Financial Services- How Well Positioned is Ireland for a Time of Change

How well prepared is the Irish financial services sector to meet the challenges ahead in a variety of areas - from international political and trade relations, regulation and taxation to technology and sustainability?

MARK KENNEDY reviews the current state of play and concludes that Ireland does indeed have its strengths in such areas as stability, strong international relationships and proven trading and delivery quality, but that it still has a lot of work to do in certain other areas. Perhaps the most important question we should be asking, he suggests, is what kind of businesses we wish to develop amidst all the change? He points out that while Ireland can be a home for financial services of various kinds, as technology develops the nature of these services will change, as will the type and sustainability of the employment that attach to them.

Twenty seventeen was marked by a feeling of volatility and impending change. Brexit, US policy changes, regulation, cyber-security and the implementation of new technologies all combined to create a feeling of change and challenge to many businesses. How we are positioned and how we strategically position against the backdrop of likely changes in the coming years will affect our success as a location for key financial services in Ireland. The Irish financial services sector has for many years been more than adept in positioning itself well and will draw on this experience as it faces these challenges in the coming years.

So what are the likely focal points of change, and how do we interact with them? We assess the key areas facing financial services businesses under six broad headings; economic backdrop, international political and trade relations, regulation, taxation, technology, and sustainability.

The broad economic backdrop is positive of late, with generally strengthening European and US economies, with Ireland notably strong within that. The likely trajectory on interest rates is a gradual increase over the next number of years and this will likely be manageable from an Ireland perspective. However, any sign of a potentially overheating German or French economy will need to be watched, as the ECB mandate will require relatively swift action in the event of indications of gathering inflation.

In Southern Europe the combination of political stresses in Spain and in Italy, with a continuing challenging NPL situation in the banking sector, will also mean a leaning towards holding interest rates in the current range. Given the history of the past decade, this is perhaps as benign a position as we could hope for and we should look to manage the return to a more ‘normal’ rate environment progressively over the next number of years. Similarly the foreign exchange environment is likely to remain in a broadly similar position to now, although this is harder to call. No one seems to anticipate a change in the sterling position over the next two years, but the U. attitude to trade relationships may mean a more volatile dollar relationship with a number of currencies.

The political and trade relationships between the major economic powers are more volatile now than perhaps at any time over the past 30 years. Brexit is, naturally, the major talking point in Ireland and the ongoing uncertainty over the shape of a future trading relationship between the UK and the European Union is not helping businesses to plan in a structured, long term manner. It is likely that we will have a transition period of two years and I suspect that this will include a possibility of planned extension which will be utilised. If this assumption is correct, then the focus will be on a political deal by October 2018, with the serious and detailed work of trade arrangements then beginning in earnest.

For Ireland’s FS sector Brexit holds both threats and opportunities and we are seeing a flow of business to Ireland in line with our traditional strengths in insurance, asset management and certain aspects of the international banking sector. One area that will require focus, however, is the level of integration between Ireland and the UK and the relatively less developed integration with the European economies. In a scenario where the UK is likely to represent progressively less of our overall trade, we need to ensure that trade with Europe is as seamless as possible.

The US trade policy seems to be both beneficial and threatening. There is some prospect of Ireland being regarded as a potential bridge to Europe, which is positive. On the other hand, there is potential for a larger trade war between the US and China - or even the US and Europe - which inevitably would be damaging for all. Taking a balanced view, the implementation of stated policy by the US authorities tends to be more thoughtful than some of the political pronouncements. We can only hope, therefore, that the strong positive position of Ireland plus less uncertainty about US global trade and policy intentions will lead to continued stability in the international trade environment.

Despite a stated desire on the part of many regulators to minimise the introduction of new regulations, I believe we will continue to see an amount of change in this regard over the next few years. The two main drivers in Europe will be the continuing development of the Banking Union and the revitalisation of the Capital Markets Union as key pillars of the integration of financial services in Europe.

The ongoing detailed implementation of MIFID, CRD/CRR and Solvency II regulations are also likely to challenge FS businesses over the next few years at a domestic level. Changes in accounting rules are also likely to require commitment of significant resource, with both Insurance (IFRS 17) and Banking (IFRS 9) seeing significant amendment to rules in the near future. Both of these changes require serious consideration of business model as well as how to account for transactions and financial position.

However, it is the evolution of both US and UK regulation over the next two to three years that will be of greatest interest to regulatory change watchers. It is likely that the U.S. will relax its banking rules relatively significantly and that the interface between this and general US trade policy may render the EU less attractive to US banks. The UK may also begin to relax its rules post the Brexit transition period. The consequences for Ireland, as a connection point between EU and US, and perhaps UK in some business lines, needs to be monitored.

Taxation policy is another area where a divergence in approaches is likely to leave Ireland in a position where skillful negotiation of uncertainties is required. The UK is going to follow the OECD rules and it is likely that the larger EU member states will seek to exert pressure to deliver a more challenging framework, from an Irish perspective - with both CCCTB and a potential digital tax eroding one of our competitive advantages. It is clear that competition between nations underpins positioning on taxation issues and this will not change in the coming years.

Two final trends also seem to the forefront of any analysis. The first - the rapidly changing role of technology in our daily lives - is an enormous topic of itself. If I were to pick three themes within this general area, privacy is probably the most pressing, and I believe the new GDPR regulations in Europe will lead to significant changes in how we run businesses. This will not be an easy change, as many businesses benefit enormously from the exploitation of data at present. It will be interesting to see how European authorities implement the new regime, particularly in the area of enforcement. Linked to this is the issue of digital security and this, too, is a rapidly evolving area, with both the industrialisation and politicisation of hacker activity. Finally, the triple ‘A’ of automation, analytics and artificial intelligence are changing business models profoundly - with consequences right along the value chain.

The second trend is the increasing impact of ethical investing and the impact of sustainability issues more generally. Both have potentially significant implications for businesses, whether through regulation or customer behaviours, and will colour the performance of many financial services businesses in Ireland.

So how well positioned is Ireland to navigate all these changes? A fair assessment would probably point to strengths - certainly in terms of stability, strong international relationships and proven trading and delivery quality. However, I believe we still have a lot of work to do in certain other areas. Most immediately, we need to play an active role in concluding a political Brexit deal that leaves as much scope as possible for Ireland and the UK to trade goods and services in a reasonable way. We also need to negotiate the considerable challenge of a changing international taxation landscape. There is also the issue of regulating businesses effectively without overwhelming enterprise - and keep regulation at least at a level commensurate with business risks, as business models change.

Perhaps, however, the most important question we should ask is what kind of businesses we wish to develop amidst all this change? We can be a home for financial services of various kinds and, as technology develops, the nature of these services will change, as will the type and sustainability of the employment that attach to these services. Ireland is not always the venue of choice for some of the most innovative aspects of financial services, but the coherence of our offering in both technology and financial services positions us to be a destination for many of the emerging business opportunities. These areas will be increasingly regulated and subject to strong competition. Our ability to cope with both and to flourish in the future will depend on our ability to further develop and enhance the strong competitive basis we have forged over many decades, while also adopting a resilient and sustainable approach to regulating new businesses appropriately.

This article first appeared in the Finance Dublin Yearbook 2018.

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