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By John Plender
The decline and fall of financial centres used to be determined by war and peace. Today, it is more a matter of relative levels of regulation and tax. So the European Commission's proposed directive on alternative investment fund managers, with its cumbersome registration and disclosure requirements for hedge funds and private equity, raises a serious question about London's position as an international financial centre.
The draft legislation is not devoid of logic. Its declared aim is to address systemic risk. And, in the fluid modern financial world, it is important that all institutions, whether banks or non-banks, should be properly regulated if they have the potential to torpedo the system.That said, it is questionable whether any private equity manager poses a challenge to the system. The number of hedge fund managers with such potential is much smaller than the number the draft legislation would capture with its current size thresholds.
Some argue that this will give US alternative investment fund managers an advantage over their European competitors and that London will lose out.
Yet it is possible to overestimate challenges to London. The numbers involved in any exodus from the hedge fund alleys of Mayfair would be small because this is essentially a cottage industry. Many will stay because the buzz and quality of life in London is preferable to the quiet life in some offshore Caribbean haven. The appeal of planters' punch can pall pretty quickly.
At the City end of town, the damage from the financial crisis can likewise be exaggerated. There are other big businesses in the Square Mile, such as foreign exchange, which is thriving on volatility, and insurance, where the cycle has turned up.
Nor is the UK economy quite the hostage to the financial services sector that its detractors claim.
Financial services account for 8 per cent of gross domestic product, which is similar to the US and much less than Singapore or Hong Kong. Sir Win Bischoff's report to the Treasury last week on the future of UK international financial services adds that almost half the gross value added and more than half the employment in the sector is generated outside London and the south-east.
In reality, all centres have been hurt by the crisis. Yet, as the last edition of The Global Financial Centres Index showed, financial centres see a flight to quality in a storm. This ranking, prepared for the City of London by consultants Z/Yen Group with input from market practitioners and regulators around the world, shows that the top centres have been much more resilient than those lower down the scale. London and New York remain the only truly global financial centres in first and second place respectively.
One plausible thesis is that the real competition for London and New York will come from Asia, though not from Tokyo, which is plummeting in the rankings. Non-Japanese Asian banks are in reasonable shape, with lending financed entirely from deposits. And China's huge current account surpluses could make the country a natural contender in international finance.
Its domestic financial sector is seriously underdeveloped. Yet China's State Council recently endorsed a plan to turn Shanghai into a global financial centre by 2020. This need not be at the expense of Hong Kong and Singapore. The US, after all, offers a model in which New York engages with regional centres such as Chicago, Boston, Miami and San Francisco in a positive sum game.
Whether the authorities in Beijing have the political will to liberalise the capital account sufficiently to allow Shanghai to play a global role by 2020 remains to be seen. As for today's global leaders, the political and regulatory game is much more zero- or negative-sum than positive. Continental European politicians are taking delight, in the latest draft directive, in taking London down a peg. Nor is there any shortage of people on Capitol Hill itching to inflict similar damage on New York.
The winners and losers in global finance may now be determined as much by politicians as practitioners.
John Plender is an FT columnist and chairman of Quintain plc
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