1. UK Financial Sector Market Landscape

The financial sector is redefining purpose with the use of technology driving the digital transformation, and making transactions a click away. The global financial sector moves in tandem with global growth and economic outlook. Some of the key factors that influence the overall growth are GDP growth, interest rate movements, house price growth and commercial real estate price growth. The main services provided by financial institutions are retail banking, commercial banking, asset management, mortgages, credit cards, motor finance and small enterprise loans.

The UK is the hub and a leading centre for finance and banking, and some of the top-notch banks in the world are situated in the UK. In 2019, the UK had an FDI (foreign direct investment) inflow of USD 59 billion, which was lower than the FDI inflow of USD 65 billion in 2018. The nation held the eighth position in the ranking of FDI flows as per the data released by UNCTAD World Investment 2020 report. The financial institution of the UK plays a critical role in attracting overseas investments and companies. The increasing number of users for banking, payment, cards and money wallets signifies the growth of the sector.

The regulatory authorities in the UK have been very stringent in making sure that the financial services business is carried in a secured manner. The UK has formed the Financial Sector Cyber Collaboration Centre (FSCCC), a joint venture between the UK's leading banks and insurers, UK Finance and the National Crime Security Centre and the National Crime Agency (NCA). The cybersecurity body will address and tackle cyber threats, and it will help in mitigating systemic risks to the financial sector.

The UK's payment system has transformed significantly, and it has the most innovative system in the world. The consumers in the UK have access to a wide range of products for payments such as cash, cheques, debit cards, credit cards, Bacs Direct Credit, Direct Debits, standing orders and CHAPS. Contactless cards and mobile payment services have provided more ease to businesses and consumers.

The card spending in the UK has also increased significantly, and it includes both debit and credit card. As per the recent data released by the ukfinance.org, around 1.6 billion transactions took place in August 2020, and it increased by 3.9% month on month. The card transactions increased by nearly 2.5% year on year. The total card spending stood at £58.4 billion. There were a total of 273 million credit card transactions in August with a total value of £13.8 billion. The total outstanding balance on credit cards has contracted by 12.6% year on year.

The Bank of England (BoE) is the UK's central bank, and it delivers the monetary and financial stability for the people of the UK. BoE takes action to meet the target that the government sets to keep the inflation low and stable. BoE sets the interest rate that determines the interest rate we pay to the commercial banks for borrowing money. The commercial banks change their interest rates on borrowings and savings, and it might be slightly different from the BoE's bank rate as bank banks need to cover their costs, the bank needs to pay less on lending than they pay on borrowing. The current inflation rate in the UK is 0.7%, and the target rate is 2%.     

Key Trends in the Financial Sector

• Digital Transformation - This is not something new for the financial sector, and the industry has witnessed immense change in the last two decades. The digital journey will continue to be trending in the financial sector as more technologies and innovation evolve that can improve security and enhance customer relationships.
• Intelligent Tools for RMs - Smart inventive employees augmented by the right technology. Commercial banking relationship managers will use artificial intelligence to enhance their ability to add value.
• Digital Onboarding of Customers - It makes onboarding fast and seamless, the profile check of the customer can be performed digitally without need of physical presence. It creates a lasting experience for Gen X and millennials. It has also ensured business continuity during the pandemic, and at the same time, it has lowered the regulatory and operational risks.
• Innovation Through Fintech Collaboration - The traditional banks are facing increasing threats from neo-banks and digital-only banks. Thus banks are collaborating with fintech for fast forward innovations. Fintech deals with innovative technologies that can help in areas such as digital lending analytics, analytics, default and credit risk, and better customer insight to determine the development of future banking products.

Risk Exposures to the Financial Sector

• Declining Trust in Financial Institutions – The liquidity crunch, frauds and bankruptcies have deterred the trust and faith of customers. The decline in confidence can make people insecure from putting money in the bank for savings.
• Financial Data & Money Misappropriation – The risk relating to governing, managing and control of data might lead to unethical decisions, poor customer outcomes and loss of value and mistrust. The data is subject to significant regulatory oversight. It is essential that the information held by the banks are accurate, secure, and they are appropriately managed.
• Legal & Regulatory Compliance – Failure to identify, assess, correctly interpret, comply with or manage legal requirements can result in financial penalties, regulatory censure, criminal or civil enforcement action.
• Impact of Brexit - The near-term outlook of the UK economy looks unclear given the current deadlock situation related to EU and UK trade agreement.

Benchmark Index Performance

Based on 2-year performance, FTSE All-Share General Financial Index outperformed the FTSE-100, FTSE-250 Index. FTSE All-Share General Financial Index generated a return of around 27.9%, which was better than the FTSE-250 Index return of nearly 11.4%. FTSE-100 Index has generated a return of about -3.63% over the period of 2-years.

Fig 5: Benchmark Index Performance

(Source: Refinitiv, chart created by Kalkine Group)

SWOT Analysis

Financial Sector Outlook

The UK's financial sector is a major contributor to the economic success of the nation, and it is the largest exporter of financial services in the world and attracts a significant portion of the global investment. 

In 2019, the UK had an FDI (foreign direct investment) inflow of USD 59 billion, which was lower than the FDI inflow of USD 65 billion in 2018. The Brexit process has made some of the investors sceptical about the increase in trade costs with Europe and the volatility of the British pound. Banking in the UK is also playing a major role in helping first time-buyers own a home. Alongside retail banking, the banks are also supporting commercial banking by extending support to small businesses. The banks are also offering other products and services such as insurance, wealth management.

The advent of digital banking and fintech platforms will continue to revolutionize the sector. The increasing use of mobile banking and mobile phone penetration with improvement in internet speed will boost the growth of faster payments by businesses and consumers. The lockdown restrictions made people opt for contactless payments using cards. As the lockdown eased, the amount of spending in the UK declined slightly in August 2020 and stood at £58.4 billion. 

The UK is expected to have close to £10.1 trillion of assets under management (AUM) in 2020-2021 as per the IBIS World report. The asset management market in the UK has grown at a CAGR of around 5.4% between 2015 and 2020. The AUM revenue has fallen significantly in 2020 between February and April; however, the markets have recovered slightly, and much of the bounceback is expected in 2021. Amid extreme global market volatility, in the current year fund managers' portfolios are expected to become increasingly focused on low-risk fixed-income assets, such as government bonds, rather than riskier securities, such as equities.

2. Investment analysis and stocks under discussion (STJ, QLT, BRW, SDR)

After gaining insights into the financial sector, we would look at the business model of four financial players listed on the London Stock Exchange.

A. St James's Place PLC (LON: STJ)

(Recommendation: Buy, Potential Upside: 12.04%, Market Capitalization: GBP 5.82 billion)

St James's Place is a UK based wealth management company. The products and the services offered by the Company include Advice, Investment, Retirement & Protection. St James's Place is listed on the FTSE-100 index.

 Valuation Methodology

Our illustrative valuation model suggests that the stock has the upside potential of ~12.04% over the closing price of GBX 1,080.50 (as on 8 December 2020).

B. Quilter PLC (LON: QLT)

(Recommendation: Buy, Potential Upside: 16.10%, Market Capitalization: GBP 2.71 billion)

Quilter is a provider of advice, investments and wealth management in the UK and international markets. The Company categorizes the business under three segments which include, Financial Advice, Investment Solutions and Wealth Platforms. Quilter is listed on the FTSE-250 index.            

Valuation Methodology

Our illustrative valuation model suggests that the stock has the upside potential of ~16.10% over the closing price of GBX 151.90 (as on 8 December 2020).

C. Brewin Dolphin Holdings PLC (LON: BRW)

(Recommendation: Buy, Potential Upside: 25.00%, Market Capitalization: GBP 858.20 million)

Brewin Dolphin Holdings is engaged in the business of wealth management. The Company provides services such as direct online investments and wealth management. The Company is listed on the FTSE-250 index.

Valuation Methodology

Our illustrative valuation model suggests that the stock has the upside potential of ~25.00% over the closing price of GBX 281.00 (as on 8 December 2020).

D. Schroders PLC (LON: SDR)

(Recommendation: Hold, Potential Upside: 4.25%, Market Capitalization: GBP 8.59 billion)

Schroders is a global asset and wealth manager. The Company delivers a broad range of investments to meet the diverse needs of the institutions, intermediaries and high net worth individuals. The Company employs around 5,550 people and operates in 37 countries.

Valuation Methodology

Our illustrative valuation model suggests that the stock has the upside potential of ~4.25% over the closing price of GBX 3,257.00 (as on 8 December 2020).

*All forecasted data and peer information have been taken from Refinitiv, Thomson Reuters.

*The "Buy” recommendation is also valid for the current price as covered in the report as on 9 December 2020.

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