Building an International Financial Centre
1
Building an International Financial Centre
Paper prepared for the 50th Anniversary International Conference
of the Central Bank of Nigeria, May 2009
Omotunde E. G. Johnson
Quite a number of writers have recently addressed the question of what are the structural factors that make for a reputable world-class financial centre. One publication[1] lists the factors as follows:
•open and fair financial markets;
•free flow of capital and a convertible currency;
•skilled workforce/flexible labor laws;
•prevalent use of a globally familiar language;
•fair, transparent, efficient legal and regulatory regime;
•sound and fair tax regime;
•implementation of international standards and best practices;
•low cost of doing business;
•high quality, reliable and appropriate physical infrastructure; and
•stable political and economic environment.
One element which is stressed by all writers on international financial centre, not highlighted in the above list but clearly subsumed somewhere in it, is that quality of life is very important in assessing financial centres. Indeed, the evidence seems to indicate that being high on that index is an essential requirement —a sine qua non —for becoming a highly competitive international financial centre. The geographical area in which the centre is located must be attractive as a place where people want to live, work, and visit. Hence, transportation— within the locality and between that locality and the outside world—housing, hotels, physical security, medical services, facilities for leisurely activities (theatres, museums, art galleries, other cultural attractions), and educational facilities must be of high quality. A cursory look at the leading centres in the world (see Table 1) lends support to the view that cities attractive to live in, from this general perspective, do win. Mumbai, for example, with dreams of becoming an important financial centre is racing to cleanup and beautify its city for precisely this fact.
Much has also been written about countries taking carefully thought-out steps to improve the competitiveness of their financial centres. For example, Mumbai, Shanghai, Moscow, and even Tokyo which is well-established as a financial centre, have been back to the drawing board making plans for major reforms to boost their financial centre development.[2] In Europe, both Germany and France have been taking well-organized steps since the 1990s which for a while at least raised serious concerns for promoters of the City of London.[3] Among the UK’s reactions was the reinvention of the organisation, British Invisibles, to become, on February 1, 2001, the International Financial Services, London (IFSL) and to focus more coherently and resolutely on promoting the UK-based financial services industry throughout the world.[4]
Thus, not only is there broad agreement on the major characteristics of a world-class financial centre, many places with some reputation of having achieved international financial centre status, although of varying degrees, are engaged in serious planning and promotion to gain or retain competitive advantage in the international financial centre business. This means, inter alia, that competition in that business will only get stiffer over the next two to three decades.
Clearly, there are implications for new entrants, especially those for which the financial centre business, even for the domestic market, remains seriously underdeveloped. For the new entrants, a coherent strategy as well as benchmarks would be useful to motivate action and facilitate objective monitoring and assessment of progress. In addition, for new entrants, a simple and obvious way to start is to look at what others have done and are doing (that is, their policies in some detail) and seek to understand the rationale for the others’ actions . That will help the newcomers to define the problem and design an appropriate strategy.
For a country like Nigeria, of course, more financial development is valuable in its own right. Hence Nigeria wants, in any event, to have a coherent program for developing its financial system. The idea of striving to build an international financial centre is merely to ensure that, in the process of developing the financial system, there is, as an integral element, a well thought out strategy for starting a robust export business in financial services.
In this paper, I outline a strategy for developing such an international financial centre, which builds on the stock of international experience. This strategy entails the following:
• conceptualizing a financial centre as a cluster;
• finding a niche for entry at the international level;
• enhancing competitiveness by building capacity, structuring incentives, and improving the quality of the national governance environment;
• putting in place high quality financial services supervision and regulation; and
• promoting the centre by assisting it to access global value chains, implementing other selective intervention policies, and granting it some enclave privileges.
The strategy would involve substantial cooperation among the government, the central bank, the financial services supervisors and regulators, and the service providers in the financial centre.
A Financial Centre as a Cluster
A financial centre, whether international or purely domestic, is a cluster or agglomeration of markets and firms in financial and other related services. Seeing the financial centre as a cluster and understanding the benefits of clustering and the sources of the benefits should help organize thinking on strategy and the ordering of actions to develop the centre.
Benefits of clustering
The most fundamental benefit of clustering is knowledge externality. Firms are embedded in a network of users, suppliers, consumers and knowledge producers. In general, a well-functioning cluster will be characterized by increased collective efficiency. Collective efficiency accrues to clustered firms from two factors: external economies, generated from the agglomeration of firms, and joint action. At least four types of external economies have been outlined in the literature: market access, labour market pooling, intermediate input effects, and technological (or, simply, knowledge) spillovers.
Market access has to do with the ability to attract buyers of the services as well as suppliers of inputs. Labour market pooling is associated with concentration of specialized skills that will tend to develop within the cluster. The pooling will occur through skills upgrading within the cluster and the attraction to the cluster of persons who already have relevant skills. Intermediate input effects are externalities associated with the emergence of specialized suppliers of inputs and other services. This will be due especially to specialization among existing firms in the cluster or attraction of new firms from outside. Technological (or knowledge) spillovers involve the diffusion of technological and other knowledge and ideas among the firms in the cluster. Collective efficiency, in other words, augments the benefit to any service supplier of locating within a well-developed and functioning cluster and thus attracts investors and users to the cluster.
An important consequence of all this will be greater depth and liquidity in the financial markets located in the centre. [5] Hence, the opportunities for hedging, trading and diversifying risks will expand as will be the access to alternative sources of funding and to greater investment opportunities. Balance sheet management will be easier.
To reap the full benefits from clustering, there need to be high levels of collaboration and interaction among key agents and organizations in the cluster. In particular, effective communication and cooperation among firms will create opportunities for joint action. Such agglomeration effects will also help the clustered firms shape patterns of innovations and technical change.[6] In short, when they work well, clusters help enterprises innovate, and upgrade their processes, products, and functions.
Like other types of clusters, financial centres can emerge spontaneously or via central direction and planning (constructed clusters). The most famous case of the latter is probably Singapore. Dubai is a more recent example. For newcomers, in order to speed up the development process, some central coordination of the institutional and organizational activities should be useful, if carefully done.
The role of the firms, markets and individuals in the centre will be to (1) advise clients, (2) structure and arrange deals, (3) provide finance to borrowers and equity issuers, and (4) manage funds and investments of individuals and so-called institutional clients. In the process, they would perform the five basic functions which have been highlighted in the finance and growth literature.[7] Namely, they will: (1) facilitate the trading, hedging, diversifying, and pooling of risk; (2) allocate financial resources among competing users; (3) monitor managers and exert corporate control; (4) mobilize savings in all the geographical areas they serve; and (5) facilitate the exchange of goods and services in their niche countries.
A dense financial centre (cluster) will contain a substantial number of fair sized financial services firms, major international accounting firms, and legal services and telecommunications and computer engineering firms (including consultancies). The financial services firms will, as a sector, be highly diversified with firms engaged in activities covering the whole spectrum of activities in major areas like banking, securities, foreign exchange trading, insurance, derivatives, fund management, and professional services. Not being strict about “firewalls” (for instance between bank and securities business) will facilitate open competition among financial services firms, joint action and exploitation of external economies.
Organizational issues
I argued above that to reap the full benefits of clustering, there need to be high levels of collaboration and interaction among key agents and organizations in the cluster. Left to evolve spontaneously, such cooperation could be slow in emerging, especially in the early stages of development of the centre. Hence, there will be benefit to all, under such circumstances, from official intervention to foster the process of cooperation. The authorities will need, though, to be cautious in their approach to enhancing cooperation among firms in the centre. In particular, the authorities must ascertain that, in fact, there will be benefit to intervention. Once they feel a need to intervene, they should avoid imposing their agendas or preferred processes; rather they should allow these to emerge via discussions and negotiations among the firms, even if with government participation. The authorities should simply play the role of facilitators. In that case, they must ensure that their representatives have credibility, especially by demonstrating knowledge and competence.
More generally, there will be major issues associated with developing the financial centre in a coherent and efficient way. Because of this, rational organization will help. A reasonable approach would be to establish some national coordination council, say an International Financial Services Development Council (IFSDC). This council would comprise representatives from the national government, local government, the central bank, the financial services supervision authority or authorities, and the major sectors of the financial services industry. The objectives of the IFSDC would be: (1) to promote cooperation among all public and private persons and authorities with substantial interests in the development of the financial centre; (2) to promote adoption of standards and practices in the financial centre which meet international norms; and (3) to promote policies, institutions (that is, rules governing behaviour) and infrastructure, which enhance the international competitiveness of the centre, including the fostering of beneficial innovation. Within the IFSDC, ideas should be openly discussed. It would be a forum where the different parties would be informed of what others are doing. Such information should motivate joint action and timely exploitation of external economies. Also, the national authorities would be able to hear suggestions and criticisms, from private parties, that could improve policy plans and actions.
It would be useful to have working groups within the IFSDC structure to develop initiatives and ideas on different aspects of the financial centre development. Final decisions, when necessary, can then be taken by the whole group; alternatively, there could be an IFSDC board, which arrives at such final decisions. The IFSDC would be concerned with all aspects of the financial centre development. But its focus would be on broad policy matters and on hearing all sides of an issue. As regards its legal status, the IFSDC would be an advisory group to the authorities and to the industry as a whole. But it should have enough stature to make its decisions respected. This would be aided by its being able to arrive at recommendations by consensus, after hearing all sides.
Finding a Niche
The financial services industry can be subdivided into sectors which supply a variety of products, where a product is a specific bundle of services. The products in this case are highly heterogeneous. Still, it is a highly competitive industry; in fact, groups of products compete with each other.
There are really only two truly global financial centres—London and New York. In these global centres, the sectors cover the full range of financial services and their products are supplied (marketed) all over the world. This means that their immediate clients are, or can be, global. The other major centres (among, say, the top 50) tend to be international, in the sense that they conduct significant cross-border transactions. Each of these other top centres could still be major global players in only one or two sectors, although, even there, they may tend to have a relatively limited number of products. Moreover, many (perhaps, most) of the financial centres are international only within a small geographical region; in that sense, they are regional financial centres.
An international financial centre, then, could operate cross-border only within a certain geographical area, mainly in certain sectors, and provide only a certain limited range of products. Domestically, of course, that same centre could operate more broadly (sectors and products) in financial services in general. The competitive advantage of the centre (and hence the level of demand for its services) will depend on the cost of doing business with that financial centre, as well as the reputation of the centre.
A Nigerian financial centre, say in Abuja, will inevitably be a niche centre for the foreseeable future. But geography, rather than range of services, will be the more dominating factor determining the niche. Of course, for some time there may need to be a niche also in terms of products. But a Nigerian financial centre is unlikely to be global niche for any service area for some time to come. Still, the speed with which the Dubai International Financial Centre has established itself since 2004 shows what is possible, particularly with substantial investment in financial and other infrastructure, generous tax incentives and legal framework flexibility. Apart from these and other factors to be mentioned below, the success of a Nigerian centre in realizing its chosen niche will depend greatly on the availability of domestic financial assets available for investment domestically or inside the African region.
Finding a niche, then, is mainly a matter of deciding on the geographical area, the sectors, and the general types of products/services for which it is possible, with appropriate policies, to build reputation and comparative cost advantage in the provision of financial services to enable domestic financial service providers to operate profitably in an open and competitive international environment. In this conception, there must be a clear view, by the promoters, of the potential clients of the products to be provided.
Clientele
As to geography, it makes sense for a Nigerian international financial centre to begin with the Economic Community of West African States (ECOWAS),[8] and then slowly expand to the rest of the African continent. Within such a niche area, the clientele would be diverse. In particular, it would include governments, public enterprises, local financial institutions and markets in the various countries, private nonfinancial businesses, foreign companies who have operations in Africa, and Africans in the Diaspora, particularly in Europe and North America.
As African enterprises grow in size and become more efficient and respected, they should be able to raise outside finance from a global market—by issuing corporate bonds or equity. A well-respected international financial centre in Nigeria can be useful in such operations. A financial services firm located in Abuja, for instance, could be employed to help manage the process for a particular enterprise X. Such a financial firm might have established relations with financial services firms in Europe or America to get one of them to underwrite the X securities and probably organize a syndicate. Other financial firms around the world could be invited to join the syndicate and to encourage investors (e.g., pension funds, sovereign wealth funds, insurance companies), with whom they have relations, to subscribe to the X securities. A rating of the X securities by one of the big rating organizations (Standard and Poor’s, Moody’s) could also be arranged. The securities could be issued by a financial firm in a country outside Nigeria.