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

1. The City of London as a Global Financial Centre: An historical and comparative perspective Professor Ranald Michie, Durham University July 2012

2. The City of London

3. 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

4. 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?

5. 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?

6. Was the Second World War a Tipping Point for theCity of London?

7. Or, was the Second World War a Titanic Moment for the City?

8. The City of London has long been one of the world’s 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?

9. 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

10. The Position in 1911 • The City of London was an even more important financial centre a century ago • London possessed the world’s most important Stock Exchange • London possessed the world’s most important money market • London’s investment bankers were among the most important in the world • London’s commercial banks were among the most important in the world • London had no rival as a global financial centre

11. London and the Global Capital Market Today1 World’s 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

12. London and the Global Capital Market Today 2 World’s 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

13. 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

14. 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

15. 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

16. 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 York’s success has always relied upon the business generated by US business

17. 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 • London’s success as a global financial centre now relies on the business done there by banks from around the world.

18. 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.

19. 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

20. 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 London’s 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]

21. 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 London’s Financial Services: Final Report 1995

22. ‘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 York’s and the US’ Global Financial Services Leadership 2006

23. 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

24. Rise of the Financial Cluster

25. 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%)

26. 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

27. The Early Development of the London Money Market

28. 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%”

29. Banking Networks 1

30. Banking Networks 2

31. 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

32. Banking Networks 3

33. Banking Networks 4

34. 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.’

35. Shocks: The Second World War:Before ‘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 day’s work was done. J. Wadsworth, Counter Defensive 1946 (Midland Bank)

36. Shocks: The Second World War:After ‘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 Britain’s 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

37. Resilience: Networks and Markets Survived • The networks remained • The market remained • Greater Government Control • Competition from New York

38. 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

39. End of the 1960s

40. End of 1990s

41. The Basis of London’s Success as a Global Financial Centre:Markets • 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.

42. The Basis of London’s Success as a Global Financial Centre:Networks • 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

43. 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

44. 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

45. 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

46. 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