A very different week in the markets
October 5, 2022
Are the markets warming to the 'growth plan'?
Growth in the UK has been trailing other G7 countries in recent years, and currently we’re the only economy that is still below pre-pandemic levels (albeit by a very small amount). We need a growth package, and why not now given all the other problems we’re facing.
One area that the UK is famous for around the world, is the City of London and its financial service exports. For years EU regulation has tried to strangle its growth. Europe has been looking to seize on the opportunity Brexit provided and steal businesses away from our financial hub. This isn’t anti-EU chat, we aren’t anti-EU, it’s just a fact.
Something needed to be done to stop it. During the pandemic, US investment banks were posting record gains and huge profits from their trading arms. In London, our own banks were not only failing to keep up, they were losing money. Part of the reason for this was that between 2009 to 2015 the number of people lost from London trading floors employed in securities trading was down 42%, from 16,400 to 9,400 and it has never recovered.
In 2020 we needed those traders to provide revenue and hedges to our troubled banks. They need multiple departments all working together in an investment capacity. If one area has a bad year, it can be propped up by another. Get rid of one and you’re over exposed to whatever is left. Many London investment banks dropped trading to focus on retail, and the next crash (the pandemic) left the retail side exposed to bad debt about which the banks could no longer defend themselves. It all ended without disaster thanks to a huge injection of capital from the government and the vaccine, but things could have been very different.
After extra regulation was brought in in 2014, a lot of brokers moved to Paris to avoid new EU regulatory rules. Last time I checked, Paris was in the EU but the problem is the UK was the only one enforcing the rules. Nobody else seemed to care and the French regulators were nowhere to be seen.
Now we’re not in the EU, don’t you think we should have another look at the rules and throw out the ones that never worked? It would appear that this is what Liz Truss and Kwasi Kwarteng are doing.
City officials have welcomed Truss' newfound warmth towards the sector after years of being left out in the cold following Brexit. They also hailed her appetite for bold action on the economy.
"That's fine if you're doing it within parameters that people are comfortable with and expect, but don't lose your moorings from the institutions that allow you to be reasonably radical without consequences to it," said Miles Celic, chief executive of TheCityUK, which promotes Britain's financial sector abroad.
Britain's £261 billion financial sector is one of our biggest industries, with a trade surplus of around 90 billion pounds, meaning much is at stake.
Its reputation for robust, predictable and credible institutional frameworks has been a bedrock of the City's international reach, but they have been missing over the past week or so.
Unpredictability in UK policymaking risks denting the impact of Kwarteng's moves due this month to make financial rules friendlier.
The message is clear. The changes are welcome, but don’t rush everything through at once and catch The City off guard again. While growth is great, suddenly flooding a market with debt will increase the price of that debt very very quickly. His failure was to not fully understand the consequences of his actions. A mistake he won’t make again.
Even before the bond market crash there were concerns among some in the financial sector over how Truss and Kwarteng were planning a 1980s-style "Big Bang" of deregulation.
There is already an extensive bill before parliament to update existing financial rules, ease insurance capital requirements and begin regulating new sectors like stablecoins.
The City of London Corporation, which runs the "Square Mile" financial district, said a government focus on financial services competitiveness would support Britain's economic revival.
But Truss' promise to scrap all remaining EU rules by the end of 2023 has raised some concerns given the existing rulebook is largely based on tested international norms which Britain was key in shaping.
Having said that, rules can be wrong, and if they suffocate growth as they have, then we now have the power to change them, and a government that seems willing to do so.
Kwarteng has rolled back to some extent, telling financiers last week he would not tinker with the current structure of regulators - quelling talk of a merger of watchdogs for now - and saying on Monday he had never "rubbished" the central bank.
Kwarteng’s proposal to scrap bankers bonuses is another City-friendly policy enacted by the government as it tries to head off attempts by the EU to force more financial jobs, activity and tax revenue to the continent after Brexit.
The news has been greeted with glee by UK and US investment banks, which will both benefit from the change.
Wall Street executives have consistently argued that the bonus cap does not encourage lower pay but rather pushes up salaries, which are fixed and hard to cut when revenues fall, whereas bonuses can easily be slashed to zero in a bad year.
The likes of Goldman Sachs and JPMorgan will also be able to more easily relocate staff between New York and London without having to alter their pay structures, keeping salaries comparatively low and retaining variable bonuses as the bulk of remuneration.
One US bank executive based in London said: “A bonus cap exit would be a massive positive for the City and us in terms of talent attraction, investment and reduction of fixed costs.”
It might not be an obvious and popular decision, but the fact is the UK were always against it when the EU pushed it through in 2014. The UK strongly opposed the legislation, with the then chancellor, George Osborne, even attempting to overturn the bonus cap at the European court of justice.
Andrew Tyrie, the former chair of the Treasury committee, who also chaired the parliamentary commission on banking standards, said a cap would not necessarily promote higher standards, which instead required “fundamental reforms” that could include longer bonus deferrals and clawbacks.
Some argued that a clampdown would damage City competitiveness and send bankers fleeing to rival hubs in New York, Zurich or Singapore.
The Bank of England was concerned the cap would lead to a rise in fixed salary costs and squeeze bank finances.
This also happened.
On its own, it’s a very strange piece of legislation to have introduced in the first place. Why is it right for the banking sector but not all sectors?
Executive bonuses in Silicon Valley were up 400% in 2020.
In 2018 Tim Cook took home $132 million on top of his $3 million salary.
Tan Hock Eng of Broadcom’s bonus skyrocketed 1,585% in 2021 from $3.6 million to $60.7 million.
Nandella of Microsoft got a $49.9 million bonus.
Robbins of Cisco got a $25.4 million bonus.
I’m not saying that it’s right or wrong, but if you cap one sector do you not have to cap them all? What’s clear from the above is that the biggest companies in the world, give very large bonuses and not doing so would simply take away their competitive edge.
It’s not about whether we should scrap it, it’s that it should never have been introduced in the first place.
We understand that nobody likes bankers, but then nobody likes estate agents, lawyers, or journalists either. Think objectively and the deregulation in the growth package makes sense. As Kwasi himself said yesterday, “We need to move forward, no more distractions, we have a plan and we need to get on and deliver it.”
It wasn’t our plan, but we might as well see where it goes.
Sentiment on our platform suggests that our traders believe in the 'UK Growth Plan' with many holding a position in the FTSE 100. After the recent pullback, and the discounted prices, will we see more purchases of the F100 Index?
Previously our team published an article titled FTSE to Reach 12600 by 2032? After plunging below 6800 last week, it would be quite the story.
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