Policy Papers

Start Up Britain is Here in London: Why it is crucial to support financial SMEs

The impetus for this paper arose in a most unlikely manner. At a meeting with the NCI, the Business Secretary Dr. Vince Cable asked about the scale of small and medium sized financial services businesses, and how many jobs this sector provided, in the capital. Nobody had the answer. The Board of the New City Initiative promised to find out and to report back to the Secretary of State. With the significant assistance of IMAS Corporate Advisors and the Lord Mayor’s office, we delved into the data, and found that this interesting question revealed some surprising statistics. We therefore thank the Business Secretary for inadvertently initiating our latest policy paper, which we hope will fill some gaps in knowledge about this robust and thriving section of the financial services sector in the UK (and indeed by inference in Europe more widely). As this paper will demonstrate, the so-called “City” is far from being about the financial giants alone.

Taxpayers were called upon to bail out ‘big banks’ after the financial crisis, leading many voters to resent the financial services industry bitterly. But there is another City. It is made up of entrepreneurs who manage significant sums on behalf of investors and employ many tens of thousands of people. Some of us have come together to form the NCI, whose members alone have some £200 billion under management and employ several thousand individuals.

However we represent but a small part of the diverse body of financial SMEs that contribute to the City. According to our research sources, the financial SME sector (typically defined as firms employing less than 250 employees) as a whole employs up to an astonishing 57 per cent of the UK’s total financial services staff. Accurate figures for assets under management are harder to come by, but the UK’s Financial Services Authority (FSA) suggests that UK-based hedge funds alone manage some $550 billion.1 In Europe as a whole, it is estimated that the hedge fund industry – just one category of the SME sector – employs 50,000 people across the EU, and that their partners, employees, consultants and service providers pay taxes of more than $8 billion every year.2 Clearly this is just the beginning as far as the wider financial SME sector is concerned across Europe.

We believe that financial entrepreneurs are a valuable asset for the UK and wider EU at a time when economic growth, particularly outside the European core, cannot be taken for granted. Given the rise of emerging economies and the pressing need for developed nations to compete, SMEs are vital because they stimulate excellence and hence competitiveness within the financial services sector.

In the light of financial SMEs’ significant roles as employers and innovators, as discussed further below, we believe that there is a vital need for regulators to ensure that the new regulatory framework distinguishes between different kinds of financial businesses with a particular focus on the levels of risks they may (or may not) create for the financial system. This will help the City and financial centres throughout Europe to thrive as valuable economic assets for their own countries and for the EU more widely. The alternative is to expose Europe’s financial centres to avoidable competition from offshore regimes such as those in Switzerland and many emerging markets, where the authorities aim to attract institutions through lighter regulatory and tax burdens.

This paper covers lots of ground, but it focuses on one key point. We must avoid imposing regulations designed for banks and shadow banks on SMEs.

The first step towards this is to correct the misconception – common in policymaking and regulatory circles in both the UK and Europe more widely – that the financial sector consists solely of big banks. When regulators and other officials deal with financial services companies, they must distinguish between two categories. The first includes those businesses which use their balance sheets for trading purposes. The second is comprised of companies that do not – which are, effectively, third-party advisers – and which also demonstrate a strong focus on alignment with their clients. The UK government set out its commitment to small businesses of all industries in its budget of March 2011, although many would argue that its proposals did not go far enough. With this principle established, we would like to see measures taken to encourage SMEs in the financial services sector specifically, based on the key distinction identified above.