.
August, Carney gave three reasons base, following what the Institute “We shouldn’t underestimate how
why he still believes it will be a for Fiscal Studies (IFS) describes as material the public sector cuts that
while before unemployment reaches a “lost year” for the UK economy in still have to kick in will be,” says
the 7% threshold which will trigger a 2012. Dannhauser. “Putting the debt ratio
rise in rates. The first, he said, is that “The marked improvement in on a sustainable course is going to
the Bank’s projections for growth are recent economic performance is require very large fiscal tightening.
“solid not stellar”. no reason for George Osborne to So the big picture is that the public
The second is that although a fall declare victory,” says Dannhauser at finances still have years and years of
from the current level of around Lombard Street Research. “One or austerity to go through before they
7.7% to 7% may look achievably two quarters of strong data does not are back into shape.” s
6 EUROWEEK | September 2013 | UK Capital Markets 2013
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2013-09-12 Advert.indd 1 16/09/2013 11:45
Bank of England Profile
Communication will define
Carney era at beefed up Bank
The Bank of England has been shaken up. A new governor with new targets, a new monetary
policy focus, and a new means of communicating them is now in charge of a central bank with
new powers. Philip Moore assesses Governor Carney’s first few months in charge and the Bank’s
prospects of success.
Search for Mervyn King in You- his audience that
Tube and you are presented with a the Bank’s man-
choice between a speech by the former date of maintain-
governor of the Bank of England and ing a 2% inflation
highlights of a darts match between target, remained
his namesake and an opponent named unchanged and
Dean Winstanley. Search for Mark had been recon-
Carney and you are offered a string of firmed by Chan-
interviews and speeches broadcast on cellor Osborne in
a range of television channels. March.
Granted, some of these date back to The message
the new governor’s tenure at the Bank seems to be perco-
of Canada. Granted, too, not all of the lating through. In
clips are complimentary. They include the August edition
ill-tempered tirades against a mone- of the Bank of Eng-
tary policy that some believe will con- land/GfK Inflation
demn UK pensioners dependent on Expectations sur- Move over Mervyn: The Bank of England’s new governor
bank savings to penury for many years. vey, carried out just Mark Carney relaxes at a music festival earlier this year
Whether or not the British elector- after the release of © Chris Eades / Daily Mail
ate approves of Carney’s approach to the Bank’s inflation its 2013 Q1 Quarterly Bulletin. “Fail-
monetary policy is scarcely the point. report, only 29% of households said ings in pre-crisis arrangements have
More important is that the new gover- they expected rates to rise in the next prompted the government to intro-
nor has brought a refreshing openness 12 months, which is down from 34% in duce wholesale changes to the UK reg-
to an institution that has historically May and is the lowest since November ulatory landscape.”
been stereotyped — rightly or wrong- 2008, at the height of the crisis. This reform has given the Bank new
ly — as stuffy, distant and insensitive regulatory powers, with responsibil-
to public opinion. It is impossible to Regulatory shake-up ity for supervision from a prudential
imagine his predecessor, for example, While Carney’s forward guidance may and conduct perspective passing from
being described as “chillaxing” in a have been unfortunately timed, it has the now defunct Financial Services
“lilac polo shirt, crumpled shorts and been impeccably managed and clearly Authority (FSA) to the new Prudential
suede loafers”, as the Daily Mail did delivered. “It may have made more Regulation Authority (PRA) and Finan-
when it spotted Carney and his wife at sense if it had been implemented after cial Conduct Authority (FCA). The PRA
a musical festival in August. the first round of quantitative easing in was quick to bare its fangs, identifying
“Carney’s openness towards the 2010,” says Jens Larsen, chief Europe- a capital shortfall of £12.8bn at Bar-
media has surely been very helpful an economist at RBC Capital Markets clays when it imposed a 3% minimum
in getting his message about the rela- in London. “The strong macro data leverage ratio on Britain’s eight largest
tionship between interest rates and and rising long term bond yields may banks and building societies. The FCA,
unemployment across to companies make monetary policy difficult at the then slapped a £138m fine on JP Mor-
and households,” says Melanie Baker, moment, but let’s reserve judgement gan in September.
UK economist at Morgan Stanley. until there is more clarity on how suc- The PRA’s zealousness on leverage,
Critically, Carney appears to have cessful it has been in influencing inter- the Bank insists, is in no way incon-
chosen his words to reinforce the mes- est rates.” sistent with supporting economic
sage that monetary policy should be If it is too early to digest the impact recovery. As Carney said in August,
used to nurture growth. “The Bank of Carney’s arrival on the UK econ- “some argue that the repair of banks’
of England’s task now is to secure omy, it is also probably too soon to balance sheets holds back economic
the fledgling recovery, to allow it to assess the effects of the shake-up recovery because it causes banks to
develop into a period of sustained and in the regulatory environment that cut back their lending. The reality is
robust growth,” he said in August. “We came into force in April. “The Bank the opposite: where capital has been
aim to get there in part by reducing the of England is experiencing its most rebuilt and balance sheets repaired,
uncertainty that has held back growth.” important institutional and function- banking systems and economies have
At the same time, he reminded al changes in a generation,” it said in prospered.” s
8 EUROWEEK | September 2013 | UK Capital Markets 2013Interview With Sarah Breeden, Bank of England
BofE’s Breeden: ‘A banking
licence is a privilege —
banks must remember that’
Sarah Breeden is head of the Market Sectors and Interlinkages Division in the Financial Stability
Directorate at the Bank of England. The division is responsible for assessing and identifying ways of
reducing risks to the stability of the UK financial system that arise in financial markets and the real
economy.
Having led the Bank’s work to support the transition of prudential regulation of banks and
insurance companies from the Financial Services Authority (FSA) to the Bank of England, Breeden
is well positioned to discuss the impact of regulatory change on the UK financial services sector. In
this interview, she shares her thoughts with Philip Moore.
EUROWEEK: It’s five years — almost to the day — since
the Lehman collapse. What has been done since then
to make the banking industry systemically safer?
Breeden: It’s been a busy five years, and I would highlight
four international developments in that time that have
played a key role.
The first is too-big-to-fail and resolution frameworks.
Compared to where we were five years ago, there has been
a step-change in the authorities’ willingness and com-
mitment to ensuring that institutions that operate in the
financial system are able to fail in a way that doesn’t bring
the system down with them.
That’s a big change. If you go back to 2008, when we
were dealing with Bradford & Bingley in the UK, we had
no resolution regime for banks. Now we do, and plenty of Sarah Breeden: “We need to make sure we remain vigilant
work is still being done to ensure that our most systemi- to the emergence of new sources of risk”
cally important institutions are able to fail in a safe man-
ner. ards for those bilaterally-undertaken transactions that
The second theme is re-regulating banks based on will remain in the OTC derivatives space. The working
international standards established by the Basel III capi- group on margin requirements has set out minimum
tal regime to ensure that they are better capitalised, with standards that will apply to all derivatives transactions.
better measured risk on their balance sheets, that are Since derivatives can be a source of leverage and a
therefore less likely to fail. There are many dimensions to potential means of propagating shocks throughout the
that. These include changing the definition of capital and system, when these reforms have been implemented over
focusing on going-concern capital that is there to absorb the next couple of years the market will be a much safer
losses while firms are still operating. But as well as chang- place. Some aspects of this reform programme will come
ing the composition of capital, and increasing the quanti- in sooner than others, with the implementation of man-
ty that is available, we are also trying to make sure that we dated central clearing in the US now imminent. But even
are smarter in the way we think about the risks that are on on a two year horizon, the market will be much safer.
banks’ balance sheets. The final theme to highlight internationally is shad-
We’ve had some good news in this area recently with ow banking. It is likely or perhaps even inevitable that as
the Capital Requirements Regulation (CRR) coming in at we re-regulate banks, activities that had previously taken
the end of this year in Europe and in the US. So not only place on banks’ balance sheets will migrate to other parts
do we have a framework, we are also well on the way to of the financial system. That’s not necessarily a bad thing.
making that framework an implemented reality. But as authorities, we need to ensure that the regulation
The third theme I’d highlight is the significant inroads of those entities is appropriate to their risk profile.
that have been made in regulating the OTC derivatives A lot of work is being undertaken under the banner of
market. We’ve mandated that there should be central the Financial Stability Board (FSB) setting out a variety of
clearing for some derivatives products. This means that measures for dealing with things that we currently know
margins will be determined by the central clearing house to be shadow banking, defined as credit intermediation
and that there will be effective oversight of the risks outside the banking system with leverage and maturity
embedded in those products. transformation. Money market funds is one example of
In addition, we’ve started to introduce minimum stand- where this happens. Securitisation vehicles and struc-
UK Capital Markets 2013 | September 2013 | EUROWEEK 9Interview With Sarah Breeden, Bank of England
tured finance conduits is another. So we’re making sure Breeden: In that period, we have already had some
that regulation deals with these known issues appropri- examples of occasions on which these new bodies have
ately. worked together very effectively. When you look at the
But we also need to make sure there are regimes in public recommendations that the FPC has made to the
place to ensure that we remain vigilant to the emergence PRA about banks’ capital and liquidity, and to the PRA
of new sources of risk. We may be able to point to money and the FCA about the risks that might arise in the event
market funds as a potential source of risk now. But what of interest rates normalising, you’ll see evidence of the
will be the issue in two years’ time? Will it be real estate three working effectively together.
investment trusts in the US, for example? We need to keep The very first weekend after the PRA and the FCA
an eye on any area where we see credit being intermediat- came into existence, we had the Cyprus crisis. Both
ed outside the banking system with leverage and maturity institutions had to work together to ensure a satisfactory
transformation. resolution of those Cypriot banks that operate in the UK.
A lot has been done to design frameworks to ensure Within days we had a true test of how effectively the
that authorities such as the Financial Policy Committee two organisations could work together in an important,
(FPC) in the UK and other systemic risk regulators look at high profile case. So the experience we’ve had to date
all activities within the financial system to identify where has been encouraging.
systemic risk might arise.
These are the international areas where I think we’ve EUROWEEK: Do we now have absolute clarity on UK
made very considerable progress. But we’d be fooling our- banks’ capital and leverage requirements going for-
selves if we didn’t recognise that there was still plenty ward?
more to do.
Breeden: The Basel framework has set the internation-
EUROWEEK: All those areas are predicated on a degree al standards. So the international benchmarks to which
of international co-operation. What are the main UK- banks are being held are clear, and have been supported
specific measures that have been taken? by the FPC’s own recommendations that were published
in March.
Breeden: The main measures specific to the UK are the There is of course still some international debate on
legislative changes that were introduced in April 2013, the details of the leverage ratio, with the Basel Commit-
when we did two things. tee’s recently circulated consultative document looking
First, we created the Financial Policy Committee (FPC) at the detail of how to calculate it.
as our macro-prudential authority, which is charged with
identifying, monitoring and taking action to remove EUROWEEK: In the UK is there a specific timetable on
or reduce systemic risks to enhance the stability of the observance of the 3% leverage ratio?
financial system.
The new legislation also took the old Financial Servic- Breeden: The FPC recommended in March that the PRA
es Authority (FSA) and chopped it in two, with the intro- should have regard to high levels of leverage as well as
duction of a Twin Peaks regulatory regime. The Financial to risk-adjusted measures of capital adequacy. And the
Conduct Authority (FCA) is responsible for ensuring the PRA has said that six of the eight banks and building
integrity of financial services, while the Prudential Regu- societies will already meet the 3% leverage ratio as part
lation Authority (PRA) is responsible for prudential regu- of meeting the broader 7% capital adequacy ratio by the
lation and supervision of all deposit-takers and insurance end of this year.
companies in the UK. For Barclays and Nationwide, a time frame has been
Both these institutional changes are very impor- agreed within which they will reach 3%. In each case
tant in ensuring that the international framework that I the time line is different and that reflects the individual
described earlier is applied rigorously in a domestic con- nature of their business. Barclays expects to reach 3% by
text. It is clear, for example, that the PRA together with the middle of next year while Nationwide has until the
the Special Resolutions Unit at the Bank will be absolutely end of 2015. I think that underlines that we are imple-
focused on ensuring that systemically important financial menting these targets in a reasonable manner.
institutions in the UK are able to fail in a way that is safe
for the rest of the system. EUROWEEK: How do you respond to the stability of
And following on from what we were saying about the the graveyard argument, which says that too much
importance of being vigilant to risks from outside the regulation may stifle growth?
banking system, the FPC will be charged with monitoring
the regulatory perimeter in the UK so that those risks are Breeden: I think we’d all agree that well capitalised
monitored and identified, and that regulation is capable banks are in a better position to lend to the economy. It’s
of addressing those risks. common sense that if you have confidence in your own
solvency you’ll be more comfortable with taking more
EUROWEEK: April 1 was only just over five months risk on to your balance sheet.
ago. Is it too early to assess what the impact of Twin Our aim is to ensure that our banks are well capitalised
Peaks has been in that short time? and so able to lend to the economy, which is the best way
10 EUROWEEK | September 2013 | UK Capital Markets 2013Interview With Sarah Breeden, Bank of England
ed as a privilege, not as a
right. I think it’s impor-
tant for banks to remem-
ber that.
EUROWEEK: What tools
does the FPC and the
PRA have at its disposal
to address some of the
broader concerns about
financial stability? For
example, would the FPC
and the PRA be able to
act early to head off an
unsustainable housing
boom?
Breeden: This comes back
to the statutory objectives
of the PRA and the FPC.
Understanding and moni-
toring the risks that are on
Breeden: “Banks themselves have gone a long way to address the misdeeds of the past. banks’ balance sheet is an
However, there is still much to be done, and the main objective of the new regulatory integral part of those objec-
framework will be to ensure that the financial system as a whole is safer and more resil- tives.
ient to any future shocks” If the FPC were to be
concerned about the risks
to make certain that we don’t create the stability of the to financial stability that were arising in the housing mar-
graveyard. More generally, the objective to achieve finan- ket, it would respond in just the same way as it would if
cial stability while supporting the government’s growth it were concerned about risks to stability arising from the
and employment objectives is recognised in the remit that commercial property market or from dealings with hedge
the FPC has been given by the Treasury and in the statu- funds or Reits. We begin by thinking about banks’ under-
tory framework under which the PRA operates. writing standards, and the terms on which they do busi-
But the important point is that the right conditions for ness, to try to ensure that they are appropriate. We also
growth could not possibly be created with an unstable communicate our views of the risks, as we already have in
financial system — as any company and any household the Financial Stability Report and in the record of the FPC
that has lived through the last five years would recognise. meetings.
The FPC has wide-ranging powers to make recommen-
EUROWEEK: Where does a regulator draw the line dations to the PRA in respect of the prudential regime for
between regulating banks and seeking to influence the housing market, and to the FCA in respect of conduct
their commercial strategy? rules for mortgage lenders. The FCA is in the process of
implementing a new code of conduct for mortgage lenders.
Breeden: The PRA has a clear objective, which is to pro- Finally, the FPC has a power of direction over sectoral
mote the safety and the soundness of the firms it regulates. capital requirements which might mean that if all the other
That necessarily requires it to understand the business tools have failed to reduce the risks in the system arising
of those firms and to make a judgement on the risks that from the housing market, higher capital requirements can
those businesses entail. It needs to do this not by looking if necessary be imposed on residential mortgage lending.
at what’s happening today or what happened in the past, So there is a very broad range of tools available to the FPC.
but by taking a forward-looking approach to assessing
what risks might arise and by ensuring that a firm is well EUROWEEK: Finally, do you have the impression that
prepared to deal with those risks. public confidence in banks is now being restored?
As soon as we’re in a judgement-based, forward-looking
world, reasonable people will differ in their views of risk. Breeden: The financial crisis highlighted the importance
I think it is inevitable that the banks will sometimes disa- of having a safe and well-functioning banking system to
gree with the judgements that their prudential regulator maintain the flow of credit to the economy. Banks them-
makes. In that context, the prudential regulator’s respon- selves have gone a long way to address the misdeeds of the
sibility is to its statutory objective. This is to promote the past. However, there is still much to be done, and the main
safety and soundness of the banks it authorises to take objective of the new regulatory framework will be to ensure
deposits from members of the public. Having a banking that the financial system as a whole is safer and more resil-
licence and the ability to take deposits should be regard- ient to any future shocks. s
UK Capital Markets 2013 | September 2013 | EUROWEEK 11London as a Financial Centre
City faces taxing future
despite fading crisis
With the equity market performing strongly and job numbers in the City back to pre-crisis levels,
the mood in London is at its most upbeat since 2007. But is this optimism misplaced? As Philip
Moore reports, the threats to its status as the world’s premier financial centre are greater than ever.
For the City of London, until mid- a devastating excoriation of the con-
September no news over the last year duct of UK banks.
or so had been probably been good The opening paragraph of its sum- “London is feeling
news. The chorus of public disapprov- mary set the tone for the indigesti- much better about
al about the City, which reached a dis- ble volume, saying: “Banks in the UK itself than it did a
cordant crescendo at the height of the have failed in many respects.” They year ago”
Libor scandal, had gone reassuringly have failed taxpayers, it added, they
diminuendo over the last 12 months. have failed retail customers, they Roger Gifford, Lord
It remains to be seen if the fine lev- have failed their own sharehold- Mayor of the City
ied on JP Morgan in September pro- ers, and “they have failed in their of London and UK
vokes a fresh wave of vilification of the basic function to finance econom- head of SEB
banking industry, and by extension ic growth, with businesses unable
of the City of London, which is where to obtain the loans they need at an
the dodgy derivatives dealings that acceptable price.” Said Business School shortly after this
prompted the $920m settlement took survey, Lloyds Bank’ chief executive,
place. Criminal acts Antonio Horta-Osorio, was frank about
But prime time media coverage of It included the dire warning that “a the need for the industry to rebuild its
Jamie Dimon describing a $6.2bn loss risk of a criminal conviction and a reputation to attract good people. “The
as a “tempest in a teacup” is unlikely prison sentence would give pause for next generation should see banking
to have gone down well with the Brit- thought to the senior officers of UK as an industry that helps to build eco-
ish public, many sections of which banks.” nomic wealth and is playing its part as
continue to attach frequently ill- The City strongly endorses this a useful member of our local commu-
informed blame to bankers for the threat. “Our stance on the Libor scan- nities,” he said. “We want the best and
wider economic downturn. dal is very clear,” says Alderman Roger the brightest to see banking as a cred-
It would be a pity if the so-called Gifford, Lord Mayor of the City of Lon- ible career choice. This is vital for the
London Whale shenanigans are don and UK head of SEB. “If there was industry’s long-term viability.”
allowed to reverse the progress that criminality involved, the guilty par- It will be important for London to
has been made in rehabilitating the ties should be brought to court and maintain its vigilance against compla-
image of financial services, which is an be prosecuted. That would help to cency and hubris, because it still faces
important pillar of the UK economy. show that it was a criminal act, not a number of formidable challenges
According to TheCityUK, finan- something that was symptomatic of a and no shortage of competitors and
cial services posted a trade surplus broader market malaise.” antagonists only too eager to take the
of £46.3bn in 2012, down slightly on Gifford insists, however, that the City down a peg or two. As the CBI’s
2011’s total but “still by far the biggest mood is upbeat. “London is feeling Ringer says, one of these is the Finan-
net contributor to the UK balance of much better about itself than it did a cial Transactions Tax, proposed by 11
payments.” year ago,” he says. “The economy has EU member states, including France
“Restoring confidence among politi- picked up, the equity market is per- and Germany, but fiercely opposed by
cians and the general public is critical, forming well and job numbers in the the financial centres with the most to
not just to the financial services sec- City are back to their 2007 levels, so lose from the tax, most notably the UK
tor but also to the wider UK econo- there is plenty of quiet optimism.” and Luxembourg.
my,” says Leo Ringer, head of financial Perhaps. But there have been some “Our main concern about the finan-
services and corporate governance at unsettling recent signals about the cial transactions tax is that it under-
the CBI. “The regulatory response has degree to which the UK financial ser- estimates its impact on basic services
already gone some way towards bol- vices sector has recaptured the con- provided by financial institutions such
stering public trust through, for exam- fidence of the young people upon as risk and cash management that
ple, the establishment of a profession- whom its future depends. A Lloyds are fundamental for businesses,” says
al body on banking standards.” Bank survey in May found that 28% Ringer. “Our argument is that the tax
This new entity, headed by former of students would be “embarrassed” will not achieve what it sets out to do,
CBI head Sir Richard Lambert, was to tell their friends if they worked in a which is to reduce risk. Instead, it will
one of the recommendations made by bank, 41% distrusted banks, while 56% hamper the financial services’ support
the cross-party Commission on Bank- trusted them less than five years ago. of economic growth.”
ing Standards, which in June released In a speech to at Oxford University’s Although the UK has the right to
12 EUROWEEK | September 2013 | UK Capital Markets 2013London as a Financial Centre
remain outside the so-called 11 mem- international bond trading, account- “I worry that London
ber FTT zone, the potential impact of ing for an estimated 70% of second-
may have seen the
the tax on London’s leadership in the ary market turnover in 2012, accord-
zenith of its
European capital market would be ing to TheCityUK.
importance as a
devastating. This is because the archi- Although the European Coun-
financial centre and
tects of the tax propose that it should cil’s legal services commission has
that its leading
extend to any transactions involving recently questioned the legality of
position is under
counterparties headquartered in the the planned tax, the CBI — for one —
threat for a number
FTT zone, including overseas branch- remains wary of the threat it poses
of reasons”
es of firms with their HQs in the zone. to the UK. “The tax would have an
In other words, a transaction between impact on centres such as New York
Colm Kelleher,
the London offices of, say, Deutsche and Singapore, but we feel it would
Morgan Stanley
Bank and BNP Paribas, would be sub- hit London disproportionally,” says
ject to the tax. Ringer. “The proposal remains on Japan, for one, has made it clear that
That, however, is only the half of the table, and we see it as very much a its investment into the UK would be
it. Consider, for example, its poten- live issue.” jeopardised if it were to withdraw from
tial impact on the European govern- The bickering over the FTT is one the EU.
ment bond market. Although primary of several examples of Europe’s frag- The prize is London’s to lose,
issuance by debt management offices mented approach to regulation that because by a host of qualitative and
would be exempt from the tax, a pres- some bankers see as a menace to Lon- quantitative yardsticks, the figura-
entation prepared earlier this year by don. “I worry that London may have tive Square Mile continues to be the
ICAP cautions that “the FTT will sig- seen the zenith of its importance as a world’s premier financial centre. It was
nificantly increase funding costs for financial centre and that its leading ranked first among 79 cities by GFCI in
governments and corporates in the position is potentially under threat for March 2013, scoring 807 points to New
FTT zone, and to a lesser extent those a number of reasons,” says Colm Kelle- York’s 787.
outside the zone, with consequences her, president of institutional securi- TheCityUK says London accounts
for the real economy.” ties at Morgan Stanley in London. for 37% of global foreign exchange
This, says ICAP, is because the pro- His concern is that a side-effect of trading and 19% of international bank
posal does not safeguard secondary competing regulations are going to lending. There are 251 overseas banks
market trading in public debt, which hand a competitive advantage to cen- in London (more than in New York
is an essential component of the tres such as New York — and possi- or Frankfurt) and 588 foreign list-
effective operation of public financ- bly Chicago — where the regulatory ings on the London Stock Exchange
es. “This would result in an increased reform agenda is at a more advanced (compared with 524 on the NYSE and
cost of funding and capital burden for stage. “For example, we all oper- 290 on Nasdaq). The UK is also home
governments,” says ICAP. “Bank of ate under Basel II or Basel III,” says to more than 800 hedge funds, with
America Merrill Lynch estimates the Kelleher. “But risk weightings are still about 85% of the industry’s total Euro-
FTT will result in an increased annual applied on a national basis, and 87% pean assets.
cost of €6.5bn-€8.5bn for Germany, of RWA models in Europe are self- Areas such as foreign exchange and
Italy and France in the first year.” The certified. That risks creating regula- equities trading, cross-border lend-
implications for London are obvious tory arbitrage, which will lead to more ing and investment management are
enough, given that it is the fulcrum of pressures from the regulator.” all long-standing fortés for London.
Perhaps more significant, however, is
Employment in financial & professional services in London
London’s to lose the UK’s commitment to ensuring that
Employment in financial and professional A more distant, but very it captures new opportunities. When
services in London dangerous, threat to Gifford spoke to EuroWeek, he was
Thousands London’s future comes in China, between meetings with the
700 from those whose mayors of Shanghai and Beijing, and
hostility to Europe few new business opportunities for
600 extends to a desire to the global financial services industry
pull the UK out of the are as exciting as those in the rapid-
500 EU altogether. Kelle- ly internationalising renminbi (RMB)
her says that although market.
400 he regards this as a tail In 2012 alone, spot RMB trading
risk, it would be very volumes in London rose by 240% to
300 damaging for Lon- $2.5bn a day. RMB bond origination
don. Gifford agrees. “A rose by 36%, although disappointing-
200 substantial number ly dim sum bond trading fell sharply.
of US and Asian com- Nevertheless, London has clearly posi-
100 panies have located tioned itself to play a pivotal role in the
themselves in London inexorable growth of the RMB market,
0 because of the access it which is another positive signal for the
2007 2008 2009 2010 201 1 201 2 gives them to the Euro- UK and its much maligned financial
Source: ONS, TheCityUK London Employment Survey pean market,” he says. services industry. s
UK Capital Markets 2013 | September 2013 | EUROWEEK 13You can also read
