It’s a refrain that seems to get recycled every few years: London’s storied financial center, “the City”, is under existential threat from onerous new regulations or competition from emerging financial capitals.
But could the dire warnings prove true this time? Five years after the financial crisis, Britain’s financial system is still suffering. The reputation of British banks is at a low after RBS, UBS and Barclays were caught manipulating inter-bank lending rates. Taxpayers remain angry over £66 billion ($107 billion) in bank bailout funds for which the country is still paying. Jobs in the City have dwindled and the value of commercial real estate there has fallen. The UK has lost its triple-A credit rating for the first time since the 1970s. New surveys of the world’s financial centers show cities like Frankfurt, Paris and Zurich gaining on London in competitiveness and appeal. And all the while, conservative UK politicians keep calling for an exit from the European Union no matter the cost to British financial institutions.
Today, London is home to the world’s largest center for foreign exchange trading, more lending between global banks, and more international financial firms than anywhere else in the world, including New York City, according to TheCityUK, a lobbying group. The country’s overall financial services industry, much of which is concentrated in London, accounts for 10% of the United Kingdom’s GDP. Formerly just an area of a little over 1 square mile, settled by the Romans, the City now encompasses a stretch of land along the north bank of the Thames River; the former docklands of east London, or Canary Wharf; and Mayfair in west London, where boutique hedge funds take up shop in centuries-old row houses.
But in response to the scandals that have tarnished the City’s image, the EU and Britain are finalizing harsh regulations on the sector. That, plus a dwindling regard for the role of global finance in the UK, will drive business away to financial centers like Singapore, Hong Kong or possibly New York, as well other European cities. Or so the argument goes.
London’s been through worse before
The Confederation of British Industry predicts that 43,000 financial sector jobs in the UK will be cut before the summer. The Centre for Economic and Business Research forecasts that employment in the City will fall to 236,000 in 2014, the lowest level since 1993 (pdf) and down from a peak of 354,134 in 2007. Residential property in central London is more expensive than commercial property, according to a March report by Ramidus Consulting. London’s newest skyscraper, a 72-story spiky glass tower in London’s south bank called the Shard, has no commercial occupants yet (though a spokesman tells Quartz the company behind the building expects to sign tenant agreements soon). Expectations seem to have subtly shifted. Almost two thirds of 450 British investment bankers surveyed last year by the head-hunter agency Astbury Marsden said Hong Kong, Shanghai or Singapore would be the top global finance center in 10 years. British banks HSBC and Standard Chartered (paywall) have both threatened to relocate their headquarters from London, though both subsequently backtracked.
But London’s financial services industry has survived larger crises. The destruction of the British economy after World War II and the rise of America as an industrial power didn’t kill it. (In fact, strict US regulations pushed international finance to London, where it flourished in the 1960s and 1970s). When the UK chose not to join the euro in 1999, debate raged over whether London would lose its place to euro zone financial centers like Frankfurt. Instead, the City became the continent’s main offshore market for euro-denominated transactions, with more than twice as many euros traded as in all of the euro-area states combined.
“We are having the exact same debate again,” says Mats Persson, head of the London-based think tank Open Europe, “Is this going to be the point when those warnings come true? There clearly is a tipping point; the question is, ‘What is that tipping point?’”
The new regulations aren’t as scary as they seem
Skeptics of the City’s future say the tipping point is recent EU regulations, like a cap on bonuses for bankers, a banking union of the largest euro zone banks that could marginalize the UK, and a tax on financial transactions to be levied in 11 EU countries. More pressure could come if the EU mandates that clearinghouses conducting “sizable amounts” of eur0-denominated trade have to be on the continent. (More than half of all derivatives traded in London are euro-denominated.) “We have to keep the City of London out of the clutches of the EU,” chief executive officer of the City of London firms Tullett Prebon and Fundsmith, Terry Smith said at a panel at the Bruges Group, a think tank in London, in February. Some 50 proposed EU regulations would impact the City, according to Open Europe.
But it is far from certain how these regulations, many of which must still be negotiated among EU members, will affect the City. “It doesn’t all go one way,” says Charles Goodhart, director of a financial regulation research program at the London School of Economics. “There are elements in what the euro zone is doing that will benefit London… and there are elements that will pose a threat.”
For instance, the set of taxes on financial transactions, known as the Tobin tax, could end up putting a small charge on trades done between the UK and any of the 11 EU states, even though Britain is not part of the scheme. But ultimately it should drive more business to the UK, Goodhart says. Moreover, the tax, which levies 0.1% on shares and bonds and 0.01% on derivatives trades, is much less than the 0.5% tax, or stamp duty, that the UK already levies on any UK stock traded in the world. And that stamp duty hasn’t pushed international companies away from listing shares in London.
A European banking union isn’t unequivocally bad for the City either. Some fear that the European Central Bank (ECB), by setting liquidity and capital requirements for the biggest banks in the euro area, will favor those institutions at the cost of the UK’s. But the union, negotiated late last year, includes safeguards to prevent Britain from being be marginalized should the currency union consolidate into a political one—a kind of United States of Europe within the EU. Aside from a pledge that the ECB will not discriminate against any EU state, the European Banking Authority is expected to introduce a voting system such that if a majority of EU member states outside of the banking union oppose a banking rule, they can block it.
And as for the European cap on bonuses, it isn’t likely to drive talent away from the City, Persson says. The caps can be evaded through higher fixed salaries (paywall) and other loopholes.
What’s more worrying is Britain-Europe relations
The biggest risk to the City right now is perhaps not these new regulations, but the deteriorating relationship between the UK and EU. Before the financial crisis, British officials could reasonably argue that the City, which served as an entry point to the EU for foreign financial firms, was an asset to the EU, says Philip Whyte, a research fellow at the Centre for European Research in London. When Britain wasn’t able to negotiate a more lenient European bonus cap, many surmised that its influence had waned.
But the bonus cap debate also reflects a structural shift in British influence in the EU. “The most interesting development is the growth of the power of the European Parliament,” Goodhart says. The directly elected parliament has been increasingly flexing its new legislative powers since the Lisbon Treaty gave the body, as well as other EU institutions, more power when it came into effect in 2009 and supported the bonus cap, against British protests. “The City has much less clout with the Parliament than with the relevant directories in the [European] Commission. I think it puts the City of London at some greater risk,” Goodhart says.
At the same time as Britain has been losing influence in Brussels, support has been growing in Britain for leaving the EU altogether. One popular argument is that Britain is “shackled to a corpse“—the struggling euro zone. Another is that British sovereignty and democracy are being compromised. “It’s a combination of mistrust and the idea that British democracy is weakened…that EU institutions interfere too much, are unaccountable, and only look after themselves,” Whyte says. Extreme statements, comparing European influence to the rise of fascism in the 1930 or communism after World War II—as one panelist warned at the Bruges event—are becoming increasingly common.
What a British exit from Europe would mean for the City isn’t clear, but the uncertainty could encourage banks to set up elsewhere. “Large international and European companies see Britain divorced from the EU as a much less attractive place,” wrote Michael Sherwood and Richard Gnodde, co-CEOs of Goldman Sachs International in an op-ed in February. The authors said the impact of the UK leaving the EU would be gradual but decisive. “It would begin with a decline in investment and hiring as London suffers relative to cities such as Frankfurt and Paris.”
But the city is also less popular in Britain than it used to be
“Before 2008, the City was the golden goose that the government openly defended… Now that’s been blown out of the water,” Whyte says. With British chancellor George Osborne promising to forcibly break apart banks that don’t “ring-fence” their retail from riskier investment operations, British regulators seem willing to go even further than their counterparts on the continent or in America. The Financial Services Authority, which previously operated by publishing guidelines and regulating with a light touch, has split into two bodies in an effort to “reset” the British banking system by being more aggressive.
Meanwhile, some politicians argue that the British economy needs to become less dependent on finance and to renew formerly important industries like manufacturing. And in the long term, British immigration policy limiting foreign students and other immigrants could curtail talent and connections to emerging markets, John O’Sullivan of the Economist observed in January [video, 05:55].
It’s too early to discount the City
Events elsewhere in the world will also determine the City’s fortunes. Banking systems, especially in Asia, are becoming more complex and important as European banks deleverage in emerging markets, which could pose competition to London. On the other hand, Hong Kong’s future as a financial center for money flowing through China depends on the still uncertain direction of financial-market reform in China, which is under new leadership. And regulations in US financial reform this year could prompt foreign banks to retreat from the US or face stiff capital requirements and liquidity provisions.
“I think [London's] status as a global financial center remains very strong. There are potential threats, but they are simply potential at the moment,” Goodhart says. Many traits that made London a center for international finance—the dominance of English as the global language of business, London’s overlap between Western and Asian working days, and the city’s existing cluster of law firms, accountants, and financial-services groups— won’t be changing soon.
The City is also about more than just finance. London is the third largest insurance market in the world. “There is always global competition but… London is very important and I don’t see that changing,” says Graeme Trudgill of the British Insurance Brokers’ Association.
Financial capitals like London have, in the words of economic historian Youssef Cassis, “remarkable longevity.” In fact, since the 17th century, the world has basically seen only three major centers: Amsterdam, London and New York. Their rise and fall happens at a glacial pace, Cassis writes in his book Capitals of Capital, and seem to lag behind larger changes in the global economy. We are still at the beginning of the rise of emerging markets in Asia and elsewhere. The demise of the City of London, should it happen, likely won’t be any time soon.