Cherry Reynard examines the impact of the International Financial Services Centre in Dublin - and discusses the story behind its success
When entrepreneur Dermot Desmond persuaded the Irish government to create the International Financial Services Centre (IFSC) in Dublin in 1987, few could have foreseen how this would rejuvenate Ireland's ailing economy and unleash the 'Celtic Tiger'. Over the past 20 years, Desmond's vision has mushroomed and 700 businesses now operate from the IFSC. Dublin now rivals Luxembourg and other major financial centres in terms of business flows. So what is the story behind its success?
Desmond is now better known for his interests in Manchester United football club and London's City Airport, but when he helped create the IFSC, Ireland's economy was in dire shape. Interest rates and unemployment levels were both running at nearly 20%; the Irish punt was under significant pressure and around 50% of Ireland's students emigrated after graduation.
That said, Ireland had a number of things in its favour that provided fertile ground for the development of an international financial services industry. It had a small but long-standing domestic financial services industry. Its insurance industry had been established for almost as long as the UK insurance industry and had a similar legislative environment. Its financial services regime was 'principles-based', which allowed for flexible product development and innovation. It also had a cheap, well-educated workforce, ripe for training.
But the Irish government also introduced some sweeteners. The most important was a 10% corporate tax rate for 10 years for new businesses. When that came to an end in the late 1990s, the government dropped the overall corporate tax rate to 12.5% to ensure that the international companies that had arrived in Dublin in their droves did not pack up and leave.
The companies that arrived were a mix, but included banks, asset managers, corporate treasury, custodians, administrators, insurance and reinsurance groups. David Healy, managing director of Aegon Scottish Equitable International, says that around 65% of the top 50 global financial institutions now have a presence in Ireland. He adds: "Citibank, for example, has now centralised all its custodial services activities for Europe into Dublin."
The region also benefited from being part of the EU. European legislation gave Ireland a respectability that was lacking in other international financial centres. The introduction of the euro in 2002 also helped Ireland establish itself as a single market proposition. Many institutions set up in Dublin because it provided them with a passport to sell financial services across Europe, and a matching currency helped them do that. The lower interest rate environment of the eurozone proved another advantage. The UK remained one of its biggest export markets.
Healy says that the region also benefited from the strong service environment that built up around the burgeoning financial services centre. He adds: "Top-quality lawyers, accountants, tax and compliance specialists grew up within the region. The skill set grew in order to take advantage of the cross-border business. This became an industry in itself."
The greatest success stories have been in the fund administration/custodian field and in international insurance and reinsurance. On the funds side, Dublin has established itself as the domicile of choice for many hedge fund providers, who favour its more progressive regulatory environment. Its biggest competitor has traditionally been Luxembourg. With $1,859bn (£946bn, at June 2007, source: Irish Funds Industry Association) in funds under administration, it is catching up with its continental European rival, which now has EUR2,059bn (£1,536bn, at December 2007, source: Association of the Luxembourg Fund Industry). Around EUR700bn (£522bn) of Ireland's funds under administration are in alternative investments. Some 44% of the funds come from a US-domiciled parent company. British, Italian and German fund promoters also make up a large chunk of the region's funds under administration.
The life insurance industry continues to be buoyant. Mike Claffey, a director at consultancy Life Strategies, says that the cross-border life insurance sector sales for 2007 were around EUR19bn (£14bn), up from EUR15.4bn in 2006. This is the 13th consecutive year of growth and over the last four years, sales have grown at over 20% each year. The cross-border market is now substantially bigger than the domestic market.
Claffey says that this growth comes from both new companies coming into the market and existing companies maturing and growing. Dublin now has seven companies selling over EUR1bn each.
The life industry in Dublin started with simple, unit-linked products. The development of open architecture brought portfolio bonds to the fore. These sold well in the UK and in Italy, where they helped save capital gains tax.
Portfolio bonds remained among the biggest sellers in 2007. However, the new CGT rules set to be introduced in the UK on 6 April remain a threat to offshore and onshore portfolio bonds. The life industry is lobbying hard to ensure that these bonds retain their favourable tax treatment under the new rules. At the moment, with a reduced CGT rate of 18%, these bonds would lose their tax advantages for higher-rate taxpayers and would only be suitable for basic-rate taxpayers who needed a regular income.
This does not spell disaster. Portfolio bonds are still sold into Italy and there is emerging interest from other countries. Claffey says that Germany has tax changes scheduled for 2009 that will make portfolio bonds attractive, and as a result Dublin providers are seeing increasing interest from German buyers.
It has forced the local life offices to innovate. The major area of development has been in the variable annuity market. Aegon launched its 5 for Life product in 2006. Hartford, MetLife and Axa have launched similar products and the market has seen significant growth over the past year. Healy says: "Dublin's regulatory environment is ideally placed for the next wave of new-style products. Because it is principles-based, products can be built using derivatives. It enables life insurers to be flexible and creative when designing products."
The variable annuity market is back in traditional life insurance territory - managing risk rather than investments. They have already been a big success story in the US. A number of other Dublin-based providers have said that they will be moving into this market in due course. There is demand for variable annuities across Europe, though most providers are concentrating their efforts on one market. Claffey says that Dublin has managed to establish itself as a centre of excellence for variable annuity products and many pan-European providers are setting up shop there.
Dublin has a number of other challenges to hold its position as a major international financial centre over the next few years. As the cost of living has increased, Dublin no longer provides the cheap workforce on which some of its success was built. Costs have increased across the board.
However, Healy believes that Dublin retains some important advantages. He adds: "A lot of the business we're doing is complex and requires English-speakers. It would be a challenge for a country like Poland to replicate what we have in Ireland. That said, I don't think we can afford to be complacent. We have to work to keep costs down."
Dublin has matured and while this has meant sacrificing some of its early advantages, it can now boast a sophisticated administrative infrastructure for businesses wanting to distribute financial services across Europe. The changes to the CGT rules may dent exports of portfolio bonds for the life sector to the UK in the short term, but there is an increasing range of products growing up to take their place.
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