Analysis: The Republic of Ireland's finance sector

AS next week's knife-edge vote on the Lisbon Treaty forces one of the Republic's periodic reflective bouts, the Irish financial sector - which rose from nothing in the early 1990s to employ nearly 10,000 people today - wishes the Celtic Tiger had been tamed a few years ago.

Ireland's financial fortunes have long been held up as a model for those of a future independent Scotland. Scottish ministers cross the Irish Sea visit to learn from a proven success story. But adverse headwinds over there are prompting tough questions about what Ireland can teach similar-sized nations. Some Dubliners are even casting envious eyes to Edinburgh and asking which financial sector's endemic weaknesses are easiest to fix.

The furious pace of Irish growth over the past decadehas been too much for the international financial services sector, hampering cost competitiveness against rival locations. The boom has made Ireland one of the richest parts of the EU, but its corollaries have been wage inflation, rapid staff turnover and intense competition for skilled labour.

Office rentals have also increased dramatically, touching 56 (£45) per square foot in 2001, although they have now dropped to about 35-55 thanks to a glut of new space. Equivalent rentals in Edinburgh are in the 31-38 range.

Ireland's property-based economic boom is well and truly over. The country's GDP is expected to slow to a feeble1% this year, according to Fergal O'Brien, chief economist of the Irish Business and Employers' Confederation (IBEC). He predicts economic growth will rise to about 2% next year and to the more manageable3-4% after 2010.

Willie Slattery, Dublin-based managing director of global fund administration giant State Street, calls this good news. "It has been absolutely necessary," he says. "It means that the escalation of costs driven by the overheated domestic sector has stopped. It will give us a much better labour market from the point of view of the employer."

Slattery, whose firm employs 2200 people in Ireland and 800 in Edinburgh, adds: "There has been a very unhealthy imbalance in the Irish economy over the last five years with too much bad cholesterol' growth, driven by unhealthy volumes of borrowing."

Slattery, who worked as a regulator within the Irish central bank for 23 years, feels successive governments, including that of recently departed taoiseach Bertie Ahern, failed to wean the country off bad habits, stoking the boom with tax breaks for property-related business as recently as last December's budget.

He believes that now that the economy has hit the buffers, local market-focused businesses such as Bank of Ireland and Allied Irish Bank will hire fewer staff. This will ease some of the pressure for international players such as State Street, based in Dublin's International Financial Services Centre (IFSC). This much lauded economicdevelopment zone, which has been critical to Ireland's astonishingturnaround, nowstands at the crossroads.

Two decades ago, the square mile of land that accommodates the IFSC was derelict docklands., avoided even by Dublin's rats. Today, it has been transformed into a vibrant and cosmopolitanbusiness hub, much larger than Edinburgh's Exchange district. and no further from the city centre.It is made up of rows and rows of modern eight storey office blocks, built around a series of docks and canals. interspersed with chic restaurants and cafes With parts of the site still under construction, it is as if a cosmopolitanlow-rise Canary Wharf had burst onto the Liffey's south bank., where taller buildings are permitted. The change has been "as extraordinary as that in any city in Europe in the last 20 years," says Slattery.

The transformation started when former taoiseach Charles Haughey picked up and ran with an idea originally floated by the billionaire entrepreneur Dermot Desmond in 1987.

Desmond, a former stockbroker (and a director of Celtic FC), had the brainwave thathad the bright idea that Ireland should target global financial services players in hand-picked sectors - including banking and structured finance, asset management and asset servicing, and insurance - and offer them tax breaks.

Firms taking advantage of the 10% corporation tax rate were more or less obliged to create jobs in a designated zone to the east of the city centre, on the Liffey's north bank. "Brass-plate" operations were effectively barred: fund administrators flocking to the zone, for example, had to carry out certain activities, such as maintenance of shareholder registers, within the IFSC itself.

Slattery stresses that tax breaks alone were not enough to attract global financial services players. "Tax was a key factor, but others were more important for its subsequent success.First of all, the fact we have had a regulatory regime designed to facilitate international business."

Ireland has taken a risk-based approach to regulation along similar lines to that of the UK's Financial Services Authority. Instead of box-ticking or standard-setting, the regulator prefers to identify possible risks taken by its financial services players - then measure, mitigate, monitor and report them. The system is seen as particularly effective in small jurisdictions where supervisors can personally know all the movers and shakers. The regulator, The Irish Financial Services Regulatory Authority (IFSRA) is widely seen as accessible and nimble.

Mary Fulton, a partner in the Dublin office of accountants at Deloitte, says the IFSRA is very approachable. "Unlike the Financial Services Agency (FSA), which tends to gold plate' EU directives, it applies best European practice."

Rob Richardson, chief executive of Pioneer Investments - one of the few fund management groups to have a "front office" in Dublin - says: "In Dublin, there wasn't an indigenous funds industry to dictate how mutual funds were supposed to be structured, so it was easier to look outside Ireland and accept the need to accommodate a number of different models. The lack of legacy structures meant more openness and greater flexibility."

A number of other factors, including a plentiful supply of graduates (60% of the Irish enter tertiary education, compared with 53% in Scotland) and relatively low wages at the time of the IFSC's launch, were also critical. Unemployment in the 1980s meant many graduates were delighted to be offered stimulating work back home.

Before long, Ireland had established a reputation for the listing and administration of mutual and other funds. The country has been particularly successful as a domicile for UCITS (Undertakings for Collective Investment in Transferable Securities) funds, which once registered can be sold anywhere in the EU. It now administers 650 billion worth of such funds.

Overall, the IFSC enjoyed remarkable early success, and many of the highest profile names in finance - AIG, Allianz, Citigroup, BNP Paribas, BNY Mellon, Fidelity, Goldman Sachs, Merrill Lynch and State Street - have built a significant presence there. The financial cluster benefits from - and feeds - a mass of professional services firms: lawyers, accountants and corporate financiers.

The IFSC hosts players in areas outside fund administration, including aircraft leasing, international banking and securitisation(a quiet market at the moment), reinsurance and cross-border life insurance. After Bermuda, Ireland is the biggest underwriter of wholesale insurance, with a focus on reinsurance and "captive insurance" (companies financing risks to businesses emanating from their parent group).

Overall, financial services contributed 7.2bn to Ireland's total service exports last year, 11% of the total, and 22,000 people work for international financial services companies in Ireland., with about 10,000 in banking, 9,000 in funds and 3,000 in insurance. There are 148,000 people in the broader financial services field in Ireland, compared with 86,000 in similarly-sized Scotland.

Low tax does not mean no tax. IFSC firms have had their rate of corporation tax increased from the special rate of 10% to 12.5%, which is the standard Irish rate (EU rules only allowed the 10% rate to endure for 20 years). Altogether, the international financial services sector paid 1.12bn in corporation tax in to the Státchiste, or Irish exchequer in2006.

But has the IFSC become a victim of its own success? Many based in other financial centres like to claim, not without schadenfreude, that Dublin has priced itself out of the market.

By 2004, skills shortages had become so extreme in the IFSC that fresh graduates could command 20% pay rises after six months in the job if they switched employers. and the starting salary for a graduate trainee had risen from 10,000 in 1990 to about to about 27,000.Rents had also risen dramatically.

After the tax breaks dried up in 2004, many financial firms relocated some jobs to premises on the south bank of the Liffey or to provincial cities such as Cork, Galway and Kilkenny.,Limerick., Waterford and Westford. There has even been a remarkable deal struck with Belfast, whereby Irish-based financial firms that carry out activities there will pay the Republic's 12.5% corporation tax rate rather than the UK rate of 28%.

There are also questions of whether Dublin can survive as a leading fund administration player, and whether, by focusing on fund administration, Ireland backed the wrong horse. If it was a mistake, it was the same one made by the then Scottish Executive in 2000 when it decided to focus on luring financial "back-office" players with RSA grants.

Asset servicing specialists today employ 3800 people in Scotland and service a staggering £685bn (870bn)of assets, according to Scottish Financial Enterprise. However, just like some of the fund administration jobs in Ireland, these jobs could become as transient as some of the electronics manufacturing jobs that preceded them.

Fund administration is essentially low-value activity that has become increasingly commoditised. International fund management groups don't care where the processing is done as long as it is cost-effective.

Sean Quinn, managing director and head of fiduciary services at Citigroup's global transaction services unit, says the cost of running operations in Dublin, Edinburgh and Luxembourg is driving his bank to transfer some back office activities to Poland and India.

He says that in countries like Poland, "You're not competing with other foreign banks; you're competing with local companies in hiring quality people.

"In this context, some in Ireland look enviously at Scotland's success in building an indigenous asset management sector - where front-office staff make investment decisions - believing this to be more rooted than so-called back-office functions."

Many in Irish asset-servicing believe the shift of processing work to lower-cost destinations may be a positive for Ireland. It has forced the country to rethink its commitment to basic fund administration to focus on higher value-added activities. As part of this process, educationalists are being urged to place greater emphasis on creating highly numerate graduates in advanced scientific and mathematical disciplines.In words that echo the long-held view of Scottish development specialists, Fulton says: "Ireland is clearly no longer a low-cost destination. It was inevitable that other parts of the world were going to come in and undercut us. What you have to do is to move up the value chain and focus on the more sophisticated, high-end things."

One area of real promise for Ireland - all but ignored in Scotland - is hedge fund administration, which requires greater technical nous than servicing so-called "long only" funds.

Dublin already leads in this field, servicing an astonishing 37% of the world's hedge funds, many of them domiciled in the Cayman Islands or British Virgin Islands, which equates to assets of more than $1 trillion (£507bn). Gary Palmer, chief executive of the Irish Funds Industry Association, says: "Hedge fund servicing has been a significant growth area, andWe are head and shoulders above anywhere else in the world in expertise and the experience."

State Street's Slattery, however, is convinced big chunks of the more traditional asset-servicing industry will remain in Ireland. He says: "In Ireland, we look after assets of $600bn. We do trillions of dollars of transactions every year. There are all sorts of transactions going in and out of those assets every day that we're responsible for. It's complex, high-value activity and low-cost jurisdictions simply will not strike the right balance in terms of managing client expectations."

So as low-value, processing-based activities drift away from Ireland, and the country contends with a period of slower economic growth, what are the lessons for Scotland?

The first is that the right mix of fiscal stimulus, skills, regulation and enthusiasm can create a world-leading cluster in niche areas of the financial services market. out of the ether.But if growth is too rapid, it will inevitably put pressure on costs and service standards. And the third is that even if low-value aspects drift to low-wage economies, once a small country has gained recognition in financial services niches, it has an wonderful opportunity to build on this by moving up the value chain. Ireland may be wobbling, but Scotland should continue to look and learn.

Leading opinions

Liz Cameron, director, Scottish Chambers of Commerce "It really is time to end hollow gesture politics on the energy issue. The first minister is quite right to talk about the need for Scotland to get its just desserts from oil revenue, and last week's other promises about accelerated exploration and recovery fail to deal with the real problem, which is our lack of an integrated energy policy. Our members are willing to issue every assistance in developing the detailed knowledge of the sector to enable the first minister to arrive at that policy.

"We are absolutely opposed to any increase in fuel duty as the chancellor's pockets are bulging from the exponential increase in pump prices. If we fail to act on this, then, that failure will be the biggest single driver for inflation and the consequences for all of us."

David Watt, director, Institute of Directors, Scotland "The high price of oil and other energy resources is extremely damaging to business and our economy and will drive up all product and service prices, reduce our competitiveness and cause considerable pain for customers. The UK government is right to try to work with the oil companies to increase production and bring the price down, but it has to face up to the additional tax burden it lays on us all (in fuel tax and VAT) and needs to do something about that - the only element it really can control.

"Interesting also are the "green taxes" placed on road users, which are going straight into the Treasury rather than ring-fenced to provide incentives for positive green behaviour or to radically improve public transport provision. More taxation is only justified by the environmental argument if it is spent on environmental improvements. What business wants and needs is affordable energy and fuel, with security of supply now and in the predictable future, as well as politicians who really seem aware of the real issues, the damage caused and that do everything they can to alleviate the problems."

Andy Willox, Scottish policy convenor, Federation of Small Businesses, Scotland "HIGH fuel prices are crippling small business owners in every sector and in every area of the country. Excluding the immediate extra costs of filling up at the pumps, spiralling fuel prices have a knock-on effect on all aspects of Scottish society in terms of more expensive food and consumer goods and isolating our vulnerable individuals and communities. Throughout both the public and private sectors, budgets are being recalculated, with money redistributed from core services to pay for fuel.

"Scottish small businesses have been looking to the UK government to provide leadership and give clear assurances that things will improve, or at the very least not get any worse. Alistair Darling's refusal to commit to scrapping the postponed 2p fuel duty increase, despite record oil revenues, sends the worst possible message to hard-working families, businesses and individuals.

"If the UK government refuses to act on this damaging issue, then it would be unsurprising if the Scottish business community and the Scottish people increasingly turn to the Scottish government for answers."