Liz Truss got a lot wrong but she was right that action is needed to boost the growth rate. UK productivity has risen very slowly over the past 15 years and it dictates how fast an economy can grow without fuelling inflation. Nobel Prize-winning economist Paul Krugman famously said: “Productivity isn’t everything, but, in the long run, it is almost everything.”
Truss was fixated on tax cuts but most economists say the key to higher productivity is “supply-side reforms” – a term that covers everything from investment in digital and physical infrastructure, and education/skills, to smart deregulation, removing trade barriers and easing planning laws. Some are more politically difficult to deliver than others.
Financial deregulation is a crucial arena, given the sector’s dominance. For the government, it could also show Brexit can work for, not against, the economy.
When he was finance minister, Rishi Sunak produced an array of plans – what some are calling Big Bang 2.0 – to bolster Britain’s pre-eminence as a finance centre and free up capital for long-term investment. Many are housed within the government’s Financial Services and Markets Bill which is working its way through parliament.
Jeremy Hunt fleshed out those plans last week, trumpeting a 30-point plan to galvanise the financial sector. You can read the details here.
Billed as the biggest shake-up in 30 years, this laundry list includes some sensible ideas that will surely be introduced over time.
Critics have seized upon the dangers of unwinding measures put in place to prevent a repeat of the 2007-9 financial crisis but those fears look overdone. Sunak and Hunt are pragmatists, and some of the bolder plans are already bumping up against reality. Furthermore, all of this is yet to be fully scrutinised in parliament, particularly by the House of Lords’ cohort of finance experts, many of them veterans of the financial crisis.
The bill will give the Bank of England’s Prudential Regulation Authority and the Financial Conduct Authority a new objective to boost growth and competitiveness.
That sounds like a big shift but while Hunt’s remit letter for the Bank’s Financial Policy Committee, released alongside his Autumn Statement, said it should support supply-side reforms needed to break down barriers to enterprise, it added a big get-out clause – only if that does not conflict with the primary objective of ensuring UK financial stability.
More strikingly, ministers had wanted powers to override regulators’ decisions. After unusually blunt objections from the Bank and the FCA, the Treasury ditched that idea, perhaps recognising that recent events have demonstrated the value financial markets and investors place on independent institutions.
Exhibit B is Britain’s freedom from EU Solvency II rules which limit the scope of insurance and pension funds to hold long-term assets. The government says allowing funds to invest in transport, housing and green energy would unlock vast potential. The Bank is concerned about the danger of insurers getting stuck with unsellable assets when trouble hits. The near-miss for pension funds after Kwasi Kwarteng’s ill-conceived “mini budget” reinforces that worry.
The government believes it could create over £100 billion pounds for investment. The Bank has talked of 5-7% of the capital held by life insurers being safely releasable for wider investment, which would equate to something in the low 10s of billions.
Insurers have lobbied hard to be unleashed from Solvency II, largely because returns on the government bonds they invest in have been so low. But that too is changing. As interest rates rise, 10-year UK gilts now offer an annual return of 3%, so the urge to seek higher returns elsewhere could wane.
The Solvency II bang could turn out to be more of a whimper and it gets to the heart of the regulation debate – there is always a balance between cutting red tape and protecting the public. It may also prove to be emblematic of the bigger picture. There will be changes to the regulatory landscape but they are more likely to be modest than dramatic.
It looks like a similar story for government plans to relax bank ring-fencing rules – which split banks’ retail and investment banking operations after the financial crisis to protect business and households from risky trading bets. Ministers say it ties up too much bank capital. The regulators are resolute that it should remain in place for systemically important banks. That is where we seem to be heading. Only smaller banks with no significant trading operations will qualify for looser rules.
Shortly before Hunt’s call to arms, the Bank of England announced its intention to adopt the latest tranche of global financial regulations, arguing that alignment with strong international banking standards promotes economic growth by supporting investor confidence in the banking system and ensuring banks can keep lending during downturns.
The Bank is keen to use the opportunity outside the EU to refine rules for a financial sector which holds assets that dwarf the size of the UK economy. But it is aghast at any idea of creating “Singapore-on-Thames”. Major divergence from EU rules would also scupper any remaining hope of increasing UK financial market access to the bloc and would raise costs for London-based international banks.
It isn’t all conflict. The Bank and FCA are content to see the end of the bonus cap. Wrongdoing often takes time to come to light. The regulators can claw back bonuses after the event, to punish miscreants, and see that as a key deterrent. They also know banks responded to the cap by raising salaries, so financiers were rewarded regardless of performance.
But they will be much less happy at Hunt’s proposal to change the Senior Managers’ Regime – another post-financial crisis measure which holds top Bank executives personally responsible for wrongdoing or costly mistakes.
Reports suggest Sunak will abandon Truss’s pledge to scrap all EU-derived laws by the end of 2023, after a letter from bodies including the Institute of Directors, the Trade Union Congress, the Chartered Institute of Personnel and Development and the Employment Lawyers Association said the plan would sweep away thousands of pieces of legislation, resulting in interpretation of the law becoming “highly uncertain”.
In a different vein, the government has dropped plans to impose mandatory housebuilding targets on local councils in the face of backbench Tory opposition.
So, the government will try to remodel the regulatory landscape in the hope of building a competitive advantage. How far events, financial market dynamics and political and regulatory opposition allow them to get remains to be seen. Perhaps Liz Truss’s unintended legacy has been to fundamentally strengthen the Bank, FCA and Office for Budget Responsibility.
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