Mending the cracks in the capital

The position of London as a leading global insurance and financial services centre is under pressure. Centres such as Bermuda, Dublin and Dubai have been growing in strength in recent years, aided by favourable tax and regulatory regimes.

This year has seen a growing number of businesses relocate abroad. In recent months insurers Amlin and Brit said they were considering their options.

Mounting concerns that London is losing its edge has prompted a flurry of recent initiatives from the government and London policymakers.

In June, London Mayor Boris Johnson also asked senior UK financiers and executives to work with the Corporation of London to examine how London could maintain its competitive edge.

Earlier this month, the Treasury announced that the Chancellor, Alistair Darling, would jointly head a working group comprising senior financial services executives that would look at ways to maintain London’s leading position.

The Financial Services Global Competitiveness Group, co-chaired by Sir Win Bischoff, chairman of Citi, will meet monthly to analyse global trends affecting the competitiveness of the international financial services industry, such as the impact of the sub-prime crisis and the rapid growth of new financial centres in emerging markets.

Members of the group include Lloyd’s chairman Lord Levene, FSA chairman Sir Callum McCarthy and Prudential chairman Sir David Clementi.

The Chancellor is also creating a standing group focusing specifically on the insurance industry, although details of the group have yet to be announced.

The Treasury said the group’s analysis would help to inform the government’s policy response to these global challenges.

It reports to the so-called High-Level Group of senior representatives from the financial services sector, which was set up by the then Chancellor Gordon Brown in 2006 to develop a strategy to promote London as an international financial centre.

The global competitiveness group will report its findings in spring 2009.

So what are likely to be the key issues for the insurance industry? Sources agree that the key areas that need to be addressed are tax and regulation.

Sarah Knight, the ABI’s assistant director of financial regulation and taxation, says: “As it is led by the Chancellor it will invariably come down to tax and regulation.”

The FSA’s regulatory regime and the UK tax environment have been bugbears for the insurance industry for some time.

Insurers have complained of the stifling burden of FSA regulation, with senior industry executives warning that the burden of rules was depressing the market and contributing to the low number of start-up businesses in London compared to other jurisdictions.

Hiscox director of mergers and acquisitions Charles Dupplin agrees: “My sense is that the regulatory issues are now starting to be addressed, but this is at an embryonic stage and there is a lot of work to be done.”

He point to the cost of compliance. “The FSA requires vast reams of data compared to other jurisdictions. Why not retain the power to ask for it and get much less on a standard basis. The Arrow visit process, where FSA inspectors pay surprise visits to broking firms, is becoming better. This I think is where one can see improvement.”

Dupplin also says greater clarity around the FSA’s Treating Customers Fairly initiative. “As the FSA is not prescriptive, there are lots of different interpretations. An example is the definition of a ‘complaint’.”

Knight says the FSA needs to become more focused on the needs of regulated businesses. “The FSA is business focused, but other regulators proactively court business.”

She also points to the high level of overlap with foreign regulators, which adds to the compliance burden on multi-national businesses, and the level of gold-plating of regulations by the FSA.

But tax is seen as the biggest issue for insurance businesses. The tax burden on UK insurers is increasing, with the UK slipping in terms of tax competitiveness compared to other jurisdictions.

Of the 30 OECD countries, the UK has the nineteenth lowest combined corporate tax rate; earlier in the decade it had been the sixth lowest.

“The regulatory issues are now starting to be addressed, but this is at an embryonic stage and there is a lot of work to be done.

Charles Dupplin, Hiscox

Corporation tax revenues have increased from £32bn in 2001/02 to £47bn in 2007/08. The insurance sector is the third largest contributor.

Stephen Catlin, chairman of Catlin Group which redomiciled to Bermuda a number of years ago, has said that the group would return to the UK if corporation tax were cut from its current 28% level. In Bermuda, corporation tax is zero.

In recent years, other insurers such as Hardy, Hiscox and Kiln have redomiciled to Bermuda, attracted by the zero tax regime.

Earlier this year, Brit chief executive Dane Douetil said he was considering moving the company offshore to a jurisdiction such as Dublin or Geneva. He said this was driven by the UK’s tax regime, pointing to the high level of tax and uncertainties around the taxation of foreign profits.

Dupplin says: “The tax side is a real problem. Look at Malta and Ireland. Both are full EU members and with much lower tax rates.”

Malta has an effective corporate tax rate of 7% and Ireland levies corporate tax at 12.5%.

Given the current economic conditions and the rising level of public borrowing, the Chancellor has little room to cut taxes.

“We are losing on tax competitiveness, but the Treasury doesn’t have money to spend,” says Knight.

Last year, ahead of a key meeting between the insurance industry and government officials looking at competitiveness, the Treasury made it clear that it would not reduce corporation tax.

Nonetheless, the insurance industry is still pushing for changes to the tax regime.

Some argue that a cut in tax rates could lead to an overall increase in tax receipts.

“I hope the Chancellor can be convinced that by charging less he will get more,” says Dupplin. “I hope the government amid its current difficulties has the energy and courage to do the right things here.”

This is a view shared by other Lloyd’s insurer executives. Ewen Gilmour, chief executive of Chaucer, has said that cutting corporation tax to 20% could see more money come into the Treasury’s coffers.

The ABI this week published a report calling for a package of measures on tax. These include reducing corporate tax rates and developing protocols for consulting on tax changes to end ill-considered proposals and improve certainty for businesses.

Knight says that even if a reduction in the headline tax rate is not achieved then insurers would be looking for other ways to cut their tax burden.

“The complexity of the rules and the cost of complying with the regime is an issue for our members,” says Knight. “In the insurance sector, the tax regime changes every year. For a multinational group it is tortuous [complying]. It would be good if we can get some stability. That is a key thing for us.”

The Treasury’s recent decision to amend its proposals relating to the taxation of foreign profits businesses – seen by some as a U-turn – and to consult further with businesses is a positive step.

Knight welcomes the change of stance, but says there are still concerns over the proposals. The proposed changes to the rules on interest restrictions could have an impact on transactions between group companies. “We want to ensure that arms length inter-company transactions are not restricted,” Knight says.

But there are some questions about the effectiveness of another working group on competitiveness.

Knight says: “The more interaction between the government and business the better. But there are concerns that a plethora of groups will overwhelm the Chancellor.”

Kari Hale a partner in Deloitte’s financial services practice says: “There is a degree of working group overload. The High Level Group has been in place for over two years and it is far from clear what the new group will do differently, apart from meet more often.

“The High Level group has done some good work. But are the different groups adding a different perspective?”