Every month, some young bureaucrat in the Chinese State Administration of Foreign Exchange (known, slightly menacingly, as SAFE) reaches out to a trader in London and buys or sells billions of dollars' worth of U.S. Treasury bonds. You've heard the overblown fears that China owns too much U.S. debt, but you might not realize that it's a British firm that regularly gets the commission. That's because London is the world's largest market for dollars. When a company in Shanghai or São Paulo decides to sell public shares internationally, they're very likely to choose London, too.
In fact, if you follow the flow of money around the world, you might be surprised to find that the central node of global finance, the place where money passes through most often, is London, not New York. Wall Street, of course, is no piker. American investment banks — partly because the U.S. economy is the largest in the world — do more business and make more money. But when it comes to international transactions, London is the world's financial center. The City of London, its Wall Street, employs more than 300,000 people, whereas Wall Street itself employs fewer than 200,000. Banks in the United States hold total assets that come to about 85 percent of the country's gross domestic product. In Britain, the banks hold almost 400 percent more money than its G.D.P., mainly because so much international business takes place there. And as the U.S. share of global finance shrinks, international business matters more.
How did London surpass Wall Street? In part because even in a world of electronic trading, brokers still want to know there is a human being at the other end of their 0's and 1's. London's working hours overlap with those in the U.S., the Middle East and Asia; New York's don't. The more significant reason, however, is regulation. In 1986, Margaret Thatcher instituted what's known as the Big Bang, which blew up centuries of regulations protecting Britain's old, slow-moving firms. In an instant, the City of London went from a charming, ancient system of legally protected, relatively small institutions to electronic banking, enormous investment conglomerates and millionaires who made their money via speculative bets. Out were the Oxbridge set and oak-paneled rooms. In were ambitious young men with Cockney accents and walls of Bloomberg terminal screens.
More than any specific change in the law, however, the Big Bang signaled that the government wasn't going to obstruct people from making oodles of money. And so between 1986 and 2002, this lack of regulation, often called the light touch, helped London catch up with New York. Then, after Congress passed the Sarbanes-Oxley reforms in 2002, the balance of power shifted further. Designed to prevent another Enron, this legislation mandated, among other things, numerous reporting requirements that firms complained were expensive and bureaucratic.
U.S.-based companies may have been stuck with this new law, but foreign companies weren't. They could avoid it by simply listing their stocks in London. And many did just that. From 1996 to 2000, U.S. exchanges captured an average of 74 percent of the total value of global public offerings. In 2007, their share fell to about 14 percent. The trend became so troubling that Mayor Michael Bloomberg, Senator Charles E. Schumer and Treasury Secretary Henry Paulson mounted a push for less of a regulatory burden. In other words, New York wanted to become like London.
But after the crisis, things flipped; there were heightened calls for tougher regulation on both sides of the Atlantic. In the City of London, the plea was amplified by the fact that the meltdown was caused, in part, by A.I.G.'s financial-products group — remember, the one that opened offices in London and traded its risky credit-default swaps in the lax regulatory atmosphere? Somewhat as a result, Adair Turner, Britain's top bank regulator, committed to a "heavier" touch in 2008. Since then, the Financial Services Authority has fined the New York hedge fund darling David Einhorn, as well as employees of a JPMorgan Chase subsidiary, for insider trading. The message was clear: London was no longer quite so thoroughly open for business.
As calls for reform continue, it's unclear just how banks in either city will react. Will they find ways to deal with the legislation or plan to move their operations to less-regulated locations? The European Union is considering implementing a transaction tax — applicable in London — that would put a levy on every financial trade. London's banks hate this idea. HSBC has even threatened to pull up stakes. (Yeah, right. Although HSBC, which moved from Hong Kong to London before China reclaimed the territory, has some experience in this department.)
Alternatively, some suggest that if the U.S. institutes a strict version of the Volcker Rule — which would prevent profitable but risky proprietary trading — then Wall Street institutions would high-tail it across the pond. Will any U.S. banks actually make good on their threats? It's unlikely anytime soon. But it's certainly a convenient ploy for banks in either city when lobbying regulators or Congress. Barney Frank, the former chairman of the House Financial Services Committee, told me that he came to think of it as "the 13-year-old son of divorced parents who tries to play Mommy off against Daddy."
It's even less likely that any large banks will up and leave for a less-regulated environment like Switzerland, Dubai, Singapore or Beijing. Sure, bankers want less regulation, but they also want longstanding rule of law, well-established property rights and a reasonably stable currency. The other candidates — Frankfurt, Paris, Tokyo — have, in some cases, even stricter regulations. Switzerland may be famously banker-friendly, but its financial sector is already far too big relative to its small size.
At least for now, the big banks are stuck with New York and London. Within a decade or two, the center of global economic gravity will shift again. It looks as if China's economy will be larger than the United States', and India's won't be far behind. Throw in a few of the Asian tigers — Indonesia or South Korea — and it seems clear that a majority of the world's financial activity will take place somewhere between the Indian and the Pacific Oceans. Other quick-growing nations, like Brazil, Chile, South Africa and Turkey, should also move from global financial backwaters to major commercial centers. By as early as 2020, or certainly by 2030, it may seem quaint that we once worried about whether the world's center of finance would be on one side of the Atlantic or the other.
Read the full column here.