Professor Michael Mainelli and Mark Yeandle, The Z/Yen Group
[This article first appeared as "Cooperation During Crisis: The Future Of Financial Centres", Washington Times, Special Report: The Cayman Islands (22 December 2008) page 1-2.]
Financial centres funnel investment towards innovation and growth. Vibrant, competitive financial centres give cities economic advantages in information, knowledge and access to capital. A strong financial centre connects the wider economy to a global network, and the wider economy gains from global trade and growth. Inward and outward investment opportunities increase the wealth of cities with financial centres and the wealth of their citizens. Although financial centres compete with one another, the competition is not a "zero sum" game, and global centres can play many different roles — domestic (e.g. the national financial centre), niche (e.g. Hamilton in insurance), regional (e.g.,Sydney for Australasia), international (e.g. Hong Kong) or global (London and New York). How can financial centre competition be win-win? In theory, a wider, global allocation of risk and reward increases overall economic efficiency. In practice, the ability to tap cheaper capital for inward investment increases overall economic activity for the host country and increases portfolio diversification for the investor, thus benefiting both. More prosaically, a back office in Mumbai supporting a Singapore trading operation benefits both financial centres.
The Global Financial Centres Index
In order to research financial centre successes, the City of London Corporation and Z/Yen Group launched the Global Financial Centres Index (GFCI) in 2006. The GFCI is updated every six months and rates over 50 financial centres. GFCI 4 was published in September 2008. The GFCI aims to improve understanding of influential factors in financial centre competitiveness. GFCI factors fall into five groups:
"People" factors assess the availability of good personnel, the flexibility of the labour market, opportunities for business education, and the development of "human capital."
"Business Environment" looks at regulation, tax rates, levels of corruption, economic freedom and the ease of doing business."
"Market Access" examines the levels of securitization, volume and value of trading in equities and bonds, as well as the clustering effect of having many financialfirms together in one centre.
"Infrastructure" is mainly concerned with the cost and availability of buildings and office space, as well as transportation.
"General Competitiveness" compares more general economic factors such as price levels, economic sentiment and how centres are perceived as places to live.
Overall GFCI scores put London and New York at the top, followed by Singapore, Hong Kong and Zurich (see box). Intriguingly, specialist centres rate highly, e.g. Geneva at 6th place, or Dublin and Jersey at 13th and 14th, respectively. GFCI responses show that regulation is the principal competitive differentiator; however regulation is a sensitive factor and interacts subtly with people, business environment, market access and infrastructure. At a global level, Hong Kong and Singapore threaten New York and London for top spots well within the next decade, as the competitive gap between them narrows rapidly. The current financial crisis and consequent geo-political adjustments may accelerate their progress. Middle Eastern centres have also risen strongly in the ratings, which is hardly surprising given their expenditure on building new financial centres. The top three cities likely to be "… significantly more important over the next two to three years…" are believed to be Dubai, Shanghai, and Singapore. Somewhat surprisingly, South America and, less surprisingly, Africa, have yet to develop a centre that places highly.
For potential financial centres in Asia (e.g. India or Korea), Africa or South America, closing the gap could take decades, as infrastructure and a strong regulatory environment take time to develop. Some of the new small ponds will attract enough liquidity in new products to become great lakes, and in turn attract the attention of the largest financial centres, either as allies or competitors. How can centres further improve their attractiveness? To oversimplify it, SPIN:
Structure: Good quality basic infrastructure is essential. Obviously information systems, communication, telephony, transport links and commercial property must be of significant quality, but 'lifestyle' infrastructure — housing, schools and leisure facilities — must also be good.
People and Regulation: Financial services skills such as IT , legal, accountancy and actuarial professionals are essential, but a balanced regulatory environment with knowledgeable people overseeing markets is equally necessary.
Information and Interaction: While a formal stock, commodity or derivatives exchange isn’t always required, a "buzz" is — marketplaces need prices.
Networking: Financial centres need to be nexus points for many activities. Deals are inherently unstructured — otherwise they could be automated — and require face-to-face contacts to build trust. Thus, a mining conference leads to a property deal, or a legal conference on structured contracts leads to a trial document exchange.
If anything, SPIN puts the access on accelerating the frequency of informal contacts — conferences, annual meetings, airport lounges, social and leisure facilities — and then seeing what develops. This emphasis on frequent contacts leads one to question the role of offshore centres, often off the beaten track and not natural nexus points. Yet many offshore centres do well in the GFCI. A good degree of networking can arise if there is a favourable tourist element, for example, the Cayman Islands or Bermuda. Some offshore centres have tax and confidentiality (secrecy) differentiators, but tax-neutral and open centres, such as the Isle of Man or the Cayman Islands, do better. In economic jargon, offshore centres "signal" that financial services are important to them, so they won’t do anything foolish or swift (tax changes, legal changes, regulatory changes) to jeopardize these offered services. Good offshore centres cultivate an aura of stability in the financial services regime; the rules of the game are stable. The best offshore centres gain ompetitive advantage not from secrecy or tax evasion but from confidence — they are good places for long-term financial planning.
The "liquidity crisis" and "credit crunch" have multiple causes and effects. Already, the two global financial centres, London and New York, are suffering. Long-term issues for the two global centres are the two R’s:
Regulatory Knee-jerk: Knee-jerk reactions to the credit crunch that increase regulation may have unintended consequences. Eurodollar markets grew swiftly in the 1960s when U.S. tax rule changes meant multinationals found it attractive to leave dollars outside the control of U.S. authorities. Sarbanes-Oxley requirements after 2000 increased the attractiveness of London as a "light touch" regulatory environment and increased listings on AIM at the expense of NYSE.
Recession: New York and London anticipate significant economic losses from the credit crunch, due to their heavy dependence on revenues derived from financial sector performance, but they will also be hurt by national recessions. London is more exposed to the credit crunch than New York, as international wholesale financial services counts for a larger share of GDP, while New York has a large "hinterland" domestic USA economy that generates a base level of financial services activity.
A bad reaction, particularly for London, would be to become defensive and try to protect jobs. London became Europe’s leading financial centre in part because of the flexibility of the U.K.’s labour laws. Senior finance professionals note that while financial institutions can downsize rapidly in bad times, as soon as business begins to improve, flexibility encourages them to rehire and grow again quickly. In the dynamic global financial industry, "downsizing" restrictions in France and Germany choke off job opportunities in the long term.
An equally bad reaction would be to assume that lack of regulation was the cause of the credit crunch. First, there is a good argument that overregulation was the cause, leading to restrictive markets with the result that there were four global auditing practices, two credit rating agencies, two actuarial firms and fewer than two score global investment banks. Perhaps regulation should have been more traditional, more about increasing competition (hundreds or thousands of smaller investment banks) than about direct control. Too big to fail = too big to regulate. Second, more regulation may not be an answer. Still, as the U.S. Congressman Thomas "Tip" O’Neil said, "All politics is local." Thus, large electorates out for blood are unlikely to care about the preservation of a relatively small financial services industry, while electorates depending on financial services may be more circumspect. Being a beacon of stability and not over-reacting should be everyone’s strategy, but may favour the smaller centres and the offshore centres.
London and New York are not to everyone’s taste but they are, and have been for over two centuries, largely to the taste of those who work in financial services. Their choice, a tough one, is to try to remain "light touch," while local electorates call for greater regulation or submit to greater domestic regulation, and watch the gap with emerging centres shrink. However, if global financial centres are cooperating in a win-win game, then any future decline for London and New York hurts all financial centres. The challenge for all financial centres will remain, as ever, "to think global, act local, be social."