Is it time to change?

The IFSC changed the face of the Irish economy, but has the time come for it to reinvent itself or risk growing irrelevant?

IN SEPTEMBER 1987, Banking World magazine reported that "bankers in New York and London tended to chuckle when they heard that the Irish government was mounting a global drive to turn Dublin into an international financial services centre".

They may have chuckled in 1987, but Dublin is laughing today. There is now no doubting the importance of the IFSC as a financial services centre. From a policy document of the mid-1980s sprung an industry whose towering emerald buildings in Dublin's docklands now stand as a symbol of the Celtic Tiger's growth and dynamism.

At the forefront of the global financial services market, Ireland has been ranked as the 13th most important international financial services centre in the world.

It is the fourth largest European funds centre; the eighth largest global banking centre; the fourth largest reinsurance centre; and the leading European cross-border centre for life assurance. All this has been created from practically a standing start 20 years ago.

Launched at a time of economic destitution and against a background of cynicism and negativity, the IFSC has defied all expectations to place Ireland firmly on the global financial services map, while at the same time contributing significantly to the unparalleled economic expansion that Ireland has experienced over the past decade.

As former taoiseach Charles Haughey wrote in his private papers, "the establishment of the IFSC was basically the most important step we took" in controlling the country's debt problems, as it was to have "dramatically favourable impact on our public finances".

While in its short lifetime the IFSC has been an unquestionable success, its future looks unsure, as the factors which built the centre back in 1987 - low tax, a plentiful supply of skilled labour and low costs - diminish.

The importance to the IFSC of the 10 per cent corporation tax rate introduced in 1987 cannot be overstated. Tim Brosnan, the founder of the first IFSC company Gandon, suggested that the tax regime should be used to just kickstart the centre, "we should not become overly reliant on the IFSC - the key is to grow a really excellent skills base," he told Euromoney in May 1990.

The tax incentives were vital to attract companies and to keep the centre going during the 1990s.

Without it, the international financial institutions that now dominate Ireland's financial services sector and populate Dublin's docklands, simply would not have come.

While Ireland still has a very attractive tax regime vis-à-vis, other financial centres - in the most recent Global Financial Services Centre Index (GFCI) review of global financial centres, Ireland was ranked as having the fourth most attractive "total tax rate" ahead of London and New York - steps have been taken to undermine this regime.

In January 2006, the remittance basis of tax was abolished. The regime had been used for very different reasons in the construction sector, most notably by Turkish group Gama, to pay workers based in Ireland the going rate back in Turkey.

Under political pressure, former taoiseach Bertie Ahern took the unfavourable decision, in the view of the international financial services industry, to abolish it all together.

As Henning Ludolphs, former head of Hannover Re's Irish operations says: "The change itself was not annoying, but the fact that a 40-year-old rule was changed within 15 days. I know that within the ex-pat community this has cost Ireland tremendous goodwill and I would not be surprised if one or more investment decisions have been turned against Ireland because credibility was lost."

One of the major aims of the IFSC, along with urban renewal, was to create jobs.

In the Fianna Fáil policy document that launched the financial centre concept - Ireland as an International Financial Services Centre - it was hoped that the IFSC would create 7,500 jobs over five years "at a conservative estimate".

At the time, half of Ireland's population was under 28, and 55 per cent of students entered third-level education, which meant that skilled labour was in plentiful supply.

In its first marketing brochure for the IFSC, the IDA referred to Ireland's "young, enthusiastic, educated and computer-literate people" as a key selling point of the centre.

In spring 1988, the first IFSC firm to be licensed, Gandon, placed an ad in The Irish Times looking for six trainee dealers, and the response gave some measure of the availability of labour for the financial centre.

The firm told Finance magazine that over 1,000 people had replied, with more than 100 coming from Irish people working in the city of London. In 1988, AIB reported that it had received 11,000 applications for 300 jobs. In 1992, German reinsurance firm Aachen Re's IFSC operation told The Irish Times that it received 10-15 CVs on average a week "on spec".

However, while the availability of a skilled and plentiful workforce was a major factor in getting the IFSC off the ground, by the turn of the millennium, with the Celtic Tiger roaring, this major selling point had begun to weaken substantially.

Despite initial scepticism, by 2000, the IFSC had evolved to make a significant contribution to employment, with around 10,000 people working directly for IFSC companies. However, in a country with full employment, finding staff to fulfil the needs of the growing international financial services sector became problematic, and while IFSC employment has since more than doubled to over 25,000, finding the right staff has become a major - and expensive - problem for IFSC companies.

In 2001, German insurance firm Mannheimer closed its Irish operation, because as board member, Lothar Stockbauer, told Lloyds List in April of that year, the firm was "fed up" with the staffing situation in Ireland.

"You do not get the right staff because there is so much demand; staff fluctuation is high and office rents are exorbitant if you find something suitable at all," he said.

The employment intensive funds sector has suffered the most from a tight labour market. The 2007 Irish Funds Industry Association (IFIA) employment survey revealed the massive turnover rates blighting the sector. In 2006, staff turnover rose to 29 per cent as 2,414 people changed jobs. At the general staff level, turnover rates were almost at the 40 per cent level, turnover levels at supervisor and manager level were both very high at 23 per cent and 18 per cent respectively.

While regionalisation of the IFSC, whereby companies are entitled to locate their operations outside of Dublin's docklands following the end of the 10 per cent licensing regime in 2000, has acted as a salve to employment problems. For example, according to the IFIA survey, 15 per cent of the funds servicing workforce is now employed outside of the capital city. Perhaps the biggest boon for firms struggling to recruit and retain staff is the recessionary Irish economy, which means that people will begin to value secure employment more than they have done during the boom times.

As Gary Palmer, chief executive of the IFIA, says: "People will start fostering careers in companies, whereas at the moment they're fostering careers in the industry."

Another important factor for a financial centre - particularly one which is predominantly focused on back-office, servicing type operations - is competitiveness. When the IFSC was launched, it was known as a low-cost centre, but like many other things, this has changed considerably over the past 20 years.

In 2000, Ireland was fourth in the world for competitiveness according to an IMD ranking. However, by 2007 it had slipped to 14th out of 55 countries. In the World Economic Forum's Global Competitiveness Report, Ireland's ranking declined from fifth in 2000 to 21st out of 125 in 2006.

While salaries in Ireland were always considered relatively high - in April 1992, Floris Deckers, regional director for Europe, ABN AMRO, told The Irish Times that salaries are "perceived as very high across the board and are coming in among the highest in Europe" - the overall cost of doing business in Dublin used to be much lower than its counterparts.

Another serious problem impacting on Ireland's competitiveness as a financial centre is the weakening dollar, as the strength of the euro relative to the dollar has made Ireland a more expensive place for US companies to do business. Much of the business of US funds companies comes from the US, which means that a significant portion of their revenue stream is in dollars.

However, most of their expenses, in particular salaries, are in euros, so rising salaries are having a double whammy effect on may of these companies' cost bases.

This waning in Ireland's competitiveness has been further compounded by the rise of alternative financial centres and the fact that back-office servicing type activities continue to dominate Ireland's international financial services sector. As The Economist wrote in September 2007: "Rather than dying out, financial centres are proliferating." And these new financial centres are all trying to emulate Ireland's success. Although considerably limited by its size, Malta is one of the "hot" emerging financial centres according to the GFCI survey, which placed it in the "top five financial centres that might become significant" and the "top five financial centres where organisations may open new operations in the next two to three years". Worryingly for Dublin, Luxembourg also joined Malta in the second category.

Other "hot" locations are the new EU accession states in eastern Europe. Armed with low tax rates and a plentiful supply of skilled labour, these countries are keen to copy Ireland's success.

Dubai is emerging as a real contender and while some believe that the country's efforts are more hype than reality, a host of the world's leading names have already committed to the centre. Low-cost locations such as India are also attracting big financial names.

So the challenges facing the IFSC are clear. It is no longer a low-cost jurisdiction; it is less attractive from a tax perspective, and it no longer has a plentiful supply of skilled labour.

If Ireland had attracted predominantly front-office financial activities to the docklands, this might not be such a concern. But the fact is that the majority of activities conducted by either IFSC companies, or their "IFS" predecessors, remain focused on back-office functions. And high costs and a tight labour market do not align well with servicing type activities.

Already, there has been a leakage of IFSC business, and while emerging centres may not be able to replicate the full IFSC model, they can steal away chunks of business, and some less specialised tasks are being transitioned out of Ireland as they no longer align with the cost base and the dwindling staff pool.

In 2007, Swiss bank UBS chose Poland as the location for its new servicing centre, which has the capacity to employ 1,000 people, 200 of whom will work in funds servicing. Complaining to industry publication Funds Europe, Gerhard Fusenig, global head of fund services at UBS Asset Management, said that it took UBS eight months to hire 14 qualified professionals in Dublin, something which influenced the firm's decision to look to the east.

"We wanted to avoid the error of being in a small domicile again. It doesn't make sense to go to a country where you could be sold out again in three years," he said.

Merrill Lynch, which added a European support servicing business to its IFSC capital markets bank in 2004 and employs over 800 people in Dublin, decided to move as many as eighty of these jobs to India in 2007. State Street, Bank of Ireland and HSBC have all looked to hive off certain, less complex activities to lower-cost jurisdictions.

How then should the IFSC reposition itself to overcome the challenges it faces and ensure its future success? The solution does not lie in simply reducing costs. London, the world's leading financial services centre, has steadily risen in terms of costs, but this has had only a negligible impact on its business, and it now ranks as the leading global financial centre having overtaken New York.

"Often costs are not the main driver when it comes to companies making a locational decision," says Kieran Donoghue, divisional manager of international financial services at the IDA of the issue. "We're looking for projects that aren't going to be very cost sensitive, recognising the different operating environment in Ireland," he says.

"There will always be somewhere cheaper. Ireland got 20 years out of being a low-cost location. Central Europe is going to be lucky to get a decade. We were able to build a platform over a longer time frame. They're already being squeezed by lower-cost locations like Cyprus," he says. Instead, the IDA is now looking to reposition Ireland's international financial services sector as a global location for talent and product innovation, reducing its predominance on back-office activities and increasing the number of front-office operations.

As part of this strategy, in 2005, the IDA began offering research and development (R&D) grants to international financial services companies, which have since been taken up by a number of companies, including Citi, Merrill Lynch and Fidelity.

Indeed, Ireland's high-cost structure means that it is now imperative that more front-office operations, which are willing to absorb higher costs, are attracted to Ireland.

"If international financial services is to remain relevant in this country and continue to grow, it's got to be about higher-value activity, because that's the only thing that can survive and prosper in a higher-cost economy," says Pat Farrell, chief executive of the Irish Banking Federation.

However, it is a considerably more difficult task to attract front-office financial services operations. Efforts to position Dublin as the "Connecticut of Europe" by attracting a cluster of hedge fund managers have had little success, and it is unrealistic to expect that Ireland, with its small domestic financial services market, can ever compete on a level with London and New York, despite the success it has had already with the IFSC. Perhaps Ireland's route into the top 10 global financial services lies in further developing its expertise in niche sectors. Already, Ireland has emerged as a major player in niche front-office sectors such as reinsurance and security.

Moreover, it should also be remembered that in addition to low tax, low costs and a pool of skilled labour, there were a number of other less tangible factors behind the success of the IFSC. Undoubtedly, the IFSC would not have developed as it did were it not for the commitment and drive of those people involved in it.

"It was about a genuine sense that it was a national effort," says Michael Buckley, former chief executive of AIB, who has been involved in the IFSC from the start. "Ireland was very lucky to have the individuals that were involved - it couldn't have happened without that extra effort from everyone," he says.

And while the names may have changed over the years, professionals in the industry remain keenly involved in driving the sector forward, whether it be through Taoiseach Brian Cowen's IFSC committee, or through membership of the various industry associations. And it isn't just the commitment from the private sector that has made the IFSC what it is today. The various governments and civil servants which have come and gone since the days of Haughey and his department secretary Padraig Ó hUigínn, have also been massively important in creating the IFSC, through initiatives such as sponsoring legislative change to enable companies such as Merrill Lynch to open Irish operations back in 1995.

While there are fears that the Government has become more complacent with regards to its approach to Ireland's international financial services sector, the fact remains that no other industry sector has its own government forum consisting of key players from both the private and public sector, which is chaired by the secretary general of the Taoiseach's department.

So, while the IFSC will most likely continue to see less complex servicing-type roles transitioned out to lower-cost economies, companies will still be loathe to move entire operations out of Ireland.

After all, they continue to do very well out of the regime. Indeed of Ireland's 100 most profitable Irish companies for 2005, 17 - a sixth of such firms - were either IFSC or post-IFSC international financial services firms.

Ireland's IFSC: A Story of Global Financial Successwill be published by Mercier Press on September 25th