Aspects of the Financial Services Sector in the United Kingdom - Coursework Example

? al Affiliation) UK FINANCIAL SERVICES The United Kingdom financial services sector is one of the largest (if not the largest) in the world. It contributes billions of pounds every year (?37 billion in 2007) to the UK economy, and employs over 2 million people. The financial services sector has been a major player in global financial services, and any uncertainty and instability is likely to result in an equal level of uncertainty and instability in the global financial system. During the 2008 global financial crisis for example, the UK and US markets (two of the biggest financial services sectors in the world) were the first to start suffering. This in turn led to a sequential inductive effect on other countries’ economies, which eventually caused a global financial crisis. This shows the power that that the United Kingdom’s financial services sector wields. This paper will discuss various aspects of the financial services sector in the UK, including the main financial services product types and their functions; financial advice; UK taxation and social security systems; and inflation, interest rate volatility and other relevant socio-economic factors. By the end of this paper, I hope to have examined, evaluated, and discussed the United Kingdom’s financial services sector with regards to these aspects. Key words Financial services; interest rate volatility; inflation; social security systems i) The Main Financial Services product types and their Functions Banking UK banks are generally public limited companies (plcs) that are owned by shareholders.The banking sector in the UK has the second largest assets in the world ($11 trillion). It offers borrowing and lending services, corporate financing, financial advice, and other financial services. The Bank of England regulates lending and borrowing rates by setting interest rates. By doing this, it also regulates foreign exchange services, cost of goods and services, the money market, and the cost of doing business. When it comes to international banking, the UK is the largest individual market for bank borrowing and lending. Approximately 20% of cross-border trading and 22% of borrowing is organized in the UK. The county also has a long tradition of well-developed systems for processing complex transactions, as well as a strong regard for corporate activity. The UK banking industry is very diverse, and this is shown by the presence of over 551 international banks in London alone in 2007. By comparison, New York has 250, Paris 271, and Frankfurt 280 (British Invisibles 2009, pg. 22). The UK also has very dynamic money markets which cater for institutional/corporate customer activity in forward and spot markets as well as the proprietary trading activities of banks. In April 2009, the United Kingdom estimated to have a 36% share of the total worldwide foreign exchange turnover with around $1.7bn daily. Local retail banking is entrenched in the UK, with 5 big banks leading the way. These are Lloyds Banking Group, Barclays, HSBC, Santander, and RBS Group. Together, these banks control around 65% or more of the total retail banking market in the UK (Copperfield 2010, pg. 27). There are about 52 building societies which complement banks. The largest of these are Yorkshire, Skipton, Coventry, and Nationwide. There are also a couple of retail groups (Marks & Spencer, Tesco and Sainsbury’s) which provide a variety of financial services products ranging from current accounts to credit cards and insurance (Copperfield 2010, pg. 33). Capital Markets Securities trading and issuance (including trading of commodities and derivatives) is done by more than 170 firms headquartered London, and is dominated by international banks like Barclays Capital, Goldman Sachs, Bank of America, Citigroup, Morgan Stanley, Merrill Lynch, and JP Morgan. It is a sub-sector that is also consolidated since 60% is controlled by the top seven entities. The UK accounts for about 25% of the total banking fee revenues in the Europe, while London handles about 50% of investment banking activity in the same region. 20% of total global foreign equity activity is located in the UK, with in excess of 600 multinational companies listed in London alone (HM Treasury 2009, 47). Market capitalization is the 3rd largest in the world (after the United States and Japan) and contributed about 7% of global turnover, while London remains one of the leading markets for new equity issues. London is also a major player in international bond trading. The United Kingdom is the 2nd largest country for issuance of securitization. In 2008, it had almost $450bn of gross new issues, although this figure has dropped since the 2007 global financial crisis. The county has strong and stable derivatives and commodity activities, both conducted through exchanges like London Metal Exchange, ICE Futures Europe and NYSE Liffe, and OTC (over-the-counter) markets. In 2008, NYSE Liffe had Europe’s largest, and the world’s 2nd largest, exchange-trade derivatives that were trading at the time (UK Trade & Investment 2009, pg. 92). In addition to this, the UK accounts for 46% of derivatives trading done on Eurex. Meanwhile, an increasing share (46%) of derivatives trading on Eurex originates from the UK. With a global slice of 43% in 2008, the UK is also the world’s number one market for OTC derivatives; this represents an increase of 7% from the 36% recorded in 2001. London is the world’s leading market for a majority of wholesale over-the-counter trading in gold and silver (bullion); in 2009, around $20.5bn of average gold volumes per day was cleared at the Bullion Market Association in London. Emissions trading and carbon markets are growing rapidly, with London being central to this as well. Asset Management Over 145 firms conduct asset management in the UK. These firms manage assets valued at over ?3 trillion in 2008, representing a decline of 10.5% on the previous year. When property funds, private customer investment managers, independent hedge funds, and property funds are added to the equation, this figure goes up to ?3.4 trillion. The United Kingdom manages 1/3 of all assets managed in the European continent, a share that is more than the total combined markets of Germany and France (UK Trade & Investment 2009, pg. 50). Asset management firms based in the UK manage assets worth over ?1 trillion for overseas clients, representing almost 30% of total funds managed. Assets managed in the UK are found in a variety of investment vehicles, including insurance funds, pension funds, and authorized investment funds. As of 2008, managed assets were allocated as follows: equities 42%; fixed income 38%; money/cash market funds 11%; other assets (currency overlays, alternative assets and structured products) 5%. Around 80% of assets under management are institutional, with 17% drawn from retail sources and 3% from private clients. Leading firms include players include State Street Global Advisors and M&G Securities, Legal and General Investment Management, and BlackRock. Although alternative assets like hedge funds and private equity account for just a tiny proportion of total assets under management, the United Kingdom is a leader in these two markets (British Invisibles 2009, pg. 42). London manages around 19% of global hedge fund assets, coming second to New York. In 2008, UK private equity funds accounted for 18% of global investments and 15% of funds raised. Apart from this, London is an automatic centre for services associated with asset management. Such services include prime brokerage, custody and administration. Insurance and Reinsurance The insurance industry in the United Kingdom entails not only the both the conventional provision of risk protection to individuals and companies, but also a good market for complex risks and international business. The UK is the world’s leading market for the transaction of risk, whether portfolio or single, and in all forms of business. Both short and long-term risks are well-covered. Short-term risks covered include liability, motor, property, marine and aviation, while long-term risks covered include pensions, long-term savings products and life cover. 972 firms are registered to transact insurance business in the UK. This number conceals the consolidation in this sub-sector, however (HM Treasury 2009, pg. 53). The reason for this is that the ten leading general insurance groups represent 70% of business written, whilst the ten leading life and pensions groups represent 80% of the market. The UK insurance industry has about 314,000 people and accounts for investments amounting to ?1.5 trillion. The UK’s global insurance premium income was US$397bn (?214bn) in 2008, representing 11% of global insurance premium income. This puts it at position three behind the United States (30%) and slightly behind Japan (11.5%). Brokers continue to be a vital way of accessing the best cover at the most affordable price, especially when complex insurance needs are involved. The reinsurance market provides an opportunity for domestic and international insurance firms to manage their own risks. It is an active, vibrant and dynamic market that is dominated by Lloyd’s of London, and whose influence is very significant. Other well-known corporate players in this market include Aviva, RSA and RBS. In addition to this, multinational/global companies have a presence in London, accessing international business through the market. Lloyd’s is a unique company that runs a self- regulating market composed of 85 syndicates involved in the writing of insurance and reinsurance business. Lately, the corporate sector in the United Kingdom and abroad has seen rising cross-ownership, with major players including Amlin, Hiscox and Catlin (Grosse 2009, pg. 39). Total written premiums grossed about ?23bn in 2009 alone. Top brokers in the sector include major multinationals like Marsh, Willis, and Aon Benfield, while top reinsurers include Swiss Re and Munich Re. ii) Financial Advice Summary You have ? 13,743.234.32 and you have already decided that you never want to work again. You are also moderately cautious but happy to take risk. In addition to this, you intend to spend ? 2,000,000 on real assets. You intend to spend the next 5 years travelling the world, something which will cost you ? 1, 500,000. Advice First, let us take away the ? 1, 500,000 you will spend travelling the world, you will be left with ? 12,243,234.32. Since you do not intend to work for the rest of your life, you must invest the remaining amount in areas with real value. First, I recommend that you increase the ? 2,000,000 you intend to spend on real assets to ? 7,000,000. These real assets include property and real estate, which I recommend to take up the whole ? 7,000,000. Since you do not intend to work for the rest of your life, you will need to hire a professional property and real estate manager to look after your investments. Now you are left with ? 5,243,234.32. I recommend that you invest ? 4,000,000 in stocks, and I mean real stocks with good value. This means buying high value bonds, shares and equity that would guarantee long-term dividends and returns. Now you are left with ? 1,243,234.32. I recommend that you invest this amount in start-ups founded on promising and unique ideas that represent long-term growth and development. I must stress that in this regard you focus on technological start-ups because they are often the most promising and practical. iii) UK Taxation and Social Security Systems UK Taxation UK residents are taxed on their global income, although with latent reliefs. Non-residents are only taxed on their UK source income. In addition to this, the UK taxes capital gains, which usually apply to taxpayers who are either ordinarily resident or resident in the UK, but who make disposals. There is also an inheritance tax, although (assuming that one lives outside the UK and is not considered to be living there, which a person will be if he/she has been a UK resident in 17 of the previous 20 tax years) this rarely applies unless one dies or makes substantial gifts while living in the UK. The tax year comes to an end on 5th April. For instance, the tax year 2013/2014 runs from 6 April 2013 to 5 April 2014. Income and gains are taxed based on taxpayer’s resident and ordinarily resident status, as well as his/her domicile (UK Trade & Investment 2009, pg. 48). Resident, ordinarily resident and domiciled taxpayers are taxed on their global income on the arising basis and on their global capital gains. Other taxpayers can claim a remittance basis (this allows specific types of gains and foreign income to be taxed only if remitted) as follows: a) Resident but not ordinarily resident taxpayers can claim remittance basis on offshore investment incomes. They may also claim relief from tax based on income for any overseas working days so long as those earnings are not only paid but also retained outside the United Kingdom. b) Non-domiciled taxpayers (regardless of whether they are ordinarily resident or not) can also claim remittance basis on overseas investment income and overseas capital gains. In addition to this, earnings from work with foreign employers whose duties are performed entirely outside the UK can only be charged on the amount of tax remitted to the UK. In 2008, a significant reform of the remittance basis was introduced. It became effective on 6th April 2008 but interpretation of some of its details remains vague at the time of writing this paper. Taxpayers who claim remittance basis are required to give up any claim to tax-free personal relief for income tax and the yearly exemption for tax on capital gains. Also, those who have lived in the UK for any period in not less than 7 of the previous 9 tax years must pay a ?30,000 charge on remittance basis for any tax year in which they would like to access the remittance basis. Determining the funds are classified as remitted to the UK is difficult, unless funds are remitted from accounts containing gains or income of only one tax year and only one type (British Invisibles 2009, pg. 37). In cases where separate segregated funds are used, it is relatively easy to determine the amount remitted to the country. However, if one bank account contains gains or income of multiple types or tax years it will be classified as a mixed fund. Statutory rules are now used to determine the amount remitted from mixed funds, and taxpayers are unable to “choose” the amount they are remitting from mixed funds. Extreme caution is therefore required in structuring overseas bank accounts and separating gains and income properly so that potential reliefs available from remittance basis are maximized. When it comes to husband and wife, each individual is taxed separately based on a mechanism of independent taxation. Each spouse has his or her own tax bands and personal allowance and the gains and income of married couples are not compounded. There are, however, some conditions in which specific rules apply to transactions between married people, for example gifts being considered to occur as “no loss, no gain” transactions for tax on capital gains. Starting from 2005, civil partnerships between same-sex partners are recognized and treated in a similar manner to married couples. On determination of residence, one remains a UK resident for a tax year if he/she spends at least 183 days there in that tax year (Copperfield 2010, pg. 19). On determination of domicile, being non-domiciled affords one the opportunity to choose the remittance basis for taxing particular types of overseas income and any overseas capital gains. A taxpayer is allowed to have only one domicile at a time and this is normally a domicile of origin that will usually be where his/her father was domiciled when that particular taxpayer was born. The taxpayer might subsequently have altered this by acquiring a preferred domicile if, for example, he/she immigrated to another country which he/she now considers to be his/her permanent home. Social Security Systems The UK has a very comprehensive and well organized social security system that is financed by the National Insurance payments of individuals. Once residents reach 16 years they are given a National Insurance number which serves as reference for later access to the social security system (HM Treasury 2009, pg. 61). The social security system includes state benefits for persons who are cannot work because of illness, injury or disability. It also issues payments to people who are unemployed or on maternity leave. The contributions are also used to finance pension payments to those who have reached the retirement age of 65. If one decides to live abroad it may affect his/her eligibility for social security both in his/her country of residence and his/her home country. Whether or not one is entitled to security will therefore depend on whether or not he/she lives in the EU or any other country that has reciprocal and identical social security partnerships with the United Kingdom. iv) Inflation, Interest Rate Volatility and other relevant Socio-economic Factors Inflation Having remained stagnant for 4 months prior to March 2013, UK inflation has now risen to 2.8%. This is according to the latest report released by the Office for National Statistics (ONS). In the UK, inflation is measured using two methods. One is the consumer price index (CPI) measure which is favored by the government (HM Treasury 2009, pg. 56). The CPI is crucial because it is required in uprating wages, pensions and benefits. The second method is the retail price index (RPI) which has now been abandoned but which the ONS will continue publishing for a while. Currently, however, the method used is the CPIH, which consists of the housing costs of owner occupiers and RPIJ, which is the new version of RPI. Between 1989 and 2013, UK’s inflation rate averaged 2.82%, reaching an all-time high of 8.51% in 1991 and an all-time low of 0.52% in 2000. Interest Rate Volatility It has been proven that the volatile properties of both short and long interest rates are inherently different. First, in contrast with previous research on interest rate volatility in the US and Canadian, the situation in the UK shows that shorter rates are more dynamic compared long rates. Second, studies done using GARCH methods to gauge uncertainty show that in the UK, short rate volatility tends to be more dependent on news concerning volatility from past periods. On the other hand, long rate volatility tends to be averagely equally dependent on the news about, and level of volatility of past periods (UK Trade & Investment 2009, pg. 35). The degree of volatility in the post period tends to be more relevant compared to that in the pre period. In conclusion, origin country and term to maturity appear to be vital factors for the sequence of integration of interest rates. As a result, priorigeneralizing notions concerning the sequence of integration of interest rates can be misleading. References British Invisibles 2009, United Kingdom financial & business services, British Invisibles, London. Copperfield, F. 2010, The city: United Kingdom financial services: leadership through innovation, UK Trade & Investment, London. Grosse, R. E. 2009, The future of global financial services, Blackwell Publications, Malden, MA. HM Treasury 2009, UK international financial services, the future: a report from UK based financial services leaders to the Government, HM Treasury, London. UK Trade & Investment, 2009, UK financial services: delivering regional expertise, UK Trade & Investment, London. Read More