TheGreatGame ClusteringinWholesale FinancialServices · TheGreatGame:Clustering...

TheGreatGameClustering inWholesaleFinancial ServicesDRMALCOLMCOOPER

2 – 2011FinancialCentre Futures

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TheGreatGame:ClusteringinWholesale Financial ServicesDRMALCOLMCOOPER

TheGreatGame: Clustering inWholesale Financial Services 1

CONTENTS

Preface 3

Foreword 4

Financial ServicesClustering:The Paradox 5

Cluster Theory:The Basics 8

TheModernCluster:A Stylised Model 11

AHistoryofClusters: From Medieval to Modern 24

BuildingaCluster:The Role of the State 30

Financial ServicesClustering:Continuity and Change 32

InformationTechnology:Revolution or Acceleration? 34

PeoplePower:The Forgotten Factor 37

TheDurableCity: From Coffee Shop to Gherkin 40

Conclusions:Cluster Formation and Sustainability 47

Bibliography 51

Endnotes 52

Malcolm is an historian by training, and has spent his entire career in the research profession, dividinghis time between academia, the City and public policy/economic development. He holds a First ClassBachelor of Arts in History from Dalhousie University, a Master of Arts in History from the University ofWestern Ontario, and a Doctorate of Philosophy in Modern History from Oxford University.

His thesis on the formation of the Royal Air Force was subsequently developed into a book, The Birth ofIndependent Air Power, and published in 1986. His early career included a Research Fellowship atDowning College, Cambridge, a teaching post at the Memorial University of Newfoundland, andmanagement of the research programme of the Institute of Chartered Accountants in England and Wales.

He then moved into investment banking, serving as Head of Research at Carnegie International, SeniorEmerging Europe Equity Analyst as S G Warburg, before ending this phase of his career as Head ofEmerging Europe and Middle East Research at ABN AMRO. Malcolm then moved to the public sector,becoming the City of London Corporations first Head of Research and overseeing a programme ofindependent research centring on economic development, competitiveness and regulatory issues. Hislast post before setting up Athena was as Head of Research for the independent public policy think tankCentre for Cities.

Malcolm was the first foreigner to take up coverage of the Istanbul and Athens stock markets and spentmost of his investment banking career in European emerging markets. Most of his subsequent workhas concentrated on financial service competitiveness and innovation, and on UK public policy,particularly in the area of economic development within UK Cities.

Malcolm has published widely, including books on British air policy, maritime history, and auditingpractices, and articles in journals ranging from International Affairs and The Journal of ContemporaryHistory to Local Economy and The Journal of Urban Regeneration and Renewal. Malcolmcommissioned and worked with Z/Yen on the Global Financial Centres Index, and has since writtenseveral pieces on the impact of the recession on financial services employment in the UK.

He has recently published 'In Search of the Eternal Coin: A Long Finance View of History' and hasco-authored three papers aimed at promoting greater collaboration between the scientific andfinancial services communities in the increasingly important areas of forestry, water, and biodiversityand ecosystem services.

About theAuthor

AcknowledgementsThe author would like to thank Neil Blake, Brandon Davies, Lynton Jones, Professor Michael Mainelli,Duncan McKenzie, Grant Murgatroyd and Dr Dariusz Wojcik for their contributions to a seminar on anearly discussion draft of this paper; and Brandon Davies, Con Keating, Professor Michael Mainelli,Grant Murgatroyd and Jan-Peter Onstwedder for detailed comments on the draft report itself. He isalso extremely grateful to Mark Yeandle, Jez Horne and Stephanie Rochford at Z/Yen for their helpthroughout the project.

DrMalcolm Cooper

2 TheGreatGame: Clustering inWholesale Financial Services

Having been a strong supporter of Long Finance since its establishment, I am very pleased to write thepreface to this publication on the subject of clustering in wholesale financial services. In it, Dr MalcolmCooper brings both his analytical and explanatory skills to a very important subject.

I am writing this in Singapore, a tiny country that 40 years ago had the same GDP per head as Uganda.Now it is the third richest country in the world, with GDP per head of $57,238 in 2010, according tothe IMF, ahead of the US, Japan, Hong Kong and Switzerland. It has achieved this success by exploitingits geographic location, the vision of its leaders and the expertise of its people. Financial servicesclustering on a regional – and increasingly global – basis has been one of the main drivers of thisprosperity.

The UK economy dwarfs that of Singapore and London is a much longer established global financialcentre. While London has taken full advantage of its time zone, acting as a bridge between Asia,Europe and North America, its other historic advantages are increasingly open to all comers:Singapore, like New York, conducts its business in English under English Law (or laws that are verysimilar) and uses internationally accepted standards for accounting and much of its financial servicesregulation. Most importantly, as an educated and experienced financial services workforce becomesincreasingly international and mobile, the key ‘people’ factor is becoming less of a differentiator.

It is fashionable to ask whether this matters. Does the UK – or any other country – need a strongfinancial services industry, a sector that politicians and the public deem responsible for the economicpain of recent years. Could they not compete in other industries, such as high tech manufacturing orrenewable energy? As Malcolm points out, the financial services industry – largely through the wagebill of its employees and those of the accountants, lawyers and advisors that service it – pays an awfullot of tax. Building a similar position and reputation in industries where there is considerablecompetition and no discernable advantage will be challenging to say the least.

Malcolm’s contribution to this topic is considerable. The future may or may not be like the past but,whatever it is, we as a nation are going to have to find our place in it and – taking the long view –decide just how we are going to do this. If established centres rest on their laurels or regulate awaytheir competitive advantage, there are myriad other clusters willing to take their place. It is animportant discussion that will determine the future prosperity of many countries and, as such, it needsto be informed. In this paper Malcolm has set a very high standard for the debate.

BrandonDavies,Board Director, Gatehouse Bank plc

Preface


The only industry that isn’t clustering these days seems to be the clustering industry. Clusters are all therage for policymakers and are popping up everywhere. When you consider the location parameters oftwo similar firms – their customers, suppliers, infrastructure, people, regulation, tax and so on – itwould usually seem more peculiar that they deliberately choose different locations, rather than thatthey cluster around the same location. I am, of course, ignoring excludable goods, saturated markets,monopolistic resources and a number of other issues; but it is interesting that many people seem tolaud clustering as a profound insight into economic development. Thus, it is exciting for Long Financeto have Dr Malcolm Cooper challenge some of the over-simplifications and circularities in the thinkingon financial clusters.

For me, perhaps the most illuminating observation in Malcolm’s paper is that clustering forces maywell be strongest in one of the most weightless of industries – financial services. In fact I have oftenwondered why there should be more than one global financial centre. Malcolm reminds us that anindustry that makes money from volatility only thrives in conditions of stability, particularly political,regulatory and tax certainty. Malcolm highlights the fact that established financial centres are lessprone to revolution or conquest than their rivals. I have argued that the attraction of London,historically and globally, is its tradition of ‘not treating foreigners unfairly’.

Business people and policymakers talk about certainty, but they frequently confuse the desire forcertainty with a desire to maintain the status quo. Business people know that rules must evolve, butwant certainty about the way rules are made, changed and enforced. Business people don’t mindcompetition, but they want to know that competition will be fair. Business people don’t mind rulechanges for fairer markets, but do mind capricious rule changes for electoral gain or to fill depletedstate coffers.

Financial clusters seem an easy win for policymakers. They have low investment costs (mostly rewritingrule books) and attract lots of high-paying jobs (it would be interesting to see how keen they would beon developing financial clusters if the jobs they created had average pay rates). While Malcolmquestions policymakers’ abilities to create financial clusters, he certainly doesn’t question their abilityto nurture them. For policymakers in aspiring financial centres, the gauntlet that Malcolm throwsdown is to create a stable regime while growing. Malcolm points out that policymakers in leadingfinancial centres must be careful not to kill the goose that lays the golden egg. The challenge forestablished and emerging centres is to create and maintain the conditions that will allow financialclusters to grow and flourish. It is a game that few policymakers want to lose. For both, Malcolm’spaper is required reading.

ProfessorMichaelMainelli,Executive Chairman, Z/Yen Group Limited.

Foreword

“The sun, with all the planets revolving around it, and depending on it, can still ripen abunch of grapes as though it had nothing else in the universe to do.”Galileo Galilei


In an age when every aspect of modern livinghas been re-shaped by the increasing power,range and sophistication of informationtechnology (IT), the international financialservices industry stands out as havingexperienced the most profound transformation– it is now almost entirely based on IT platformsand digital communication networks. But thereis a profound paradox. In most other cases, newtechnology has had a centrifugal effect:members of parliament stay in touch with theirconstituents via websites and blogs, rather thanpersonal appearances; many workinghouseholds rarely visit a supermarket, preferringinstead to shop online and have their groceriesdelivered; multinational companies havedeliberately de-centralised management,product and supply chain infrastructure,exercising operational control throughproprietary information and control systems.Despite its almost total dependence on IT, theinternational financial services sector has movedin the opposite direction.

The IT revolution should pose a great threat totraditional financial clusters and should alreadybe leading to their fragmentation. With littlemore than a laptop and a satellite phone it ispossible to carry out any financial transactionsitting on top of a mountain thousands of milesfrom a financial marketplace. Whilst manyinvestors lack the physical attributes to get tothe top of a mountain, they can – and do –transact their business electronically, remotefrom any intermediary, exchange orcounterparty. Traders in most financialinstruments no longer need to leave their owndesks to execute client orders. A largeproportion of daily volume in most large capstocks is generated by computer programmesthat react automatically to price movements,seeking to generate returns by exploiting smallpricing asymmetries, trading in and out of largepositions in timeframes measured in fractions ofseconds. Human ingenuity is required to writeand adapt the programmes, but intervention is

only necessary when a systems failure needs tobe rectified.

If the need for human intermediaries to interactdirectly with each other was the first pillar ofpre-computer financial clustering, the need toaccess market-relevant information was thesecond. The desire for timely and reliableinformation – one of the two raw materials offinancial markets, the other being capital – wasthe driving force behind the formation of thefirst modern exchanges in the late 17th century.Both Lloyd’s of London and the London StockExchange had their origins in City coffee shopswhere market participants would seek andexchange information on investments and thenews that affected their value.

Information is now distributed worldwide insomething very close to real time. Not only isthis information accessible from just aboutanywhere, there is a great deal more of it.Regulatory demands have produced moredetailed, regular and dependable disseminationof data on financial strength, operationalperformance and an increasing array of otherdisclosures, from directors’ remuneration andshare dealings to environmental impactassessments. Information itself has become aglobal market, occupied by the large dataproviders such as Reuters and Bloomberg and ahost of specialist consultancies operating inalmost every corner of the investible universe.

An unstoppable force?In an environment where markets seem close tobecoming ‘weightless’, location and distanceshould logically have become far less relevant.Traditional international financial centres suchas the City of London and Wall Street ought tohave been fragmenting or fading away. In fact,the opposite has occurred: large, highlyconcentrated financial centres have becomeincreasingly global in their reach, growing at theexpense of smaller regional competitors.

FinancialServicesClustering:TheParadox

CHAPTER 1

“In most cases,new technologyhas had acentrifugaleffect but,despite itsalmost totaldependence onIT, theinternationalfinancialservices sectorhas moved inthe oppositedirection.”


Market share figures for London, the world’slargest and most competitive internationalfinancial centre, are particularly compelling.London emerged as a global financial centrebecause of its place at the centre of the largestcolonial empire and trading network in theworld. Whilst these factors are no longerpresent, London has maintained its financialprimacy. Its share of international foreignexchange markets, for example, is 37% – largerthan its two closest rivals, New York and Tokyo,combined; its share of over-the-counter (OTC)foreign exchange derivatives is 46%; theLondon Stock Exchange has more foreign listedcompanies than any other exchange in theworld; and the London Metal Exchange is thelargest non-ferrous metals exchange, whileother institutions occupy leading positions inequity options and electronic trading for globalenergy markets.1

The continued strength of London’sinternational cluster is clear from thecompetitiveness rankings in the Global FinancialCentres Index (GFCI). London’s score of 775 ismore than 100 points above that of Chicago in7th place, 150 points above Vancouver (22ndplace), 200 points above Sao Paulo (44th place)and 250 points above Buenos Aires and Lisbon(equal 64th place). Only New York with 769points and Hong Kong with 759 are within 50points of London (although Singapore in 4thplace falls short by only 53 points).2 London hasmaintained its top ranking since the GFCI waslaunched five years ago, despite the physicaland reputational damage caused by thefinancial crisis of 2007-2008.

A final measure of London’s continued strengthas a global financial centre is its banking sector.UK banking sector deposits are the third largestin the world, despite it having only the sixthlargest economy. Half the deposits are managedby foreign banks which had 241 branches andsubsidiaries in London in 2010. The

combination of domestic strength and foreignpresence meant the UK banking sector wasresponsible for 18% of cross-border lending,the largest share of any country in the world.

Lessons fromhistoryLondon’s continued primacy appears to presenta second paradox. The City’s rise to globaldominance was achieved on the back ofBritain’s emergence as a great power in botheconomic and political terms. The coreinstitutions of the 18th and early 19th centuries– the London Stock Exchange, the merchantbanks, discount houses and the Lloyd’s maritimeinsurance market – all rose to prominence asBritish naval power cleared the way for thenation’s merchant fleet to dominate theexpanding ocean trade routes. The IndustrialRevolution transformed its economy into the‘workshop of the world’, producing a massexport trade and generating large surpluses ofcapital for re-investment at home and abroad.Finally, having lost much of its first overseasempire as a result of the American War ofIndependence, Britain built up a second, farlarger one over the course of the 19th century,including the entire Indian sub-continent,Australia, New Zealand and more than a third ofAfrica. It played the leading role in the westernpenetration of China, gaining a strategic base inHong Kong, and building up significant tradingnetworks based around Treaty Ports such asShanghai and Ningpo. By the late 19th centurythe City was not only operating as the financialhub of this vast portfolio of home-controlledmarkets, but as a platform from which Britishcapital could be deployed to finance a multitudeof enterprises around the world.

Britain’s global economic position deteriorateddramatically in the first half of the 20th century.Other countries, notably the United States andGermany, began to challenge her industrialcompetitiveness, and although the First WorldWar temporarily removed Germany from thescene, it severely dented Britain’s economywhile stimulating acceleration in the US. Britishindustry was only beginning to recover from theravages of the Great Depression when theSecond World War broke out. Britain’s fiscalresources were rapidly depleted after its mainEuropean allies were defeated by Germany and,

“London emerged as a global financial centrebecause it was the centre of the largest colonialempire and trading network in the world and,whilst these factors are no longer present, theCity has maintained its primacy.”


even before the US entered the war in late 1941it was already subsidising the British war effortvia the Lend-Lease programme, which grewsteadily until victory was achieved in 1945.

Although the domestic economy graduallyrecovered in the 1950s, it was never more than ashadow of its former self. The dramaticimplosion of Britain’s colonial empire in the post-war period, led by India achieving independencein 1947, continued to weaken the UK economy.Residual assets such as a large merchant fleetand a number of large, well-establishedmultinationals delayed the inevitable, but by the1960s most of the actors that had originallysupported the City’s position at the centre of theworld’s financial system had departed.

Far from losing its position, the City’s role asleading actor became more complex and moreprominent. London became the centre of thenew Eurobond market, due in no small part tothe fact that there were large dollar depositsheld in European banks to avoid potential USpolitical risk. The first Eurobond, aninternational bond denominated in a currencyforeign to the country in which it is issued, was a$15m six-year loan arranged by SG Warburg forItalian motorway operator Autostrade in 1963.As foreign exchange controls were progressivelylifted during the 1970s, the City emerged as thelargest player in a rapidly growing market that isnow approaching an average daily turnover of$4 trillion.

The ‘Big Bang’ de-regulation of 1986 wasanother boost to London’s primacy. Foreignbanks, particularly from the US, arrived in theCity in increasing numbers but rather thandivert business back to their home country, theysought to establish a position in the Londonmarket. While the bulk of the British-ownedinvestment banking sector was swallowed upover the next decade by these new arrivals, the

re-branded institutions remained firmlyanchored in a financial cluster whose globalreach was enhanced by the multinationalnature of its ownership base.

A vision of the futureSo why has London’s financial services sectorcontinued to cluster – at an increasing rate – inthe face of a technological revolution thatshould not only be weakening the forces thatgrew its clusters together in the first place, butappears to offer obvious advantages for de-centralisation? Why have the two pillars of theold financial order, London and New York,retained their position as the world’s premierglobal financial clusters in the face of the re-balancing of the world economy triggered bythe rapid growth of ‘new’ economies, inparticular those of China and India?

This paper will address these apparentparadoxes through a multi-level analysis ofinternational financial services clustering. Wewill begin with a brief summary of cluster theoryand its application to financial services beforeattempting a more detailed analysis of financialclusters by building a stylised model of thefactors that contribute to their formation andfragmentation. Today’s financial universe is aproduct of its history, so we will therefore followour modelling exercise with an historical survey,beginning with the medieval bankinginstitutions to which 18th century institutionssuch as discount houses and stock exchangescan trace their roots (though the history offinancial intermediation in cities dates backthrough the Bronze Age).

We will combine the results of our clustermodelling with our historical analysis and applyit to the contemporary global financial centresuniverse as defined by the GFCI. We will pay agreat deal of attention to London, not becauseof any attempt to produce a definitive analysisor health-check on the City, but becauseLondon, as the world’s first global cluster and itsleading global cluster today, provides the mostobvious point of reference for charting financialcluster growth and competition.

“British-owned investment banks were swallowedup in the 1980s and 1990s by foreign rivals, butthe re-branded institutions remained firmlyanchored in a financial cluster whose global reachwas enhanced by the multinational nature of itsownership base.”


Although its intellectual roots stretch back intothe late 19th century, the concept of the industryor business cluster was developed andpopularised by Harvard academic Michael Porterin his 1990 study The Competitive Advantage ofNations.3 Porter defined clusters as:

“Geographic concentrations of interconnectedcompanies, specialist suppliers, serviceproviders, firms in related industries, andassociated institutions (for example,universities, standard agencies, and tradeassociations) in particular fields that competebut also co-operate.

A cluster is a form of network that occurs withina geographical location, in which the proximityof firms and institutions ensures certain formsof commonality and increases the frequencyand impact of interactions.” 4

There is now an extensive library of work todescribe what is a very simple premise.Businesses in the same field will tend to clustertogether in places where resources and locationoffer competitive advantages. These businesseswill in turn attract interconnected supportindustries and the overall effect will be toincrease cluster productivity, stimulateinnovation and act as a magnet for other firmsin the same sector seeking to benefit from theseadvantages.

In its most basic form, this sounds obvious.Hybrid disciplines – economic geography in thiscase – sometimes strain to develop theoreticalframeworks to guide their research, which canproduce highly suspect generalisations, such as

the assertion, taken from the introduction toHarvard’s own Institute for Strategy &Competitiveness website, that “clusters arisebecause they increase the productivity withwhich companies can compete.”5 Thisstatement might be mixing cause and effect.Clusters emerge because of a combination ofeconomic, business and human factors, whichin turn improve productivity, which thensustains cluster growth.

Much of the impetus for the development ofthe industrial clusters of 19th century Britaincame from the exploitation of steam power,with the result that the clusters themselves grewup close to the country’s major coal deposits inthe North of England. The critical second stagefollowed in which specific industry-centredclusters emerged, for reasons that were partiallygeographic and partially historic. Yorkshirebecame the centre of an industrialised woolindustry that had its roots in pre-industrial woolproduction, while Lancashire, with better accessto the great trading port of Liverpool, becamethe centre of a cotton industry entirelydependent on imported raw cotton.

Any systematic survey of the emergence ofdifferent clusters in different industries over timewould make it clear that the only safegeneralisations that one could make on theemergence of clusters is that they are driven by amixture of geographical, resource, technologicaland trade factors, and that, in the case of the lastof these drivers in particular, the role of the statehas been important. In the pre-modern era, thestate generally shaped clusters throughprotectionism and restrictions on trade, while inthe colonial era the development of industrialclusters was tied closely to state control andexploitation of overseas markets. The Lancashirecotton industry is a case in point: much of itsimported cotton came from British-controlledIndia, while the same colony was a major marketfor finished goods. Taking all this into account, itwould seem safer to modify the original

ClusterTheory:TheBasics

CHAPTER 2

“Any systematic survey of the emergence ofclusters would make it clear that the only safegeneralisations that can be made is that they aredriven by a mixture of geographical, resource,technological and trade factors.”


assertion and posit that clusters grow ratherthan arise because of benefits of co-location.These benefits include economies of scale, theconcentration of supporting infrastructure, theability to attract both labour and talent and theimpact they have on accelerating the diffusion oftechnology and ideas.

It is important to point out that much clusteranalysis depends heavily on ‘20:20 hindsight’. Inthe 1880s the financing of British enterprise inIndia was heavily clustered on the west coastaround Liverpool and the Lancashire cottonindustry, and the east coast around London,home to the successors of the now defunct EastIndia Company. A decade before, however,Glasgow was pressing hard for financialprimacy, particularly in the development ofindustry in India’s major west coast port,Bombay. The collapse of the City of Glasgowbank in 1878, brought on largely by over-speculation in colonial investments, effectivelydestroyed Glasgow’s international financialcluster and ended its involvement in foreigntrade finance. There was nothing inevitableabout Glasgow’s fall: it was the product of badmanagement by a small banking elite and thefailure of counterparties to protect themselveswith limited liability.

What is a cluster?Two specific issues involving the application ofthe clustering concept are worthy of specialnotice. First, it can be easy to confuse clusteringwith what is actually ongoing urbanisation.Cluster theory makes a great deal of theagglomeration benefits of clustering, whichsees the growth of individual clusters producinggrowth in other industries, but this is a chickenand egg situation. The extent to which industryclusters stimulate urban growth, as opposed tobeing attracted to a growing metropolis, is afunction of the relative maturity of the economyin question. While the growth of high-techindustry in Bangalore might fall into the first

category, the growth of similar companies alongthe M4 corridor between London and SouthWales is clearly in the latter.

The financial services industry provides anexcellent example of apparent clustering actuallybeing the result of urbanisation. Financial andrelated business services are the largest privatesector employer in every sizeable British city. Inmost cases, however, they are there simply tomeet the needs of the population, and are nomore clusters than general retailers on the HighStreet. Regional clusters do exist where thecombination of attractively priced office spaceand an educated workforce has pulled togethergroups of call centres and asset-servicingfacilities, but these lack many of the dynamics oftrue financial clusters.

The work of scholars in the late 1990s helpsidentify different theoretical models ofclustering. A particularly useful piece of analysisidentified three distinct cluster models. Twowere derived from conventional economicthinking which defined clusters either as ‘pureagglomeration economies’ or in terms of an‘industrial complex’, a form of geographicconcentration of a traditional input-outputmodel. The third was a ‘social network’ model,with its intellectual origins in the field ofsociology, defining a cluster in terms of anetwork or ‘club’ in which the dominant driverswere essentially human.6 This typology isextremely useful, not because it is usually easyto fit a given cluster into one category oranother, but because it provides a simple way ofclassifying and measuring the relativeimportance of inputs that are likely to bepresent in most well-developed clusters.

The visible handThe second issue involves attempts to createclusters through public policy intervention.‘Cluster policy’ has become one of the majortools of economic development programmes. In

“The extent to which industry clusters stimulate urban growth – asopposed to being attracted to a growing metropolis – is a functionof the relative maturity of the economy in question.”


“Clusters are dependent on theexistence of economic pre-conditions and will onlysucceed if they generate aviable and self-sustainingmixture of economic and socialinputs and outputs.”


the UK, the New Labour government expendedconsiderable time and money attempting tocreate new business clusters as part of itsregeneration agenda. The returns have beenmediocre at best.

The bulk of the ‘clusters’ incubated wereextremely small and only a minority have shownsigns of sustainable growth, generally becauseof a failure to take into account the full range offactors affecting cluster development. Clustersdepend on the existence of economic pre-conditions and will only succeed if theygenerate a viable and self-sustaining mixture ofeconomic and social inputs and outputs. In theabsence of such factors, they are highly unlikelyto take root, let alone flourish. It is insufficient toidentify a broad industrial grouping such as lifesciences as a growth area and then attempt tospin off clusters from any university with someexpertise in the subject.

We will apply these lessons to the newinternational financial services clusters that havesprung up over the past two decades as a resultof state intervention to attract inwardsinvestment, normally through the provision oftax incentives and the development of anundemanding regulatory regime. These newcentres were tested to a greater or lesser extentby the Credit Crunch of 2007-2008.

The most comprehensive academic study offinancial services clustering, Financial ServicesClustering and its Significance for London, is thestarting point for our analysis of clusterdynamics. Written by academics fromLoughborough University and the University ofManchester and published by the City ofLondon Corporation in 2003, the report takesan orthodox, Porter-driven view of clustering toproduce a reasonably sophisticated supply anddemand model of clustering:

“On the supply side, large and complex financialservices firms need access to large pools ofspecialised labour. Thus we observe thatinvestment banks are almost exclusively basedin financial centres such as London, New Yorkand Frankfurt. This point is reinforced firstly bythe fact that financial services skills are in largepart acquired by shared experience... andsecondly by the increased pace of innovation infinancial services. This has further raised theimportance of tacit knowledge, which is moreeasily exchangedwhen agents aregeographically close...

“Another supply-related explanation forclustering arises from the reliance of financialservices firms on a vast array of supportingservices... and again these are most prevalent inmajor financial centres. Related to this, the co-location of associatedmarkets... leads toeconomies of agglomeration resulting inimproved flows of information, greaterefficiency and higher liquidity. The importanceof economies of scale has also increased inrecent years, driven by the increased use ofinformation technology. This new technologyhas enabled rapid innovation following apattern... in which financial services innovationoccurs in a ‘reverse product cycle’ manner (thatis, the process of innovation is preceded by theadoption of new technologies developed inother sectors).

“Three distinct characteristics of services ingeneral – that they are consumedsimultaneously with their production, cannot bestored and are intangible – imply an extensiveproducer-consumer relationship and underliemany of the demand-side benefits of financialservices clustering... Thus we observe newentrants preferring to locate in recognisedfinancial districts. Also, the bespoke nature ofsome financial services... requires a closesupplier/customer relationship built on the trustthat can only be generated through frequentface-to-face contact. The producer-consumerrelationship can also be amajor source ofinnovation. Finally, positive reinforcement canbe observed. Liquidity attracts further liquiditybuilding the cluster’s reputation as it grows.” 7

While this analysis provides a fair description ofhow financial service clusters function, it is lessconvincing on the dynamics that governcompetition between them, and thus ultimatelyfails to fully explain the process of clusteringitself. To do so it is necessary to look at each ofthe dynamic constituents of global financialclusters in depth and explore how they interactwith each other to determine bothcompetitiveness and durability. We haveidentified ten features that define a cluster:

1. SpecialisationSpecialisation is the central component of anycluster. It can be broad – wholesale financialservices in London – or narrow – private bankingin the Swiss financial centres – but it defines theindustry or service in which the sectorcompetes. Specialisation is also a useful tool foridentifying smaller competitive clusters withinlarge urban economies. It would make littlesense to claim that London has a retail cluster,but it could be argued there is a fashion clusterin the West End or a jewellery cluster aroundHatton Garden. It is important to point out herethat there are some industries where clustering

TheModernCluster:AStylisedModel

CHAPTER 3


is simply not an issue, such as UK food retail,which is dominated by four large companies butby its very nature not clustered.

Beyond general specialisation in wholesalefinancial products there is a level of narrowerspecialisations. The full range is too wide to belisted here, but it includes equities, bonds,derivatives and commodities. Twocharacteristics of global financial clusters arethat they deal in a common range of financialproducts and use a common language todescribe them, though the composition ofindividual clusters will feature a mix ofspecialisations. London, for example, is theworld leader in non-ferrous metals trading(90% market share), international bondstrading (70%), over-the-counter (OTC) interestrate derivatives (46%) and foreign exchangetrading (37%).8 London’s nearest rival, NewYork, enjoys a huge advantage in equitiestrading, in part because of its advantage inforeign equities trading, but primarily becauseWall Street is the centre of a domestic equitiesmarket that dwarfs its British equivalent.

The Global Financial Centres Index (GFCI)employs an extremely useful methodology ofclassifying second tier global financial centres interms of their depth or breadth. There are threecategories:

• Clusters that are both deep and broad.• Clusters that are deep.• Clusters that are broad.

Centres in the first two categories pass a simpletest of clustering. To achieve their classification,they must be attracting and maintainingparticipants who both seek and benefit from co-location. Those that are simply broad do notnecessarily past the test. Most are the business(and often the political) capitals of the countryin which they are located. In many cases, therange of financial services activities there issimply the product of there being no alternativenational location, as is the case for Athens,Helsinki, Oslo and Vienna, where these cities arethe major national centre for almost alleconomic activity.

2.MarketplaceThe marketplace is the key feature of anyfinancial cluster. Financial services aretransactional and revolve to a considerableextent around intermediation. These propertiesdistinguish them from most other industryclusters, where the driving forces are more likelyto be access to resources, a common product orhighly specialised innovation. Before the ITrevolution the marketplace was a physical entityand, in larger centres, an interconnected web ofentities. The usual core of any financial centre isthe exchanges on which instruments such asequities, bonds, derivatives and foreigncurrencies can be traded. The degree to whichthese are integrated is variable. In London, forexample, the equities, derivatives and foreignexchange markets are inter-related, with pricemovements on one likely to have an impact onthe others, while the re-insurance market builtaround Lloyd’s of London is related to otherinsurance and re-insurance markets, but notdirectly to the other exchanges.

All large international financial services centresare based on exchanges, but they can also havesatellite clusters with other specialisations.Edinburgh, for example, is an internationalcentre for fund management, pensions andinsurance, but it is effectively a satellite ofLondon, where most of its constituents actuallytransact their business. Another class of satelliteprovides a specialised service to a range oflarger centres. Examples include the extremelystrong private banking centres of Zurich andGeneva (which normally rank about 10th in theGFCI), and offshore centres such as Jersey to

“Specialisation is the central component of anycluster. It can be broad (wholesale financialservices in London) or narrow (private banking inSwitzerland) but it defines the industry or servicein which the sector competes.”

“Financial services are transactional and revolvearound intermediation. This distinguishes themfrom other industry clusters, where the drivingforces are more likely to be access to resources, acommon product or highly specialised innovation.”


Mauritius, whose prime functions are related tothe provision of liberal taxation and regulatoryregimes. Interestingly, all the major offshorecentres are, or were, British possessions.

It is necessary to distinguish between anexchange and a marketplace. An exchange is aphysical entity with physical infrastructure thatis not readily moved. A marketplace is, andalways has been, effectively weightless – itsexistence depends on the choices made bymarket participants. Companies can and do de-list on one exchange and re-list on another, orlist on more than one exchange simultaneously.Investors can choose the markets on which theywish to do business, while intermediaries deploytheir resources in line with the choices made bytheir counterparties.

This distinction is critical to understanding thefierce competition between exchanges, many ofwhich are now listed companies and areincreasingly fighting for a share of a single globalmarketplace. While the exchanges attempt toachieve dominance through mergers andtakeovers, the overwhelming importance of themarketplace makes it questionable whether themega-mergers currently being attempted areactually worth it. Technology ultimately benefitsthe investor and, as one consultant recentlyquoted in The Economist put it, “technology hasmade the idea of a global exchangequestionable rather than compelling”.9

If a given city has no financial marketplace and itis not part of the global infrastructure ofwholesale financial centres, then it does notreally possess a financial cluster. Financialservices is one of the largest private sectoremployers in every British city, but in most casesemployment is made up of a mixture of retailfinancial services to meet the needs of the localpopulation and, particularly in lower cost cities

away from London and the South East, backoffice and support functions. The Leeds cityarea, which stretches across the bulk ofYorkshire and combines ten separate localauthorities, claims to be the second largestfinancial centre in the UK after London, but it isnothing of the sort. It is simply the secondlargest employer of people working in theindustry, the bulk of whom work in regionalheadquarters, telephone contact centres andback office administrative facilities.

We will return later to the larger question of theextent to which the IT revolution hastransformed the physical structure of markets.For now it is only necessary to make two points:international financial centres have existed on acontinuous basis in Western Europe since theMiddle Ages; and these centres have alwaysinteracted with each other and with their clientsover considerable distances. This brings usneatly on to the second key feature of anyfinancial cluster: connectivity.

3. ConnectivityWhile a variable – and often quite significant –proportion of the transactions conducted withina financial cluster are internal, the cluster itselfwould not exist if it was not connected to awider universe. Connectivity can be broadlydefined as a measure of the volume of tradingand the transmission of information betweencentres. These now almost entirely depend onIT, but connectivity retains a distinctly humanside through a steady two-way flow of visitingmarket professionals. All financial centres havea web of connections linking them with marketparticipants in their own country, but aninternational financial cluster’s competitivenessis based on the strength and breadth of itsconnections to other clusters around the globe.

Connectivity has two particular dynamicsworthy of comment:

• The physical constraints or advantages arisingfrom the level of its own IT capacity, such as itsbandwidth and power supply.

• Second are time and time zones. Mostmarkets have regular opening hours and,even if a great deal of work is done outside

“While exchanges attempt to achieve dominancethrough mergers and takeovers, theoverwhelming importance of the marketplacemakes it questionable whether the mega-mergers of exchanges currently being attemptedare actually worth it.”


these hours, it is only when market time zonesoverlap that it is possible to have same-dayconnectivity. Historically London has been themajor beneficiary of this as the beginning ofits business day overlaps with the end of thebusiness day in the Far East, while the closinghours of its exchanges overlap with theopening hours of their counterparts in NorthAmerica. The major exception is the globalforeign exchange market, which operates ona 24/5 basis, although the bulk of tradingactivity falls within normal working hours ofthe three major markets and these are thecritical times for establishing marketmomentum.

4. CriticalMassAny marketplace only becomes viable when itattracts a sufficiently large number ofparticipants. It is important to get the chain ofcausation correct here. It is not a matter ofbuilding a market and then attempting toattract participants, rather market formationarises as a result of participants congregatingbecause of a shared desire to trade and thepossession of a range of goods, services andfinancial resources that are of interest tocounterparties.

To become an established institution a marketmust achieve critical mass. When it does, itbegins to attract new customers and develop aninfrastructure to support and facilitate highervolumes of trade with greater certainty andsecurity. In this context, we will see that earlyEuropean financial clusters grew out of themedieval textiles trade. Textiles were easily themost heavily and widely traded goods in theMiddle Ages, and the development of criticalmass in financial services was a direct result ofsuccessful textiles merchants capitalising ontheir accumulated wealth and trading networksto diversify into banking and trade finance.

Critical mass is the most important factordriving certain financial clusters into positions ofcompetitive superiority over others. Onceachieved, it accelerates the formation of marketinstitutions and attracts supporting businessesthat add to the attractiveness of the cluster. Thesame achievement often weakens rival clusters,whose participants begin to migrate to thelarger marketplaces. While financial marketforces are very important in determining theroute of travel towards or away from criticalmass, they have always been heavily influencedby political and geographic factors. The mostsalient example is London, whose rise to aposition of global dominance in internationalfinance was directly connected to theemergence of Britain as the world’s firstsuperpower. Critical mass is one of the mostimportant reasons why the City has remainedthe premier global financial centre, despite theUK shedding most of the political advantagesthat supported its growth.

5. LiquidityLiquidity is the ultimate measure of critical massand thus of cluster strength. The most basicdefinition of liquidity is the volume of assets thatcan be traded without the trade itself having asignificant impact on price. In equity markets, forexample, it is broadly determined by the rangeand size of the companies listed and, morecritically, by their free float – the percentage ofshares that are not held on a long-term basis byan owner who is unlikely to sell.

In large, mature western markets, most listedcompanies have very high free floats. This tendsnot to be the case in less developed or relativelynew markets, which are dominated bycompanies in which the state or the originalprivate owner has retained a large enough staketo control the company. If the company hasbeen listed to raise a relatively limited amount ofnew capital, or even just its profile, the free-floatcan be very small in percentage terms. Lowliquidity is behind the relatively low ranking ofthe financial centres of some of the world’slarger countries in the GFCI. The ‘BRICs’ (Brazil,Russia, India and China) provide a goodexample: Sao Paulo ranks only 44th and Rio deJaneiro 50th, while Mumbai and Moscow are58th and 68th respectively.10 China’s clusters are

“It is not a matter of building a market andattempting to attract participants. Markets formwhen participants congregate because of ashared desire to trade and the possession of arange of goods, services and financial resources.”


more highly rated, though it is worth notingthat Hong Kong’s third spot is in no smallmeasure due to its history as a BritishDependent Territory and Shanghai’s fifth spot alegacy of its role as a Treaty Port.

Liquidity across all asset classes is essential tosustain a global financial centre. It is nocoincidence that the three established globalcentres before the rise of the new markets ofAsia were London, New York and Tokyo, whichbetween them accounted for roughly two thirdsof all world foreign exchange turnover. Forexmarkets are extremely important because oftheir sheer size. In London the daily averageforex turnover in the fourth quarter of 2010 was£1.8 trillion, compared to just £882 billion forUK equities. The rapid growth of derivatives,particularly OTC derivatives, in the past twodecades has reinforced the liquidity advantageof the established centres, as the derivatives arebased on assets, such as equities, foreignexchange and commodities, that are themselvestraded within the same cluster.

Finally, liquidity is the most important magnetpulling new participants into a financial cluster.Companies will seek listings on highly liquidexchanges to access deeper pools of capital.Investors will gravitate towards the samemarkets because of a desire to be able to tradequickly and in volume without distortingpricing. Intermediaries, particularly market-leading investment banks, will establish apresence in as many of the world’s largestfinancial centres as is necessary to support theirown principal trading activities, to win initialpublic offering (IPO) and mergers andacquisitions (M&A) mandates, and to providebroking, research and new productdevelopment services for institutional investors.Liquidity is also the force that pulls industrialparticipants, such as those with large

commodity or foreign exchange exposures,directly into the financial cluster. If themarketplace is the nervous system of a financialcluster, then liquidity is its blood supply.

6. SkillsPublic perceptions of those employed infinancial services have always tended towardscaricature. The bowler-hatted, be-suitedgentleman of the mid-20th century, whose dayrevolved around lunch, has given way to anunsavoury and irresponsible risk taker with anexcessive lifestyle, who earns huge bonuspayments for making huge bets with otherpeople’s money. This report is not the place todebate investment banking models or bonuses– the point is that these highly-charged imageshave obscured two of the most importantcharacteristics of global financial clusters: theyemploy large numbers of professionals withspecialised skills unparalleled in any otherindustry sector; and they play a vital role refiningthe specific skills required in the sub-sectors ofthe cluster. While financial clusters are tied intonetworks of universities, think-tanks and otherrepositories of skilled labour, it is the clusteritself that turns the potential financier into aprofessional who can be trusted with a job everybit as difficult as flying a jet aeroplane.11

Given that financial markets are now so highlyIT-intensive, it might be thought that therewould be less need for human skills. Theopposite is true. While IT has reduced the needfor manpower in many basic administrativetasks, this has been more than balanced by therange of opportunities that have been openedup by digital technology. However advanced itsapplications have become, IT is still largely anenabling and enhancing tool that requires theapplication of human ingenuity to add value.This has opened the door for people with skillsnot traditionally associated with financialservices. For example, constructing vendiblederivatives is a competitive business thatrequires people with the mathematical skillsrequired to build complex algorithms. As aresult there has been extensive recruitment ofgraduates with degrees in mathematics andphysics, and calls from the financial servicesindustry for universities to increase theirteaching capabilities in these subjects. Similarly,

“Liquidity pulls new participants into a financialcluster. Companies will seek listings on highlyliquid exchanges to access deeper pools ofcapital, while investors gravitate towards thesame markets to trade quickly and in volumewithout distorting pricing.”


structured products require financial expertiseand the accounting and legal knowledgenecessary to construct products that complywith tax and regulatory requirements in multiplejurisdictions.

Ultimately, a financial cluster is only as good asthe people who work in it. In an era when inter-firm job mobility has become the norm ratherthan the exception, financial services stand outas a sector in which the rate of employeeturnover is exceptionally high. Today, the word‘mercenary’ has pejorative connotations, butthis has not always been the case. There areclear parallels between the experiencedspecialist financial services employee of the pre-2008 bull market with the Swiss pike men andhalberdiers who dominated the battlefields ofWestern Europe in the 15th and 16th centuries.Both groups possessed highly sought after skillsthat were in sufficiently short supply foremployers to pay premium rates. Both entered acontract in which the guiding principle wasprofitable employment, not loyalty. As a result,both groups were highly mobile and selective intheir choice of employers.

Both professions have their downsides. In thecase of the Swiss pike man it is a matter of lifeand death – there was a fairly high chance ofbeing killed. The downside for today’sinvestment banker is less obvious, especially tothose outside the industry. In the first place, thephysical and mental demands of the highervalue-added jobs are immense. Employees arepaid very well, but they work exceptionally longhours and make extremely important decisionsin rapidly moving and very stressfulcircumstances. Second, employer to employeeloyalty is no higher than it is in the otherdirection. With profitability driven by turnoverand turnover subject to considerablefluctuations, employers frequently resort tosignificant and sudden downsizing. Mostemployees will experience one or more

redundancies or forced job changes during theircareer. Here the cluster often comes to theirassistance as most new opportunities will befound within it.

The market for experienced financial servicesemployees is global and highly competitive. Thecontinued cohesion of a cluster depends on itsability to attract the best talent when it wants it.Employees are not robots, nor are they all drivenentirely by the size of their pay packet – qualityof life and diversity of its social milieu plays animportant part in determining the attractivenessof a given centre as a place of employment. Sotoo does its reputation. Established globalleaders like London and New York enjoy aconsiderable advantage in the job marketbecause both are global multi-cultural citieswith many amenities, but they also attractprofessionals from all over the world who wantthe City or Wall Street on their CV. A successfulcluster is always likely to have a floatingpopulation of foreign nationals who intend tospend three to five years working there beforedeciding where to put down roots. Theadvantage their presence gives to the clusterwas neatly summed up by a respondent to astudy of London’s internationalcompetitiveness: “If you want a Greek quant,you’d look in London, not Athens.”12

7. Tax, Regulatory & Legal EnvironmentMeasuring the impact of the business and legalenvironment on financial clusters is complicatedbecause the environment itself is multi-dimensional. Three external factors have thebiggest impact on cluster competitiveness: thetax regime, both corporate and personal; theregulatory environment; and the wider legalsystem. Tax and regulation are importantvariables and are subject to change – to thebenefit or detriment of a cluster – depending onwhich way the political wind is blowing. Thelegal environment, however, is the foundationon which a functioning economic system is builtand certainty over the legality and enforcementof contracts is one of the most importantbuilding blocks for any financial centre. While itis important to avoid generalisations here, it ispossible to construct a fair summary of theoptimal mix from a financial marketsperspective.

“The market for experienced financial servicesemployees is global and highly competitive. Thecontinued cohesion of a cluster is dependent on itsability to attract the best talent when it wants it.”


All businesses want low taxes on their earnings,but this does not mean they will rush to re-locatesimply because of the tax regime. Financialservices companies will bear the burden oftaxation as long as it is broadly in line with that ofequivalent centres. They will also place a highvalue on consistency in the tax regime and onthe tax authorities not behaving in an overlyintrusive or arbitrary fashion. All industries wanta degree of certainty in taxation, but financialservices firms also run the risk of being treated ascash cows with their earnings tapped byextraordinary industry levies when profits arehigh. Given that most large financial companiesare multi-nationals with some scope for keepingtheir tax bills low by allocating income todifferent operating sub-units, there is oftengreater concern about personal taxation than itscorporate equivalent. A significant percentageof the sector’s workforce is professionally mobileand will take close account of the way theirearnings will be taxed when calculating the netbenefits of where to work.

Whilst most companies can manage their taxexposure, the same cannot be said aboutregulation, which has become something of aone-way street for the leading global financialcentres over the past two decades. In the UK,the major regulatory impetus has come fromthe European Commission with new directivesaimed at constructing a single level playing fieldacross the EU. They have, however, failed tocreate a single European market in financialservices and their impact on the industry hasbeen to impose heavy cost and time burdensand restrict flexibility and innovation. This hasbeen most keenly felt in the City, whichoriginally had a more liberal regulatoryenvironment than its continental rivals. Despitea reputation for laissez-faire capitalism, the UShas always had a more interventionistregulatory environment. The federal

government is prone to react to perceivedproblems with sweeping legislation that mightbe characterised as ‘shoot first, ask questionslater’. The second Glass-Steagall Act of 1933,which imposed a separation of commercial andinvestment banking, is the best-known exampleand was not repealed until 1999. In addition,the national regulatory body, the Securities &Exchange Commission (SEC), created in 1934,has long maintained a more intrusive anddemanding regime than its Europeancounterparts.

Before the emergence of a multi-centred globalfinancial centres environment, the dominance ofLondon and New York was such that thedamage from regulatory intervention waslimited, with a more liberal City generally beingthe beneficiary of restrictions on Wall Street. Bythe 1990s, however, cross-border regulatoryarbitrage was becoming a global phenomenon.In addition to the traditional use of taxincentives, national governments seeking tobuild global financial centres from the bottomup have made increasing use of liberal regulatoryframeworks and practice to attract businessaway from established markets. Resorting tosuch arbitrage has obvious dangers andmainstream market participants have generallytreated it with caution, if not outright disdain.One contributor to GFCI 9 put it bluntly: “I thinkthat competition between locations from aregulatory perspective could be damaging to theoverall financial services industry.”13

The Credit Crunch made it obvious that a pre-requisite for success in the regulatory arbitragegame was deep enough pockets to weather astructural financial storm. The US and UK wereable – albeit at huge cost to the taxpayer – torescue large banks with massive bad debts.Small centres that had sought marketadvantage through lax regulation and easymoney were swept away. Reykjavik, forexample, is in last place (75th) in GFCI 9, 20points below its nearest competitor. It is a fairjudgement on a centre crippled by insolventbanks unable to repay the billions of depositsthey attracted from Europe with unsustainablyhigh interest rates. Dublin, once on its way tobecoming a genuine off-shore rival to the UK, issliding down the GFCI league table following a

“Given that most large financial companies aremulti-nationals with some scope for keeping theirtax bills low by allocating income to differentoperating sub-units, there is often greaterconcern about personal taxation than itscorporate equivalent.”


wave of unaffordable bank recapitalisations anda massive €85bn EU bail-out, its rating fallingby 13 and its ranking from 4th to 33rd.

The banking crisis of 2007-2008 raises questionsabout a bank’s relationship to its location. Thereis a significant difference between a countrybeing ‘home’ to a bank and a country simplyplaying ‘host’ to it. A ‘home’ cluster effectivelyassumes financial responsibility for its financialinstitutions, while a ‘host’ cluster does not.When something goes wrong the ‘home’country has to pick up the pieces. For example,the investment banking arm of ABN-AMRO wascovered by the UK government’s rescue of itsnew owner, Royal Bank of Scotland, while theDutch bank’s retail and fund management armshad to be re-capitalised by the Dutch andBelgian governments.

Whatever the attractions or otherwise of the taxand regulatory regimes, the legal system is thereal foundation of any financial cluster. It wouldbe possible to write an entire paper on theimpact of law, but the basics can be spelled outin simple terms. Every financial transaction is aform of contract and the certainty underpinningthat contract comes from the legal frameworkand its enforcement. Most financial contractsare based on information provided by one of thecounterparties or assumed to exist by the other.The reliability of the information in forecasts,and the basis on which any assumptions aboutfuture events are made, must similarly beunderwritten by legal clarity about theresponsibilities of both parties. Given that fewfinancial transactions are risk-free, theestimation, potential scope and documentationof that risk are also subject to legalrequirements. International financialtransactions are complex because of thedifferent legal systems in different countries.These differences can be profound and

conceptual, but even if two systems havesprung from a common root there will bedifferences in detail, practice and precedent.

Legal certainty is the single most importantrequirement of any financial market – certaintyover exactly what the law permits, how it isenforced and access to redress if it is violated.Two of the major reasons why many emergingmarkets have significantly higher risk premiathan their established counterparts are that theframework of laws is ill defined and that theirenforcement is not consistent. A widelyaccepted legal system deeply rooted inprecedent and case law is of huge importance inbinding a cluster together and enhancing itscompetitiveness. The City enjoys an incalculableadvantage on this score. Not only is EnglishCommon Law well established and highlyrespected, it forms the basis for the legal systemsof many of the countries that were once in theBritish Empire. Such are the attractions of EnglishCommon Law that it acts as a magnet, drawingbusiness between two foreign counterpartiesinto the City. Of all the assets that make Londonthe prime global financial centre, its legalenvironment is one of the least likely to sufferfrom competitive erosion.

8. Professional SpilloverThe term ‘spillover’ is widely used in the clusterliterature. The most common broad theoreticalstrain is that an industry cluster will produce aspillover effect through which related andsupporting industries grow up around thecluster. This is a fair explanation for theproliferation of IT companies, business printers,restaurants and coffee shops in and aroundcontemporary financial clusters. It does not,however, capture the most important spilloverphenomenon: the growth of relatedprofessional service providers, primarily lawyersand accountants, within the working core of thecluster itself.

The presence of lawyers and accountants in theCity or on Wall Street is nothing new. Over thepast two decades, however, the number ofprofessional services employees has grown at arate far exceeding that in financial services atthe cluster’s core. This hugely significant shift isthe product of three factors:

“Two of the major reasons why many emergingmarkets have significantly higher risk premia thantheir established counterparts are that theframework of laws is ill defined and that theirenforcement is not consistent.”


• Financial services employment within themain clusters has tended to level off or evendecline slightly due to the outsourcing of backoffice and support functions.

• The increasingly global nature of markets andtransactions has produced a dramaticincrease in the requirement for complex cross-border due diligence that only professionalspecialists can provide.

• Finally, and most importantly, the largefinancial cluster based law and accountancypractices are a product of increasingregulation.

More onerous regulation, combined withregulatory zeal for independent assessors, hasled to an increase in the need for compliancework well beyond the capacity of the in-houseteams of even the largest investment banks. Theburden is heavy enough when the bank only hasto deal with the regulatory requirements of thehost country it is operating from, but it increasesdisproportionately when a transaction becomesinternational. Regulators might be striving forgreater transparency and fairer competition,but the immediate consequences of theiractions has been an ongoing change in both thelines on the pitch and the rules of the financialgame. Financial services firms are constantlyplaying catch-up and, to extend the sportingmetaphor, the only way they can avoid a streamof penalties is to have a team of legal andaccounting advisors in their dugout.

8. Physical InfrastructureModern global financial clusters depend uponlarge, complex and inter-related IT platforms foralmost every aspect of their business. We willconsider these later when we attempt anassessment of the impact of this technology onthe durability of established financial centres.The important point is that market institutionsexercise control over this IT infrastructure. Thereis, however, a matrix of external infrastructureover which financial clusters have either limitedor no control, but which are just as important totheir success. For the sake of simplicity, we willclassify this as ‘physical infrastructure’.

At the centre of the physical infrastructurenetwork are the buildings that house thecompanies in the cluster. The extent to which acompany can influence the sorts of buildingsthat are built is generally correlated to its size.The major employers, particularly the banks andinvestment banks, have high floor spacerequirements and can exercise considerableinfluence over the public sector planningauthorities, architects and property developerswho take the key decisions on the location anddesign of buildings. The trend in recent years hasbeen to consolidate front-line executive andservice functions in a single building located in ornear the geographical centre of the financialcluster. Investment banks, and any otherinstitution with a significant trading function,have special requirements for large floor-platesto accommodate dealing facilities. With space ata premium, the emphasis is normally on highbuildings. This can sometimes cause problems inlong-established centres containing protectedbuildings of historical significance and heritage-related planning restrictions, such as themaintenance of clear viewing corridors to StPaul’s Cathedral on the western edge of the City.

Successful global clusters such as the City havelong since outgrown the traditional boundariesof the Square Mile financial centre. With theseclusters located at the centre of dense urbanconurbations, their scope for expandingoutwards is normally limited and sometimes allbut non-existent. The result has often been thecreation of a satellite financial centre, either ona green-field site if any are available within areasonable radius, or on a brown-field site in theprocess of re-development. In London, the latteroption produced the highly successful CanaryWharf financial centre, built on abandoneddockland a few miles to the east of the City. Theimportant determinant for either option tosucceed is that distance and transportationissues are not significant enough to prevent theold and new centres operating as one cluster.

Just as modern financial services firms havebecome more demanding in terms of the officesthey work in, the availability of sufficient highquality housing stock has become a more andmore important factor in attracting andretaining a multi-national labour force. In an


industry where the majority of employees are intheir 20s or 30s, this tends to mean a mixture ofmodern city-centre flats for those who aresingle or married without children, and housesof similar quality in prosperous suburbs orcommuter towns for those with a family. Giventhat financial services workers will normallyhave the buying power to meet even very highownership or rental costs, the most importantvariable is the availability of choice of locationand type of accommodation. Here, oldercentres established in large cities will normallyhave the advantage over new competitors, suchas those in the Gulf, which need to buildresidential quarters at the same time as theybuild the corresponding offices.

Global financial clusters require transportationlinks to other centres around the world, whilethose employed within a given cluster requiredependable, high-density transportinfrastructure to link their homes to their places

of work. Here the older financial clusters tend tosuffer by comparison. London and New Yorkboast a number of large airports but havebecome victims of their own success: global hubstatus has increased traffic flows but, withrelative proximity to their cities limiting theroom for expansion, they have becomecongested and vulnerable to delays. Thesituation is if anything worse when it comes tocommuting infrastructure: newer centres havebuilt high-speed rail networks, whileestablished cities are dependent on networksdeveloped in the 19th century that areextremely difficult to modernise. London’sunderground system has become synonymouswith delays, cancellations, over-crowding andventilation problems – the line connecting Bankwith Waterloo station and the stockbroker beltof Surrey is affectionally known as ‘The Drain’.

London’s infrastructure shortcomings wereeloquently summed up by a London-basedGerman banker responding to a pre-GFCIsurvey in 2003: “In Frankfurt, the stress endswhen you leave the office. Here, that’s when itstarts.”14

It is important to put transport issues intoperspective. While research has shown thattransport delays do cost the London economybillions of pounds in lost revenues, the state ofthe system is an irritant rather than a majordeterminant of its competitiveness as a globalfinancial cluster. Long distance links areprobably more important. It is vital for themutually supportive position of London andNew York that it is always possible to find a seaton a plane flying between the two at shortnotice, as well as easy access to all thesignificant financial centres around the world.Long distance links are even more important tosatellite financial clusters. A prime example hereis Edinburgh, where the Scottish global fundmanagement cluster simply would not remainviable were it not for the East Coast mainlinetrain service and hourly flights to London.

As far back as 1987, a Harvard academicobserved that “a robust ICT infrastructure is nolonger a motivator for financial services to setup shop, it is a hygiene factor.”15 A 2009 reportfor the City of London identified five mainelements of ICT infrastructure: networkconnectivity; data centre capability; electricalpower supplies; security and resilience; andskills. While four of these elements are obviouscomponents of the equation, electrical powersupplies could easily be overlooked. They are,however, potentially the weakest link within anincreasingly energy hungry computingmegalith. In this context, it is notable that thereport concluded that electrical power supplieswere the least tractable of the City’s ICTchallenges16 – UK peak energy demand isexpected to exceed supply by 23% in 2015.17

With generation capacity being squeezedbetween increasing demand on one side andenvironmental concerns on the other, it wouldnot be surprising if the same was not true formany other global financial centres.

“Just as modern financial services firms havebecome more demanding in terms of the officesthey work in, the availability of sufficient highquality housing stock has become a more andmore important factor in attracting and retaininga multi-national labour force.”


9. LanguageEnglish is the universal language ofinternational financial markets, a result of thedominance of two English-speaking countries,the UK and the US. It has retained its position,partially due to the ongoing dominance ofLondon and New York as global financialcentres, but more importantly because English isthe international business language and onschool curricula all over the world. Mostdeveloped countries now have a large cadre ofmulti-lingual university graduates from whichthe financial services industry can recruit.

Most studies of financial centre competitivenesscite the English language as one of the factorscontributing to the premium positions of

London and New York. It is doubtful if this isreally the case any longer, except in the sensethat both would be seriously damaged in theunlikely event of another languageundermining the position of English, though it isdifficult to visualize a world in which theinternational business language has switched toMandarin. China does not require any suchchange to move closer to centre stage in globalmarkets – there are already more Englishspeakers in China than there are in the UK.English, like ICT infrastructure, has become a‘hygiene factor’.

The same cannot be said for other forms oflanguage where early Anglo-Americandominance has established a global standard. Inthe critical area of financial reporting, mostcountries – and all multinational companies ofany size – have adopted InternationalAccounting Standards (IAS) for their financialstatements, even if they continue to reportsimultaneously under a separate nationalregime. The competitive advantage for Englishspeaking financial clusters is that IAS are closelymodelled on the Generally AcceptedAccounting Principles (GAAP) of the US and the

UK. US- and UK-listed companies havetherefore had little difficulty in adapting to IASand the financial clusters of the Englishspeaking world consequently provide much ofthe accounting expertise for cross-bordertransactions around the world.

Other languages and systems exercise an evenstronger grip on global markets. Oracle canboast that it “is the world’s most complete,open, and integrated business software andhardware systems company”, and such is itsdominance that its use is virtually a pre-requisitefor international business. Much the same canbe said for Microsoft’s Windows and Apple’sMac in PC systems, and for search engines likeGoogle and Yahoo. Even social networking sitesand services such as Facebook, LinkedIn andTwitter, which are making increasing inroadsinto business communication, are of Americanorigin.

Taking all the above languages together, onlyone is really a factor in cluster strength. TheEnglish language and the matrix of computerhardware, software and applications are allfactors that tend to level the playing field, atleast for advanced and relatively advancedeconomies. In the case of accounting, however,the dominance of IAS provides a definiteadvantage for established UK and US centres,first because the analysts and corporatefinanciers working on the accounts theyproduce will be experienced in using them; andsecond – and more importantly – because theclusters will be supported by a breadth anddepth of international accounting expertisewhich rivals will struggle to match.

10. The Human FactorFor all their dependence on IT systems andworldwide reach, financial services clustersretain an extremely important humandimension. The non-market related dimensionsof clustering are as much a human as aninstitutional phenomenon. As the City ofLondon’s 2003 study made clear, a cluster’sworkforce and the relationships within it arewhat make it work:

• London’s labour market is one of its greatestassets. The supply of skilled labour, from both

“It is doubtful if language is really a factor inLondon and New York’s strength, except in thesense that both would be seriously damaged inthe unlikely event of another languageundermining the position of English.”


domestic and international pools, is a majorfactor sustaining growth.

• Personal relationships supported by closegeographical proximity and on-going face-to-face contact are vital processes that sustainthe London financial cluster.

• The localised nature of relationships betweenskilled labour, customers and suppliers is acritical factor that helps firms achieveinnovative solutions, develop new marketsand deliver services and products to clientsmore efficiently. 18

The international financial services workforce ispotentially far more mobile than its equivalentin most other sectors. It is also highly ambitious.A financial services professional can oftenchoose where he or she wishes to work, theirskills are readily transferable, language isunlikely to be a barrier and the global marketplace is sufficiently large and varied to meanopportunities are always available. Superiorfinancial incentives are often reason enough tomove, but quality of life outside of the officecan be even more important.

The bulk of the workforce is relatively youngand in possession of much higher than averagedisposable income. This can shape decisions onwhere to work through a range of factors, suchas the size and cosmopolitan nature of the cityin which the financial cluster is located, thecultural milieu, the educational offering foryoung children, the real or perceived safety ofthe city, the size of the relevant expatriatecommunity and even the climate. The variablesare so disparate that generalisations aredifficult, but two observations do seem justified:

• Rising financial centres such as Singapore canattract a skilled workforce as long as theyoffer both higher rewards and an attractivequality of life.

• The advantage continues to rest with thelong-established clusters such as London andNew York, which can offer just aboutanything a discerning investment bankercould wish for, except an optimal climate.Global city status is a particularly strongmagnet – it is difficult, for example, toimagine that either Zurich or Geneva couldprise away a major financial institution or itsemployees from London, though some nichebusinesses such as hedge funds haverelocated to Switzerland in recent years.

As the premier global financial centres, Londonand New York are the most attractive targets forthe ambitious industry professional. Whether itbe getting an early posting to improvepromotion prospects or position in the jobmarket, or achieving a senior management role,the major global clusters are centres of gravity.Thus the human dynamics of the globalfinancial services industry have a built-inmechanism that reinforces the competitivenessof the market leaders.

It is fitting to end this analysis of the factors thatcontribute to the cohesiveness of globalfinancial centres by considering the humanfactor. The only other industries that so heavilydepend on the talents of a large number ofindividuals are those at the cutting edge ofinformation technology and some sciences.Professional team sports are probably theclosest parallel to the financial services industryin terms of emphasis on human talent and highrewards – it is no coincidence that the onesizeable group of employees in the UK whoseearnings are roughly equal to the cream ofthe City are the footballers of the PremierLeague. Bankers’ remuneration is anissue of considerable populardiscontent and political sensitivity inthe wake of the Credit Crunch andthe rescue of Royal Bank of Scotland(RBS) and Halifax Bank of Scotland(HBOS), but this does not alter thefact that City professionals havealways been well paid and willcontinue to be so. A cluster is only asgood as the people who work in it andleading clusters will continue to payhandsomely for the best.

“City professionals have always been well paid andwill continue to be so. A cluster is only as good asthe people who work in it and leading clusterswill continue to pay handsomely for the best.”



Financial Clusters: Infrastructure,Institutions and InterchangeHaving completed our stylised model of a globalfinancial cluster, we can impose a simple three-level hierarchy upon it:

• At the base is market infrastructure, a broadcategory that stretches from the buildingsand transportation hubs of the financialcentres themselves to the trading platformswithin them. All are vital to the existence ofthe cluster but they are not generally sourcesof competitive advantage.

• Above these sit the political, regulatory andlegal institutions that govern how the clusteroperates. These are extremely important, notleast because the trust and certainty thatunderpins any financial transaction would beimpossible to guarantee without them. Theyrepresent a potentially strong source ofmarket advantage but, because their controllies outside the market itself, they are also apotential source of vulnerability.

• Finally and most importantly, there is theinterchange – the marketplace itself – whichsits on top of the infrastructure andinstitutions. It is here that real competitiveadvantage is pursued through the interactionof high liquidity, large institutions, stronginformation flows and the retention of ahighly skilled workforce.

It is obvious from our structural analysis thathistory has played an extremely important rolein shaping the global financial clusters of today,despite the fact that the language ofcontemporary society suggests the opposite.Terms like ‘knowledge economy’, ‘informationtechnology revolution’ and ‘globalisation’ pointto some sort of radical break with the past butare misleading. Western nations, for example,were trading far more intensively with China in1875 than they were in 1975, while the dollar-sterling forex rate is still widely referred to as‘the cable’ in recognition of the Transatlanticcable, laid in the mid-19th century, along whichthe business originally developed.

Global financial clusters have evolved in stepwith the wider sweep of history rather thanthrough any recent revolutionarytransformation. It is easier to trace their routeback through time in the West than in the Eastand we will concentrate on the former. WhileChina was easily the largest and most advancedeconomy in the world until the West wastransformed, first by colonisation and then bythe Industrial Revolution, its path was broken onseveral occasions by invasion or internal politicalcollapse. Only with the metamorphosis ofCommunist state control into a workablesystem for tapping the county’s huge marketpotential has China begun to take back itsnormal place in the global economic order.

Financial Clusters: A Pre-HistoryWhile European cities have always been centresfor financial transactions, this business was localin nature for most of the millennium followingthe collapse of the Western Roman Empire andits associated trading network. Internationalfinancial centres began to re-emerge in the 13thand 14th centuries, primarily in the north Italiancity-states of Genoa, Florence and Venice.Critically, the new financial institutions all grewout of a common heritage – participation in theonly well developed trading network, that fortextiles.

The family banks that emerged existed tofacilitate cross-border trade and payments viabills of exchange and chains of agents in foreigncities. With the accumulated wealth andcontacts from their trading activities, theleading houses diversified into banking. Beyondbuilding up their deposit bases from localcontacts, these banks developed what wasoften to prove a fatal attraction for lending toEuropean monarchies. The two dominant banksin 14th century Florence both made substantialloans to Edward III of England to finance theearly campaigns of the 100 Years War and wentbankrupt when he followed the already well-established royal habit of defaulting.

Later medieval banking dynasties proved moredurable, the Medici in Florence because theybecame the main banker to the papacy and theFuggers in Augsburg because they secured ashare in the revenues of Imperial mines assecurity on their loans to the Holy RomanEmperors.

Late medieval banking was quite sophisticated,using a system of multi-currency bills ofexchange to get around religious prohibitionson charging interest, but the industry wasdominated by extended family networksoperating from different city bases. In thevolatile political environment of the late 15th toearly 17th centuries, the banking institutions

AHistoryofClusters:FromMedieval toModern

CHAPTER 4

“Terms like ‘knowledge economy’, ‘informationtechnology revolution’ and ‘globalisation’ pointto some sort of radical break with the past but aremisleading. Western nations, for example, weretrading far more intensively with China in 1875than they were in 1975.”


proved far more durable than the clusters theycreated around themselves. In northern Italy,the centre of financial activity moved to Venicebut the bankers themselves remainedFlorentines. In the Low Countries, the financialcluster moved successively from Bruges toAntwerp and then Amsterdam under thepressures of war. Amsterdam remained animportant international financial centre longafter the Dutch republic had passed its zenith asa maritime trading power and it was onlyinvasion by revolutionary France and the arrivalof Napoleon that drove its merchant banksoverseas to the safety of the rapidly expandingfinancial cluster in the City of London.Alexander Baring left Amsterdam in 1795 asBaring’s partner Hope & Co migrated toLondon, where it was joined by establishedbanking families from Germany such as theSchroders of Hamburg and the Rothschilds ofFrankfurt as French armies pushed eastwards.19

The first clusters: durable andmobileThere is a valuable lesson to be learned fromthese early proto-clusters. Given the turbulentpolitical situation within which they operated,the late medieval and early modern financialclusters were impressively durable. While therewere casualties along the way, most majorinstitutions survived for centuries. Theygenerally stayed in their establishedgeographical cluster well beyond the mothercity’s politico-economic decline and, when theymoved, they moved en masse and intact. To putit another way, the financial clusters of the 16thto 18th century were very robust but, ultimately,also mobile.

Early financial centres shared two commonfeatures. In the first instance, they providedpools of trans-national liquidity in anenvironment in which most economic activitywas still highly localised. More importantly, they

provided places where information could becollected, pooled, discussed and translated intobusiness decisions. It was no accident that thetwo most venerable institutions in the City,Lloyd’s of London and the London StockExchange, began their lives in coffee shops.Financial activity has always depended on theinterplay between liquidity and informationand, in the 17th century, it was often the latterthat was most valuable.

Employing an extremely broad-brush approachto history, it is possible to identify threeoverlapping developments that triggered theemergence of proto-clusters of financial servicesbetween the 17th and 19th centuries. The firsttwo were the parallel emergence of modern,centralised states in Europe and theircolonisation of large parts of the non-Europeanworld. These produced an explosion inseaborne trade, which was supported bygovernments that sought to benefit directlyfrom it through taxation on the trade itself andindirectly through the growing wealth of itscitizenry. It is highly significant that thecontinuing cycle of wars between Europeanstates now tended to be triggered by trade andcolonial rivalries, rather than competing claimsfor territory within Europe itself. Long distancemaritime trade required four things:

• Access to investors to finance trading ventures.

• Financial instruments to facilitate themovement of capital that was otherwise tiedup in the holds of very slow sailing vessels.

• Information on distant markets.

• A way of spreading the not inconsiderablerisks of total loss of vessel and cargo.

The answers to these problems were joint stockcompanies with tradable share capital, bills ofexchange and a marine insurance market thatmaintained its own international news service.

Once established, the pace of growth wasimpressive. By the end of the 17th century therewere approximately 150 joint stock companiesin the UK alone and London had developed thefoundations of a stock exchange in two coffee

“Early financial centres provided places whereinformation could be collected, pooled, discussedand translated into business decisions. It was noaccident that the two most venerable institutionsin the City, Lloyd’s of London and the London StockExchange, began their lives in coffee shops.”



shops in the City. Bills of exchange had been inexistence for centuries, but the take-off in tradeproduced specialist finance houses to deal inthem. These were the predecessors of theinvestment banks of today, but they wereoriginally known as discount houses and thenmerchant banks, as their business was builtaround buying, selling and discounting bills ofexchange associated with foreign trade. Finally,the marine insurance market began to develop,also in a late 17th century coffee shop, intandem with the other institutions. There wasthus a functioning, albeit limited, financialcluster in London by the beginning of the 18thcentury. Similar clusters struggled to emerge inother countries due to Britain’s increasingdominance of maritime trade routes. It is alsoworth noting here that London was not the onlyinternational financial cluster in the UK and thatregional rivals such as Glasgow would survivewell into the 19th century.

Limited liability: the key to growthThe third and final trigger to the growth offinancial centres was the Industrial Revolution.The impact was limited at first, with much of theinvestment coming from local merchants whohad made their money in overseas trade, but asfixed capital requirements grew as industryexpanded to serve international markets, familypartnerships gradually gave way to joint stockcompanies. The introduction of limited liabilityin the 1860s gave sounder foundations to astock exchange that was still viewed withsuspicion by many – it would take another halfdecade before a significant proportion of Britishindustry was listed. The growing importance ofthe London Stock Exchange was critical to theCity’s growth as an international financialcluster, as was the consolidation of the bankingsector which saw most regional banks absorbedinto the large London (and in Scotland,Edinburgh) headquartered institutions we arefamiliar with today.

Three technological innovations of the IndustrialRevolution played an important role inexpanding the reach and accelerating theconcentration of financial clusters:

• The rapid development of railway networks inthe mid-19th century reduced domestic

journey times from days to hours, aiding theflow of information and capital into financialcentres.

• The advent of the marine steam engine andcontinuous improvements in its power andefficiency reduced and regularised oceanicvoyage times. It is significant that the earlysuccess of companies such as Cunard wasbased not on mass European migration toNorth America, which only gatheredmomentum in the second half of the 19thcentury, but on government subsidies to carrybusiness mail.

• The Transatlantic cable, driving connectivity,was only one of a growing web of cables thatconnected the businesses of the world inwhat can be seen as a precursor to theinternet. Markets have always thrived onnews and by the 1870s international financialmarkets were increasingly able to supportclusters taking advantage of up-to-dateintelligence from a rapidly growing portion ofthe globe.

Modern Cluster History and FinancialGeographyHistory has played a significant role in shapingthe geographic distribution of the world’sinternational clusters. Financial clusters haveproved as durable as the economies andpolitical structures within which they grew.Given that the 19th century witnessed theemergence of competing global superpowers,mass colonisation and migration, andindustrialisation, and that the 20th century sawtwo world wars, mass revolutions, the GreatDepression, decolonisation, unprecedentedtechnological change and tremendous overalleconomic and demographic growth, it issurprising how little the financial cluster map ofthe world has changed since 1900.

London and New York were dominant then asthey are now, while Tokyo was emerging as thefirst independent Asian financial centre on theback of rapid industrialisation and aggressivemilitary expansion and the Swiss privatebanking centres were establishing their uniqueposition. While the financial geography ofcontinental Europe would take some hard

knocks during the world wars, the landscapewas not dissimilar to the modern map.

London’s pre-eminence was due more to itsposition at the centre of the world’s largestempire than to Britain’s early lead inindustrialisation. The City grew its size, reachand reputation by helping finance first colonialexpansion and then colonial development. Itwas helped by the fact that the British merchantmarine was roughly twice the size of the fleetsof the rest of the world combined and the RoyalNavy at least as strong as the second and thirdlargest navies combined for most of the periodbetween 1815 and 1914. The returnsgenerated by empire building helped themerchant banks to build worldwide businessesand profit from growth in areas not underBritish control.

Baring Brothers provides an illustrative exampleof the highs and the lows of this frontier age. In1803 it helped facilitate the largest landtransaction in history, the Louisiana Purchase bythe US from France, a feat achieved despite thefact that Britain was at war with France. In1890, buoyed by a series of successes infinancing railroad expansion in North America,Barings was brought to the brink of ruin by over-exuberant underwriting of what would todaybe classed as ‘sub-prime’ Argentine andUruguayan debt. It was rescued by a consortiumput together by the Bank of England. TheBarings crisis was only one of a series to hit theBritish banking sector as a result of high risktaking. When London discount bank OverendGurney & Co went bankrupt in 1866 it draggedanother 200 businesses, many of them smallerbanks, with it. The collapse of the City ofGlasgow Bank in 1878 virtually eliminated thecity of that name as a financial centre.

Casting the global networkLondon was the undisputed centre of themarine insurance world, while British tradinghouses were dominant not only in India, but

also in the three most important Far East tradecentres: Singapore, Hong Kong and Shanghai.In addition, Sydney was emerging as thefinancial capital of Britain’s dominions in theAntipodes as the economies of Australia andNew Zealand expanded rapidly with large-scaleagricultural exports funding industrial andinfrastructure development. In Canada, whichbecame a nation in her own right in 1867,Montreal on the St Lawrence River and Torontoon the northern shores of the Great Lakesserved as twin financial centres, a situation thatpersisted until the 1960s and 1970s whenseparatist politics in Quebec triggered a massbusiness exodus from Montreal to Toronto. Onthe west coast, Vancouver emerged as a semi-independent financial centre heavily involved intimber and mining.

New York’s emergence as a rival to London wasdue partially to its position as the main point ofentry for people and capital from Europe, whichhelped fuel the rapid westwards expansion ofthe US. Its position was not unchallenged and aslate as the 1870s it was facing seriouscompetition from Philadelphia, due largely tothe concentration of railroad, coal and steelinterests. If London owed its position tofinancial strength overseas, New York’s growthwas largely driven by its increasing dominancein financing the westwards development of itsown country, a position that was strengthenedas financiers like JP Morgan and AndrewCarnegie used the stock market to seize andconsolidate control of most of the country’smajor industries in huge cartels. As New York’sreach extended overseas, so Chicago emergedas the country’s second major financial centre.Its growth was based on its position as the hubfrom which the exploitation of the West wasfinanced, and through which much of that hugearea’s produce was distributed eastwards.Finally, San Francisco became the financialcentre of a west coast that, even after thecompletion of the transcontinental railroad inthe late 1860s, was still a week’s journey fromNew York.

The financial geography of the English speakingWest developed largely undisturbed by war orpolitical upheaval. The only major exceptionwas the American Civil War, which completely

“If London owed its position to financial strengthoverseas, New York’s growth was largely driven byits increasing dominance in financing thewestwards development of its own country.”


dislocated the economies of the southern statesfor a decade and, through a curious mixture ofwartime expedients and misguided post-warlegislation, led to the virtual disappearance ofthe Stars & Stripes from the high seas for half acentury.

The rise of the EastIn the East, the situation was completelydifferent. With the exception of Japan, financialcentres emerged either within the existingcolonies of the Western powers or as a result ofarmed Western intervention in imperial China.

India was easily the largest and most importantcolonial asset in Asia. While it had alreadyexperienced significant commercial expansionunder the administration of the East IndiaCompany, it was only after the Indian Mutinywas crushed in 1857-58 and the Britishgovernment took charge that domesticfinancial clusters began to emerge around themajor ports of Karachi, Bombay, Madras andCalcutta. Although major capital inflows camefrom Britain and British merchant houses werefinancing economic development, there was asignificant local presence. Indian merchanthouses were dominated by ethnic Parsis,operating as family businesses or in partnershipswith the British. The growth of financial clustersin India is hard to measure but should not beunderestimated. With the development of amass two-way trade built around the export ofcotton, jute and tea, and the import of capitalgoods and fabric, the Indian clusters weresignificant players in the global financial centresmatrix of the late 19th century.

In contrast to India, Singapore was a regionalentrepot and the fulcrum around which thedevelopment of British economic interests inSouth East Asia was based. Here, local financialcommunities, largely composed of Chineseimmigrants, played an even more dominant rolethan was the case in India. Here also we findone of the relatively rare examples of genuinecooperation between two colonial powers, withmany merchant houses being joint venturesbetween British interests in the StraitsSettlements and longer established Dutchestablishments in the East Indies. Singapore wasto become an ever more important

international cluster as the economies of thecountries around it developed. It would retainits status right through to modern times, withthe exception of the Japanese occupation of1941-1945.

The development of modern financial centres inChina followed an entirely different path. By theearly decades of the 19th century the long-established practice of isolationism wasbreaking down in the face of increasinglyaggressive western merchants. The QingDynasty’s hold over its sprawling empire wasalready in decline, but it attempted to assertitself by enforcing a ban on the import of theopium that foreigners were bringing in by theshipload. Opium was illegal in China (althoughuse and addiction were becoming increasinglywidespread) but legal in the West, and whenImperial officials seized the opium stores ofBritish merchants the latter called for itsgovernment to intervene. British naval andmilitary forces inflicted a series of humiliatingdefeats on the Chinese in the First Opium Warof 1839-1842 and the Second Opium War of1856-1860.

There is no room here to document the collapseof central authority in Peking. It is sufficient tofocus on the three most importantconsequences of European armed interventionfor the development of international financialcentres. The first was the emergence of HongKong, ceded to Britain after the First OpiumWar, as what was effectively an offshore tradingand financial centre for Canton and southernChina. The second was the creation of the so-called ‘Treaty Ports’, of which Shanghai at themouth of the Yangtze River was by far the mostimportant, allowing foreign powers to operatefrom compounds which were free-trade zonesin everything but name. Finally, foreigners wereallowed unimpeded access to the wholecountry, with their safety guaranteed by theChinese government but backed up by standingEuropean military and naval forces on Chineseterritory. The overall result of thesedevelopments was the emergence of HongKong and Shanghai as financial and businessclusters from which the huge economicpotential of China was exploited on terms veryfavourable to the colonial powers.


Thus, while the political geography of the worldhas changed significantly, particularly as a resultof the disappearance of the British Empire, andthe final emergence of China as a globaleconomic power, the top 10 of a GlobalFinancial Centres Index compiled in 1911 mightnot have looked that different from that of theGFCI of today. This reinforces the view thatinternational financial clusters are very durable;and that a mixture of history and geographycontributes more to the composition of the 21stcentury global financial centre universe than isusually thought to be the case.

“While the political geographyof the world has changedsignificantly, the top 10 of aGlobal Financial Centres Indexcompiled in 1911 might nothave looked that different fromthat of the GFCI of today.”


Financial markets thrive on volatility. Without it,most trading strategies would not work,investment would be a long-term process, andliquidity would be severely reduced. Financialmarkets, however, do not cope well withexternal uncertainties. The two most immediateand important of these are the politico-economic environment around them, and themanner in which governments seeks to regulatethem, in terms of rules and financialimpositions.

The long-standing primacy of London and NewYork as global financial centres is in partattributable to the simple fact that neither hashad to contend with revolution or invasion.Leaving aside the ‘Glorious Revolution’ of 1688,the last time London saw an invading army was1066. The worst it had to contend with duringthe violent 20th century was the ‘Blitz’, a fairlymild experience compared to what much of therest of the world went through. The last seriousthreat to the US was the American Civil War of1861-65. Unless you are one of the romanticminority that believes the South had any chanceof winning that conflict, you can extend theabsence of external threat back to the end ofthe Anglo-American War of 1812-15. Apartfrom other North American financial centres,the only significant centres to have enjoyedsimilar levels of peace and stability are those inSwitzerland, which have remained wrapped inneutrality since 1815.

Continuity of government alone is insufficientto support cluster cohesion if it is attended byunpredictable policy swings on the regulation ofmarkets. Until 2008 at least, one of theadvantages London enjoyed over New York wasits ‘light touch’ regulation. A lot of nonsensehas been written about the ‘Governor of theBank of England’s eyebrows’, but Britishgovernments had been by and large happy tolet the City govern itself within fairly loose,commonly agreed parameters, until the CreditCrunch sparked what some see as a regulatory

over-reaction. US legislators have tended to bemore intrusive, on several occasions to thebenefit of London, but again the politicalclimate has been generally benign. It is ironicthat the repeal of one of the most importantpieces of intrusive legislation, the Glass-SteagallAct of 1933, has been seen by many as acontributory factor in the Credit Crunch,dealing New York the heaviest blow to itsreputation since the Great Depression.

Both the industry and surveys of relativecompetitiveness such as the Global FinancialCentres Index (GFCI) regularly pick outregulation and taxation as two of the mostimportant factors in supporting stable financialclusters (see Chapter 3). While the expression ofsuch sentiments in London and New Yorkreflects the perceived influence of rule-booksand taxes, there is also a sense that suchcomments are akin to complaints about theweather. Both centres owe their enduringstrength in no small measure to the relativerestraint and consistency of government. Thereare as yet un-quantified ‘tipping points’ on boththe regulatory and taxation fronts beyondwhich both Whitehall and Washington shouldproceed with care. We are still in fairly choppywaters following state bailouts of distressedinstitutions in 2008. Public sentiment isgenerally hostile to the industry and politicianspersist in efforts to be seen to make the industrypay for its undoubted fecklessness in the yearsleading up to the crisis. To date there have beenno major defections from London or New Yorkbut there is a genuine need for common sensefrom policymakers.

This need was clearly spelled out in the 2003study of the importance of financial servicesclustering for London:

“The research suggests that successfulclustering can be facilitated or eroded by publicpolicy. Government administrative andorganisational boundaries, lack of policy

BuildingaCluster:TheRoleof theState

CHAPTER 5


coordination and focusedmanagement relatingto regulation and transport are perceived by theresearch respondents to be a barrier to effectivedecision-making and investment. Co-ordinationacross policy and departmental as wellgeographical boundaries will therefore beessential to support sustainable financial andbusiness services clustering...”20

The financial services industry itself has a clear,pragmatic and widely shared view of what itwants and does not want from regulation. Thetwo guiding principles are proportionality andconsistency. The essence of this industry viewcan be distilled from a selection of responses tothe GFCI 9 question “Which single regulatorychange would improve the competitiveness offinancial centres?

“Focus on the effectiveness of the regulatorysupervision of firms, as opposed to capital,liquidity and product regulation, whichincreases costs and stifles growth.”

“Effective regulation that does not stifleinnovation but provides reassurance toinvestors – this maymean less bureaucracy butmore engagement.”

“Greater regulatory responsiveness to specificevidence of how a particular organisationconducts its business, rather than reliance ontop-down, one-size-fits-all approaches which,in practice, usually discriminate against smallerorganisations by imposing a disproportionateand inappropriate regulatory burden.”

“The key factor that underminescompetitiveness is difference betweengeographies. Increasing standardisation in anyarea reduces the amount of work required toenter a market/geography and increasescompetitiveness.”

“I am not comfortable with the statement thatregulation improves competitiveness, although Iappreciate that it is the framework within whichall centres should be working to a consistentstandard.” 21

Regulation and taxation can be important toolsfor building up financial clusters. Offshorecentres, which persistently rank higher in theGFCI than logic suggests they should, owe theirposition entirely to low or no taxation andpermissive legislation. Taxation and regulationhave been used as cluster-building incentives bycountries intent on moving up the competitiveladder. It has often been possible to gainmomentum quite rapidly in this fashion, butmaintaining it is dependent on the ability of thenational economy in question to underwrite theprocess. As we have seen, only large globalcentres can provide ‘homes’ for largeinternational banks.

“It has often been possible for financial clusters togain momentum quite rapidly through low taxesand light regulation, but maintaining it isdependent on the ability of the national economyin question to underwrite the process.”


The financial services industry has changedbeyond recognition over the last century,particularly in the last two to three decades. Theconventional argument attributes this to threefactors: the information technology revolution;globalisation; and the rapid growth in the Asianeconomies, particularly China. There is nodenying the importance of these factors but itcan be argued that each card has beenoverplayed in making the case for a really bigbang. In this chapter we will examine the twogeographical engines of change: globalisationand the re-birth of Asia. The IT revolution is amore complex and contentious subject and willbe covered separately in the next chapter.

In the context of the development ofinternational financial markets, globalisation isprobably the weakest of the three explanationsfor revolutionary change. There has been aquantum leap in the volume of globaltransactions, but their geographic range haschanged less than might be expected. Inessence, the globalisation of recent decades hasbeen a matter of scale more than scope. Withthe exception of most of Africa, wherepenetration of global financial services is stillrelatively recent and weak, the internationalfinancial centres had already been in existencefor some time by 1911. China might appear tobe an exception, but classifying it as such is toconfuse political boundaries with financialrealities. Hong Kong and Shanghai were bothlarge financial centres right up to Japan’s entryinto the Second World War in December 1941.Hong Kong, of course, was a British colony andmajor point of access to the markets of SouthChina. Shanghai, was not, but as the largest ofthe Treaty Ports its position at the mouth of theYangtze made it an even more significant centreof trade and finance. Pre-1930s photographs ofthe International Settlement along the Bund,where all of the major foreign trading andfinance houses were located, are morereminiscent of the European capitals of the timethan they are of any contemporary Chinese city.

China would slip off the map of global financialcentres as a result of war, revolution andisolationism. Its gradual return to the globalstage initiated by Deng Xiaoping under anevolving Chinese form of state-managedcapitalism is as much a matter of it re-assertingits natural place as a major player in the globaleconomy as it is the emergence of an industrialsuperpower. It is also important to realise thatthe great British trading houses that had been atthe heart of the 19th century financial clustersin Hong Kong and Shanghai are still there. SwireGroup, established as Butterfield & Swire inShanghai in 1866 and Hong Kong in 1870, isnow a diversified multi-national with itsheadquarters in Hong Kong. In 2009 its listedarm, Swire Pacific, was ranked second in theWall Street Journal’s “Most AdmiredCompanies in Hong Kong” list. First positionwent to the airline Cathay Pacific, in whichSwire is the largest shareholder. JardineMatheson & Co was founded in Canton in 1832and moved to Hong Kong in 1842, the firstmajor western commercial enterprise to do so.It too remains a major multi-divisional player inAsian markets. The company is substantivelymanaged from Hong Kong but it is registered inBermuda and listed on the London andSingapore stock exchanges, to protect it from arepeat of a 1980s hostile Chinese takeover bidfor its extremely valuable Hong Kong propertyportfolio.

This leads us on to the second – and arguablythe strongest – of the explanatory factors: therise of the East. The emergence of China andIndia has had a huge impact on the financialgeography of the world. While Hong Kong andShanghai would certainly rank lower in ourmythical 1911 GFCI than they do in the GFCI oftoday, they would probably still have been in thetop 20. Japan had become a major industrial,financial and military power by the 1930s.While its sphere of influence was regional ratherthan global, it was expanding rapidly. It wasonly the disastrous upheaval in domestic politics

FinancialServicesClustering:ContinuityandChange

CHAPTER 6


that diverted expansion from economic tomilitary goals that interrupted what mightotherwise have been a smooth progression tothe position Tokyo occupies today.

The status quo?It is easy to argue for an ongoing change in theglobal economic balance, but less easy to do sofor a complete upheaval in the geography offinancial clustering. Asian financial clusters aregrowing to accommodate the rapid economicadvances taking place around them and theassociated growth in political power. The samefive Asian financial centres – Singapore,Shanghai, Hong Kong, Seoul and Beijing – wereranked in the GFCI as the most likely to becomesignificantly more important over the next twoto three years and the most likely site of a newoffice for their organisation by respondents tothe GFCI questionnaire. It is, however, by nomeans clear that these centres are expanding atthe expense of established western clusters.They might even be strengthening them, asWestern retail investors pour money into home-domiciled mutual funds and as Westerninstitutional investors seek exposure to Asiangrowth through home-based multinationalswith growing business interests in the East.More interesting questions are whether Chinacan sustain four global financial centres – HongKong in 3rd place, Shanghai in 5th (equal withTokyo), Shenzhen in 15th and Beijing in 17thequal (with Washington) – in the top 20 of theGFCI ratings; and why the only Indian entrant,Mumbai, languishes in a lowly 58th positionbehind Oslo, Johannesburg, Prague, Gibraltarand Helsinki, none of which have remotelycomparable financial pulling power.22

“Asian financial clusters aregrowing to accommodate therapid economic advancestaking place around them andthe associated growth inpolitical power and are likely tobecome significantly moreimportant over the next two tothree years.”


The third factor believed to have transformedthe financial services sector is the ongoinginformation technology ‘revolution’. Logicsuggests it should pose the greatest threat totraditional financial clusters and should alreadybe leading to their fragmentation. IT andcommunications advances mean financialtransactions can be completed at any time fromany location. Information – one of the two rawcommodities of financial markets along withcapital – is now distributed worldwide insomething very close to real time and isaccessible from anywhere.

The impact of IT on the temporal dimensions offinancial transactions has been profound.However, it has not necessarily worked againstfinancial clustering and, on a global scale, haseven worked to its advantage. With order andinformation flows working in close to real time,the importance of time zones has become muchmore significant. While machines do not needto sleep, people do, and although it would bepossible to operate both exchanges and theheadquarters of a global financial institution ona round-the-clock basis, there has been noserious attempt to do so outside of foreignexchange markets in which the baton isfiguratively passed from centre to centre aroundthe globe. Thus the location of financial centresrelative to each other remains an importantfactor. That its business day overlaps with boththat of New York to the west and Asia to theeast is one of the key factors in London’smaintenance of its position as one of the world’stwo strongest financial centres. Rather thanLondon losing business to rival centres, majorfirms came to London from foreign centres.

The spatial impact of the IT revolution has beenfar less significant than might be expected. Wehave already mentioned the Louisiana LandPurchase of 1803, where the ‘principals’,Napoleon Bonaparte and Thomas Jefferson,never came within 3,000 miles of each other, letalone shook hands. Although there was a great

deal of transatlantic negotiation throughdiplomats, the transaction itself went throughthe hands of a British and a Dutch merchantbank, which took delivery of the bonds the USgovernment had issued to meet the bulk of thepurchase price, discounted them to take theircommission, and then paid Napoleon in cash.By the late 19th century, long-distance cross-border transactions were common andlatecomers to the wider business world, likeGermany and the US, particularly active. Thecolonial powers poured capital into newcolonies in Africa, while their investment banksvied to realise the best results from underwritingthe developing independent states of SouthAmerica. While these activities involvedmanagers ‘in the field’, the transactionsthemselves took place in the growing financialclusters of Europe, the US and, to a more limitedextent, Japan.

With the laying of long-distance cables underthe world’s oceans in the mid-19th century,face-to-face negotiation in internationalfinancial transactions was increasinglyconcentrated in the major financial centreswhere international finance houses retained apermanent presence. The North Atlantic cablelinks were particularly important, with Britishcapital playing a significant role in financing theconstruction of the US rail network; and US railcompanies, anxious to gain market share in thelucrative immigrant trade, establishingEuropean shipping companies to get roundlegislation that restricted their ability to operateunder the American flag.

The compression of the spatial dimension madetwo other positive contributions to the growthof international clusters:

• It facilitated the rapid expansion of sovereigndebt markets, during which a significantproportion of underwriting and distributionwas channelled through established financehouses in London and New York.

InformationTechnology:RevolutionorAcceleration?

CHAPTER 7


• It witnessed the first major internationaltakeovers. One of the largest was JP Morgan’sambitious attempt to gain control of thetransatlantic passenger trade through a rapidseries of acquisitions, including the White StarLine, which built the Titanic in Belfast withAmerican capital. Increased corporate activitystimulated growth in equity markets, whichbegan to attract significantly larger numbersof retail investors as well as the attention ofmen like Britain’s Sir John Ellerman, the onlyBriton of the late 19th and early 20th centuryto build a financial empire rivalling those ofthe leading US entrepreneurs, with interestsin shipping, coal, newspapers and property.

IT’s gravitational pullThe third side of the IT revolution’s impact onfinancial services clustering might outweigh theimpact of remote dealing and globalinformation dissemination. Financial marketsare now built on extremely complex andexpensive electronic platforms that not onlyexecute, clear and settle trades, but also relaypricing information and transaction history.Thus any centre depends not on one system,but on a chain of inter-related systems.Electronic trading platforms represent a massivesunk cost and their efficiency, reliability andcapacity are one of the weapons financialexchanges use to compete with each other.Exchanges sit at the heart of all large globalfinancial clusters. Barriers to entry are high and,with the listing of a large number of the mostimportant exchanges, cross-border mergers andacquisitions have further concentrated power inthe hands of the market leaders. Thecontribution of electronic trading to thestrength of leading clusters cannot beoveremphasised. Whereas the real costs ofestablishing an exchange could be quite modestin the pre-IT age, and much of the competitivestrength of incumbents lay in the realms ofreputation and accumulated market share, it is

now the capacity and robustness of theirtrading platforms that play a leading role indetermining their position.

The computerisation of trading has pulledclusters more tightly together in a physicalsense. Latency, the time delay experienced inpassing information through a system, ispartially a function of distance. The timeincrements may be very small, but they are alsoextremely important in a modern tradingenvironment in which most informationasymmetries have been eliminated and where alarge number of big, automated tradingprogrammes are dependent on the rapidexploitation of transient price differentials. It istherefore in the interest of all direct marketparticipants to place their computer servers asclose to those of the exchange as possible.23 Inthis sense the IT revolution has brought financialclusters round full circle. In the past firmsneeded to be close to the exchange so theiremployees could get to the trading floorquickly; they now need to be there so that theirmachines can ‘talk’ to their market. It isestimated that high frequency algorithmictrading accounts for 60% of stock turnover inthe US and 30-40% in the UK.24 Once again itmust be remembered that the tradingalgorithms are not themselves generated bymachines but are the product of humanexpertise and interaction.

Overall, advanced IT infrastructure is one of thekey requirements for maintaining thecompetitiveness and cohesion of a globalfinancial services cluster. It is hardly surprisingthat the new challengers for a share of theglobal market in the Middle East and Asia haveconcentrated on building state of the arttrading platforms as one plank of their bid toentice listed companies and financialintermediaries away from the establishedcentres of the West. It is extremely important,however, to emphasize the difference betweenexchanges and markets. It is the location ofmarkets, not exchanges, which determines thestrength and durability of clusters. One of themost important but least understood aspects ofthe impact of IT on financial markets is theextent to which it has made the marketsthemselves effectively ‘weightless’. Companies

“The computerisation of trading has pulledclusters more tightly together in a physical sensebecause latency – the time delay experienced inpassing information through a system – ispartially a function of distance.”


can – and do – de-list from one exchange andre-list on another. If enough of these companiesmake the same move they will pull the marketwith them. High quality IT infrastructure canhelp bind a cluster together, but only whenother inputs are present.

It is one thing to argue that world class IT – notonly trading platforms but also the structuralsupports of network connectivity, data centrecapability, electrical power supply, security andback-up systems, and a skilled labour force – isnow an integral part of any financial cluster anda key aspect of its competitive offer. It is anotherto explain why the vast majority of the financialservices workforce is concentrated in closeproximity to colleagues and competitors in whatis usually expensive real estate with significantrunning costs. A 2009 report on the City’s ICTinfrastructure quoted one respondent saying,“Culturally we are not ready for home workingbut we think this will become common in threeto five years.”25 The report itself concluded that“there is evidence that large organisationswould like to use the flexibility of home workingto reduce the costs of office space, althoughonly a few have achieved this yet.”26 Theproblem with both the quotation and theconclusion is that both could have been dated adecade earlier. Remote working is a train thathas been expected to arrive for a long time, butthere is still little sign of it. To understand why itis necessary to look at one of the least studiedaspects of the clustering equation: the humandimension.


There are very few sectors so heavily dependenton interpersonal relations as financial services. Itwould be easy to assume that the traditions of‘my word is my bond’ and a series of longlunches have been swept away by a dialoguecarried out exclusively via digital and otherremote media, but that is not the reality.Anybody working in the industry today willknow that two of the major obstacles toarranging a business meeting are full diaries anda chronic shortage of meeting rooms.Telephone and video conferencing facilitiesnotwithstanding, industry participants remainextremely keen to meet each other andtherefore most market participants continue tovalue geographic proximity to theircounterparties.

Beyond rather vague sociological postulatingabout bonding, there are some more tangiblefactors that help explain the continuedimportance of personal interaction andproximity. The first is the nature of themarketplace itself. The marketplace is neither aweb of machines nor an abstract concept – it isa place where humans congregate to dobusiness. Given that the business in financialservices is entirely transaction-driven and basedon established relationships between marketparticipants, it is hardly surprising that academicresearch has shown that individual fundmanagers operating in large financial clustersdeal more frequently than those outside theseclusters.

Beyond this, human proximity and interactionare important for three reasons:

• It is extremely rare for anything more than themost routine transactions to be executedwithout the principals or their counterparties

meeting first to establish a personalrelationship. This is an essential part of theestablishment of mutual trust on which anongoing financial relationship needs to bebased.

• Earnings or currency forecasts and theinvestment recommendations they produceare themselves the product of a combinationof close collaborative working within oneinstitution and up-to-date intelligence on theviews of competitors.

• The high informational content in financialmarkets produces its own cloud of sharedsecondary knowledge. While all are party topublicly available information, there is amarket ‘buzz’ made up of everything fromrumours and earnings forecasts toimpressions formed in meetings with listedcompanies and the cumulative knowledge oftraders on stock overhangs or shortages.27

People: themost valuable assetAt the end of the day the most importantconstituents of a global financial cluster are notfinancial institutions but the people who workfor them. London provides the clearest exampleof this. After ‘Big Bang’, the City’s long-established merchant banks like MorganGrenfell, Kleinwort Benson and SG Warburg,launched major expansion programmes aimedat transforming their franchises into globalinvestment banks. Simultaneously, a wave ofmergers produced large independentinternational brokerages such as Smith NewCourt and Hoare Govett. The history of theseventures was not to prove a happy one. Acombination of out-dated managementtechniques, poor decisions and lack of capitalproduced what Philip Augar famously describedin his book, The Death of GentlemanlyCapitalism.28 One by one the British houses fellby the wayside, either retreating to marketniches, or in most cases surrendering to foreigntakeovers. The largest beneficiaries were the US

PeoplePower:The Forgotten Factor

CHAPTER 8

“The marketplace is neither a web of machines noran abstract concept – it is a place where humanscongregate to do business.”


investment banks, already established in theCity, which used their vastly superior capitalresources to buy market share, either throughoutright acquisition or by wholesale recruitmentfrom the ranks of the British incumbents.

The most symbolic fall, however, was that of aEuropean bank. SG Warburg was receivingunofficial Treasury support to maintain itsposition as a British-owned global investmentbank. Warburg pursued a policy of overseasexpansion and mergers, but in the end thesewere not enough to save it. In the mid-1990s,the bank surrendered its independence to SwissBanking Corporation which later merged withUBS – a Swiss bank that had already establisheda significant investment banking footprint in theCity – and emerged as UBS Warburg. After apolite interval of a decade the name Warburgwas dropped and the bank became knownsimply as UBS.

These dramatic changes in ownership did notinvolve mass displacement of staff. Whileduplication produced some redundancies, mostemployees were hired by foreign arrivals in theCity anxious to build market share andcredibility. The only significant changes occurredat very senior board level. Front line operationswere generally left in the hands of senior staffwith established City franchises. The foreigninvaders had not come to conquer but toassimilate. The prize was not really the brand orthe often-fragile structures behind them, butthe legions of skilled and highly experiencedbrokers, traders, market makers and corporatefinanciers that had kept the City at the forefrontof international markets.

Ongoing globalisation, the emergence ofLondon as one of the most cosmopolitan citiesin the world and the development of a singleEuropean financial market have all played a rolein increasing the proportion of foreign nationals

working in the Square Mile and Canary Wharf.Their arrival, however, has been as much aproduct of London’s allure as a global financialcentre as of transfers from overseas. Far fromdamaging the skills base of the City thecorporate storms of the past two decades havestrengthened it. The balance of ownership hasswung back partially in Britain’s favour with thedevelopment of large investment bankingdivisions by several of the country’s High Streetbanks, but this is not really a factor in themaintenance of London’s global competitiveposition. The real strength comes from a self-reinforcing labour market. To put it simply, top-grade financial professionals, both young andambitious and older and more experienced,want to work in London. They, rather thaneither their firms or their IT systems, are whatreally drives the marketplace.

Man andmachine: a symbiotic relationshipThere can be no doubt that IT has transformedsome segments of international capital markets.Global foreign exchange markets could notoperate as seamlessly as they do, handling suchhigh volumes around the clock, without robustIT systems. At a different level, the over-the-counter (OTC) derivatives market is dependenton advanced software and integrated platformsthat could not be replicated without heavydependence on computing power. This said, thevery fact that financial activity remainsconcentrated in global financial clusters issufficient to merit caution about any conclusionthat IT has triggered a structural revolution. Thevast majority of the world’s financial servicesworkforce still commutes to its computerstations and trading screens and engages in ahigh level of person-to-person interaction in thecourse of the normal business day.

The impact of IT should be described as catalyticrather than revolutionary. Markets are larger,faster and more complex, but many of theirbasic features remain intact. If anything,advances in digital technology havestrengthened global financial clusters ratherthan threatened their cohesiveness. Marketprofessionals may rely on their Blackberries,Smartphones and iPads to organise theirbusiness lives, but these technologies are thelinear descendants of the telephone, fax and

“Top-grade financial professionals, both youngand ambitious and older and more experienced,want to work in London. They, rather than eithertheir firms or their IT systems, are what reallydrives the marketplace.”


cable – they do not represent a quantum leapaway from the marketplace and their real utilityis to collect information and to communicate.Given the huge ICT infrastructure required bythe modern financial cluster, it would be easierto argue that the overall impact of advances inIT has been centripetal not centrifugal.

A recent academic study highlights theimportance of the interaction between man andmachines in the market infrastructure at theheart of each global financial services cluster:

“In summary, stock trading has become amuchmore competitive, technology driven andefficient industry, but it has not become people-less or dissolved in virtual space. People,hardware and physical infrastructure matter noless than ever before.”29

All of this has tended to work in favour of thelarge incumbent financial clusters, which havebenefited from the emergence of what onescholar has recently described as ‘two-sidedliquidity’, in which the market is functionallycomposed of ‘liquidity makers’ and ‘liquiditytakers’.30 The battle for supremacy has reallybeen a battle for liquidity – a battle in which IThas acted as a force of concentration and onewhere physical proximity has become a moreimportant binder of cluster strength.

“Market professionals may relyon their Blackberries,Smartphones and iPads toorganise their business lives,but these technologies are thelinear descendants of thetelephone, fax and cable – theydo not represent a quantumleap away from themarketplace.”


Throughout this paper we have focused onLondon, the world’s oldest and most successfulglobal financial cluster, as an example of how anincumbent market position has beenstrengthened by the key competitive drivers ofliquidity and human talent, although the pointsare equally applicable to New York, Hong Kong,Singapore and Tokyo. Once the centre of anempire where the sun never set, London hastransmogrified into a global financial clusterwhose reach is if anything even more pervasive.Developments over the past 40 years have beencritical in shaping the modern City, but theinitial impetus was delivered by the legacy ofempire and trading hegemony. With most ofcontinental Europe and Asia recovering fromthe massive destruction of the Second WorldWar and American bankers concentrating onthe development of their domestic capitalmarkets, the City had two decades to re-trenchits institutions on a financial battlefield overwhich it no longer enjoyed political or economicdominance.

Even as Tokyo rose phoenix-like from its ashes toassert its position as the global financial centrein Asia, western European capital marketsflexed their atrophied muscles and USinvestment bankers started to look across theAtlantic, a large part of the world was stilleffectively off the financial map. The SovietUnion had enveloped Eastern Europe in itsinward-looking command economy; China wasin a state of chaos, a state that would worsenunder the destructive cult of Maoism; largeparts of South East Asia were a war zone; Indiaand Pakistan were feeling their way painfullytowards sustained economic growth; and SouthAfrica, the only wealthy and stable regime in theAfrican or South American continents, haddoomed itself to sanctions and isolation bymaintaining apartheid. With the exception ofJapan and parts of Central and South America,which were firmly under American influence,British investment bankers dominated theforeign investment community.

London’s competitive position received twomassive boosts at the beginning of the 1960s, inboth cases because of obstructions to theinternational activities of US finance houses.With most foreign countries reluctant to holddollars in US banks due to fears of asset freezes,New York looked on helplessly when Londoncreated the Eurobond market in 1963 and wenton to build up a position of all but unassailabledominance. In foreign exchange markets the USmaintained its defence of the 1944 BrettonWoods fixed currency pact too long and, by thetime it renounced controls in 1971, London,Tokyo and the larger Western European centreshad already established strong positions ininternational foreign exchange trading. Theultimate irony is that while the US dollar remainsthe most heavily traded currency, with volumesmore than double those of the euro and fivetimes those of sterling, London holds thedominant position in international forex tradingwith a market share roughly double that of NewYork.

The Iron Lady’s legacyNotwithstanding advances in internationalbond and foreign exchange markets, the old-fashioned core of the City, built around thetrading of equities, was clearly acting as acompetitive drag, particularly with New York.History will bestow Margaret Thatcher, UKPrime Minister from 1979-1990, with areputation akin to that of Oliver Cromwell – aruthless moderniser who rode roughshod overopposition, antagonised many and damagedthe social fabric of Britain in pursuit of long-term economic objectives. Much of her policylegacy, however, was positive, particularly forthe City. Thatcher saw the City as an inefficientand over-regulated Old Boys’ Club. Employingher normal approach of forcing through oneintegrated package of reforms, she turned theCity upside down in 1986. The ‘Big Bang’abolished fixed commission rates, eliminatedthe distinction between stockbrokers andstockjobbers (effectively independent market

TheDurableCity:FromCoffeeShoptoGherkin

CHAPTER 9


makers), allowed foreign groups to buy Britishstock market firms and ended the UK discounthouse monopoly on issuing governmentsecurities. It was also intended that the LondonStock Exchange would move from open outcryto a floor-based screen system, but this wasrapidly overtaken by events and electronicscreen-based trading moved outside theExchange itself. While the ‘Big Bang’ wouldultimately spell doom for most British would-beinvestment banks and open up the City to awave of foreign takeovers, its impact on Londonas a global financial cluster was almost entirelypositive – the City was catapulted into themodern world and has not looked back.

The modernising record of the City’s marketinfrastructure has been distinctly uneven overthe quarter century since the ‘Big Bang’. TheLondon Stock Exchange went through aparticularly torrid time in the years before 2000,with its performance neatly summed up in ananalysis of London’s market infrastructure andits impact on the City’s competitiveness:

“In the case of the LSE, the performance of theexchange from Big Bang in 1986 for at least thefollowing 15 years was disappointing to say theleast. In 1986 it was without doubt the pre-eminent exchange in Europe, and its maincompetitors – Paris and Frankfurt – were notevenwithin striking distance. In the period sincethen, the LSE failed tomove from an electronicquote-based system to a full scale electronictrading system as quickly as it should have,failed with the Taurus project, designed tomodernise its settlement system, failed tomaximise the value of its derivatives market(which it thenmisguidedly sold to LIFFE in1992), and as a result it ultimately failed tomaintain its primacy over the other mainexchanges in Europe. The LSE also failed tocapitalize on the lead that SEAQ International

had built up in trading international shares. Itsfinal failure camewhen LIFFE was taken over byEuronext rather than the LSE in 2002.” 31

The performance of both privatised publicinfrastructure providers and new private sectorventures has improved significantly over thepast decade and much of the lost ground hasbeen made up, at least as far as operationalefficiency is concerned. Predators, however,remain on the prowl, as the current wave ofproposed mergers makes manifestly clear. It is,however, important to remember that it is thelocation of marketplaces rather than thelocation of exchanges that ultimatelydetermines the competitive position of clusters.On this front, a re-evaluation of the otherfactors supporting market dominance suggeststhat the position as the European time zone’sprimary global financial cluster is London’s tolose rather than Frankfurt’s to win. Frankfurt isnot in the current Global Financial Centres Index(GFCI) top ten, and her latest ranking of 14threpresents a fall of three places since late 2010.London’s closest European competitors in GFCIranking terms are Zurich and Geneva in 8th and9th place but neither has the capacity orambition to unseat London. Europe’s secondworld city, Paris, which mounted a challenge forprimacy a decade ago, has now fallen back to20th place.32

Streets of gold?London has bounced back from its competitiveslump through a mixture of the entry of anumber of vigorous private sector infrastructureproviders and by a long-delayed injection ofentrepreneurial aggression into the formermutuals, particularly the London StockExchange:

“Notwithstanding its rather sad past, over thelast few years the LSE has, through acombination of a global move away from theuse of the US capital markets andmanagementinitiatives, succeeded in re-establishing itself asEurope’smain international equitymarket. LIFFEand the LCH have had similar problems, whichhave nowbeen vigorously tackled. The future ofLIFFE seems to have been secured, initially by itsacquisition by Euronext and nowby Euronext’sacquisition by the NewYork Stock Exchange. In

“While the ‘Big Bang’ would ultimately spell doomfor most British would-be investment banks andopen up the City to a wave of foreign takeovers,its impact on London as a global financial clusterwas almost entirely positive.”


the derivatives field, however, it has to beconceded that LIFFE still lags someway behindthe ChicagoMercantile Exchange, which hastrading volumeswell in excess of those of LIFFE.”

“The story of the private sector infrastructureproviders such as Reuters and ICAP is quitedifferent. Of course Reuters has itself beenthrough some painful periods of adaptation,but wewould argue that it has been able tohandle thesemore rapidly and efficiently thanthe formerly industry-owned providers. ICAP isan excellent example of a company that hasgrown dramatically over a relatively short periodof time simply as a result of some inspiredentrepreneurial leadership.” 33

There is only a spread of 16 points betweenLondon, New York and Hong Kong at the top ofthe GFCI Index. Frankfurt is just over 100 pointsbelow Hong Kong. The top three account forroughly 70% of global equity trading and witheach solidly entrenched in a differentcontinental time zone, it can be argued thatLondon, New York and Hong Kong aresupporting each other in a triangle of globalcapital flows, rather than competing. It is a verydifficult triangle to break into and there is noreal evidence that any other centre, with thepossible exception of Singapore, is even close todoing so.

Of the three, London has benefited the mostfrom the global geography of the ‘two-sided’marketplace and the emphasis on proximitybetween ‘liquidity makers’ and ‘liquidity takers’.The advantages it derives from financialgeography have been clearly described in arecent academic study:

“The foremost factor affecting the geographicconcentration of the stock trading industry isthe value of proximity, which takes two principalforms: proximity between exchangeprofessionals andmarquee customers, and thatbetween thematching engines of exchangesand computers generating orders used bymarquee customers. On the side of liquiditytakers, themarquee customers of exchangesare institutional investors and investmentbanks. As a dominant headquarter location forthe British financial institutions as well as the

leading location for European institutions withinternational operations and Americaninstitutions with European operations, Londonis the decisionmaking centre for the largestpool of money in Europe. On the liquiditymaking side, marquee customers are highfrequency traders, operating as departments ofinvestment banks or as independent specialisedfirms. The latter are mostly US based firms, suchas Getco, Tradebot and Infinium, for whomtrading in London affords a familiar legalenvironment, as well as offers theneighbourhood of other US financial firms anda great pool of specialised labour.”34

It is important to note here that the three criticalcompetitive variables we are talking about areonce again liquidity, people and legalenvironment. If anything, the passage aboveunderstates their importance. Liquidity isflowing in and out from all over the world andthe agents of its exchange, themselvesinternational in origin, are closely grouped inLondon because the rewards of working thereare commensurate with the scale and status ofthe marketplace.

Market externalities provide the City clusterwith sources of strength that most of its rivalswill find difficult if not impossible to replicate.Many of these stem from its status as one of theworld’s truly global cities. London ranks 1st inthe Global Intellectual Property Index and 2nd inboth the Global Power City Index and the WorldCities Survey (New York is in 1st place in bothindices). Less quantifiable but equally importantare less tangible factors such as EnglishCommon Law, compatible accountingstandards and the draw of London’s vibrantcultural and entertainment environment.London, in short, is a place in which aspiringprofessionals from all over the world want tolive and work. Given the importance of thewidth and depth of the talent pool to a multi-functional, multi-national global financialcentre, London has a significant advantagestemming from a constant inflow of potentiallyvaluable recruits for the City to choose from.London-based firms rarely have to look faroutside of the City and Canary Wharf to find theskills and experience on which theircompetitiveness is ultimately based.


London: durable but not unassailableMarket externalities pose the greatest threat tothe City’s hegemony. The relationship betweenthe UK financial services sector and the nationalgovernment – into whose Exchequer it is themost important contributor – has been erratic tosay the least. Foreign commentators have oftenbeen bemused by a governmental approach thatappears to swing between benign hostility andoutright hostility. A US banker, quoted in 2003,summed up the sheer incredulity of outsiders:“The one thing the Brits do well is financialservices, yet the government doesn’t do a thingabout it. We’d be all over it.”35

The City-Whitehall relationship was pushed tobreaking point by the financial crisis of 2007-2008, and as yet there are few signs of fencemending. The root cause was the near collapseof Royal Bank of Scotland (RBS) and HalifaxBank of Scotland (HBOS), which was onlyaverted by £37bn of emergency capital from theBrown Government, as well as £61.6bn ofemergency loans from the Bank of England.Both the government and British taxpayers hadconsiderable cause for anger with themanagement of both banking groups, each ofwhich had paid significantly over the odds forsecond-rate acquisitions, and worse, takenhuge positions in sub-prime loans, often in theform of securitised no or low deposit USmortgages whose value was wiped out whenthe US housing bubble burst.

Governmental anger and an undoubted desireto satisfy public demands for the perceivedoffenders to be punished have led to astigmatisation of the British financial servicessector under the newly pejorative label of‘bankers’. This reaction was scarcely surprisingbut the problem is that, three years on from thebank bailouts and a year into a newgovernment, there has been little real change in

the policies or rhetoric coming out ofWestminster and Whitehall. Despite theimposition of heavier taxes and requirementsfor delayed payment, City bonuses continue toanger the public and politicians. There is a deep-seated refusal in British society to accept thecompletely correct position of City firms thathigh levels of remuneration are the product ofcompetitive dynamics in the global marketplacerather than their own cupidity.

The political offensive against the City posestwo particular dangers to the long-termcohesion of the London global financial cluster,which were identified by respondents to theGFCI 9 questionnaire in March 2011:

• The potential for firms to respond to harshtaxation, punitive regulation andunpredictable policy interventions by movingaway to another centre.

• The choking off of the supply of talentedprofessional staff by a more demandingpersonal tax regime, making it more difficultto recruit and retain talent.

Both London and New York are in danger ofreaching a tipping point as governments seekrecompense for the Credit Crunch. If that pointis reached we could see major institutionsseriously considering moving their headquartersaway from the City and Wall Street.

The situation in Britain in the aftermath of thefinancial crisis, where the government is notonly raising taxes on banks’ profits but is alsoimposing onerous restrictions on financialservices bonus payments, shows how thecentre’s continued success is guaranteed. Pressand market speculation about the likelihood ofan exodus of financial institutions has beenwidespread and there is anecdotal evidencethat a significant number of foreign nationalsdeparted, either to a different office of theircurrent employer or back to their native country,as personal tax rates rose and the bankerbacklash gathered steam. However, London issufficiently attractive that its financial cluster isprobably managing to find fresh talent tocompensate for this very real brain drain, but itis walking a fine line. The importance of this

“London and New York are in danger of reaching atipping point as governments seek recompensefor the Credit Crunch. If that point is reached, wecould see major institutions seriously consideringmoving away from the City and Wall Street.”


issue cannot be over-stressed – competitiveadvantage comes down to human talent andany serious loss of it can only have negativeconsequences.

There are some signs that David Cameron’sgovernment is gradually letting some of thesteam out of the offensive against the City.There is still, however, a tendency acrossWestminster to view the City as an errantgolden goose that can be coerced intoproducing multi-billion pound golden eggs viaspecial tax levies to prop up the government’sfailing finances. The City is also concernedabout the future course of regulatoryintervention. Regulatory uncertainty is theenemy of any financial cluster and, given theCity’s global status, such uncertainty isparticularly corrosive.

Two cross sections of data from GFCI 9underscore the strength of the positions held bythe leading global financial centres:

Table 1 (page 45) cross-tabulates the 11 GFCIsub-indices for the top 20 global centres,showing how many of the latter were ranked inthe top 20 for each pair of sub-indices. Forexample, 18 of the top 20 centres were in thetop 20 for both ’people’ and ‘infrastructure’,whilst just 12 of the top 20 centres were in thetop 20 for both ‘banking’ and ‘wealthmanagement’. This is explained by the fact thatwealth management centres such as Zurich andGeneva have evolved as specialised clusters.While there is only one perfect correlation –‘banking’ and ‘general competitiveness’ – thenumber of top-20 centres ranked in the top 20of each of the sub-indices is consistently high,except in the more marginal sub-indices wehave identified, such as professional servicesand wealth management.

Table 2 (page 46) shows the rankings of the top 20centres across the same range of sub-indices. Thisshows exactly why the leading four centres enjoysuch a clear advantage over the rest of the field –consistently high ratings across the field of sub-indices. To take our wealth managementexample, Geneva manages 9th spot overall inGFCI 9, despite only ranking in the top 10 financialcentres for ‘government & regulatory’ (9th),‘banking’ (7th) and ‘wealth management’ (2nd).

Overall, the crisis of 2007-2008 has underlinedone of the key messages we derived from ourearlier structural and historical analysis. A well-developed international cluster, established as aliquid marketplace and supported by a deeppool of skilled labour, is extremely durable if thestate institutions around it remain in place. It isoutside the brief of this report to comment onthe systemic faults in the international financialservices industry that led to the Credit Crunch,or on the efficacy of remedies that nationalgovernments and transnational regulators arepursuing to cure the malaise (these areexamined in detail in The Road to Long Finance:A Systems View of the Credit Scrunch, byProfessor Michael Mainelli and Bob Giffords,published by the Centre for the Study ofFinancial Innovation in 2009)36. For this paper,the significant point is that London and NewYork, the global financial clusters that absorbedthe greatest financial losses, have maintainedtheir positions as 1st and 2nd in the GFCIrankings throughout the crisis.

“There is still a tendency acrossWestminster to view the City asan errant golden goose thatcan be coerced into producingmulti-billion pound goldeneggs via special tax levies toprop up the government’sfailing finances.”


People

BusinessEnvironmen

t

MarketA

ccess

Infrastructure

Gen

eral

Competitiven

ess

AssetMan

agem

ent

Ban

king

Governmen

t&Reg

ulatory

Insurance

ProfessionalServices

WealthMan

agem

ent

People 18 17 18 18 18 18 18 18 16 12

Business Environment 17 18 19 18 19 17 18 15 13

MarketAccess 17 18 18 18 16 18 15 12

Infrastructure 18 18 18 17 18 15 13

GeneralCompetitiveness

18 20 16 18 14 12

AssetManagement 18 16 18 16 13

Banking 16 18 14 12

Government&Regulatory

16 17 14

Insurance 14 11

Professional Services 14

WealthManagement

Table 1 | Correlations of top 20 centres across sub-indices


Centre People

BusinessEnvironmen

t

MarketA

ccess

Infrastructure

Gen

eralCompetitiven

ess

AssetMan

agem

ent

Ban

king

Governmen

t&Reg

ulatory

Insurance

ProfessionalServices

WealthMan

agem

ent

Average

London 1 1 1 1 1 1 3 1 4 1 1 1.45

NewYork 2 2 2 2 2 2 1 2 3 2 3 2.09

HongKong 3 3 3 3 3 3 2 4 1 3 5 3.00

Singapore 4 4 4 4 4 4 4 3 5 4 7 4.27

Shanghai 5 7 5 10 6 8 7 17 2 26 32 11.36

Tokyo 6 6 6 5 5 5 6 5 6 6 17 6.64

Chicago 7 5 8 7 7 6 11 8 9 4 14 7.82

Zurich 12 8 7 9 9 12 8 12 17 12 8 10.36

Geneva 14 11 12 10 17 13 16 9 25 7 2 12.36

Toronto 15 9 10 15 12 10 14 12 10 10 6 11.18

Sydney 17 9 11 13 8 11 10 16 11 15 15 12.36

Boston 9 15 13 8 15 9 20 14 14 8 19 13.09

SanFrancisco 9 17 14 16 12 6 18 10 15 9 26 13.82

Frankfurt 13 12 16 12 12 14 15 6 18 13 13 13.09

Shenzhen 8 18 9 26 16 16 9 52 7 46 45 22.91

Seoul 38 25 20 25 19 32 5 22 35 38 39 27.09

WashingtonDC 9 19 15 6 18 15 17 15 13 11 35 15.73

Beijing 15 13 26 19 9 17 12 30 8 41 43 21.18

Taipei 20 20 17 17 20 18 19 43 16 30 54 24.91

Paris 19 16 23 14 9 24 12 7 12 23 24 16.64

Table 2 | Rankings of top 20 centres across sub-indices


To draw conclusions on the formation andsustainability of global financial clusters we willreturn to the tripartite division of academiccluster theory: industry-centred complexes,agglomeration and social networks, or ‘clubs’.Testing their explanatory power through thetwin lenses of history and contemporary clusterdynamics produces two fairly stark conclusions:

• Most clustering results from a mixture of allthree inputs.

• Academic theory falls far short of providingcomprehensive answers to the questionsposed.

It is very clear that social networks played anextremely important role in early clusterformation. This is scarcely surprising, given thatearly financial services institutions tended to befamily firms, partnerships and syndicates.Industry-centred complexes and agglomerationtheories do, however, have some explanatorypower in understanding early stage clustering.Market participants were pulled into earlyfinancial centres in the Low Countries becausethese centres were operating as capital nodesfor trading networks that linked the Baltic,central Europe, Italy, Spain and Britain. Thisagglomeration was attended by thedevelopment of increasingly complex multi-tiered businesses and exchanges, the mostsignificant of which in purely financial termswere trans-national banks and discount houses.

As clusters matured, the dynamic mixturechanged. Growth was based on accelerated

agglomeration and the expansion of industry-centred complexes. Social networks remainedimportant, not least because most marketinstitutions remained private businesses, butthey effectively became intertwined with theindustry-centred complexes which werecompletely dependent on human talent andinteraction. Subsequent agglomeration hasacted primarily as an indicator of cluster health –strong clusters continue to pull in newparticipants at the expense of weak ones.

The importance of externalitiesWhile this exercise is neat enough, it tells us verylittle about why certain clusters have grown topositions of global dominance and maintainedthose positions in the face of a host ofchallenges. There is an extremely important setof factors that theoretical cluster models tend tooverlook, which might be labelled‘externalities’. A combination of geography andinternational politico-economic history hasalways shaped the map of where clusters havegrown and survived. This is as true today as itwas when the Barings and their neighbours fledfrom Napoleon to the safety of London. Themost significant change in the map of globalfinancial clusters in our lifetime has been theemergence of China from internal chaos andself-imposed isolation to begin asserting her fullpotential on the international stage.

Below the level of geo-politics, however, thereal battle for cluster supremacy is being foughton two different battlefields – one internal andone external – about which academic theorytells us very little. Neither of these have much todo with information technology which is a vitalsupport system for any financial centre, but nota source of competitive advantage asimbalances can be, and usually are, remediedquickly through a combination of investmentand imitation. The only sense in which IT canreally be seen to have exercised a prolongedinfluence over the competitive position ofinternational financial clusters is that it has,

Conclusions:Cluster FormationandSustainability

CHAPTER 10

“A combination of geography and internationalpolitico-economic history has always shaped themap of where clusters have grown and survived.This is as true today as it was when Barings andtheir neighbours fled from Napoleon to the safetyof London.”


because of the sheer scale and complexity ofmodern multi-dimensional infrastructure,widened the gap between a small number oftruly global players and a much larger group ofnational or regional financial centres.

The internal battle is for control of the variousglobal financial marketplaces. The weapons arecontrolled by the clusters themselves, of whichthe strength and depth of their labour pool, theability to attract flows of liquidity and the sizeand the strength of their large financialinstitutions are easily the most important.Although this battle is continually being fought,the general rule is that the largest and best-established global clusters maintain theirpositions and have sufficient reserves to retakeany ground lost during periods of weakness,such as that experienced by London in theaftermath of ‘Big Bang’. Global financialclusters and global marketplaces require globalcities, and particularly the global concentrationsof skilled market professionals that only thelatter can support.

The external battlefield is – and always has been– that of tax and regulation, underpinned by thelegal environment. In established centres, thelegal system and the certainty it gives allowsparticipants to transact and do business. Taxand regulation are more variable. It was themedieval Catholic Church’s banning of usurythat accelerated the use of bills of exchange ascross-border financial instruments, using thesimple device of drawing the originalinstrument in one currency and making itpayable in a second, with a built-ininterest/cum-profit margin in the designatedrate of exchange to avoid usury. Taxationtended to be a blunt instrument, usuallyemployed by the state to finance wars, andfinancial centres were always vulnerable to suchlevies simply because they normally representedthe largest and most liquid sources of capital.

The battle today is a more complex war ofattrition. The entire taxation regime haschanged beyond recognition since the start ofthe 20th century with the pace of changeaccelerating over the past three decades asgrowing state sectors imposed higher andhigher burdens on the public purse. While thefinancial services sector has had to shoulder thegeneral increase in corporate and personaltaxation, it has often also attracted additionaltaxes, such as the Stamp Duty on all equitypurchases in the UK, as well as extraordinarylevies on profits.

Large financial services institutions areinternational conglomerates with the expertiseto manage their corporate tax payments aroundthe globe. The same is not true of smaller firms,such as the financial boutiques that are often atthe cutting edge of competition and innovation,and thus these are far more likely to seek lowertax regimes. As long as their destination issimply a tax haven, then no real damage will beincurred by the cluster they have left as theirbusiness will still be transacted in itsmarketplace. The situation changes completelyif they decamp to a rival global cluster.

This time its personalThis said, it is personal rather than corporatetaxation that is the real danger. Ultimately, afinancial cluster will rise or fall dependent on itsability to attract and retain a multi-talentedworkforce. The bulk of that workforce is madeof experienced professionals in their 20s and30s who are extremely mobile. Only a smallportion of this workforce will remain in theindustry after they turn 40 and fewer still untilretirement, so they focus on maximising incomeand savings while still in the mainstream ofcareer development. The entire European Unionis one labour market, but it does not have onetax regime. Confronted with rising personal taxrates, EU nationals can easily move elsewhere inthe Union, particularly in cases where theirexisting employers have offices in otherEuropean centres. With aggressive new marketentrants such as the Gulf States and Singaporeoffering significant personal fiscal incentives,there is also a general threat of a ‘brain drain’from established global centres that push taxesbeyond the level deemed a fair charge for the

“It is personal rather than corporate taxation thatis the real danger. Ultimately, a financial clusterwill rise or fall dependent on its ability to attractand retain a multi-talented workforce.”


professional and social attractions of the globalcity in question. There is, for example, a very realfear that the recent UK increase of the upperincome tax band from 40% to 50% has crossedthat line.

The importance of the personal taxation issuecannot be overemphasized as it impacts directlyon one the key assets of a successful globalcluster, its skilled workforce. It is currentlyestimated that something in the order of 25%of the income tax collected in the UK is paid byabout 275,000 people, of whom at least halfare likely to work directly or indirectly infinancial services.37 As we have stressed before,many of these people are highly mobile andtheir continued presence in the cluster shouldnot be taken as a given if the tax burdenimposed on them is significantly out of line withthat in rival centres.

The price of uncertaintyRegulation tends to be more of an institutionalbarrier than a personal one. As is the case withtaxation, the financial services industry’s painthreshold is fairly high when it comes toregulation. As long as a cluster is facing the sameregulatory burdens as its competitors, and aslong as the regulatory horizon is relatively stable,firms can generally pass on the increased costs ofcompliance to their customers. There is,however, an undercurrent of fear that politiciansand their regulators could cause lasting damageto global clusters that have prospered when theyheld their futures in their own hands, but nowsee their grasp being prised loose. The fear ofthis Sword of Damocles is captured in theanswer of one of the respondents to the GFCI 9question “Do you have any comments on thespecific factors that affect the competitivenessof financial centres?”

“There is a constant overhang of regulatorychange in themajormarkets – those affectedmost by the global financial crisis – that canchange the dynamics of our industry inmajorways. In the interim, the financial centresmustwaitwith uncertainty and trepidation, not fullyknowingwhat governmentswill apply assolutions and new rules to counter future crises.”38

This comment was not made with regard to anyparticular city, but to all global financial centres.Regulatory uncertainty is a global phenomenon,one that has grown in importance with theincreasing number of international regulatoryinitiatives. As the comment itself hints,international initiatives are not necessarilyimplemented in the same way or with the samespeed in different countries. Global financialclusters face both regulatory uncertainty andthe possibility of being disadvantagedcompared to some of their competitors.

Centres of the universeNone of the factors set out in the introductionof this paper as likely to erode the strength ofglobal financial clusters have been shown topose a real threat. Globalisation hasstrengthened the power of the dominantclusters by increasing liquidity flows and accessto talent. The rise of Asia has simply produced amore balanced trading network within whichtransactions between the major centres act in amutually reinforcing manner. The impact of theIT revolution has been centripetal rather thancentrifugal, concentrating liquidity in clustersrather than scattering it across a host of mini-marketplaces. The result: global financialclusters are stronger than they have ever beenbefore and the largest clusters continue to gainground at the expense of smaller competitors.

The biggest threat to this position of strengthcomes from the external environment withinwhich clusters operate. This is nothing new. Thehistory of financial clusters has consistentlyshown them to be most vulnerable to changes inthe political environment. In the past this hasusually taken the form of war or revolution.Today it is a combination of higher personaltaxation and a more restrictive regulatory regime.

“The impact of the IT revolution has beencentripetal rather than centrifugal, concentratingliquidity in clusters. The result: global financialclusters are stronger than they have ever beenand the largest continue to gain ground at theexpense of smaller competitors.”


There is nothing inevitable about the future offinancial centres. The real determinant is thespeed with which politicians and regulatorscome to terms with the recent financial crisis. Ifthey do so quickly, reducing punitive taxationand eliminating regulatory uncertainty, then ourglobal financial clusters will continue to stabiliseand grow. If they continue to extractunsustainable taxes and debate seismicregulatory changes, then existing clusters couldbegin to fragment. There are too manyunknown variables to forecast a future clusterhierarchy under this scenario, but it is difficult tobelieve that it would be as efficient as the onewe have today.


Augar, Philip, The Death of GentlemanlyCapitalism: The Rise and Fall of London’sInvestment Banks. London: Penguin, 2000.

Cox, Peter & Lynton Jones, The CompetitiveImpact of London’s Financial MarketInfrastructure. London: City of London, 2007.

Gordon, Ian R. & Philip McCann, “IndustrialClusters: Complexes, Agglomeration and/orSocial Networks?”Urban Studies 37/3 (2000):513-32.

Herzberg, Frederick I., “One more time: How doyou motivate employees?”Harvard BusinessReview 65/5 (1987):109-120.

Houlder, Vanessa, “Top 1% Poised to Pay 25%of Income Tax,” The Financial Times,February11, 2011. Accessed May 25, 2011http://www.ft.com/cms/s/0/969a605e-3616-11e0-9b3b-00144feabdc0.html#axzz1NTjliRb2

Lascelles, David, Sizing Up the City – London’sRanking as a Financial Centre. London:Corporation of London, 2003.

Mainelli, Michael & Bob Giffords, The Road toLong Finance: A Systems View of the CreditScrunch. London: CSFI. 2009.

Martin, Ron & Peter Sunley, “DeconstructingClusters: Chaotic Concept or Policy Panacea?”Journal of Economic Geography 3 (2003): 5-35.

Porter, M.E., The Competitive Advantage ofNations. London: Macmillan, 1990.

Porter, M.E., “Clusters and Competition: NewAgendas for Companies, Governments, andInstitutions”. In Porter, M.E.,On Competition.Harvard: HBS Press, 1998.

SAMI Consulting,An Assessment of the City’sICT Infrastructure. London: City of London,2009.

Spufford, Peter, “From Antwerp to London: TheDecline of Financial Centres in Europe,”OrteliusLecture 4 (2005): 3-40.

Taylor, Peter, Jonathan Beaverstock, Garry Cook& Naresh Pandit, Financial Services Clusteringand its Significance for London. London:Corporation of London, 2003.

The City UK, Key Facts about UK Financial andProfessional Services, February 2011. London:The City UK, 2011.

The City UK, City Indicators Bulletin, February2011. London: The City UK, 2011.

Wójcik, Dariusz, “Revolution in the StockExchange Industry: Two-Sided Platforms, Battlefor Liquidity, and Financial Centres”,WorkingPaper in Employment,Work and Finance 10-10(2010): 1-25.

Z/Yen Group et al, The Global Financial CentresIndex 9. London: Long Finance, 2011.

“Competition and Economic Development,”Harvard Business School, Institute for Strategyand Competitiveness. Accessed March 15, 2011http://www.isc.hbs.edu/econ-clusters.htm

“Stock Exchanges: Maple Fig-Leaves – TheDifficult Choice between Nationalism andMonopoly,” The Economist, May 19, 2011.Accessed May 21, 2011.http://www.economist.com/node/18713546.

Bibliography


Endnotes

1 Key Facts about UK Financial andProfessional Services, February 2011(London: The City UK, 2011); City IndicatorsBulletin, February 2011 (London: The City UK,2011).

2 Z/Yen Group et al, The Global FinancialCentres Index 9 (London: Long Finance,2011), 4-5.

3 M. E. Porter, The Competitive Advantage ofNations (London: Macmillan, 1990)

4 M. E. Porter, “Clusters and Competition:New Agendas for Companies, Governments,and Institutions”. In M. E. Porter,OnCompetition (Harvard: HBS Press, 1998), 197-198.

5 “Competition and EconomicDevelopment,” Harvard Business School,Institute for Strategy and Competitiveness.Accessed March 15, 2011http://www.isc.hbs.edu/econ-clusters.htm

6 Ian R. Gordon and Philip McCann,“Industrial Clusters: Complexes,Agglomeration and/or Social Networks?”Urban Studies 37/3 (2000): 513-32. See alsoRon Martin & Peter Sunley, “DeconstructingClusters: Chaotic Concept or PolicyPanacea?” Journal of Economic Geography 3(2003): 5-35.

7 Peter Taylor et al., Financial ServicesClustering and its Significance for London(London: Corporation of London, 2003), 24-25.

8 Key Facts about UK Financial andProfessional Services, February 2011(London: The City UK, 2011); City IndicatorsBulletin, February 2011 (London: The City UK,2011).

9 “Stock Exchanges: Maple Fig-Leaves – TheDifficult Choice between Nationalism andMonopoly,” The Economist, May 19, 2011.Accessed May 21, 2011.http://www.economist.com/node/18713546.

10 Z/Yen Group et al., The Global FinancialCentres Index 9, 4-5.

11 Taylor et al., Financial Services Clusteringand its Significance for London, 65.

12 David Lascelles, Sizing Up the City –London’s Ranking as a Financial Centre(London: Corporation of London, 2003), 14.

13 Z/Yen Group et al., The Global FinancialCentres Index 9, unpublished surveyresponses.

14 Lascelles, Sizing Up the City – London’sRanking as a Financial Centre, 22

15 Frederick I. Herzberg, “One more time:How do you motivate employees?”,HarvardBusiness Review 65/5 (1987):109-120

16 SAMI Consulting,An Assessment of theCity’s ICT Infrastructure (London: City ofLondon, 2009), 3-4.

17 LogicaCMG, Mind the Gap – The blackhole at the heart of the UK’s energy supply(November 2006)


19 Peter Spufford, “From Antwerp toLondon: The Decline of Financial Centres inEurope,”Ortelius Lecture 4 (2005): 3-40.




23 Peter Cox and Lynton Jones, TheCompetitive Impact of London’s FinancialMarket Infrastructure (London: City ofLondon, 2007), 29.

24 Dariusz Wójcik, “Revolution in the StockExchange Industry: Two-sided Platforms,Battle for Liquidity, and Financial Centres,”Working Paper in Employment,Work andFinance 10-10 (2010): 15.

25 SAMI Consulting,An Assessment of theCity’s ICT Infrastructure, 52.

26 Ibid, 52.

27 Taylor et al., Financial Services Clusteringand its Significance for London, 40-46.

28 Philip Augar, The Death of GentlemanlyCapitalism: The Rise and Fall of London’sInvestment Banks (London: Penguin, 2000).

29 Dariusz Wójcik, “Revolution in the StockExchange Industry: Two-Sided Platforms,Battle for Liquidity, and Financial Centres”,Working Paper in Employment,Work andFinance 10-10 (2010), 18.

30 Wójcik, “Revolution in the Stock ExchangeIndustry: Two-Sided Platforms, Battle forLiquidity, and Financial Centres”, 1-25.

31 Cox and Jones, The Competitive Impact ofLondon’s Financial Market Infrastructure, 53-54.


33 Cox and Jones, The Competitive Impact ofLondon’s Financial Market Infrastructure, 64.

34 Wójcik, “Revolution in the Stock ExchangeIndustry: Two-Sided Platforms, Battle forLiquidity, and Financial Centres”, 16.

35 Lascelles, Sizing Up the City – London’sRanking as a Financial Centre, 20.

36 Michael Mainelli and Bob Giffords, TheRoad to Long Finance: A Systems View of theCredit Scrunch (London: CSFI, 2009)

37 Vanessa Houlder, “Top 1% Poised to Pay25% of Income Tax,” The Financial Times,February11, 2011. Accessed May 25, 2011http://www.ft.com/cms/s/0/969a605e-3616-11e0-9b3b-00144feabdc0.html#axzz1NTjliRb2



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