Two Big Giants as International Financial Centers: A Comparative Analysis of New York and London Jiao Feng1 School of Social Science, Department of Economics Lingnan University, Hong Kong April, 2007

Abstract London and New York, the only two giants in the world as International Financial Centers, share some similarities but own much comparative competitiveness as well. The framework developed by Corporation of London gives us a good perspective to look at the two cities in a comparative way. According to the factors provided in this framework, the comparison between the two giants draws a whole picture about the relative competitiveness and weakness. The future problem of these giants will be how to make up the shortage as well as keeping or even strengthen their advantage. Keywords: International Financial Centre, London, New York, Comparison Analysis

Introduction It is generally believed that New York and London are the only two leading global international financial centers today. Due to the great power of UK and its tremendous influence over the world, London since 18th century surely became an IFC with a great empire behind. While London lead the world as an international financial centre until early 20 century, New York had come up and gained its top leading statue after World War I and World War II as the rising of USA. Since then, New York and London are both recognized as the top International Financial Centers on the world stage. New York and London, therefore, are competing with each other to be the first place as an IFC. However, both of them have their own good and weak points. And it seems that both of them will still stand as the leading IFCs in the next decade. The comparative study of these two successive examples is under the framework of a survey -Centre for the Study of Financial Innovation, Sizing up the City, Corporation of London (June 2003). The survey provides the comparable factors to measure an international financial center, say, Availability of Skilled Personnel, Regulatory Environment, Access to International Financial Markets, and Corporate Tax Regime etc. First section of this paper will concisely provide some facts about the historical development 1

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of the two cities. After that, section three will analyze and compare the two IFCs in each factor under the framework above. A comparison of different financial industry sectors- Stock Exchange, Bonds, Insurance etc. - will be done base on real world data as well. In the last part, we are going to discuss about possible improvement in regard of the analysis in the previous section.

Historical Development After the independent Unite State of America in 1700s, the city of Philadelphia was the financial centre of USA, not New York City. Shortly after, however, New York City overtook the Philadelphia as the largest financial centres in the country as result of being a better harbour and a trade centre. A well developed legal system has formed and so does the government bonds business. Nevertheless, New York did not emerge as International financial centre until World War I, and New York only remained as a nation financial centre for decades. The golden age of New York came after WWI, as The US moved overnight from being a debtor to being a creditor nation—a massive outflow of capital left through New York financial institutions. Despite of bad time of some economics’ depression, After WWII, NYC picked up quickly and enjoyed a strong growth due to Marshall Plan. Huge amount of money went to outside world through New York. And since then NYC came to the top as an IFC. The story of London seems to be more tortuous. Although already been an IFC before World War I, London was displaced after World War I and World War II due to the Great Depression, the serious destructions from war and extensive bureaucratic control during war. However, London regained its statue after World War II. The liberalization of foreign currencies exchange and Marshall Plan helped London to develop the “Euro-Dollar” market and became a world leading international money market. London was especially famous for its good legal system, availability of professionals, and tight banking confidential rules. Somebody argued, from the perspective of history development, that the history determines the relative distribution between London (larger on currency market) and New York (stronger in securities and debt market). Both of them are born to be International Financial Centres: London the dealer in currencies as the centre of trade and payments for an Empire; NYC the broker in debt issues demanded by the large economy behind it.

Market Structure and Financial Sectors Table 1.1 is a comparison between New York and London in the field of Market Structure and Financial Sectors. We can directly see from this table that New York and London share some common points and focus in some particularities as well. First, both of the cities have central banks as monetary authorities of the country. And the currency is all directly controlled by the central banks. Both of these two are extremely influential to the world economy, commonly known as “Fed” and “Bank of England”. Also, their currencies are both major currencies in the world, namely US Dollar and British Sterling. In one hand, as of the foreign exchange, London had an average daily turnover of nearly

1,100 bn US dollar compare to New York only 577 m. London is a much larger foreign exchange trade centre than New York, and is well-known as the largest exchange market in the world. Moreover, London outperformed New York as the largest market of derivatives (futures & options) around the world. This is partly because the futures business in US was traditionally concentrated in Chicago, not New York. On the other hand, New York showed his strength in Bond, Insurance and Stock market. New York is the absolute leader in equity market. It has almost 30% of stock exchange volume of the whole world. NASDAQ, NYSE, AMEX are among the most renowned exchange. Besides, its world No.1 bond market raised approximately 2.5 bn US dollar each year, large part of them are US government bond- T-bills or Treasure Bonds. In terms of insurance market, both cities have equally weighted shares of the world, and seem to be neck and neck.

Table 1.1 Market Structure and Financial Sectors Financial Structure Monetary Authority

New York

London

Federal Reserve Bank of New York

Bank of England

Federal Reserve Bank

Bank of England

US$577 billion

US $1,109 billion

US$ 2,503 million

£946.5 million

US$ 9,846 billion

£4,351 billion or $8,861 bn

US$ 29.4 billion

£13.9 billion or $27.6 bn

276,152,326

515,478,934

Currency Issuer Foreign Exchange Market Net daily turnover(2006) Bond Market(2003) Stock Market: Value of Share Traded (2003) Insurance Market: Total premium(2003) Derivative Market: Option & Futures Contracts(2006)

* Data from LSE, NYSE and Federal Reserve Bank.

Comparison under the Framework of Factor of Competitiveness The approach of Factor Competitiveness was developed by Mark Yeandle, Michael Mainelli and Adrian Berendt of Z/Yen Limited in a research report named The Competitive Position of London as a Global Financial Centre. In the report, a survey was given to determine what the most important factors related to the competitiveness of an IFC are. The results are given as follows.

Table 1.2 Competitive Factors Ranked Factor of Competitiveness

Rank

Average Score

Availability of Skilled Personnel

1

5.37

Regulatory Environment

2

5.16

Access to International Financial Markets

3

5.08

Availability of Business Infrastructure

4

5.01

Access to Customers

5

4.90

A Fair and Just Business Environment

6

4.67

Government Responsiveness

7

4.61

Corporate Tax Regime

8

4.47

Utility Costs

9

4.38

Access to Suppliers of Professional Services

10

4.33

Operational Costs

11

4.30

Quality of Life

12

4.28

Cultural & Language

13

4.04

Quality / Availability of Commercial Property

14

3.89

* Data from www.cityoflondon.gov.uk/economicresearch

It is impossible to cover every factor of this survey, so this paper will only discuss the most essential factors using the competitiveness factor framework.

Availability of Skilled Personnel The factor of “Availability of Skilled Personnel” is ranked 1st of all the candidates. More than 75% people think this is the most crucial factor that made an IFC. The result of the survey indicates New York and London are preferred by skilled professionals. They got quite a few more scores over Paris and Frankfurt. The financial sectors in London and New York attract many financial professionals all over the world and this is a significant reason for both of them to keep the statue as leading International Financial Centres. Why London outperformed New York a little bit in the skilled personnel factors? Most of the respondents praised the flexibility of the labour markets in the UK. The flexibility of the labour markets made hiring a professional and firing him much easier and hence reduced the cost of the firm. Also, flexibility brings in more competitiveness and left only the most rigorously trained professionals. One of the directors working in Investment Bank once said: We recognise that banking is a cyclical business and in the good times we need to increase headcount and in the bad times we need to reduce numbers. We have consolidated our European operations in London because we can always get hold of really good experienced people when we need them and it is easier to downsize- in other places this is an expensive, time-consuming and stressful experience. - Director of Global Equity Operations ¨C Major European Investment Bank

However, almost everyone is complaining of the high living cost in London. Even some talent would choose moving to New York for a better living. Another problem is immigration policy of these two places. Strict policy may lose some professionals to less strict cities like Singapore or Hong Kong. Another issue is that both in New York and London the cost of hiring a workforce is much more expensive than other places, but most directors consider the personnel quality is the thing that makes a big business.

Regulatory Environment Another important factor relating to IFC is the regulation environment. Strong regulations are always a tradition of London until 1970s. Although strong regulations did protected London from instability, weakness of strong regulations began to show up since late 1970s. As New York deregulated in 1978, the strict rule kept London Stock Exchange a nearly close shop and soon London lose its equity market to New York. Even nowadays, New York securities are still far beyond London’s. However in 1986, UK began a series of deregulation. The reformation abolishes monopoly-enhancing fixed commissions, and, removed of barriers to foreign entry. After that turning point, London regained its competitiveness soon. Since then, Dynamic market and dynamic policies was adopted. And London now is considered the best regulations around the world. The survey clearly show that London beaten New York quite a lot in this respect. But, what’s the reason for that? Some arguments hold that: London’s FSA is mandated to listen and work with firms, so as to identify potential risks before things go wrong, rather than simply prescribing rules. US regulators, following Sarbanes-Oxley legislation (post Enron and WorldCom scandals) are mandated to stiffen standards This has put off many firms from listing on U.S. stock exchanges and is the major theme in New York’s recent self-examination A remark made by a banker revealed the truth:

The FSA listens to and understands our concern. In the USA regulators develop rules and expect you to stick to them. ¨ Head of Equity Operations ¨C Major USA Investment Bank

Hence, in the regulation factor, New York has a lot of homework to do in order to catch up with London. Fortunately, in a recent report Sustaining New York’s and the US Global Financial Services Leadership by Office of Mayor, New York, New York has now put the issue of regulation environment improvement on the table. Being aware of this problem, we would expect New York to do a better job in regulation in the coming few years.

Availability of Business Infrastructure This is another important factor to take into our account. The business infrastructure including telecommunication, IT infrastructure, and transportation links as well. As the business nowadays became largely relied on the high quality and stable background support, the importance of infrastructure will and is being valued more and more. From the figure below, we can see New York is doing better here. US are generally known as a nation of high technology. The widely-used internet and other telecommunication facilities made financial business much more efficient. New York was the first stock exchange market in the world to implement the electronic trades on shares and NASDAQ is the leading market of electronic trading even today. Moreover, US have the largest market and mature industry of IT, say, Silicon Valley, which provides financial activities strong support. Besides, US have well-developed high way system, which made transportation between cities more easily. However, almost every director in financial industry said that they will take a quality business infrastructure for granted, particularly in developed countries. And as the blooming of Asian economy, the business infrastructure is improving in Asian countries, say, Hong Kong Shanghai and India. We may expect more competition from these developing countries. London, on the other hand, was considered doing less work in this field. Some respondents of the survey even think “London is doing no or little work in the improvement of transportation in the last few years”. The London’s monopoly in the certain industry made its business infrastructure obsolete and costly. London, in order to keep its lead, has to take a serious

consideration on this. Again, a participant said: London is out-pricing itself: I’m not sure if this is sustainable without correction or dissipation of its monopoly.

Corporate Tax Regime There’s a little surprise that tax effect nowadays play such a less important role in International Financial Centers. According to the survey, the corporate tax regime is only rank 8 out of 14. Maybe this remark reveals some underlying reasons: These days the big banks are all multinational and are clever enough at declaring profits sensibly -this means that corporation tax is less of a competitive issue than it once was. Director -Major European Investment Bank. In this survey, both New York and London don’t get satisfying result. Few people rank them as Excellent. However, they are already much better than Paris and Frankfurt. The tax requirement in New York is much less demanding than other places including London especially for demanding for small companies. This relatively advantage made New York slightly better than London. However, tax system in US is more complicated than London. It is usually find to be costly to treat with tax affaires. Compare to New York, the London has a much clear and simple “One-Stop Regulatory Authority”. The simply framework was generally appreciated by investors. The competition of these leading IFCs is coming from the offshore financial centers. Generally speaking, these OFCs have very low and attractive tax rates and little regulation. In order to keep the statue of leading IFC, London and New York should improve their tax system, if we can’t win them by rates, than by system.

Table 1.2

Corporate Income Tax Rates—2007, United States of America Taxable income over 0 50,000 75,000 100,000 335,000 10,000,000

Not over Tax rate 50,000 15% 75,000 25% 10,000 34% 335,000 34% 10,000,000 35% 15,000,000 38%

* Data from www.smbiz.com

Corporation Tax on profits-2007, United Kingdom Main rate of corporation tax

30%

Small companies’ rate (SCR)*

20%

SCR can be claimed by qualifying companies with profits at an annual rate not exceeding

£300,000

Marginal small companies’ relief (MSCR) lower limit

£300,000

MSCR upper limit

£1,500,000

MSCR fraction

1/40

Special rate for unit trusts and open-ended investment companies

20%

* Data from www.hmrc.gov.uk

Comparative Advantage in SWOT Analysis New York

London

Strength 1.Equity Market & developed Bond market 2. Good source of skilled labor 3.Well-developed Law system 4.Huge domestic market 5. Perfect Ancillary and support services 6.Low Tax rate, especially for small companies 7. Technological infrastructure 8.Political Stability

Strength 1.Foreign Exchange Market and Derivative Market 2.Flexible Labor Market 3.Dynamic Policy and considerate regulation 4.Better access to EU market 5.Easy and Simple tax system 6.Political Stability 7. Ancillary and support services 8.Good Government

Weakness 1.Foreign Exchange market and Future market 2.Inflexible labor market 3.Complicated tax system

Weakness 1.Equity market and Bond market 2.High living cost 3.Little tax privilege for small companies

4. Stiffen style regulation Opportunities

Opportunities

1.Recovery of US Economy 2.Financial Globalization 3.Emerge of new financial product

1.Development of EU economy 2. Financial Globalization 3.Need for a larger bond and foreign exchange market in Europe

Threats

Threats

1.Possible lose IPO business to Asia 2. Systemic risks arising from Globalization

1.Other Europe cities such as Paris and Frankfurt 2. Systemic risks arising from Globalization

London VS New York, Final Result - Is New York City Lost Its Relative Dominance? Why? The Score of both cities are as follows: Factor of Competitiveness

New York

London

Corporate Tax Regime

14.9

14.1

Skilled Personnel

20.0

20.5

Business Infrastructure

18.9

18.2

Regulation Environment

18.1

17.0

Total

214.7

214.9

The total score, as we can see, show that New York is now a little worse than London. What is the reason for New York to lose its dominance over London? The main reason, in my opinion, is the regulation environment of New York. New York regulation has two main problems. One is excessive and stiff style regulation. New York establishes strict legislation after the Enron case and a mentality of strong enforcement. The other is fragmented regulation. Many agencies, both federal and state level, are involved in a particular sector and the responsibilities are not clear. Compared to New York, London’s regulation is referred as “User friendly” and full of creativity or innovation. Just as the report by Office of Mayor, New York said: We must take a hard cold look at the industry and our weakness. Learn from the best practice of other nations, and drawing upon strategies that will allow us to adapt to the changing realities

Conclusion After looking into the two leading international financial centers in the world under the framework of “factor competitiveness”, it is reasonable to draw some conclusion from the

comparative analysis above. First, both London and New York are going to remain to be the leading international financial centers in the world for the coming decade. No other places, from Tokyo to Frankfort, from Hong Kong to Paris, have the power to displace these two giants in a short period. New York and London are both excellent in every aspect compare to other financial centers. Second, London and New York have their own core competitiveness in different aspects compare to each other. London is good at derivatives & foreign exchange, while Bond & Equity market in New York is better. London is a fund house for Europe, while New York is a money engine for USA. Third, despite of their leading statue, both of them need some improvement in order to keep the lead and face the challenge from other financial centers. New York needs to reform its way of regulation, while London faces the problem of insufficient business infrastructure and the high level cost. Failing to do the improvement, may fail defending their role as global financial centers.

References: Mark Yeandle, Michael Mainelli and Adrian Berendt of Z/Yen Limited, 2003. The Competitive Position of London as a Global Financial Centre. Michael R. Bloomberg, Charles E. Schumer, 2006. Sustaining New York’s and the US Global Financial Services Leadership. Office of Mayor, New York Plender, John, “London’s Big Bang in International Context”, ibid., pp. 87-96 Robbins, Sidney M., and Nestor E. Terleckyj, “The Rise of New York as a Money Market”, in Roberts, Richard, International Financial Centres, vol II, pp. 137-162; Nadler, Marcus, Sipa Heller, and Samuel S. Shipman, “New York as an International Financial Centre”, ibid., pp. 187-206; Michael Maineli, 2006. Journal of Risk Finance. Global financial centers: one, two, three…infinity? Catherine Mattison Press Office, 2007. "Annual Supporting Statistics 2006". www.londonstockexchange.com HM Revenue & Customs (HMRC), 2007. "Rates and Allowances -Corporation Tax of United Kingdom" www.hmrc.gov.uk A/N Group, Inc. 1998-2006. "Small Business Taxes & Management" , Corporate Income Tax Rates Information from Lecture notes of Professor Jesús Seade