The U.K. is the highest net exporter of financial services and London, with its convenient time zone, use of English and feather-light regulations, is the world’s financial capital. Various cities, including Venice and Amsterdam, have held and lost the title throughout history.
Brexit and the possible loss of passporting rights of firms in Britain have raised questions about whether the city can keep its position at the heart of international monetary system. But how did it get there? We briefly trace the history.
The City of London
London’s primary financial district is actually a city in itself. Known as The City of London, it was established a few years after the Roman invasion in AD 50 on the north bank of the river Thames and even has its own mayor and governing body called City of London Corporation.
Like other ports, commerce flourished in the City and it drew merchants and entrepreneurs from all over. Historian Peter Borsay says London’s population went from 50,000-60,000 in the 1520s to a million by the end of the 18th century. Between 1650 and 1750, it saw the arrival of 8,000 immigrants a year, according to historical demographer Tony Wrigley. These merchants established guilds and wielded great influence and power. They were able to secure autonomy and special freedoms and rights for the residents that businesses in the area enjoy to this day.
The merchants also went into banking and developed the sector. The Bank of England, which stands in the middle of the City, was a private corporation started by merchants in 1694 during the Nine Year War to fund the government’s military efforts. It received various long-term privileges and became a monopoly.
Coffee houses, numerous within the City’s walls around this time, were used as makeshift offices that would become financial institutions. The London Stock Exchange was started by stockbrokers who conducted business in Jonathan’s Coffee House in Change Alley. Similarly, the insurance market Lloyd’s of London was named after a coffee house on Tower Street that was used by marine underwriters.
There was hardly any question as to which city in the U.K. financial activities would concentrate in. “An ancient banking tradition, a major port, the capital seat, the hub of the railroad network built after 1830, all forces were brought to bear on the single locality, itself with a minor ambivalence between the City and the West End. The Irish and Scottish different banking systems reached across their boundaries and linked up with London,” wrote economic historian Charles P. Kindleberger in The Formation of Financial Centers.
International Competition
London borrowed and improved upon financial innovations from Amsterdam, the world’s trading and financial center in the 17th century. It developed a market-centered system as opposed to the bank-centered one in the Dutch city and grew more dominant in the 18th century as the Netherlands witnessed an economic and political decline.
London then competed with Paris to be the biggest global financial hub until the mid-19thcentury. Paris lost out in 1848 when the Bank of France suspended specie payments after France lost a war with Prussia.
“Since the suspension of specie payments by the Bank of France, its use as a reservoir of specie is at an end. No one can draw a cheque on it and be sure of getting gold or silver for that cheque. Accordingly the whole liability for such international payments in cash is thrown on the Bank of England,” wrote Walter Bagehot in his famous 1873 book Lombard Street: A Description of the Money Market. “London has become the sole great settling-house of exchange transactions in Europe, instead of being formerly one of two. And this pre-eminence London will probably maintain, for it is a natural pre-eminence. The number of mercantile bills drawn upon London incalculably surpasses those drawn on any other European city; London is the place which receives more than any other place, and pays more than any other place, and therefore it is the natural ‘clearing house.’ The pre-eminence of Paris partly arose from a distribution of political power, which is already disturbed.”
London held supreme until the start of the First World War, when Kindleberger says it began to have “difficulty in maintaining its role as a center for foreign reserves and a source of short- and long-term credit.”
This period saw the U.S. gain importance as a financier and the New York Stock Exchange overtook the London Stock Exchange. New York was briefly the financial center of the world after the Second World War until the Eurodollar market developed in the 1950s and London took a lion’s share of it, according to Kindleberger. English common law meant the Bank of England could allow the lightly regulated, offshore market to flourish, and hundreds of foreign banks set up branches in London.
The U.S. had its own version of common law and could have adopted and developed the parallel market in New York, but its government chose not to and stuck to strict financial regulations.
Economist Ronen Palan explained that this was because while the U.S. was a rising hegemonic power focused on developing its manufacturing and commercial sector, the British Empire was a declining hegemonic state with a weak manufacturing and commercial sector and a relatively powerful financial sector.
“The City of London developed at the heart of the British Empire, somewhat divorced from the U.K.’s mainland economic needs, to finance trading and manufacturing throughout the formal and informal British Empire,” he wrote. “Although nationalized in 1948, the Bank of England remained effectively under the control of the City’s commercial banks. The Bank of England consistently pursued policies that favored the City’s position as a world financial center, even when such policies were seen as harmful to the UK’s mainland manufacturing needs. The pound was consistently overvalued, interest rates relatively high, in a country that saw a declining manufacturing sector.”
But the Square Mile hadn’t definitively beaten Wall Street yet.
The Big Bang to Brexit
In October 1979, Britain removed controls on foreign exchange placed during the Second World War. Nicholas Goodison, chair of the London Stock Exchange at the time, told the New York Times the restrictions had “done a lot of harm to London as one of the leading financial centers.”
Seven years later, the city’s financial markets were deregulated in a move so tremendous that it was dubbed the “Big Bang.” The removal of fixed rate commissions, entry of foreign companies and switch to electronic trading helped kick off a financial revolution that would cement London’s place as the global financial capital. The average daily turnover of the London Stock Exchange rose from 500 million pounds in 1986 to over $2 billion in 1995. Small British firms were bought off by international players and the culture of the country’s financial sector changed forever. The city also became a hub for the multitrillion-dollar global derivatives market in the ’90s.
London has enjoyed a good run since, but Brexit is a cloud that hangs over its skyscrapers.
Consultancy firm EY said assets worth nearly 800 billion pounds were being moved from Britain to other European financial centers in the run up to the March 29 exit date.
Brexit also threatens the city’s access to foreign talent, which it has relied on for centuries. In 2017, 18% of the workforce in the City was born in Europe, versus 7% for the whole country.
Vying for London’s position in Europe are Dublin, Luxembourg, Frankfurt and Paris. After being toppled from the top spot in the eighteenth century, Amsterdam may regain some of its former glory, too. In September, Reuters reported that 20 financial firms are applying for licenses to operate in the city.
New York has already replaced London as the financial center of the world, according to a survey by London-based think-tank Z/Yen. A new chapter begins.