What regulatory and tax changes mean for the UK investment industry
From accounting to enforcement to taxes, the changes are many
The wave of financial regulation ushered in by the 2008 crisis is still having a negative impact on financial services profitability and business lines, says David Fenton of RSM UK.
"We've seen a fairly significant change in the U.K. in terms of how financial accounting is carried out from the old model, which is based on cost to switch over, and have to choose between a full financial reporting standard (FRS) accounting or FRS 102." Under this change, financial instrument transactions will now be noted through the profit and loss register, so there will be a greater volatility of earnings reported within companies. As that volatility registers in the market, it could impact other areas of a company's earnings statement.
Changes affecting profits
On a real tax cash payments basis, these changes to earnings statements and accounting processes could also affect how much a company has to pay. Financial services firms may also need to increase the amount of regulatory capital they have on hand as well so that they can avoid being surprised by any changes brought on by the shift in accounting practices. The regulators in the U.K. still have some guidance to issue around these areas before participants will have a completely clear picture of where things stand.
"Some companies may be impacted more significantly than others," Fenton adds. "This is essentially the same thing that happened when IFRS was first implemented. Some firms had a lot of work to do – others simply had to adjust formatting and presentation."
As more of these rules are fully implemented, regulators are turning toward examination and enforcement. Firms will no longer be able to hide behind collective board responsibility. Greater emphasis is being placed on individual knowledge and culpability. "Within the financial manager's regime at the financial institution level, regulators want to see a very specific job description set out for those individuals with clear accountability," Fenton explains. "We are also likely to see an increase in fines if people are found to have failed to meet the expectations of the job."
MiFID2—there's more to come
In terms of the regulatory calendar, a host of new changes are still on the docket for financial services firms in the U.K. – the first of which is the Markets in Financial Instruments Directive II (MiFID2). The original directive of the same name has been in force for some six years, but the amended version includes revisions based on what regulators have learned over this period. The original goal of MiFID was to improve the functioning and transparency of financial markets and those that act as intermediaries for investors. MiFID2 includes changes aimed at providing further safeguards after the crisis and improving business processing for financial markets participants.
According to Fenton, the key takeaway on MiFID2 will be to ensure an understanding of the requirements for specific trading venues as well as the implementation of position controls. Nonequity products have also been pushed on to the radar of regulators through the MiFID regime. Market participants will need to understand the obligations involved in transactions with those products.
"We've also seen an increased focus on the use of insider information, and how that is impacting trading decisions. We are likely to see increased enforcement in that area, with more explicit disclosure requirements put in place," says Fenton. "This is also true for anti-money laundering provisions, with a greater focus on individuals instead of fining corporations."
Lower tax rates, but more changes
Where regulation has hit the bottom line for financial services firms, they may be able to mute the impact of some of that cost by realizing savings from lower rates of taxation in the U.K. In the years since the crisis, the U.K. has steadily dropped corporate tax rates, which are down to 20 percent this year from 24 percent in 2012. The corporate tax rate in the U.K. is expected to fall again next year to 18 percent. Elsewhere throughout the eurozone tax rates are slightly higher, with Ireland taxing trading income at 12.5 percent and nontrading income at 25 percent. In France and Germany corporate tax rates hover in the 30 to 33 percent range.
Companies are reacting to these rates by shifting profits, leading regulators to also take a closer look at transfer pricing regimes. The U.K., for example, taxes profits that are shifted at 25 percent. "There has been a shift in public opinion against companies in the U.K. that are making a great deal of profits offshore and paying very little taxes. That's led to a shift in the political agenda in the U.K. as well," Fenton notes.
The value added tax (VAT) is also affecting business decisions. VAT rules are beginning to change and will further take into account the impact of cross-border regimes, which may mean that businesses find that they are dealing with new areas of taxation. "A lot of financial services businesses are exempted from VAT, but that is a double-edged sword because they may then find that they are unable to recover the import tax," Fenton said. "There are very complex and evolving rules around exemptions. U.K. businesses could find themselves subject to additional taxation as it all shakes out. Financial services firms will want to keep a close eye on all of these changes as getting it wrong could be rather expensive."