CHAPTER TWO
I. WHAT IS THE STORY?
It is almost too obvious a tale-the way in which the financial services industry in London has outpaced other cities so that by the early years of this century, the UK capital had a credible claim to be the financial centre of the world. It is a story on which I have reported all my adult life, from the growth of the Eurodollar and Eurobond markets in the 1960s, to the Big Bang reforms in the 1980s, to the spurt in growth this century. With my wife Frances Cairncross, I wrote a book about the City of London as a financial centre-indeed it was because we so enjoyed writing a book together that we had the confidence to embark on another type of partnership.
I have a further connection with the City. Both my grandfathers worked there all their lives, one as a textile merchant and the other as a timber merchant. When I got a job in the City as a financial journalist, the first office I worked from, the side of Bracken House overlooking Friday Street, was on the site where my paternal grandfather’s office had been before wartime bombs swept it away. So this is very familiar ground.
However, as often happens with something familiar, you tend not to look properly. It is only when you open your eyes and try to pin down what makes it so special that you realize the depth and complexity of your subject. And so it is with the City. Let us call it that because although London’s financial operations are now located in three parts of the capital-the square mile of the old Roman City of London, the new Canary Wharf tower blocks1 and an increasing proportion of the St James’s area in the West End-the City is where it all began and it is a City ethos built up over many years that still drives the London financial services industry.
The key point is that in most areas of international financial business, London is the largest centre2 in the world. New York is slightly bigger overall on most measures-not all-thanks to its huge domestic business. Much the same applies to Tokyo. But if you take cross-border business, London is the clear leader from New York, and Tokyo is hardly in the running at all. So London has a fair claim to be called the financial capital of the world.
The reasons for this are partly historical, going back to the days of empire and the pre-1914 role of London as supplier of investment capital to the world. But that role was to be severely undermined by the loss of wealth from two world wars, while Britain’s proud status as a manufacturing nation gradually declined. The resulting weakness of the pound meant Britain could not return to its previous position.3
In the 1960s, however, the City began its revival when it discovered it did not need to use sterling but could turn to other currencies instead. That insight, coupled with applying the telephone trading system of the foreign exchange market to dealing in deposits, lead to the creation of the various Eurodollar markets. Banks borrowed other currencies, mainly dollars, and issued bonds and made loans in these rather than in sterling.
This allowed the City to regain its status as a world banking centre, with foreign institutions flocking in to trade in these new markets: by the end of the 1960s, there were more foreign banks in London than in any other city in the world.4 Gradually the merchant role of the capital diminished. Instead of being a place where goods and raw materials were actually traded, the job of my grandfathers, finance ruled.
There was no plan-no single mind that declared the balance of activity should shift in this way. What happened was that the banking techniques built up to finance trade and investment became more profitable than the actual trading itself.
The Euro markets were discovered almost by accident, with a couple of City bankers spotting the opportunity for London to do business that had previously been carried out in New York. In 1963 the USA introduced a tax on foreign bonds issued in New York-a spectacular own-goal.5 And when it did so, the Bank of England helped choreograph the City’s response. But it did not plan it; what it did was to welcome foreign banks that wanted to set up in London, even providing them with staff to help them do so.
What the City was very good at-still is-is exploiting opportunities as they arise. Indeed its whole ethos is not to plan but to respond with astonishing vigour to market signals. One effect has been to secure London’s position in international banking; another, to allow foreign banks to have the largest share in London’s business.
A second example of this opportunistic approach-and its consequences-was the Big Bang of the 1980s. While London had become the largest single centre for international banking, its securities trading-issuing and dealing in bonds and shares-remained a parochial business. There was a set of interwoven restrictive practices that kept foreign companies from taking part in British business. For one thing they could not in practice become members of the London Stock Exchange, and for another, London operated on a different trading system from the rest of the world, splitting all trading in domestic securities into two separate types of company. There were brokers, who could only act on behalf of customers buying and selling shares and could not deal on their own account. And there were jobbers, who were only allowed to deal with brokers. Commissions were fixed. The Bank of England issued government securities, or gilts, only through a handful of specialist banks called discount houses. And so on.
Meanwhile, other parts of the City were busy trading in international shares and bonds, where these restrictions did not apply. On one day, 27 October 1986, all the barriers were blown away-hence the expression Big Bang.6 London shifted to the global system of share trading.
What then happened was that foreign financial institutions took over the British-owned ones. Nearly all the larger brokers and jobbers sold out, and after a few years most of the City’s famous merchant banks disappeared too.
In essence, this was a deal: Britain traded national ownership of its investment banking business7 for dominance of international securities trading. It was not planned this way; most people expected that British-owned businesses would succeed in keeping a decent proportion of trading, and there were in the early days several large British groups. But they all disappeared, selling out to foreign competitors or simply shutting up shop. London retained even less control over investment banking than it had over commercial banking. It created the marketplace and cared little as to who might play on it.
The most recent example of the City’s pragmatism has been the way in which it has jumped into the gap and gained ground on New York post the terrorist attacks of 11 September 2001 and after the collapse of the energy group Enron8 in a whirlwind of financial scandal. Since 2001 the USA has introduced a number of restrictions, some designed to improve security, some to improve financial regulation. Among these are simple measures such as visa restrictions, making it harder to employ non-Americans in New York. Others are more complex-the interplay of the Sarbanes-Oxley9 corporate legislation, which puts onerous restrictions on companies listing their shares in the USA, and various other financial regulations.
There was no specific plan for London to use all this as an opportunity to increase its share of financial business, but that was the outcome. In 2006, for the first time, more money was raised for businesses in London than New York. US businesses found it easier to expand in London; it was not hard to hire non-national staff and they found the regulation more pragmatic. Meanwhile, international companies preferred to list their shares in London because that avoided Sarbanes-Oxley. And international investors, particularly those from the Middle East and Russia, preferred to deal through the UK rather than the USA, partly for political reasons, partly for timezone reasons, and partly because of the social and other attractions that London offered.
The result: London becoming once again, as it had