Foul-weather friends

London as a financial centre

Foul-weather friends

Dec 17th 2009 | HONG KONG, LONDON AND NEW YORK
From The Economist print edition

How London risks losing its global appeal

Illustration by S. Kambayashi

 

 

AT THE start of the 1960s London’s status as a financial centre was in gentle decline, reflecting Britain’s waning importance in the global economy. Then the American government helpfully imposed Regulation Q and the Interest Equalisation Tax, two measures that encouraged investors to hold a lot of their dollars offshore. London became the centre of the so-called Euromarket, attracting more international banks than New York.

 

Despite its terrible weather and creaking transport infrastructure, London has continued to punch above Britain’s economic weight as a financial centre. The city built up critical mass in legal, accounting and fund-management expertise, and big American investment banks such as Goldman Sachs steadily increased their presence. London is not just Europe’s dominant financial hub (see chart). Before the credit crunch, talk that London would replace New York as the world’s financial centre was commonplace.

 

 

 

That claim sounds rather hollow now, thanks to a change in the political and regulatory climate. “London’s position as a financial centre is now threatened,” says Robin Bowie of Dexion Capital, which runs a listed fund-of-hedge-funds group. A special levy on bankers’ bonuses announced earlier this month has come on top of a forthcoming 50% tax rate on high earners, a charge on the worldwide earnings of expats living in Britain (also known as “non-doms”), pension rules that create marginal tax rates of over 100% and some unfriendly words from Adair Turner, the head of Britain’s financial regulator.

 

A poll of Bloomberg subscribers in October found that Britain had dropped behind Singapore into third place as the city most likely to be the best financial hub two years from now. A survey of executives this month by Eversheds, a law firm, found that Shanghai could overtake London within the next ten years.

 

To those affected it is the arbitrary nature of the tax changes that has them rattled. “There has always been a belief that Britain gets it,” says Simon Ruddick of Albourne Partners, a hedge-fund consultancy. “By ‘it’ I mean the fact that any tax gathered from the nomadic nom-doms, itinerant hedge-fund managers and overpaid bankers is all fiscal manna from heaven. Now that this truth has been un-learned, there is the real fear and strong expectation that it cannot be relearned.”

 

So far, Heathrow has not been packed with financiers fleeing the country (if staff at British Airways and Eurostar go on strike, they may find it hard to leave). But it takes time for people to adjust their plans. A survey of financial analysts in September by the CFA Institute found that 20% expected to leave Britain over the next year.

 

British banks report that since the bonus tax was announced, overseas rivals have launched aggressive attempts to poach staff away, using lower taxes as a lure. one French-born but London-based entrepreneur says he has a letter on his desk from the French government, offering a cap on his taxes if he brings his business back home. He has not taken up the offer but thinks it is “red alert” time for London, which has a large base of French expatriates. Tullett Prebon, a brokerage, is offering its staff the chance to relocate out of Britain, noting that many had expressed concern about the “increased uncertainty of the future tax regime”.

 

Hedge funds, always the most mobile of firms, are likely to be in the vanguard of any exodus. BlueCrest Capital Management, a leading British hedge-fund group, is establishing a Geneva office. Odey Asset Management, another hedge-fund titan, says it is in the process of establishing a Swiss operation in order to give itself some options, although it is unlikely that the whole operation would leave Britain. “Taxation is no longer being organised on the basis of what maximises revenue or creates the best set of incentives,” says Nick Carn, an Odey partner.

 

Driving the wealthy abroad may satisfy a political need for vengeance but could harm taxpayers in the end. The British government estimates that the top 1% of all taxpayers (many of whom work in finance or related industries) will pay 24.1% of all income-tax revenues in 2009-10, with the top 5% paying 43% of the total. It is likely that such taxpayers also pay a big proportion of stamp duty, capital-gains tax and inheritance tax. In the decade before the crisis, financial companies were paying 20-27% of all corporation-tax receipts.

 

A big decline in tax revenues would come not from the departure of a few hedge-fund managers, but from the loss of a big bank. There is no sign of this yet. The chief executive of HSBC is moving his main office to Hong Kong in February, but this decision is for “strategic reasons” and involves only 12-15 people. The bank says there are “no current plans” to move the headquarters of the overall group. But it may be wrong to assume that no big bank would leave Britain.

 

In a speech on December 14th Bob Diamond, president of Barclays, said it was worrisome that Britain is “looking inward” and added that the bonus tax “is separate from what we agreed” at the G20, where a code was drawn up to push banks into paying bonuses over much longer periods, to discourage short-term risk-taking.

For every loser

If there were an exodus from London, where might the financiers go? The grass may not necessarily be greener on the other side of the Atlantic. Congress is still pushing ahead with reform of the finance industry—the House of Representatives passed its bill on December 11th. Anger at Wall Street bonuses is widespread. “I did not run for office to be helping out a bunch of fat-cat bankers on Wall Street,” said Barack Obama on December 13th. Kenneth Feinberg, the administration’s pay tsar, has imposed restrictions on firms that have taken lots of government cash. Others are having to show more self-restraint: Goldman Sachs has promised to pay bonuses to its top 30 employees purely in shares.

 

Asia will naturally become more important as a financial centre, given its economic power and its role as the provider of global savings. Much of that money is directed at other emerging markets and need not flow through London or New York. There is no big city in Asia that does not have at least some aspiration to become a financial hub. Stymied by a small home market, Kuala Lumpur dreams of being a Mecca for Islamic finance. Seoul and Tokyo say they want to become regional financial centres; Mumbai and Shanghai say they want to become global ones. Hong Kong and Singapore, without size, money or resources, have shown what is possible: they are crawling with international fund managers and bankers, plus all the accoutrements of accountants and lawyers.

 

The success of these last two places shows how important a welcoming regulatory regime can be. It also helps if near-neighbours are far less welcoming. London has benefited from being perceived as an outcrop of “Anglo-Saxon” capitalism within the more dirigiste European Union. This difference has blurred. France has said that it will follow Britain’s lead in imposing a bonus tax, while Greece has promised a 90% levy (Athens is not renowned as a global financial hub). The heads of Germany’s biggest banks and insurers have agreed to implement G20 rules on bonus limits this year, ahead of the official 2010 implementation elsewhere, in what seemed a clear move to head off political pressure for a windfall tax like Britain’s. Earlier this year Josef Ackermann, the head of Deutsche Bank, warned that unilateral pay limits would leave it unable to attract good staff. Outside the EU, Switzerland is an obvious threat.

 

Some of the complaints of London’s financiers are special pleading. It is easier to threaten to leave the country than actually to do so. But those threats should not be taken lightly. The city’s status as a financial centre is not a God-given right.

 

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