The City of London as a Global Financial Centre: An historical and comparative perspective

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The City of London as a Global Financial Centre
An historical and comparative perspective

• Professor Ranald Michie, Durham University
• July 2012

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The City of London
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Is the City at a Tipping Point?

• The City of London is at bay its reputation
  brought low, its stars in the public dock, its
  conduct under forensic scrutiny in Washington,
  Westminster and Brussels, and its autonomy
  threatened by the prospect of a eurozone banking
  union.
• Financial Times 30th June 2012
• The media view is that a Tipping Point has been
  reached

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Tipping Point

• The name given to that one dramatic moment in an
  epidemic when everything can change all at once
  is the Tipping Point.
• Malcolm Gladwell, The Tipping Point How little
  things can make a big difference London 2000 p
  9
• The term Tipping Point describes the moment when
  the build up of internal forces makes change
  inevitable the dam bursts, the volcano
  explodes, the climate changes or a financial
  crisis takes place.
• Has that point been reached by the City of London?

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Tipping Points or Titanic Moments?

• Numerous events are described as Tipping Points
  but how many are?
• A Titanic Moment is an event that is both sudden
  and dramatic but changes nothing.
• Only the passage of time confirms whether a
  Tipping Point or a Titanic Moment has taken
  place.
• Can past experience provide a guide to the
  future?

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Was the Second World War a Tipping Point for
theCity of London?
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Or, was the Second World War a Titanic Moment for
the City?
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The City of London has long been one of the
worlds most important Financial Centres

• 18th Century London, Amsterdam, Paris
• 19th Century London, Paris, Berlin, N.Y
• 20th Century London, N.Y, Tokyo
• Are the challenges the City of London faces today
  any greater than those of the past?

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The Position of Financial Centres in 2011

• Ranking of Financial Centres
• London
• New York
• Hong Kong
• Singapore
• Shanghai
• Tokyo
• Z/Yen , The Global Financial Services Index,
  Qatar Financial Centre Authority, June 2011
• The Global Financial Crisis of 2007/8 has not
  been sufficient to remove the City of London from
  its position as the leading international
  financial centre despite predictions at the time

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The Position in 1911

• The City of London was an even more important
  financial centre a century ago
• London possessed the worlds most important Stock
  Exchange
• London possessed the worlds most important money
  market
• Londons investment bankers were among the most
  important in the world
• Londons commercial banks were among the most
  important in the world
• London had no rival as a global financial centre

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London and the Global Capital Market Today1

• Worlds Largest Equity Markets, 2010
• By market value of Domestic Companies
• Location Total Share of World
• NYSE 13.4 trillion (22.5)
• Nasdaq 3.9 trillion (6.5)
• Tokyo 3.8 trillion (6.4)
• London 3.6 trillion (6.0)
• Euronext 2.9 trillion (4.9)
• WFE Statistics, 2010

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London and the Global Capital Market Today 2

• Worlds Largest Equity Markets, 2010
• By value of share trading
• Location Total Share of World
• NYSE 17.8 trillion (28.2)
• Nasdaq 12.7 trillion (20.1)
• Shanghai 4.5 trillion (7.1)
• Tokyo 3.8 trillion (6.0)
• Shenzen 3.6 trillion (5.7)
• WFE Statistics, 2010

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London and the Global Money Market Today 1

• Interbank Financial Activity, 2010
• By total borrowing and lending between banks
• Location Total Share of World
• London 6.9 trillion (17.9)
• New York 5.1 trillion (13.2)
• Tokyo 3.8 trillion (1.7)
• BIS Statistics, 2010
• Much takes place locally

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London and the Global Money Market Today 2

• Foreign Exchange Turnover, 2010
• Daily average of trading in April
• Location Total Share of World
• London 1.9 trillion (36.7)
• New York 0.9 trillion (17.9)
• Tokyo 0.3 trillion (6.2)
• BIS Statistics, 2010

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London and the Global Money Market Today 3

• Interest Rate Derivatives Turnover, 2010
• Daily average of trading in April
• Location Total Share of World
• London 1.2 trillion (45.8)
• New York 0.6 trillion (23.8)
• Tokyo 0.1 trillion (3.3)
• BIS Statistics, 2010

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London and New York Compared Today 1

• New York is the leading capital market in the
  world
• The NYSE and Nasdaq together dominate the global
  securities market
• Investment banks located in Wall Street dominate
  corporate finance and securities trading across
  the globe
• New Yorks success has always relied upon the
  business generated by US business

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London and New York Compared Today 2

• London is the leading money market in the world
• The London inter-bank market is the largest in
  the world
• The London foreign exchange market is the largest
  in the world
• Londons success as a global financial centre now
  relies on the business done there by banks from
  around the world.

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Need for Financial Centres

• A consistent theme throughout the history of
  international banking has been the importance of
  international financial centres.
• Committee on the Global Financial System, Long
  Term Issues in International Banking BIS July
  2010 p 12
• A Financial Centre provides an interface between
  banks allowing them to make and receive payments,
  borrow from each other when short of funds, lend
  to each other when in surplus, and balance assets
  and liabilities across time, space, currency and
  risk.

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Role of London

• London has long provided the Financial Centre
  that meets the needs of bankers.
• Since the 19th century, internationally active
  banks have sought a London branch.
• Committee on the Global Financial System, Long
  Term Issues in International Banking BIS July
  2010 p 12
• A Survey conducted in 2007 concluded that London
  ranked first as an international banking centre
  by whatever measure was used number of bank
  offices, inter-bank market activity, extent and
  degree of connectivity.
• G. Von Peter, International Banking Centres a
  network perspective. BIS Quarterly Review 2007

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Continuity of London

• ...remarkable consistency in the attractions of
  the City of London for international banking
  despite repeated global financial crisis and
  ongoing financial innovation.
• C. R. Shenk, The Decline of Sterling Managing
  the retreat of an international currency, 1945
  1992 Cambridge 2010 p 240
• Reports published since the Global Financial
  Crisis of 2007/8 indicates Londons continuing
  importance as a centre for international banking
• IFSL Research, International Financial Markets in
  the UK London 2009
• H.M. Treasury, UK International Financial
  Services The Future London 2009

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• WHY?
• The concentration of international financial
  services in a small number of centres results
  from strong economic pressures affecting centres
  and the firms operating within them. The sharing
  of common services, access to pools of skills,
  speed of dissemination of information and risk
  are all forces which lead to the clustering of
  practitioners. Thus externalities are created,
  such that each firm derives extra benefit from
  the proximity of other firms.
• The Competitive Position of Londons Financial
  Services Final Report 1995

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• The financial services sector still exhibits a
  natural clustering effect despite advancement in
  remote work. Once a certain critical
  concentration of financial services businesses
  exists in a given area, the value to other
  financial services businesses of co-location
  begins to outweigh some of the potential
  drawbacks associated with that location, such as
  high occupancy costs. A high concentration of
  financial services businesses tends to be
  correlated with a similarly high concentration of
  clients and providers of support services, which
  creates the potential for additional business
  opportunities and more efficient operation this
  clustering of business has the additional benefit
  of creating a large pool of highly-qualified
  workers, which is a key differentiation in
  financial services.
• Sustaining New Yorks and the US Global
  Financial Services Leadership 2006

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What Created the Cluster?

• Britain was the first modern economy
• Economic Growth created a need for banks To
  collect savings/make loans
• Banks needed to do business with each other on
  behalf of customers and themselves
• London was the largest centre of wealth,
  population, trade and communications
• A financial cluster developed in London

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Rise of the Financial Cluster
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City of London today

• Today the City of London is a specialised
  financial centre focussed on domestic and
  international finance and related activities
• Employment in the City of London and Canary Wharf
  in 2009 Total 415,000
• Finance, Insurance/Law/Accountancy 232,682 (56)
• Other occupations 182,822 (44)

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The Connected Cluster

• Paris-London telegraph, 1851
• London-New York telegraph, 1866
• International Telephony, 1890s
• Fibre Optic Cables, 1960s
• Computer Networks, 1970s
• Algorithmic trading, 1990s
• London at the centre of international
  communications

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The Early Development of the London Money Market
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The London Money Market before the First World War

• To the discount house Smith St. Aubyn, the whole
  business was a matter of routine as in this
  comment in January 1914
• we had a big book but found no difficulty in
  getting the money required at c.2-2¼ for a week.
  Bills as scarce as ever and rates still falling.
  It is extraordinary how long the drop has now
  lasted. 1 and 2 months can be sold at 2½

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Banking Networks 1
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Banking Networks 2
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Correspondent banking networks

• Banks with London offices accepted banks from
  around the world as customers
• Banks in London accepted deposits from other
  banks
• Banks in London lent money to other banks
• Banks in London borrowed from other banks
• London was at the centre of the international
  payments system
• Banks in London were at the centre of
  international banking

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Banking Networks 3
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Banking Networks 4
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Shocks The First World War

• Smith St. Aubyn
• 1 August 1914
• The Joint Stock banks panicked, and it was only
  at quarter to one that we were able to get
  anything. A truly fearful Saturday The worst day
  we have ever had since the business began The
  whole market absolutely broke.
• 7 August 1914
• A moratorium declared for one month, which saved
  the whole financial situation. We re-opened for
  business but did nothing.

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Shocks The Second World WarBefore

• Normally, the dealing room at the Overseas
  Branch of the Bank was one of the liveliest in
  the building, filled throughout the day with the
  clamour of telephone conversations and the
  bargaining of expert dealers making and accepting
  contracts in half-a-dozen languages with their
  fellows in financial centres throughout the
  world. Very large sums were dealt in hourly by
  verbal contract, a swift, trained judgement being
  essential to ensure a satisfactory currency
  position when the days work was done.
• J. Wadsworth, Counter Defensive 1946 (Midland
  Bank)

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Shocks The Second World WarAfter

• With the first shot of war this room was
  silenced, the special equipment left in a dusty
  stillness that has lasted the past six years. So,
  also, throughout the whole field of foreign
  business normal transactions were suspended, but
  though the flow of ordinary everyday work had
  been arrested, some form of foreign trading was
  essential. International transactions are vital
  to Britains survival, and in war conditions the
  handling of the necessary financial arrangements,
  under Government direction and control, made up
  in complexity a large part of the decline in
  volume.
• J. Wadsworth, Counter Defensive 1946

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Resilience Networks and Markets Survived

• The networks remained
• The market remained
• Greater Government Control
• Competition from New York

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Euromarkets

• Eurodollars in the 1960s
• Escaping Regulation in the USA
• Creating a market in London for US deposits held
  in banks outside the USA
• London switched from to in the 1960s
• Foreign banks opened branches in London to deal
  directly with each other
• London was well positioned to provide the
  inter-bank markets required after the collapse of
  central bank control in the 1970s

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End of the 1960s
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End of 1990s
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The Basis of Londons Success as a Global
Financial CentreMarkets

• London developed a sophisticated money market in
  the early nineteenth century
• This money market attracted ever more banks from
  home and abroad
• The London money market became deeper and broader
• The London Money Market survived wars, crisis,
  government intervention and economic decline.

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The Basis of Londons Success as a Global
Financial CentreNetworks

• Correspondent networks allowed banks to lend
  money in London
• Correspondent networks allowed banks to borrow
  money in London
• Correspondent networks survived the consequences
  of conflict and the end of Empire
• From correspondent networks emerged banks with
  branches located in the major financial centres
  of the world

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Fundamentals of Financial Centres

• Centripetal Forces Driving business to the
  largest financial centre
• Deep/broad markets, expertise, facilities
• Centrifugal Forces Driving business out of the
  largest financial centre
• Cost of office space, cost of labour, burden of
  tax and regulation
• Constant flux between centripetal and centrifugal
  forces

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Conclusion 1

• There are fundamental reasons why London is such
  an important international financial centre.
• These reasons have changed over time.
• Today those reasons are strongest for deposit
  banking and money market activity
• These reasons are weakest for investment banking
  and capital market activity

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Conclusion 2

• The current problems of the City of London are
  Titanic Moments not Tipping Points despite the
  views of the media, politicians and the public
• Titanic Moments become Tipping Points if they
  provoke a sufficiently strong reaction
• Government regulation of the City could convert a
  Titanic Moment into a Tipping Point unless those
  in the City respond

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Conclusion 3

• Banks need to develop mechanisms and procedures
  that control the actions of those who work for
  them. If they do not the self interest of the few
  will destroy the livelihood of the many
• Markets need to introduce rules and regulations
  that police the behaviour of participants so as
  to prevent price manipulation and guarantee
  payment and delivery