CONFERENCE OF FIBI

Speech by John Bruton, President of IFSC Ireland, at the conference of  FIBI on opportunities for the IFSC in the Marker Hotel, Grand Canal Square, at 8.15 am on Tuesday 17 September 2013

INTRODUCTION

I would like to start by saying something about the broad economic context in which the Irish International Financial Services industry must operate, covering the euro ,the general business environment, the continuing  need for structural reforms, the lessons from the bubble,  and the global regulatory response. I will then focus on the opportunities for the IFSC. 

 THE EURO....WHAT IS ITS FUTURE?

The existence of the euro, the single currency, has not created the economic crisis in Europe.

This was going to come anyway because of lost competitiveness, the emergence of new competitors, like China, for traditional European industries, and the progressive ageing of European societies. Even more expansionary monetary policy could only have postponed the emergence of the symptoms, it could NOT have prevented the illness.

What the existence of the euro has done is impose discipline and mutual solidarity on Europe.

Without the euro, countries would have pursued the route of devaluation and inflation in response to their problems. Savings would have been wiped out.  This is not possible now, and that is good. Instead problems are now being tackled at their source.

Without the euro, wealthier and stronger European countries would not have come, so quickly, to the aid of other European countries in difficulty. They have now done so on a systematic basis, and that too is good.

The EU is moving toward a common system for winding up banks that need to be wound up, without putting the overall system at risk. It is moving toward a common system of deposit insurance. 

Much better systems are now being put in place in the European Union, to ensure that, in future, public finances, and underlying competitiveness, do not get out of line again.  Out of the crisis, we are now facing up to problems we had ignored for the past 20 years in Europe.

The euro will survive. Not only that, I believe it will eventually be imitated in other parts of the world. 

To sum up, the euro

+   is a protection against the expropriation of savings, through inflation and devaluation.+   is a factor for economic stability in the world, and+   is a major political step forward for unity Europe

OPTIMISM AT LAST ABOUT JOB CREATION BY IRISH BUSINESSES.

8 out of 10 businesses in Ireland are now optimistic about their growth prospects in the next two years according to a survey conducted in the past year by Amarach Consulting. The Survey involved interviews with 200 decision makers in businesses, large and small, native and foreign owned.

Two thirds expect to expand in Ireland in the coming years and half intend expanding abroad.

This is really important because I understand that 95% of all new jobs in Europe are created by owner managed businesses.

A majority intend hiring new staff in the next 2 years, with a strong emphasis on IT and digital skills. Already we hear of vacancies for staff with IT skills notwithstanding the high level of unemployment. 

Irish owned businesses are more optimistic than foreign owned ones

The survey showed that 6 out of 10 of the companies enable their staff to work from home during part of the working week. 77% of businesses supply laptops for work outside the office, and 79% supply smart phones for the same purpose.

Those businesses, which allow some working from home, tend to be more optimistic about their future, and more likely to be contemplating hiring more staff, than ones who do not provide for work from home at all.

BUT IRELAND HAS GROUND TO MAKE UP USING THE INTERNET AND IN GENERAL STRUCTURAL EFFICIENCY

To my surprise, the survey suggests that only 53% have a business website. This may explain why Irish based businesses sell much less abroad over the internet, than Irish consumers buy over the internet from foreign websites.

Historically, Ireland, despite its high tech record in other fields, is coming from behind in terms of development of an economy based of use of the internet.

The Boston Consulting Group measured what it called “e intensity” by comparison with GDP per head in 2010 in a number of economies.  “E intensity” measured the reach of the internet infrastructure, amounts spent via internet and the degree to which business , consumers and government are involved with the internet.

With a  higher GDP per head in 2010, Ireland has  50% less” e intensity” than the UK, and almost 100 less than Korea, which had then a GDP per head that was half Irelands. 

Ireland lagged behind Denmark, Sweden ,Netherlands and Finland ,all of which had roughly the same level of GDP per head as Ireland in 2010. Ireland   was at the same level of “e intensity” as Spain and Slovenia, which had considerably lower GDP per head in 2010.

Incidentally the OECD also identifies weaknesses or excess costs in Ireland’s hospital system, drug prescribing practices, legal and court systems, conveyancing, physical planning, as well as job search systems for the unemployed. Expenditure per pupil in primary and secondary education is very high here, by OECD standards, but is not matched by commensurately good results in international comparative tests of proficiency in maths, science and languages.

Rather than obsessing about one year’s budget numbers, we should devise structural reforms in these areas, which could, if undertaken now, be yielding  revenues enhancements, and expenditure savings, every year for the next thirty years or more.

WHY BUBBLES HAPPEN

It is also important to reflect on the mistakes of the recent past. 

Writing in the Washington Post yesterday, Robert Samuelson said of his own country:

“ We were victims of success. The crisis originated from 25 years of prosperity, from roughly the end of 1982 to the end of 2007. This conditioned people — bankers, regulators, economists, almost everyone — to take stable growth for granted. The longer the prosperity continued, the more it inspired the risky behaviours that ultimately wrecked the economy.”

To a great extent, that was true of Ireland as well.

In a way, it is easy to see why people in Ireland made the mistake of thinking, in the 2000 to 2006 period, that house prices in Ireland (and household wealth) would never stop rising. Recent history seemed to suggest that the only way house prices could go was up.

House prices had, after all, already risen by 133% between 1994 and 2000. These increases were justified by rapid economic growth, immigration, and new family formation, all of which created a genuine demand for housing.

The trouble is that the increase in house prices continued after 2000, and was financed, not by improved competitiveness, but by excessive lending, and by income generated from, inherently temporary, construction spending. 

The assumption of the bankers, who were lending this money, seemed to be that demand for housing could go on growing, to infinity.

A moment’s thought would have shown how nonsensical that was.  But, in the middle of a boom, people are often too busy, to take a moment to think

The revenue of the Government became unhealthily dependent on taxes derived from property sales such as stamp duty, capital gains tax, and VAT on house sales. Property related revenues reached 18% of all revenues in 2006, whereas they had only  been 8% in 2002.  But once house sales stopped or slowed down, of course, that revenue growth stopped, leaving a huge hole in the Government’s budget.

Again, a moment’s thought would have shown how dangerous it was, to build up permanent spending programmes, on the back of inherently temporary streams of revenue.

But very few people, in politics or outside it, took a moment to think. 

The relevant question to ask about Ireland’s recent experience is

 “How can sensible, and generally public spirited, people make mistakes like this, and how can such mistakes be avoided?”

Robert Samuelson also addresses the question of blame.

He says:

“ The accumulating evidence suggests that false ideas, not evil people, were the main culprits.”

He even cites economic research which suggests that those who were lending recklessly in their professional capacities, were making the exact same mistakes in their personal capacities. They believed their own propaganda, unfortunately.

THE CAUSES OF BUBBLES.............SILO THINKING, AND FOLLOWING FASHION, WITHOUT REFLECTION

I would identify two tendencies of policy making in both the public and private sector,that were at the heart of the problem in Ireland 

1.  “Silo tendencies” within institutions, charged with mitigating risks,  where people only thought about their own immediate responsibilities, and did not question wider assumptions.

2. A “consensus approach”, which encouraged a single view to be taken of any issue. Human beings are followers of fashion. We need institutions that deliberately challenge fashionable assumptions, and those institutions did not work, in Ireland, or in the wider European Union.

These errors can occur in ANY country, under ANY political system.

They are not unique to Ireland, Spain, Arizona, California, Florida, or any of the other parts of the world where property bubbles arose. The same mistakes could also be made in China, in the Greater London area, or any other parts of the world where house prices are rising  disproportionately fast.

GLOBAL REGULATIONS SHOULD BE TOUGH, AND WELL ENFORCED, RATHER THAN COMPLEX

Simplifying regulations, while increasing penalties for misbehaviour, must be part of any serious effort to make the European economy more competitive. 

Global Regulations in the financial sector may become so complex and costly, that only very big institutions will be able to afford to comply with them.

If that happens, we will be solving one problem, lax regulation, by making another problem, the ”too big to fail” problem, worse

The response to the financial crisis has been ever more complex rules ,that only a tiny number of professional advisors could ever hope to remember, or understand.

In the United States, the Glass Steagall Act, introduced to regulate banking after the Depression of the  1930’s ran to  37 pages .In contrast,  the Dodd Frank Act, introduced in the wake of the recent crisis, runs to  848 pages of basic text, plus 30000 pages of implementing rules.

In the UK, the 1979 banking act ran to 75 pages. The 2012 Financial Services act runs to 534pages.

Businesses themselves lobby for “certainty” in legislation, which often involves more and more complex exceptions and qualifications.  

The ingenuity of lawyers in devising complex ways of getting around rules also drives rule makers to introduce new complexities to close loopholes.

Some of these new laws are so long that parts of them are never properly debated, or even understood, in parliaments.

Complex rules are a sort of regressive tax.

They give an artificial advantage to those who can hire

 “ the most sophisticated risk modeller, the slickest tax accountant”

 as Andrew Haldane, of the Bank of England, pointed out in a speech earlier this year.

 He added 

 “There is also an inbuilt professional inertia among regulators, lawyers and tax accountants with large amounts of human capital invested in complexity”

These complex rules carry economic costs and divert talent, time, and money away from productive activity, to activity that adds nothing to the competitiveness of our economies in international markets.

In a recent study on banking in the world, McKinsey estimated that, if all the regulations currently in the pipeline were now in force, it would reduce the return on equity on European banks from 10% to 6%. This is a non trivial issue for the Irish taxpayer, who has, albeit reluctantly, acquired a disproportionately large equity holding in banks, and needs a return on that equity to meet basic services .  

On the other hand, the increased compliance cost may force financial institutions to look for the most cost effective locations in which to undertake this high cost activity, and this may be an opportunity for Ireland.

Simplifying regulations, while increasing penalties for misbehaviour, must be part of any serious effort to make the European economy more competitive. 

HOW CAN IRELAND TURN THESE TRENDS TO ITS ADVANTAGE?

I have been speaking to many people in the industry, and in public administration, in recent days, to discern where they see the opportunities for Ireland  at this juncture.

Firstly we must acknowledge we are working in a really very competitive market place

As McKinsey pointed out lately, for the past thirty years, regulated banking grew faster than the underlying economy. That trend has now ceased, and the sector is contracting almost everywhere in the world, except in parts of Asia. 

This contraction is thus not a problem unique to Ireland, or to the IFSC. Indeed it is truly remarkable that IFSC has maintained its employment and activity levels, against a much changed global background. 

On the fifth anniversary of the fall of Lehmann Brothers, aggregate employment and Foreign Direct Investment (FDI) in the sector are back up to pre crisis levels, and are growing.

The Centre, and the companies operating there, have achieved much and continue to make a significant contribution to their parent companies and to national economic recovery.

IFSC operations are highly productive and efficient. We have a large pool of available talent, and the downsizing of some institutions creates recruitment opportunities for new entrants and for existing institutions here who can expand. We have excellent intellectual capital in our universities and institutes of learning.

The recent decision, contained in the recent Central Bank Act, to allow non EU banks to open branches here is a major opportunity. Some banks, now operating in the UK in high cost locations, may be able to relocate activities, on a branch basis , in Ireland.

The ongoing Review of the workings of the Clearing House Group will help  ensure that  the Institutional arrangements for the future development of the sector are appropriate and effective;

Ireland remains a key jurisdiction for

+ the servicing, distribution, listing and promotion of  international investment funds,+ transaction Banking,+ payments,+ cross border life insurance,+ aircraft leasing and financing,+ financial technology and operations support.+investment management

We must continue to grow and develop the existing base of investment here while focussing on emerging areas of opportunity. These new areas of opportunity include, potentially, 

+clearing and settlement,+ collateral and risk management,+ green and Islamic Finance  and+ Compliance.

Compliance is an increasingly costly activity for banks. Those involved in it are well paid. As I mentioned earlier, complex regulation is an inherently expensive business. Bu for Ireland it can be an opportunity. Just as Ireland has become a centre of excellence in the fields of aircraft leasing and fund administration in the past, we should seek to become a centre of excellence in compliance, and risk management in the future. The IDA and our universities are already putting funds behind R and D in finance and this is a basis to build on.

There are big opportunities here, and this conference will help us seize them. We must ask ourselves what the world’s financial needs will be in 2020, and how Ireland can meet these more effectively than any other jurisdiction, and thereby grow our market share. Change will be constant.  We must combine bravery with imagination, and work together.