Financial Capitals

by Aditya Bothra

In the financial services sector there is increased speculation these days over what Adam Smith, yes you read correctly, Adam Smith of Time magazine terms as the “new capital of capital.” The debate over which city is the financial capital of the world, London or New York, has once again heated up after a brief interlude of a few decades which saw London fall from its preeminent position as the financial hub of the world, a position it had held for a few hundred years, due to overregulation and the rise of New York City, backed by a nimbler regulatory and investor friendly environment. But today, London is posing the closest challenge to New York City’s status and, in many cases, is edging out the Big Apple.

One of the proponents of London’s rise has been the realization that Britain is no United States and subsequently its reinvention of its strategy to attract capital to the city. What better way to attract capital than new listings or IPOs (Initial Public Offering)? While the US can and does count on its expansive economy (it is after all the largest in the world at $13 trillion) to provide a steady stream of domestic share listings on the two major Wall Street exchanges- Nasdaq and the New York Stock Exchange, London has diverted its focus to international listings in order to stay competitive. The results are there for everyone to see. In 2006, 91 foreign companies chose to conduct their IPOs on London's stock exchanges, while New York City exchanges played host to only a fourth of that number during the same period. But this was certainly not always so. London owes much of its success in attracting foreign companies to list on its exchanges to the broad reforms that were carried out starting in 1997 with the creation of the Financial Services Authority (FSA), a non-governmental regulatory body set up by the British Parliament that has served to greatly simplify the process of raising capital through listings on British exchanges. The FSA, a completely independent regulatory authority, is the only one of its kind in the world. It allows for greater collaboration with experts within the financial services industry, in addition to the wide-ranging “rule-making, investigatory and enforcement” powers that it possesses. The combination of these two attributes allow FSA to formulate rules and take action based on specific industry needs.

Meanwhile, Wall Street has seen changes of its own in recent years; changesthat are not necessarily positive from the point of view of those in the financial services industry. In 2002, the Sarbanes-Oxley Act was created to counter major accounting scandals that surfaced in late 2001 such as those involving Enron, WorldCom and Tyco. Public Company Accounting Reform and Investor Protection Act of 2002, or Sarbox, as it is commonly referred to, was formulated to increase federal oversight over corporate governance standards in publicly traded companies in the United States. Sarbox, among a host of burdensome measures for publicly traded companies, added to the already time-consuming and costly auditing procedures, created the Public Company Accounting Oversight Board (PCAOB) and called for increased disclosure of internal company operations. While the intention of the regulators were clearly sincere, Sarbox only served to further put off companies listing on American exchanges due to the major new provisions. It is estimated that the new procedures mandated by Sarbox costs US investment banks alone nearly $6 billion in addition to the cost incurred by the companies themselves, and this in turn resulted in increased business for the London Stock Exchange. If losing major international IPOs was not worrisome enough for New York, in recent years many major American investment banks have increased their operations in London to cater to a growing list of foreign companies launching their offerings there.

Over the last year major companies such as the Russian oil giant Rosneft and Peruvian silver mining Hochschild have raised $19.6 billion through listings in London’s exchanges. If you notice a trend, you would be correct. Increasingly London has been attracting companies from emerging markets such as India, China and Russia to list on its exchanges. These companies chose London over New York partly because the underwriting fees that investment banks charge in London are half of what they are in New York, but also because many of these companies would be unable to list in New York exchanges in the first place. For example, Rosneft was accused of stealing much of its main assets from another set of shareholders. Furthermore, statistics show that almost 2/3 of the small companies floated on the AIM, London’s market for small companies, are currently selling below their initial offering price, what many in the industry term as “junk” shares. While London may not have what many consider the “draconian” Sarbox rules, it is becoming overly complacent in allowing companies to list on what is considered one of the world's two most important markets, which is certainly not a good thing in the long run view of things. Additionally, the combined market capitalization of the companies listed on the NYSE and Nasdaq is much greater than that of the companies listed on the LSE. But nonetheless LSE is hot property these days; perhaps that is why Nasdaq launched a $5.3 billion hostile takeover bid for LSE last November, which was forcefully rebuffed by shareholders for greatly undervaluing the exchange.

But don’t be mistaken; the equities market is just a part of the bigger picture of London and New York City’s greater rivalry. For example, in just a time span of year, London increased it share of the hedge-fund industry from 21% in 2005 to 26% in 2006. The same combination of cost effectiveness, metropolitan resources, availability of ample support services and its status as the epicenter of European trade and commerce has helped London get increasing business over the past couple of years at an ever accelerating pace. While Britain may still have the Pound as its national currency, more Euros change hands in London for dollars, yens and pounds than in all other EU countries combined. With so much business for both bankers and money managers, London’s workers raked in $17.2 billion in bonuses alone last year. All this transfer of money has seen property prices rise by more than 10% in the London metropolitan area last year. WSJ recently reported that property in London’s most preferred areas went for as much as $2,863 per square foot, almost 63% more than luxury condos in Manhattan. Many of those who purchase into the city’s real estate market are foreigners. While Americans have been big investors in foreign countries, we have failed to get enough FDI inflow into our own cities. The British have managed to drive forward elaborate plans to invest in emerging countries while also securing FDI for their own country. Consequently, London has prospered

And the advantages of London go on. It has long been the complaint of many in the industry that due to America’s immigration policy it is becoming increasingly hard to find adequate supply of fresh talent that is needed by the financial services industry. London, with less stringent immigration standards, can boast of a much larger pool of talented candidates. Not only this, but London’s advantageous geographic location allows it to start the day trading with Tokyo and end it trading with New York.

But this rapid advance of London is not unknown to those in New York. SEC already has in the works measures to ease the burden on companies with the introduction of Sarbox. Mayor Bloomberg was in London a few months ago to meet with his counterpart to further enhance the close relationship that the cities share and at the same time observe first hand the strides that London has made over the past couple of years, including winning its 2012 Olympics bid. London and New York City can learn from each other but, at the same time, they must be wary that in an increasingly globabalized world with the rise of other cities such as Honk Kong, Tokyo, Singapore and many others, they can’t possibly expect to retain their burgeoning share of the world’s financial services sector. For now, New York City retains its title as the financial capital of the world. And anyways, Adam Smith wouldn’t mind some healthy competition between two leading cities of the 21st Century.