The Shifting Capital of Capital

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Introduction

The financial sector underpins the success of many of the world’s largest cities. "Financial services"—an umbrella term which encompasses a wide array of businesses, from retail banks and credit card companies to hedge funds and insurance firms—attract foreign investment and often provide substantial tax revenues to host cities. Prompted by technological advances and other trends in globalization, a broad reshuffling is currently unfolding among many of the world’s financial centers. A number of newcomer cities now seek traction in the competitive global financial markets—traditionally dominated by New York City and London—both to draw capital and to consolidate political power. Experts say these shifts may substantially sway global economic and geopolitical power dynamics.

Is New York still the financial capital of the world?

Probably, though the gap has narrowed significantly. New York still leads rival cities in some critical financial measures. The Economist cites data from the private research organization International Financial Services, London (IFSL) indicating that 66 percent of the world’s hedge fund assets are currently managed out of New York, though it notes that London has passed New York in some other areas of the financial services sector. Financial services account for a substantial percentage of New York City’s vibrant economy. According to data from a recent McKinsey report commissioned by the city and the U.S. Senate, 15 percent of New York’s gross city product (GCP) comes from the financial services sector (PDF), as compared to 8 percent of overall U.S. gross domestic product (GDP). Financial services accounts for one in nine jobs in the city, and nearly one-third of business income-tax revenues. These statistics notwithstanding, the McKinsey report concludes that New York might lose its premier position in the world of global finance within the next ten years if major administrative changes are not implemented.

The same can be said for U.S. financial services as a whole. Based on 2005 data, the United States still generates more revenue from financial services than any other country—$51 trillion, as compared to $38 trillion for all of Europe ($30 trillion from the Eurozone and $8 trillion from the United Kingdom), $20 trillion for Japan, and $13 trillion for East Asia (not including Japan)—but the McKinsey report notes that growth in U.S. financial services is slower than in Europe, Japan, and Asia. In terms of drawing capital to U.S. financial markets, in 2005 only one of the world’s twenty-four largest initial public offerings (IPOs) was registered in the United States. In 2007 more money will be raised through IPOs in Hong Kong than either New York or London.

Why is money flowing away from New York and the United States?

Writing in the Wall Street Journal, Sen. Charles Schumer (D-NY) and New York City Mayor Michael Bloomberg argue that several regulatory hurdles are driving the shift away from U.S. financial markets. They hope to restore New York’s financial preeminence by reducing these hurdles. One commonly cited complaint is the Sarbanes-Oxley Act, passed in 2002 to reform U.S. corporate governance in the wake of the Enron scandal. As this Backgrounder describes, the law tightens U.S. accounting standards but with the unintended consequence of frightening away foreign firms eager to list their stock on U.S. exchanges. Nestle, for example, is commonly cited as a major foreign corporation that has been unable to meet the Generally Accepted Accounting Principles, or GAAP, required of companies wishing to list on the New York Stock Exchange. "This is the biggest issue being debated right now at the SEC [Security and Exchange Commission]," says CFR’s James P. Dougherty. "Do you force international companies to produce standards in an American format, or do you allow them to do it in international formats?"

What else explains New York’s flight of financial capital?

Incompatible accounting standards are just one of three changeable factors spurring capital flight from New York, say Schumer and Bloomberg. Another factor is overregulation. They say the United States has more than ten federal, state, and industry regulatory bodies, whereas the British have only one such body. "Industry experts estimate that the gross financial regulatory costs to U.S. companies are fifteen times higher than in Britain," they write. The other factor is frivolous litigation. "The total value of securities class-action lawsuits in the U.S. has skyrocketed in recent years, to $9.6 billion in 2005 from $150 million in 1997," they write. "The U.K. and other nations have laws that far more effectively discourage frivolous suits."

What are some suggestions for reversing this flight?

Schumer and Bloomberg suggest revisiting legislative efforts to stifle frivolous suits involving securities without unduly burdening legitimate litigation. A November 2006 action plan sponsored by the Committee on Capital Markets Regulation and written by the economists R. Glenn Hubbard and John L. Thornton offers detailed suggestions (PDF) on how to make Sarbanes-Oxley’s requirements more affordable for companies, cut down on excessive litigation in American markets, and reduce unnecessary regulation on companies seeking to list on U.S. exchanges. Among their suggestions: clarifying auditing processes, strengthening shareholder rights, and applying additional cost-benefit analyses to existing SEC regulatory requirements.

Is New York losing ground to London as the world’s financial capital?

An increasing number of analysts say yes. MasterCard produces a yearly Worldwide Centers of Commerce Index, ranking cities on a number of measures, including legal and political frameworks, economic stability,financial flows, and ease of doing business. The company’s 2007 index ranked London first and New York second (a number of other U.S. cities, including Chicago and Los Angeles, also ranked near the top of the list). The IFSL data cited above shows London to have already surpassed New York City in a number of financial measures: cross-border bank lending, foreign-equities turnover, foreign-exchange turnover, and over-the-counter derivatives turnover, to name just a few. The data also shows that as a secondary market for international bonds, London now represents 70 percent of global bond sales. As noted above, New York still outstrips London in hedge-fund assets—hosting 66 percent of the world’s supply, compared to London’s 21 percent. Still, there is broad consensus that London is experiencing a boom as a financial center.

The New Republic calls London the "New New York," pointing out that the most current data available shows London markets raising more money annually through IPOs than New York. A detailed 2005 report (PDF) commissioned by the City of London Corporation, the municipal body governing London, does not rank London relative to New York, but concludes the two cities currently stand as the world’s only two truly global financial centers. The report predicts the cities are likely to retain this position for at least the next ten years and that the primary competitors to London and New York, at least for the time being, are more constructively understood as regional financial centers.

What other financial centers are competing against New York and London?

A handful of cities, many of them in Asia, are currently jockeying for position as regional or global financial hubs. Some of the most prominent, broken down by region, are listed below:

• Asia: Within East Asian markets, Tokyo still remains dominant, ranking third in MasterCard’s index of global commercial centers. Hong Kong and Singapore rank fifth and sixth on the list, respectively—and according to the Financial Times, one popular joke in Singapore has it that a visitor can pick up a "hedge fund starter kit" upon arriving at the airport. On mainland China, People’s Daily reports Shanghai is pressing to expand its role in international financial markets, though it currently only ranks thirty-second on MasterCard’s index.
• Middle East: The regional financial heavyweight is Dubai, in the United Arab Emirates. The city established a city-within-a-city, the Dubai International Financial Center, in what the Economist calls an "audacious gamble" to become the financial hub of its region. The article notes that loose regulations on financial institutions are opening the city up to more commercial banks, insurance firms, private equity firms, and even some hedge funds. In 2005, the city launched a new stock exchange that trades exclusively in dollars, with no limits on foreign ownership and low minimum-listing requirements. Dubai currently ranks thirty-seventh on MasterCard’s list of commercial capitals, higher than any other Middle Eastern city.
• Europe: A handful of longtime financial centers also promise to remain strong alternatives to London. Both Frankfurt and Paris rank in MasterCard’s top ten, and Amsterdam, Copenhagen, Stockholm, Zurich, Berlin, and Milan all rank in the top twenty-five.
• Latin America: Sao Paolo and Mexico City stand as the preeminent financial hubs. In terms of total financial flows, they rank eighteenth and twenty-third, respectively, on MasterCard’s index, though their aggregate index scores are lower, at forty-second (Mexico City) and forty-eighth (Sao Paolo).
• Africa: Johannesburg, in South Africa, is pressing to become the financial leader on a continent not known for finance. While the city remains a relatively small player on the global financial scene, it ranks at forty-seventh on MasterCard’s index, higher than any other African city. As this PowerPoint presentation by the Organization for Economic Cooperation and Development (OECD) discusses, Johannesburg’s efforts to rise as a financial center could have the greatest impact regionally, as a vibrant local financial market could help spur development throughout the continent.