Good morning.
Thank you for inviting me to Scotland’s capital and Europe’s fourth largest financial centre1. It is great to be back, and to see you all.
I was thinking on the way up to Edinburgh, what a difference a year makes. Not so long ago in the UK, we had a Labour government desperate to obliterate the word nationalisation from its constitution, and prove its ability to run a free market economy. Now the role of taxpayer as shareholder in the banking sector sounds almost normal. Meanwhile, across the Atlantic, we have heard arch-capitalist Alan Greenspan confess that he was ‘partially wrong’ about his hands-off approach to banking regulation2.
When Alistair Darling said back in August that Britain was facing arguably the worst economic downturn in 60 years and predicted that it would be worse than people had expected, many didn’t believe him. But of course, he turned out to be right. In the space of just a few months, we have seen the unthinkable become the thinkable. The thinkable became necessary. And the necessary has become the norm. All the while, the landscape continues to shift on a daily or even an hourly basis leaving new casualties in its wake – from Bear Stearns and AIG to Northern Rock, HBOS and RBS.
Of course, there have been some winners too. McDonald’s are serving a record 100 million customers a month in Britain3, while Butlin’s Skegness has seen a 15 percent rise in bookings and Sainsbury’s plastic lunchbox sales are up a third!
More seriously, in recent weeks it has become clear just how close to meltdown we have come. Now not just the financial sector itself – but businesses and consumers – are paying the price, and trying to learn the lessons. The IMF is pulling no punches in its analysis. It says that we are going through the most dangerous financial crisis since the 1930s, and identifies three failures: a supervisory failure in the developed world; a risk management failure within the financial sector; and a failure in market discipline mechanisms.
We live in very different times from the 1930s. But it has been a very long time indeed since we were in a position which required us to radically rethink the fundamentals of our free market system. This brings us challenges and opportunities both domestically and on the global stage, and I would like to outline some thoughts on that this morning.
First, we need to see strong leadership at home – from government, from regulators and from business leaders.
We have already learnt that unusual circumstances can demand unconventional solutions. Although nothing is yet certain, the temporary rescue plans recently implemented in respect of the banking sector appear to have done their job so far. The dam wall that at one point threatened to break continues to hold.
But the concepts and systems which we traditionally relied on to keep our financial systems moving, have been disintegrating. We will need strong leadership as we think through the new principles and architecture which is needed to guide our financial markets into the future.
Regulation itself is no panacea and previous experience often demonstrates the likelihood of introducing disproportionate legislation at a time of crisis – for example in the US earlier this decade. The clamour for change rightly continues. The hunt for scapegoats will gather pace. This noise makes the task for our political leaders, in particular, all the more difficult. They must act, but must act wisely.
We must avoid knee-jerk responses, and ensure that the cost of the action we take is balanced by long-term benefit. As we work through the current situation in the months ahead, I believe that there are four areas where strong leadership will be vital.
We need to better understand the systemic risk behind the situation in which we have found ourselves. It will be all too easy, behind the fire-fighting and crisis management, to fail to deal with the underlying issues. We must unravel and get to grips with the dependencies and reliances which underpin our workings, and identify the checks and balances that we need.
We also need strong leadership as we review our regulatory infrastructure. A year on from the ‘run on the Rock’ it still remains to answer the question, is the tripartite structure which we have in place the right one? And if it is, are the responsibilities and roles within that structure clear, articulated and understood?
But perhaps the biggest challenge is for business itself. If the financial services sector wants to avoid heavy-handed regulation, and wants to contribute to the change process with credibility, its leaders need to demonstrate that their thinking has radically changed. In particular, CEOs need to demonstrate that they are not part of a ‘culture of excess’ and they need to prove that they want to reward performance, not risk taking. They also need to articulate a new business model founded on basic financial principles, and which accepts that if something looks too good to be true, then it probably is.
This brings me on to my second point:
As an industry, the UK financial services sector must work more closely together.
At Lloyd’s, our approach to managing our marketplace has meant that the impact of recent events to date has not been nearly as pronounced as it has been elsewhere. We have had to learn a number of painful lessons in the past, not least dealing with the transfer of 14 billion pounds of our own ‘toxic liabilities’ to Equitas, in the mid 1990s.
Since then we have changed almost every aspect of our business – including our relationship with the syndicates in our market, and the way we manage our risks. The creation of a new franchise structure and the introduction of an enterprise risk model in particular have led to fundamental changes in our business model.
Of course, a few years ago, in the middle of the bull market, our investment strategy appeared foolish in many people’s eyes while our rejection of complicated financial products must have appeared highly unadventurous. But this conservative investment strategy and a focus on traditional insurance products mean that any fallout from the credit crisis should be largely be dealt with in the normal course of business.
But, while I am comforted by the current position that we are in, I am not complacent. This is definitely not the time to sit back and think that our work is done. And we must also accept that no business and no financial centre can be immune from the effects of the current economic situation.
Here in Scotland, despite what might have been hoped, it is now clear that what happens next is now closely linked to what happens elsewhere in the UK and Europe. Scotland’s high employment levels and its strong manufacturing exports are important strengths, however the latest Chambers of Commerce report shows that business confidence here too is now at record lows4.
In the end, London insurers and Scottish bankers are part of the same UK financial services industry. And as they were beamed across the world, TV pictures of customers queuing to withdraw their life savings have left an enduring impression of the UK even on the most financially unaware. We therefore need to work together to regain the trust of consumers, investors and politicians at home and abroad.
We are also strongest when we work together on the common issues that impact us. In tough times, we need to work harder to communicate with stakeholders in a powerful and more sophisticated way.
We also need to work together to argue together for a competitive Britain. In particular, the position of the UK tax regime has grown comparatively worse in recent years. The UK corporation tax rate is no longer below the OECD and EU average, and we know that other jurisdictions are constantly reviewing their own positions. At the same time, the number of changes to our tax regime in recent years has added both cost and complexity.
We have strong forums with which we can engage to get these messages across in a co-ordinated way. These include SFE here in Edinburgh and International Financial Services London, of which I am also Chairman.
I am also a member of the Chancellor’s High Level Group on Competitiveness which we decided from the outset must represent the interests of the whole of UK financial services, not just the City.
Turning to look overseas for a moment, we need to co-ordinate better across borders.
Some feel that our open global markets are the root of our current problems. They are certainly a contributing factor. If the crisis has made one thing clear, it is the global nature of markets and the potential for contagion in a globalised world.
At a time of crisis, it is certainly tempting to some to retrench into nationalist positions – and some have been attempting to do just that in both the US and Europe over recent months.
But globalisation is no longer some concept which we could wish away even if we wanted to. It is now fact. In the turmoil we find ourselves in, we therefore need to co-ordinate better across borders.
We have found a strong leader in the International Monetary Fund. The IMF is not shirking from telling it like it is, and is working hard to co-ordinate successful dialogue. It is encouraging too to see the positive role the UK has played on the international stage so far.
We are now making some progress. It has been accepted, not just within the UK or US, but across the developed and developing worlds that the financial services sector is too important to be allowed to fail. That’s good news whether you work in London or Edinburgh.
Looking ahead, we need to continue to press the point that in finance, the idea of national markets no longer exists. We need to regulate a global industry in a global way and we need to deal with global problems in a global way.
We also need to ensure that we have an inclusive infrastructure which acknowledges the role of all key stakeholders on today’s global stage. Perhaps understandably, in retrospect, the rating agencies were as taken aback as the rest of us at the recent extraordinary events. However, given their unique position, many of us expected more. Greater transparency of operations and processes might help close this expectation gap. And going forward, discussion is needed to identify any conflicts of interest and to review whether and how accountability might be improved.
Ultimately, I am in no doubt whatsoever that the very future of our industry hangs upon our ability to implement a more harmonised, more integrated and more inclusive regulatory structure. Action does not have to be uniform or identical. But co-ordination is not only desirable, but critical, to achieve success. Without it, we may just not be flexible and fast enough to avoid meltdown next time.
Finally, business needs to think and act global.
The global map is changing. The centre of gravity of the economy is moving – in particular eastwards – and our business plans should reflect this. Last year, for the fifteenth successive year, China was the top emerging market in attracting foreign investment. Yet the amount of investment from the US in China and the original EU states has actually dropped5 while investment between Asian countries is on the increase.
Developing partnerships with emerging economies only becomes more important now that scope for growth is more limited close to home.
Recently, Scotland has been working to market its products more forcefully in emerging markets while Lloyd’s has been building its global footprint too.
We launched an onshore reinsurance business in Shanghai in 2007, and we became the first overseas reinsurer to be admitted to the Brazilian market earlier this year. Lloyd’s success as an insurance market is based precisely on its international outlook – an openness of approach which has characterised us for hundreds of years. Even now, we are pragmatic about the amount of business we will see in these new markets in the short-term, and opportunities will take a while to emerge. But financial and professional services companies have got to take a long-term view and must start the work now.
I am not pretending that emerging markets are isolated from what’s going on elsewhere – events over the last week or so have shattered any illusions on that front. But many remain comparatively well-positioned for growth over the coming years.
We also need to build our partnerships in order to encourage investment into our industry here in the UK. Despite all the hype about the BRIC economies recently, none is yet a major contributor of investment into Europe.
The opportunity is there for the taking. By thinking global now, we will secure the UK’s status as one of the world’s most sophisticated financial markets for the future. But we need to act now if we are to benefit tomorrow and not get left behind.
In conclusion, ladies and gentlemen, I am by nature an optimist. And I am optimistic about the ability of our financial sector to survive and recover from the current crisis. Organisations, systems, and markets have remarkable powers of recovery. Lloyd’s itself is living proof of that.
We can’t yet know what will happen to the economy or the financial services sector or how and when the current problems will end. But there is one thing of which I am sure: just as those who predicted never-ending growth were wrong, so those who today predict the demise of UK financial services will turn out to be wrong.
But we must change and evolve.
- We need strong leadership at home
- We need to work together closely as an industry
- We need to encourage closer co-operation across borders
- And we need to think and act global as we prepare our business plans for the future
These are extraordinary times and right now we have a unique opportunity to change for the better, and to demonstrate the vital importance of financial services to the future of our economy.
Thank you for listening.
1. East of Scotland European Consortium (www.esec.org.uk , October 2008)
2. The Guardian, ‘Greenspan - I was wrong about the economy. Sort of’, 24 October 2008
3. The Independent 23 October 2008
4. BBC News, ‘Survey Shows recession looming’, 14 October 2008
5. China Daily, ‘Nation Top Draw for FDI in 2007’, 22 January 2008
