What’s New

2nd February 2010

Once a priority source of high value, high salary and high skill jobs, the financial services sector has gone from hero to zero in the past two years in terms of its contribution to economic strategy development. Dr Jim Coleman assesses whether or not rehabilitation is on the horizon.

How the mighty have fallen! In the UK, Northern Rock, HBOS and Lloyds TSB are on the casualty list. Internationally, the victims include Lehman Brothers and Bear Stearns, which went bust completely, and Merrill Lynch, the world’s largest stockbroker, which had to quickly merge with Bank of America to continue trading.

A massive volume of trading and counter trading in toxic assets, unfettered lending to high risk client groups, plus extremely lax regulation of financial service functions globally have been to blame. As a result, national asset bubbles have burst in Ireland, Iceland and most recently the hugely over-capitalised Dubai.

Many commentators have expressed the view that some positives will emerge from this tumultuous experience. There is a view that governments worldwide will impose more rigorous and consistent regulation, leading to a more balanced global financial system that generates increasingly dependable investment decisions. Hopes are high for a more ethical form of financial services, although a recent return to big bank bonuses may dash them.

All of these changes have interesting implications for the development of economic strategies in the UK. Until recently, economic development stakeholders and practitioners looked to financial services as a growth sector of choice. This sector was seen to offer exactly the type of employment opportunities every area sought: high value, high salary and high skill jobs. These jobs in turn generate wealth for local areas through staff spending, supply chain development, and skills base enhancement which, once it reached critical mass, could attract further quality investment.

Over the last decade, most traditional inward investment in this sector into the UK has been into London itself. Other areas, in reality, have had modest pickings, albeit welcome and important in various back-office functions such as settlements [1] and IT.

There have been some major inward investments (of internationally owned banks) setting up new operations in various British cities, such as Bank of New York Mellon in Manchester [2] and Deutsche Bank in Birmingham [3]. Outside London, what is available by way of inward investment in the financial services sector is back and middle office [4] functions supporting banks either in the UK or globally. In this respect, these investment decisions are similar to the past decisions by UK-based financial services to relocate such services out of London to places such as Bristol and Norwich.

The creation of jobs in this sector can promote local and regional economic competitiveness and support the sustainable development of a modern and dynamic local economy – or so it was thought. Many local or regional economic strategies across the UK still categorically state that the financial services sector is a key area for prioritised growth, sometimes of a highly specialised variety.

Even the casual observer can see that financial services are not what they used to be. They no longer offer the panacea of high value added, high skills economic development. Any future growth will be significantly more limited and will not necessarily be available equally to all places. Regeneris Consulting has recently undertaken detailed research for Invest Thames Gateway – the inward investment agency for the Thames Gateway area – looking at the future role of the sector in the London and Thames Gateway context.

Changing nature of the sectors

The financial services sector encompasses a relatively tightly defined set of functions that includes banking, financial leasing, credit granting, broking, insurance and pension funding.

The significance of London as a global hub for financial services activity is highlighted by the scale of employment in the sector. The ‘square mile’ of the City of London on its own contains nearly 140,000 jobs in financial services, whilst the Canary Wharf area contains a further 69,000 jobs in the sector. Further clusters of financial services activity can also be found in parts of west London. Outside London, employment in financial services in Leeds and Edinburgh (both recognised as provincial hubs for the sector) totals 32,000 and 36,000 jobs respectively – only a quarter of the jobs provided by the City of London alone. Growth in the sector was particularly strong in the City of London in the run up to the current recession – between 2005 and 2008, financial services employment grew by nearly 5%, compared to the national average of 3.5%. Of course, the data has not quite caught up yet with the contraction of the sector over the last 12 months or so – all will be revealed no doubt in forthcoming analyses.

Although London will clearly remain a key global centre for financial and business services in the future, most commentators that we have spoken to expect a relatively static pattern over the next few years. In the context of inward investment, for example, it is expected that the short term will be dominated by non-cash mergers and consolidation as companies strive to survive the downturn.

In the longer term, the scale and nature of the financial services sector is likely to be heavily directed by the functioning of a series of overarching drivers which are already exerting increasing levels of influence over the global economy. Key amongst these global drivers are;

• The continuing globalisation of markets, including the growing interdependence of global markets;
• The continued growth of emerging markets, which is resulting in the rise of local and regional capital markets such as Shanghai and Moscow.
• Demographic change. In developing countries, continued population growth will result in the need for longer term savings products and better developed domestic financial markets. In the developed world, the ‘pensions time bomb’ is likely to impact upon global savings, with increased levels of financial dependency.

We have consulted at length with a wide range of industry experts and commentators. In the context of these key drivers, experts anticipate that future years will see increasing significance attached to more niche forms of financial services activity. This is where a mature and high cost market such as London can continue to dominate; essentially through continuing to lead in the development of new products and services that are highly differentiated and not yet available in other centres. Specialist financial service areas that might offer future opportunities for London therefore include:

• Carbon trading – London is already a global leader in conventional trading markets and so it is reasonable to expect the City to become a global centre for carbon and emissions trading. This form of activity can only increase as the volume of legislation and protocols governing emissions proliferate. The key question is, however, the extent to which this growth will be concentrated in London; are there opportunities for other UK locations to develop specialisms and support functions allied to this service area?
• Islamic finance – this is another area considered important for the future of the UK financial and business services sectors. The UK – with activity largely concentrated again in London – has already established a dominant position as the leading western market in the sector, currently accounting for the 8th largest share of the global Islamic Finance market. In 2007, the UK Islamic Finance market was worth $18.1 billion, an increase of 74% from 2006. Islamic Finance is a highly specialised sector offering both retail banking services and niche investment functions. It is likely that the retail end of the market in the UK is already well serviced and will not need to expand significantly into the future. The possibility of Islamic financial institutions looking to the UK as a centre for investment products and activity holds out more interesting opportunities. There are key concerns here, however, especially around the extent to which Islamic finance may be overly focused on short-term investment decisions, including mergers and acquisitions, to generate a high sell-on price in a fairly limited period.
• Sovereign Wealth Funds – allied to Islamic Finance is the availability of sovereign wealth funds emanating from the Middle East and other regions; these may also offer additional opportunities for the UK, and London in particular.

New and emerging areas

In addition to the likelihood of more concentrated levels of activity in these existing niche sectors it is possible that a number of new and emerging sectors will experience growth. Future development in each of these sectors would be heavily influenced by the drivers of change discussed previously.

Providing bespoke finance to support the development of newly emerging economies in third world countries is a potential growth area. The UK financial services sector is already highly involved in this form of activity, and the development of additional opportunities may be possible in the short to medium terms. Again, the key question is the extent to which this function will penetrate beyond the highly networked London skills base, and offer opportunities to other parts of the UK, especially key financial services locations such as Edinburgh and Leeds.

Finance for healthcare is another source of activity, driven forward by demographic change and the need for governments to think more carefully about how they design healthcare systems for their populations. This would involve products on both the demand side such as new forms of affordable insurance, as well as on the supply side such as finance for public/private healthcare services financing initiatives.

A third area where UK based financial and business services operations are able to take advantage of new opportunities is in the area of climate change costs. This is linked particularly to insurance related functions, the need for which will become more pressing in the future, as well as investments in clean energy.

Whereas London may well be in a good position to take advantage of these developments, other parts of the UK may struggle to realise the vision of their economic strategies through development of financial services functions. Strategic economic planners need to face the reality that specialisation is now the name of the game. Realistically, therefore, given the way in which the sector will become increasingly specialised, it is difficult to envisage a significant share of investment in this sector going outside of London or areas immediately surrounding the capital. Specialised functions require highly specialised labour and direct routes to key markets – more easily found in the London area than elsewhere in the UK.

Recent evidence suggests that the more sophisticated parts of the financial services back office function may increasingly locate within reasonably close proximity to the main business function. The desire to off-shore large parts of basic servicing for the sector is declining. This, however, still suggests that London and areas close by – perhaps the Thames Gateway – may be first on the list for high value added services in the sector.

For more information about our work in this area, please contact Jim Coleman (j.coleman@regeneris.co.uk) on 0207 608 7200.

[1]. In other words, sorting out the paperwork of previous day’s financial transactions for international banks

[2]. Now over 1,000 employees in two city centre offices

[3]. Here a subsidiary of Deutsche Bank provides middle and back office services for the Bank globally. DBOI Global Services will occupy nearly 69,000 sq ft of space at 1 Brindleyplace. The Bank is expected to employ around 550 permanent staff at the new operational processing centre by early 2010

[4]. The middle office is the part of a financial institution's operations that provides the link between the revenue-generating front office and the administrative back office. For instance, trades executed by the front office staff of a brokerage may be processed by the middle office before being settled by the back office.