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The Future of the City of London

I've seen a couple of bits of commentary in the past week about the City of London losing its strength, namely:

City's dominance in doubt (Telegraph)

London Ponders Its Future as Financial Powerhouse (New York Times)

During the boom years of the 2000s, London competed with Frankfurt and New York to become the financial centre of the world — and won. Michael Bloomberg hired McKinsey to see what was happening to Wall Street in 2006 and their subsequent report admitted defeat to London’s financial strengths. Frankfurt meantime stuttered and coughed on London’s sheer dominance.

The question these articles raise is whether the City's strength can continue or is it a busted flush as a result of the financial crisis?

To answer such a question we have to go back to the deregulation of the City back in the 1980's under Margaret Thatcher, the so-called 'Big Bang'.

Following the dramatic changes of October 1987, when the City was dramatically restructured into an electronic trading playground, London has been one of the most open and transparent markets in which to partake in financial activities anywhere in the world.

The result has been a massive rise in employment in our financial markets and related expertise, with 420,000 people working in financial services in the City and Canary Wharf, and a further 300,000 people in related services from technology through legal to hospitality services.

Such success has been a major driver of the UK economy, with financial services contributing a major slice of the UK’s GDP. For example, at the peak of the industry’s growth in 2007, British banks represented over 1 million jobs; £70bn of the UK’s national output or 6.8 per cent of GDP; and 25 per cent of the country’s total corporation tax (£8bn).

Then Northern Rock imploded soon to be followed by the major market meltdown of September 2008 that resulted from Lehman Brothers collapse, itself caused by its exposure to the credit default swaps market that had reached $62 trillion in 2007 from a mere $1 trillion in 2001. It was this market’s failure that caused the world to pump $5 trillion into the system to try to revive the global financial sector.

Many say that this is now resulting in a change of outlook and the end of Capitalism. If that’s the case, is London’s hey-day gone? The answer is: ‘of course not’. Just because banks and bankers have a bad name right now does not mean that all banks and bankers are bad. The rotten apples are a small number compared to the hundreds of thousands who work in the City and the high level of skills they contribute.

A decade ago, when LIFFE failed to compete with Eurex and Frankfurt dominated the European derivatives and futures markets, it was believed that London was a busted flush but now more people work in the City than populate Frankfurt. London’s competitive advantages are clear: location, skills, knowledge, expertise and access. Nowhere else in Europe has such density of capability and London also is the centre of an English-speaking country that forms the bridgehead for an English-speaking world. The density of our knowledge base and the degree of openness have been a critical differentiation for the City in our past, and will be in our future.

Though London’s light-touch, principles-based self-regulating approach, which made it the ‘easy-to-do-business-with’ centre of the trading world, is now broken, that system is broken across the world. And the fact that the FSA failed in its duties, and the triumvirate approach of the FSA, Treasury and Bank of England failed, is not a matter unique to the UK. The SEC failed in America, as did their triumvirate of the SEC, Treasury and Federal Reserve.

Equally, you could point to failings in the European Central Bank and their associated authorities. This still does not take away, reduce or substitute the City’s unique features of skills, knowledge, expertise and access all in one location in an English-speaking hub.

The City’s reputation has been damaged but it is not a mortal wound, just a scar left by a joyride led by Wall Street which London pursued blindly in order to keep up. Henceforth, common sense must dictate that if you see a joyride, don’t get on it; if you see a bandwagon, don’t get on it; if you are on a rollercoaster, try and get off. The fact is that the financial markets move in a herd mentality and if you irrationally join that herd because everyone’s making money then you know something’s wrong.

That’s why so many seasoned investors looked at the internet boom of the 1990s and said it wouldn’t last, and it didn’t. Warren Buffet referred to complex derivatives as ‘weapons of financial destruction’ back in 2002 and so they proved to be. And that’s why everyone said the housing market boom and consumer-based demand-led economies of Britain and America were unsustainable, and they were. They were just fuelled by the irrational exuberance of a flawed risk model for credit default swaps in the shadow financial markets and leverage.

What is the future for the City of London’s financial marketplace? Answer: about the same but with two big changes.

The first change is that the Bank of England is gaining much greater powers through the Banking Act of 2009 and can now ask tough questions of those operating in the UK. The Bank will need to focus very heavily on looking for unsubstantiated profits and growth in the financial markets. The unchecked irrational exuberance of a bubble blowing must be caught early by checking to see whether there is actually any underlying collateral creating the bubble or whether it is all just air.

The unchecked exuberance of both the internet and credit bubbles were obvious; it is just that no-one asked the tough questions of where the collateral was to fuel such booms. The Bank must be the one to ask those questions in the future and then be even braver: to pull out of the boom before it bursts.

The hardest part about living in a boom is to turn your back on it and, even worse, to have to tell those national institutions involved in such hedonism to give it up.

But the Bank’s role in the future must be to actively seek out such hedonism and burst it, control it and keep it in check. The official national party pooper, in other words.

The second big change is that the City must no longer look to America for its leadership, but must actively become neutral in its standing in the world. Every country and nation should be treated as an equal player on the City’s stage, subject to that country’s credit, ethical and moral ratings. The City must be as easy-to-do-business-with for the Chinese and Indians as the Americans and Europeans. The City should actively engage in building infrastructure and capability to trade as a preferred destination for developed economies as well as those that are emerging, subject to those countries’ credit, ethics and moral issues.

The City has a strong future as an open trading centre for the world’s financial markets as long as the supervisory bodies have the guts and the teeth to regulate effectively and the institutions have the appetite and the ability to embrace all economies on a neutral basis.

Given those caveats, I believe the City of London will be thriving and successful for many years to come.

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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