International Financial Centres in the post-crash era Vanessa

International Financial Centres in the post-crash era Vanessa Rossi, Senior Research Fellow, Chatham House March 2009

Overview • The global recession and financial storm has not yet abated – a stress test of survival • The crisis has highlighted the massive increase in balance sheet risks compared with national incomes • Iceland marked the end of the “small country-big bank” model of global finance • Yet banks will become more important as financial intermediaries if saving deposits rise and retail investors shun risk: the “Tokyo scenario” 2

World trade smashed by storm • 2009 may be down 20 -30% versus 2007 data – larger losses for Japan and the energy exporters Exports in US $ trillion: 2007 data versus 2009 estimates Source: WTO 3

Investment trends: exodus from risk creates global asset imbalance High growth and inflation The US: “The Anglo Saxon Model” • US financial wealth was $60 -65 trn, over 4 x GDP The EU: “Balanced Portfolio” • Total financial wealth similar to US • But household wealth held in equities lower Risk averse JAPAN: Cash • Wealth $30 trn • Nearly 55% of household wealth in bank deposits Low growth and inflation • Under 15% of household wealth in bank deposits, as much as 50% in equities and corporate bonds Risk taking

Holdings of debt, equity and deposits 2008 – shaded areas represent estimated losses in equity values by March 2009

Wealth losses almost 1 year’s GDP equities shrink, role of government rises WORLD FINANCIAL WEALTH TOTAL SHRINKS FROM $200 TO $160 trillion? GLOBAL TOXIC ASSETS $3 -5 trillion? BANK DEPOSITS and CASH around $70 trillion Larger than world GDP of $55 trillion TOTAL BONDS VALUE DOWN FROM $65 to $55 trillion Government share up from 50% to 60 -65% Government debt up, corporate bonds fall EQUITIES - OTHER ASSETS VALUE FALLS From peak $65 to $35 trillion?

Implications: • Big banks: few “global players”, a cluster in the US, China and Japan and, arguably, the Gulf region backed also by “oil deposits” • Europe - cross-border issues? • Other IFCs will have to focus heavily on financial services with low balance sheet exposure – stiff competition • London may be the most affected of the major financial centres – this crisis is the banking equivalent of previous restructuring in reinsurance and Lloyds of London 7

Japan’s banks: expand assets abroad liabilities assets JAPANESE BANK DEPOSITS TOTAL $10 trillion PRIVATE SECTOR LOANS $5 trillion LOANS TO GOVERNMENT $3 tn about 35% of Gov Debt FOREIGN ASSETS $2 tn LIABILITIES $1 tn Prudential reserves $0. 2 trillion

China’s banks: “cash” now mobilised liabilities assets CHINESE BANK DEPOSITS TOTAL $6. 5 -7. 0 trillion Prudential reserves Over $1 trillion Policy easing PRIVATE SECTOR LOANS $5 trillion LOANS TO GOVERNMENT $0. 5 tn about 100% of Gov Debt FOREIGN ASSETS $0. 3 tn LIABILITIES $0. 1 tn

Economic ranking by size of GDP – which countries are big enough? GDP estimates ($ tn) Rank Region 2007 2017 1 EU (inc UK) 17 25 2 US 14 21 3 Japan 4. 4 7 4 China 3. 4 12 5 -9 Canada, Brazil, Russia, India, Korea 1 -1. 5 (India) 3 =10 GCC total, Mexico, Australia 0. 8 -1 (avg. ) ~2 World total 54 -55 95 -100 10

Comparison of GDP and Stock Market Capitalizations as Shares of World

Shares of World GDP (%) (chart data at 1990 constant prices, own estimates) • China the only economy gaining share • It is the only sizeable contender of the BRICs • Stock market capitalisations will broadly follow these GDP trends

Japan’s shares in world economy and markets • Japan’s shares in world wealth and other market indicators much larger than share in global GDP

Japan is the 3 rd largest bond market • Larger share in global bonds than equities: approx 15% versus only 8% share of world GDP and equities

Holding of JGBs by foreign investors trend up but still low, close to $0. 5 trillion

Potential growth in foreign investment in Japanese markets • High estimate: bond holdings rise to match equity stakes • Low estimate: no increase in holdings except for modest increase in equity investments based on maintaining share of market

The Asian debt market should expand • Critical to rebalance global asset demand supply and to fund development in low savings countries such as India, Bangladesh, Vietnam • Potential to grow dramatically - possibly $1 trillion pa? • Japan would be a key participant here • e. g. Samurai bonds: “rare oasis” during credit crunch. Froze after Lehman collapse but reopened in February: $2. 2 bn (Westpac), $1. 5 bn (Indonesia) 17

MARKET OPINION? 18

The March 2009 City of London Survey: Tokyo and Sydney drop below top 10 GFCI 4 (Fall 2008) GFCI 5 (Spring 2009) 1 London 1 - London 2 New York 2 - New York 3 Singapore 3 - Singapore 4 Hong Kong 4 - Hong Kong 5 Zurich 5 - Zurich 6 Geneva 6 - Geneva 7 Tokyo 7 +1 Chicago 8 +1 Frankfurt 9 +2 Boston 10 Sydney 10 +3 Dublin 23 Dubai 15 -8 Tokyo 27 Melbourne 16 -6 Sydney 34 Shanghai 23 - Dubai 43 Bahrain 28 -1 Melbourne 45 Qatar 35 -1 Shanghai 19

Recommendations regarding the City of London Surveys • Two possibilities for consideration: • (1) The report may be more widely understood and accepted as a barometer of IFCs performance and strength if it were to adopt a two-pronged strategy and rankings: • Firstly comparing countries’ leading international financial centres (ex: London, New York, Tokyo) • Secondly comparing secondary (regional or niche) financial centres around the world (ex: Chicago, Geneva, Channel Islands) • This might help focus attention on the most critical factors in the international surveys and underlying changes in view. • (2) Greater methodological weight could be placed on the size and development of financial sectors rather than on “ease of access” type factors. We agree that it is important to preserve the nuances brought into the survey by the direct personal input of market participants and these are not an issue.

GFCI 5 divided into international and secondary centres: more representative GFCI 5 - International GFCI 5 - Secondary 1 London (UK/Europe) 1 Geneva 2 New York (US/Americas) 2 Chicago 3 Singapore (SE Asia) 3 Boston 4 Hong Kong (China/SE Asia) 4 Dublin 5 Zurich (Switzerland/Europe) 5 Guernsey 6 Frankfurt (Germany/Europe) 6 Jersey 7 Toronto (Canada) 7 Luxembourg 8 Tokyo (Japan/Asia) 8 San Francisco 9 Sydney (Australia/Pacific) 9 Isle of Man 10 Paris (France/Europe) 10 Edinburgh 21

Other rankings: looking beyond IFC competitiveness surveys WEF Financial Development Report 2008 Master. Card – Worldwide Centers of Commerce 2008 PWC – Cities of Opportunity (Financial clout – 11 cities) 1 United States 1 London 1 New York 2 United Kingdom 2 New York 2 London 3 Germany 3 Tokyo 3 Paris 4 Japan 4 Singapore 4 Tokyo 5 Canada 5 Chicago 5 Frankfurt 6 France 6 Hong Kong 6 Toronto 7 Switzerland 7 Paris 7 Chicago 8 Hong Kong 8 Frankfurt 8 Atlanta 9 Netherlands 9 Seoul 9 Los Angeles 10 Singapore 10 Amsterdam 10 Singapore

THANK YOU www. chathamhouse. org. uk/internationaleconomics 23