Two cities and other tales of how financial centres flourish or fail
Shanghai vice-mayor Tu Guangshao announced this week that it would focus on being an onshore yuan trading centre, leaving Hong Kong to remain the dominant hub for offshore trading of the currency.
SCMP, July 24
They just can't stand it up there in Shanghai that Hong Kong is still the place to be for glitz and glamour in finance and Shanghai is still a hick town where these desirable superficialities come in.
I sometimes think that people like Tu could be perfectly satisfied if no financial transactions at all took place in Shanghai, just so long as Big Media calls the place a financial centre. And if Big Media won't always do it, then Shanghai will take on the job itself.
Take, for instance, this talk of offshore and onshore yuan trading centres. We are talking of a country with a closed capital account. It is against the law to convert yuan into other currencies for investment purposes and take the money out of China without special permission.
This kind of law does not sit well with fashionable notions of a developed modern state and thus everyone in authority likes to pretend for the cameras and microphones that the law does not really exist. Hence the talk of offshore and onshore yuan.
But the reality remains that only token moves have been made so far to open the capital account and even these serve only to increase income disparity. Privileges made available to favoured corporations are not offered to the working people.
The misperception goes deeper than this, however. It is based on the notion that such a thing as a financial centre exists as naturally as does the North or South pole and, while the planet may have more financial centres than it has poles, there can be no more than one to any nation state and most nations cannot have them.
In fact, the natural state of affairs is for every city to be a financial centre. Know your customer is as good a rule in finance as it is in hardware retailing and the further you are away from your customer, in distance as well as culture, the harder it is to know that customer.
The core of financial services, commercial bank lending, is very much a local community service.
In Hong Kong, for instance, property-related lending accounts for more than half of all commercial bank loans. To do the job well, you have to know Mong Kok down to the street corner level. How do you do that from New York or London?
Banks that get a little too full of themselves and develop bigger ambitions can quickly wind up destroying their shareholders' capital. Ask HSBC about the painful experience it has had of doing so in the United States.
It is true of other financial services as well. Insurance, the second-biggest finance industry in any town, is a local business that requires close acquaintance with the customer base for anyone who wants to be successful in it, as does stockbroking and private banking.
Some financial services may not require such close contact but, equally, they tend to be ones that do not require a physical location. Bond trading is done over the world's communications nets. Occasionally, it touches ground so that transactions can be registered for legal purposes but only where landing costs are low.
What financial services require above all else, however, is freedom to operate. The reason that not every city is a financial centre is that so few countries have traditionally offered the necessary freedoms. More do these days but London, New York and Hong Kong are now established.
The requirement is, first of all, an open capital account. It can conceivably be done as the Cayman Islands do it by having a financial centre exclusively in other people's currencies but a stink of criminality attaches to this practice. Reputable financial centres don't do this.
More than that, a successful financial centre needs a sound legal system with an honest judiciary, a low tax regime, congenial living conditions (pay attention, Dubai) and a welcome mat to all comers from anywhere in the world, giving local players no overt advantages.
Quite obviously, this describes Hong Kong and it does not describe Shanghai. Take special note here that the requirements do not emphasise office buildings. These come easy when the essential conditions are met. This is Shanghai's biggest mistake.
But Shanghai can be a financial centre, too. It will become one if it can meet the conditions of an open capital account, a sound legal system, etc. The only thing about this is that the national reforms that would put Shanghai in the running will also create financial centres in Chongqing, Kunming, Tianjin and any other medium to large city in China.
They just don't get it, they never have. Financial centres are born, not made.