Richard Lambert: London stalling

Tuesday 23 February 2021

For centuries, foreign talent has invigorated the City. After Brexit and the pandemic, London is losing its lustre


The glory days of the City of London are over. The history of the past 400 years shows how great financial centres have waxed and waned over time – Antwerp, Amsterdam, London, New York, a brief sidetrack to Tokyo, and back to London again. Now we can see the beginnings of another shift, this time away from London and probably in the direction of New York.

This view is not based on the immediate impact of Brexit. The few thousand job losses that have been reported so far are trivial in the context of a City workforce numbering well over 500,000. And the recent shift in the trading of equities and interest rate swaps in favour of Amsterdam and New York will barely make a dent in the huge volumes of financial transactions that take place in London every day.

There is too much capital and too much talent tied up in the City to allow for any sudden change of direction. But the questions are about where new capital will be invested in the future, and where the most talented people in the financial world will choose to work.

The relative rise and decline of financial centres over the centuries is explained in good part by three key features. One is to do with the way that regulatory and tax structures work when compared with rival cities. The second is about political stability and the risks that unexpected changes in direction might alter the rules of the game. Third, and perhaps most important, comes the extent to which international capital and talent are made welcome in the marketplace.

The City has been at its sleepiest in the decades when it has been least attractive to foreign talent – such as the early years of the 17th Century when it trailed in the wake of Amsterdam, or in the period after the Second World War when important financial institutions were closed to foreigners and British institutions could shelter behind the barrier of exchange controls. Its subsequent transformation owes everything to deregulation, political stability, and a culture which regularly put London at the top of opinion polls listing the most attractive places in the world to work.

How likely is it that these conditions will continue to apply in the next few decades? And does it matter?

The starting point for the story is Antwerp in the late 16th Century. The development of long-distance trade routes to the East and West Indies meant that merchants in Europe needed to develop new financial instruments in order to sustain their business. As the Merchant of Venice discovered to his cost, profits could only be realised after the long and uncertain waiting periods required for ships to come home.

Antwerp was the multinational, multilingual marketplace of the emerging world economy, and its key innovation was the development of the negotiable foreign bill of exchange. This, in the words of economic historian Larry Neal, made it possible for merchants operating in different ports to use local currency for local payments, while bills drawn against balances held abroad could be used for foreign payments. This revolution in the means of finance provided the flexibility that merchants needed to support long-distance trade.

But then came the first example of what can happen to a financial market that puts up barriers to talented innovators. In 1585, Antwerp expelled the Portuguese Jews and various Protestant groups. Their energies were transferred to Amsterdam, which began its long period of domination in the global financial markets.

The city had at least three key advantages. First, it welcomed international talent. Second, the success of the Dutch East India Company placed it at the heart of a growing network of information in 17th Century Europe. The Company’s sophisticated reporting techniques, its interactions with rival French and English companies and other European governments – all these led to an increasing number of merchants, consular agents and newspaper publishers congregating in the city. In the financial world, then and now, information brings power.

And third, the natural consequence of the first two, was that Amsterdam led the field in terms of financial innovation. The Wisselbank was established in 1609 to provide an efficient means for merchants to transfer money rapidly among themselves. Then came the big breakthrough: the transformation of working capital committed initially to a particular voyage into fixed or permanent capital to support a company operating in the shipping business. Which is to say, rather than having your money tied up in a single voyage, you could spread it over a fleet of merchant ships. According to Larry Neal, the Dutch had made the transition by 1612, at least 40 years earlier than their English rivals.

Why was London slow off the mark? No doubt there were legal and political constraints, and the events leading up to the Civil War must have been a major concern. Queen Mary had persecuted and expelled religious minorities in the 1550s, and although Queen Elizabeth subsequently encouraged most of these groups to return it was not until the middle of the 17th Century that Cromwell permitted the limited re-entry of Jews into England.

Then the doors began to open. The restoration of the monarchy in 1660 brought with it an increasing number of wealthy elites and their capital. Financial news began to proliferate as well. The Printing Act of 1663 had eliminated all newspapers in England except for the official London Gazette. That lapsed in 1679, and new forms of business publications began to appear, including the first regularly printed stock price lists.

The revocation of the Edict of Nantes by Louis XIV in 1685 brought a flood of Huguenot capital and talent to London, including a number of families who were to make a long-term mark on the City of London, such as the Cazenoves. An even more important event came three years later with the Glorious Revolution of 1688. William III encouraged financiers, advisers, courtiers, and artisans to join him in London along with their wide range of new skills, and he raised foreigners to high status in the land. In what looked like an early plea to “take back control”, Daniel Defoe complained that:

We blame the King that he relies too much

On Strangers, Germans, Huguenots, and Dutch

And seldom does his just affairs of State

To English Councilors communicate.

Innovation was in the air. Although joint stock companies had existed in England before William arrived, there were rapid advances in the development of something like the modern stock exchange in the years following his accession. Among his retinue were Jews and Huguenots who were able to bring to relatively backward London the institutions that had been developed over the previous century in Amsterdam. Hundreds of new companies were launched, with the main activity centred on a handful of big and very liquid issues: the Bank of England (founded in 1694), the United East India Company (1702) and the South Sea Company (1711).

Foreigners were allowed to own shares, a right upheld by the Crown despite occasional challenges from Members of Parliament, and an active resale market existed for them in both London and Amsterdam.

Moreover, Britain began to acquire a safe haven status for international capital. After a turbulent century, it now had a relatively stable political settlement and was insulated from the armies that were crossing frontiers on the continent – such as in the War of the League of Augsburg from 1688 to 1697, or the War of the Spanish Succession from 1702 to 1713.

Domestic peace, political stability, a relatively predictable legal system, open borders and growing volumes of international trade to finance: these were the foundations of a successful financial marketplace. And the long march to London’s financial pre-eminence was underway. 

As the 18th Century wore on, an increasing number of European immigrants of all kinds made their way to the City. Joseph Addison wrote in The Spectator that “there is no place in the town which I so much love to frequent as the Royal Exchange. It gives me secret satisfaction as an Englishman to see so rich an assembly of countrymen and foreigners making this metropolis a kind of emporium for the whole earth. Sometimes I am jostled by a body of Armenians, sometimes I am lost in a crowd of Jews or Dutchmen, sometimes Danes, Swedes or Frenchmen.”

Historian David Kynaston has calculated that of the 810 merchants who kissed the hand of George III on his accession in 1760, at least 250 were (on the basis of their surnames) of “alien” origin.

And continental Europe was, if anything, becoming more dangerous in the eyes of mobile elites.  The Seven Years’ War in the mid 18th Century split the continent apart and sent large armies rattling across its borders: Britain was heavily engaged, but at what turned out to be a safe distance, and it emerged with substantial gains in Asia at the expense of France. Foreign investment in the safe-looking City securities climbed steadily: on one estimate, it amounted to around a fifth of outstanding shares in the big joint stock companies by 1750.

The French Revolution and Napoleon’s armies completed the triumph of London over its European neighbours. French aristocrats did whatever they could to transfer wealth to London after 1789. Five years later, as French troops were pushing across the River Maas for the final attack on Holland, the leading Anglo-Dutch banker Henry Hope moved from Amsterdam to London. Two other members of his firm – Alexander Baring and Pierre Labouchère – followed early the next year.

More or less continuous European warfare between 1792 and 1815 strengthened London’s position yet further, with an ever increasing proportion of world trade passing through its systems, and after the French occupation of Amsterdam in 1795 there was no doubt about the location of the world’s pre-eminent capital market.

Loans organised by City bankers, notably Nathan Rothschild, kept Wellington’s armies in the field. And a growing flood of European bankers set up their bases in London in the early years of the 19th Century: the likes of the Schröder brothers from Hamburg, Emanuel Brandt from the same city, and Fredrick Huth from Hanover.  

According to Kynaston, whose great four-volume history of the City provides by far the best background to this story: “The pattern is clear enough of a ‘push’ in the form of continental Europe becoming an untenable base of business and a ‘pull’ in the form of a critical mass of support facilities existing in London to maximise the trading or trade financing potential of distinct areas of local knowledge.”

The crucial extra ingredient was the speed with which the newcomers were able to make their mark and their fortune in Britain’s economy. Nathan Rothschild could speak no English when he arrived in Manchester in 1799 to trade in textiles. Just 16 years later, he had created an immense fortune through his bullion operations on behalf of the British government. When he died at the age of 59, his funeral procession from St Swithin’s Lane was made up of 75 carriages, and the cortège took over a quarter of an hour to pass through the crowds assembled on Cornhill.

Other names that were to become well known in the City’s story arrived in the same decades. There was Daniel Meinertzhagen from Bremen and his fellow countryman Alexander Kleinwort, Carl Joachim Hambro from Copenhagen, George Peabody and Joshua Bates, both from the US, and the Ralli Brothers from Greece. It wasn’t that there were no dynamic British financiers in town: of course there were. But even some of them had cut their teeth abroad, like Walter Boyd, a Scot who had learnt his trade in the Austrian Netherlands and Paris before coming to London to speculate in risky and ultimately disastrous trades in the credit market. 

London’s appeal as a hub for global finance was reinforced by technology. In 1851 a submarine cable was laid between Dover and Calais. Other European links followed, and in 1866 a cable under the Atlantic was opened. British overseas investments had reached around £200m by the mid-1850s: they were to multiply about five-fold over the next two decades.

Then came the Franco-Prussian war of 1870. The Bank of France suspended gold payments, leaving London as the only world bullion market; the franc was non-convertible for eight years; the Paris Bourse suffered a sharp loss of business; hot money and talent flowed across the Channel. Political upheavals in Spain and what became Italy and Germany further enhanced the attractions of London. Backed by the Bank of England’s undeviating commitment to the gold standard, sterling was the essential international currency; the City’s credit markets were deep and liquid; and, compared to a turbulent continent, Westminster was a haven of political stability.

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By the eve of the First World War, Britain had achieved an international dominance and importance of a kind that it is never likely to enjoy again. According to City historian Richard Roberts, the nominal value of securities traded on the London Stock Exchange was greater than that for the Paris Bourse and the New York Stock Exchange combined: around a third of all securities in the world were traded in London. And this was a highly cosmopolitan community. Around a tenth of Stock Exchange members were reckoned to be “aliens”, with around three-quarters of them coming from Germany.

War was to have a devastating impact. Sterling was effectively forced off the gold standard, weakening the currency and its role in trade finance. A host of regulations restricted the flow of new issues, especially by foreigners, and the Bank of England took an austere grip on the money market. Around 15 per cent of Britain’s overseas investments were liquidated in order to pay for the war.

Not so obvious, but just as damaging in the long term, was the dramatic shift in attitude towards market participants from abroad, particularly Germany. Such was the level of hostility after the sinking of the Lusitania that the Stock Exchange felt it necessary to post a notice advising members of German and Austrian birth to “keep away from the House at present”, and later in the war a petition from the Stock Exchange Anti-German Union was partly successful in lobbying against the re-election of members of ”alien enemy birth”. 

Unsuccessful efforts were made to strip Sir Ernest Cassel of his Privy Council membership. Baron Bruno Schröder, who had always refused to be naturalised, found himself an enemy alien on the outbreak of war with his firm liable to seizure – with potentially dire consequences for the acceptance market in which Schroders was a major player. Within a week, the Baron was issued with both a naturalisation certificate from the Home Secretary and a licence to reside and trade signed by King George V himself.

The centre of global finance was visibly shifting across the Atlantic. But London did not give up without a struggle. Its role in the international debt market recovered somewhat in the late 1920s, and the shift back to the gold standard – with its disastrous consequences for the manufacturing industry – was at least in part driven by the idea that this would help to rebuild the City’s global power base. 

As late as 1933, the economic commentator Paul Einzig was arguing that “to some extent, London has already recovered her old financial supremacy, and the complete restoration of her old role as the world’s leading banking centre is now considered to be only a question of time”.

That, perhaps, was an early sign of the complacency that was to become one of the City’s distinguishing features in the following years. Recalling his time working there in the early 1930s, Nicholas Davenport wrote that “the City’s Establishment at that time was, in effect, an old boys’ racket…. The only rules were playing safe, resisting change, opposing new ideas, upholding the Establishment and being willing to dress up and go on the pompous dinner parade in City halls.”

Henry Grunfeld, who arrived in London around this time after a shocking experience with the Nazis and was to become Siegmund Warburg’s key partner, noticed a similar hostility to any kind of innovation. That was visible in many back offices, where there were still plenty of clerks sitting on high stools in a way that Charles Dickens would have recognised. Although female telephonists and typists were beginning to make an appearance, the City remained a resolutely male bastion.

The Second World War drained further life out of the system. One sign of this was the fact that some US banks initially considered Paris rather than the City to be the most sensible launchpad for their renewed forays into Europe after 1945. And London’s culture was the opposite of dynamic. Siegmund Warburg observed sourly in 1956 that “one of the dominant attitudes in the City is tolerance towards mediocrity”. A leading firm of brokers caused a stir in 1970 by declaring that in future all partners must be at their desks by 9.30 in the morning.

Top hats and tightly rolled umbrellas remained the everyday work-wear for senior members of the discount houses right through the 1960s, and a rearguard battle was still being fought to prevent women from becoming members of the Stock Exchange. As one leading broker put it in a letter to The Times in 1971, the Exchange was “not an institution which exists to perform a public service”. Rather, it was “a private men’s club,” and so should be free to take whatever decisions it liked about membership. The citadel fell shortly afterwards, but for the most part it still remained resolutely unwelcoming to women.

But while the old City establishment was gathering cobwebs, three developments were underway that would change the picture beyond recognition in the following decades.

The first was a rapid build up of dollar deposits in London from the early 1960s onwards. This was driven in part by the unwillingness of banks in the Soviet bloc to deposit their dollars in New York. But the main engines of growth were tax and regulatory rulings in Washington that meant dollars owned by foreigners could earn a higher rate of interest outside the US than they could at home, and the enormous expansion over time of dollar-denominated trade. The Swiss, German and French banking authorities were uneasy about this growing mountain of dollars, fearing its possible impact on financial stability, and so imposed various restrictions. But the attitude of the Bank of England was one of benign neglect, and a river of deposits started to flow to London.

That, in turn, led to the second key development, which was the arrival of large numbers of foreign banks, led by the Americans, through the late 1960s and beyond.  The new Eurobond market had been pioneered by Siegmund Warburg, with an issue for the Italian motorway company Autostrade in 1963. London was back in the international loans business, and the Americans, Swiss and Japanese soon piled in. The riotous events in Paris in the spring of 1968 and the unwillingness of the Swiss authorities to encourage a secondary market in Eurobonds further reinforced the City’s position as the financial heart of Europe.

By the late 1970s, there were effectively two financial marketplaces in London. One was the old establishment, working to club rules with restrictive practices that rivalled those of the most energetic trade union. The other was the international capital market, which had become the magnet for a rapidly growing number of foreign banks.

Then along came the third big change, in the shape of Mrs Thatcher.

In 1979, unexpectedly and out of the blue, her Chancellor Geoffrey Howe abolished the foreign exchange controls that had been in place since the Second World War. That freed up capital movement and knocked down the barriers between the old and the new City. At the same time, radical changes in the planning regime were making possible the development of a massive new financial centre in Docklands, well away from the overcrowded alleyways of the Square Mile.

And then in 1986 came the big one – the Big Bang reforms that blew away restrictive practices in the Stock Exchange and opened its doors to new competition. One immediate need was for new capital in the marketplace. Stock Exchange members in the old days had acted mainly as agents and hadn’t put much of their own capital at risk in trading activities. Now all that had changed. Many member firms decided that the easy way out was to take their money and run by selling out to capital-rich foreign banks that were keen to pay whatever it took to get a foothold in the marketplace.

In the past, British regulators had taken a very sniffy attitude to foreign institutions looking to get a foothold in the City. As recently as 1981, the governor of the Bank of England had put his eyebrows into overdrive when HSBC had indicated an interest in buying the Royal Bank of Scotland. Now, just about everyone seemed to be welcome. For better or worse, most deals went through. In the space of a couple of decades, the City had been transformed.  

London became a magnet for talent from all around the world: according to the City Corporation, 40 per cent of City workers in 2019 had been born outside the UK. Political and legal stability, the English language, and London’s place in the global 24-hour time clock also worked in the City’s favour. 

The results show up in the numbers. London ranks alongside New York as one of the only two full-scale international financial service centres in the world. It’s the largest centre for cross-border bank lending and foreign exchange trading. It has the largest insurance and legal sectors in Europe. It’s second only to the US when it comes to fund management. And the UK financial services sector as a whole generated a trade surplus of over £60bn in 2019.

So will London still be the place to be in ten years?

After Brexit, it may well feel rather less welcoming to incomers. The immigration rules will be designed to accommodate well-paid City workers, but they won’t be free from friction. And the political predictability that was one of the UK’s most attractive features has been shattered, not just by Brexit but also by the government’s apparent indifference to the wellbeing of the financial services sector in the negotiations that followed. The fishing industry, economically insignificant but full of photo opportunities, appeared to be given much greater prominence.

Sooner or later, some kind of deal will be reached with Brussels on the future terms of trade in financial services. The economic costs of failing to maintain a powerful, open and liquid marketplace would fall on both sides of the channel. But the question is how much of a land grab Brussels will have managed to achieve before that happens.

A separate question is about the economic scars that might be left by the pandemic. Will London be quite as much fun as it has been in the next few years, and will so many people still be willing to take the risk of upping sticks and moving there?

But if London is coming off the top of the wave, what city might begin to take its place? In the immediate aftermath of Brexit, some of the US banks started to talk about Paris again. The gilets jaunes put a stop to that for the most part, and there is now an uncertain presidential election coming up next year. Things would have to change a lot for ambitious international financiers to decide that they might achieve greatness in Frankfurt or Amsterdam. Equity trading in Hong Kong is being boosted by big inflows from mainland China, but it is heading in the wrong direction when it comes to political certainty and its attractions as a place to live and work.

Put the question this way. Any list of the dozen most significant City financiers over the past 300 years would include at least three who were born in Germany – Nathan Rothschild (Frankfurt, 1777), Ernest Cassel (Cologne, 1852) and Siegmund Warburg (Seeburg, 1902). Where would their modern-day equivalents decide to make their careers? The answer, probably, is New York.

But would it matter if the City were indeed to head into a genteel and very gradual decline? In one sense, of course it would. Financial services are one of the very few business sectors in which the UK has global leadership. They pay more than ten per cent of all taxes in a normal year and make a massive and badly needed contribution to the balance of payments.

But the success of the City over the past 40 years has not been without social and economic cost. It has contributed significantly to the UK’s stark regional inequalities. And the size of Britain’s banking sector relative to the economy as a whole was one reason that the financial crisis of 2008-09 caused so much pain. 

The City has not just been a magnet for the brightest and best from around the world: it has also sucked in a high number of the country’s most impressive and ambitious graduates over recent decades. That surely has had an impact on the dynamism of other business sectors. So if more young people in this changing environment were to decide that their future lay somewhere in the UK other than Canary Wharf, maybe that wouldn’t be such a bad thing over the longer term.

Levelling up, anyone?