Sometimes the conditions for the formation of today’s top IFCs happened organically and largely because of the related domestic markets (eg New York); sometimes the conditions were a combination of originally organic growth because of the related domestic market combined with luck (ie common language and legal system with its successor) and then sure-footedness (eg London); sometimes a combination of being an international trade hub, luck (ie language and legal system) and sure-footedness (eg Hong Kong and Singapore); and sometimes as a very conscious and precise government decision (eg Dubai).
Some of the more obvious criteria for IFC success include a good reputation, general macro-economic stability, availability of skilled people, adequate physical infrastructure, taxation and cost competitiveness, reliable financial reporting
Less obvious criteria include economies of scale and clustering. An IBRD-IFC report on Moscow, said: “One common obstacle to all cities wishing to become financial centres, is the advantages of scale enjoyed by existing major centres. The larger a centre, the better the service it provides: its markets are deeper and more liquid and it provides a richer array of services. These advantages of scale are self-reinforcing: since new business tends to be attracted to the largest center, the latter tends to grow still larger.”
Michael Porter’s “The Competitive Advantage of Nations” gave a description of the benefits that can accrue to a business that operated in the same geographical location as other similar businesses. Such clustering makes it easier, for example, to find suitable skilled labor and externally provided services.” Both London and New York initially built their economies of scale – and clustered – because they directly served large economies.
Market access is also important. Singapore and Hong Kong have each prospered and grown despite not serving large domestic markets. Initially, at least, they benefited from the commercial activities surrounding their positions as international trade hubs.
The issue of legal system and regulation is more complex. There are often suggestions that the “common law” legal systems of the UK, the US, Singapore, Hong Kong, Dubai FTZ, Australia etc are – for the purposes of financial innovation — superior to the “civil law” systems of countries like China and Japan (and Russia). Dubai essentially imported a “common law” legal framework for its IFC. The issue of legal system does not explicitly arise in most IFC surveys, but always seems to be lurking in the background.
According to its official internet site, “the Dubai IFC is an independent jurisdiction under the UAE Constitution, and has its own independent civil and commercial laws, which are written in English and which default to English law. It also has its own courts, with judges taken from the common law world including England, Singapore and HK.” Singapore has used its “common law” system, as well as its reputation for efficiency and honesty, to become an increasingly important wealth management center.
The appropriate level of regulation is a tricky issue. Too much regulation will stifle innovation and agility, and London (for example) has in the past been praised for its “light touch”. However, in recent times this “light touch” has been blamed for a series of City scandals.
The Foreword to the March 2014 Z/Yen GFCI says: “Since the financial crisis of 2007, New York hasn’t done anything particularly well, but in a number of areas no one in London has accepted responsibility for regulation or self-regulation. Despite some regulatory restructuring, which only appears to have delayed reform, London appears ill-served in domestic regulation with examples such as RBS’s Global Restructuring Group scandal, the dragged out Payment Protection Insurance scandal, or the miss-sold swaps scandal. Domestic regulation has not tackled the oligopolistic banking market … London suffers when global financial news tarnishes (its) brand – London-IBOR, the London Whale, the foreign exchange scandal only now starting to bite, with rumours circulating about other index, benchmark, and commodities scandals. In fact, it seems increasingly apparent that authorities were aware of, yet tolerated, the LIBOR scandal well into 2012. If the regulators are unimpressive, they are certainly not inexpensive. Some claim that the majority of jobs created have been in compliance departments or compliance providers, accountants or actuaries or lawyers. A Middle Eastern businessman states the problem plainly: “though deals have become vastly more expensive, I don’t feel any safer.”
When reviewing the system of regulation that best survived the Global Financial Crisis, the World Bank study, “Global Financial Development Report, 2013” said: “Non-crisis countries— those that did not have a banking crisis in 2007 through 2009—had more stringent definitions of capital, higher capital levels, and less complex regulatory frameworks. They had stricter audit procedures, limits on related party exposures, and asset classification standards; and their supervisors were more likely to require shareholders to support distressed banks with new equity. Non-crisis countries were also characterized by better quality of financial information and greater incentives to use that information—among other reasons, because they have relatively less generous deposit insurance coverage.”
The UK has tried a number of regulatory approaches. A May 2013 paper, prepared by TheCityUK for the Moscow IFC initiative, entitled “Scenarios for Russian Financial Market Regulation and the UK Experience”, has an informative description of the UK experience. The paper noted that “over the last three decades the UK has been a laboratory for different approaches to financial regulation”. It noted that, “probably the strongest lesson in the UK experience is that particular structures are not in themselves guarantees of effectiveness: the key question is how to develop the supervisory framework best suited to the challenges and circumstances of a particular market.” It noted “the importance of a judgment-based approach to supervision, rigorously designed to avoid a ‘box-ticking’ mentality relying on purely formal compliance features. This in turn requires investment in capable and critical supervisory staff resources.”
The same TheCityUK paper described the 1996 “Big Bang” as “the start of the existence of the City of London as an international financial centre in the form known today.” “It produced a consequent revolution in the structure of the London market, with the introduction of investment banks (largely US-owned), operating in far more competitive conditions.”
A TheCityUK report entitled, “Moscow as an International Financial Centre Regulatory and Administrative Environment”, said that “a trusted bankruptcy regime is probably the most important law a financial system can have as it protects and regulates the threat of potentially large investment losses”
TheCityUK June 2012 report, “Final Report of ADR Work-Stream”, examined ways in which alternative dispute resolution (ADR) in Russia might be improved and so “serve as one of the pillars” of the Moscow IFC. “The principal, universally understood methods of ADR being arbitration, mediation, and expert determination”
The report said that “success in creating Moscow as a world-class seat of international arbitration will depend in large measure on there being in Moscow an arbitral institution which can be considered a serious competitor to pre-eminent global institutions such as the International Court of Arbitration of the International Chamber of Commerce (ICC), the London Court of International Arbitration (LCIA), the Arbitration Institute of the Stockholm Chamber of Commerce (SCC) and the Singapore International Arbitration Centre (SIAC)”
TheCityUK report raised the possibility of a completely new “rules and organizational structure” with Dubai International Arbitration Court as a possible example. The Dubai IFC, has been established by design rather than evolution. While located on the UAE, is an entirely separate legal system, with its own laws and courts.
According to the TheCityUK 2012 report, “Final Report of ADR Work-Stream”: “The practice of the DIFC courts includes a number of features which makes it attractive to international users: a common law based legal system; an internationally renowned panel of judges; proceedings being conducted in the English language; and the principle of the winning party being able to recover its legal fees from the losing party.”
Once again, the issues of “common law” (visa a -vi “civil law”) and language comes to the fore.