A not-so-secret code for cities

What strange alchemy turns a city into an “international financial centre”? Many of those who study the Asia Pacific economy are thinking particularly hard about this question at the moment, thanks to President Xi Jinping. The People’s Republic of China has, as all agree, taken a particularly aggressive and authoritarian turn under Mr Xi, even to the extent of harming its own interests. And the latest iteration of this blundering is the new national security rules to be applied to Hong Kong. (I shall not call it a “law”, as many in the media seem to thoughtlessly do, since it has been promulgated by the Standing Committee in Beijing rather than by the Hong Kong Legislative Council.)

According to the British government, the new rules are a violation of the terms by which the former imperial possession was handed over to the People’s Republic in 1997. Yet that is not the main point here. The question instead is what it will do to Hong Kong’s reputation as the finest financial centre in Asia. In particular, financial research done in the island on the mainland, particularly when it comes to sensitive issues like macro dynamics, political risk, and state-owned companies, could be stifled. One researcher told the Financial Times that “analysts already engaged in self-censorship to an extent in order to maintain relationships with mainland Chinese clients” but under the new regime this could be “institutionalised”.

There is a clear link here that is too little understood. Freedom of speech has important positive economic externalities. Overall economic efficiency requires the appropriate allocation of capital between various possible destinations and potential projects and investments. This is the job of finance, and determining the risk-return profile of these various possibilities is the contribution of financial research to the wider market. In order that risk profiles are widely understood and internalised by market participants, however, the analysis needs to be protected under the broader guarantee of freedom of speech. Otherwise self-censorship will lead to dangerous misallocation. This is a lesson that India’s rulers have consistently failed to apply in their relationship with the corporate and financial sector.

Illustration: Ajay Mohanty

This is not to say that the financial sector in Hong Kong has distinguished itself by its willingness to tell the Chinese Communist Party what it is doing wrong. In fact, if anything, it is happy to settle into a symbiotic relationship with the leadership in Beijing at the expense of broader efficiency (and, of course, freedom). Unfortunately, this will not work; for one reason because a change in the special nature of Hong Kong will make it a less valuable place to do China-facing business; and, for another, because the CCP’s leaders would much rather that the international financial centre that dealt with China was under their careful control in Shanghai anyway, and they will continue to seek to undermine Hong Kong in Shanghai’s favour.

Clearly, the rule of law and minimal restrictions on relevant speech are essential, foundational aspects of what creates an international financial centre. What else matters? History gives us a couple of pointers. One is the willingness to change and adopt new technology within the institutions of finance — even if the change comes at the expense of entrenched interests or in spite of fear from the old-fashioned that change is dangerous. It is easy to forget that there was a point, in the late 1970s, when it appeared that the City of London was in permanent decline, especially as compared to New York, in spite of US regulations since the 1950s aimed at reducing foreigners’ holdings of dollars. The crucial reforms in the Thatcher era — from the scrapping of exchange controls to the removal of restrictions on competition imposed by the London Stock Exchange — rendered the City competitive for decades to come. 

The Big Bang of October 1986 provided the final leg up: The introduction of electronic trading and the opening up of access to market makers. London proved to be the ideal test case for what works: First, a willingness to trade in any currency; second, a willingness to innovate; third, the rule of law, particularly of investor-friendly “common law”; and, finally, geographical and cultural proximity to a large investment destination that is underserved or over-regulated. In London’s case that was, of course, the European Union, whose own financial centres in Frankfurt and Paris were crippled by government intervention. As Hong Kong was to China, London was to Europe: Part of, yet not part. The rewards to being a financial entrepot are vast. For it to work, however, you must be simultaneously able to access the large investment destination and yet have regulations and norms that make you a far better location for finance. This worked for both Hong Kong and the City of London — but may not survive Mr Xi and Brexit, respectively.

The golden age of finance in Hong Kong and London was driven by a common commitment to openness: To foreign capital, to foreign personnel, to foreign ideas, and to foreign investment strategies. And, equivalently, the self-confidence to allow capital to flow in and out freely. Yet we should not underestimate the intangibles, even beyond the freedom and security of Anglosphere legal tradition. The English language is one. A broadly welcoming environment is another. These are reasons why other candidates for international financial centre have typically struggled. Tokyo does not have English. Dubai has troublesome intangibles, and problematic speech laws.

But then there’s Singapore. Which, for Indians, at least, over the last decade and some has become a preferred offshore listing and trading (and round-tripping) destination. For the Association of Southeast Asian Nations, perhaps, Singapore can serve as the entrepot financial centre. I seriously question, however, whether in the long term it is either free enough, culturally/geographically “close” enough, and for that matter welcoming enough to do for India what Hong Kong did for China.

Perhaps India needs a New York, not a Hong Kong. It needs one of its own cities to become a beacon of freedom, prosperity, anonymity, and the rule of law. There is one obvious candidate, of course, and the 2007 Percy Mistry Committee report on “Mumbai as an international financial centre” makes excellent reading even today. Most of it, of course, is about financial reform. In fact, practically all of it. The very last recommendation, however — no 82 on p 208 — reads: “Mumbai needs to be seen across India and around the world as a welcoming, cosmopolitan and cultured metropolis capable of accommodating a large number of expatriates. It is only with such an ethos that Mumbai can become an IFC.” So, openness, transparency, freedom — and no dietary restrictions please.

Note: In this column, I have not even considered the Gujarat International Financial Tec-City or whatever that boondoggle along the Sabarmati is called. When it was launched a decade ago, we were told it would be over 60 million square feet — larger than Canary Wharf — in a decade. In 2014, we were told it would create a million jobs. Recent reports suggest that it is still two towers with a couple of thousand people, mainly from state-connected companies.

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