Enhance the Capacity for Independent Financial Innovation; Accelerate Shanghai towards Becoming a Global Financial Center [II]

 

Promoting the development of Shanghai into an international financial center

General rules of the formation and development of an international financial center

A financial center, by definition, is a market with various types of financial institutions assembled in a certain city or area. A financial center essentially plays the function of a financial intermediary, which differs from the intermediary function of financial institutions, as a financial center serves as the "intermediary of intermediaries" by offering a marketplace for trading and clearing for financial institutions. If a financial market serves transactions among domestic residents only, it is a domestic financial center. If large amounts of foreign investors actively make transactions of various types in a city or area, then it is an international financial center.

 

An international financial center can be classified into a functional center and booking center. A booking international financial center is a financial center serving as a legal registration place for financial transactions that are made in other locations. The Bahamas, Bermuda, the Cayman Islands, Barbados and the Virgin Islands are all such booking centers. A functional international financial center, on the other hand, is a financial center in which financial institutions provide customers with substantial financial services in the local financial market. The well-known global financial centers of New York, London, Tokyo, Hong Kong and Singapore all belong to this category, and the international financial center that China is building should also be functional. Functional international financial centers exhibit five key features. First, it's a center with highly developed financial markets and extremely active transactions. Second, it hosts various international financial institutions offering a wide range of sophisticated financial services. Third, functional centers act as a hinge in allocating resources and a hub for clearing funds. Fourth, it is a bridge linking domestic and global financial markets. Fifth, a functional international financial center should have impressive achievements in financial innovation.

 

Throughout history, many countries have aimed to build an international financial center, but only a few have succeeded; and lots of cities and areas that used to be major global financial centers failed to maintain their status and declined. Therefore, not every city or area can become an international financial center. The forming and development of an international financial center has its own rules, and building an international financial center should be based on some fundamental conditions.

 

1. A brief history of international financial centers

According to Tschoegl (2000), an American economic geographer, the location of international centers is not random. They are where they are because of a historical process that has resulted in certain places offering a cluster of attractions to various financial institutions that established their activities there.

 

Charles P.Kindleberger (1974), has traced the history of western financial centers. According to his research, financial market activities can be dated back to the Temple of Babylon in 1900BC, and the ancient Roman court in 500-300 BC is regarded as a forerunner of concentrated, supervision on financial markets. The following feudal monarchy in the West caused a setback in financial activities. After the Industrial Revolution, European financial centers embraced their renaissance. Before 1870, a large number of cities provided regional and global financial services, but no single one dominated the others. At times, more than one city in a country competed for this position. These centers included Amsterdam, Berlin, Florence, Frankfurt, Genoa, Hamburg, London, Milan, New York, Paris, Philadelphia, Rome, Turin, Venice, and Zurich. By the late 19th century, London began to win out. London is situated in the southeast of England, lying astride the River Thames only 80 kilometres from its estuary. The River Thames with its wide waters is nice for ships to go east across the Dover Straights and through the English Channel in the south to the continent; in the north, they can arrive in Iceland and the Scandinavian Peninsula across the North Sea. At the end of 18th century, Great Britain had become the most important trader and fund exporter in the world. London, consequently, turned into the most significant trade, commercial and shipping center in Europe. In the meantime, the British government issued a mint of bonds with large volumes in repeated wars, thus further advancing London's financial markets and making it a trade and financial hub in the world. In the 19th century, the boom of international trade accelerated the progress of London's financial market and made Sterling the tool of international payment. In this way, London developed into a real global financial center of significance, since all countries should make international settlement through London.

 

After the First World War, the status of Sterling waned by degrees and the United States established great power as an exporter. As the Dollar turned into a major currency convertible against gold, the US set up huge infrastructure for capital markets, and international financial transactions witnessed unprecedented prosperity. New York challenged London and started its ascent to a leading international financial center. New York, also a seaport city, is located on the East Coast and enjoys the position of being the best seaport in the North Atlantic with miles of sea line. Raritan River and Hackensack River in New Jersey, the Hudson River and Long Island Sound in New York State funnel millions of ships to New York. As early as 1690, the city of New York was a known center for pirates. After the establishment of the United States of America, its free trading facilities helped New York become a major place for the circulation of commodities in the world. New York replaced Philadelphia as the top financial and commercial center in the US in 1810. During the First World War, European financial centers, particularly London, suffered the ravages of war, while the US remained neutral, evading the impact of the war and attracting a flood of gold and capital. This boosted the rapid development of New York as a financial center. As the Dollar became a major means of international trade and clearing, New York leaped to the position of international financial center. When the Second World War ended, the US came to be the top creditor in the world, and its mighty economic and financial power drove New York to surpass London as the world largest international financial center. New York remained the leading international financial center until the 1970s.

 

Since then, international financial activities moved their center for the second time. The US interest equilibrium tax on domestic residents' purchases of foreign securities hampered the attraction of borrowing from the US and thus encouraged many foreign investors to turn to European markets where the supervision was comparatively loose. In the meantime, the introduction of Regulation Q that restricts interest rate competition spurred US banks and securities' traders to expand business in their European branches. All these factors stimulated the development of the Eurodollar and money markets and the heavy volume of international financial transactions shifted back to London. In the early 1980s, foreign banks in the City of London jumped from 45 in 1959 to 351 in 1983. London resumed its role as the leading international financial center.

 

During this period, with the rapid development of Asian and Latin American economies, some new international financial centers began to emerge or take shape to meet regional markets' demands. In Asia, Hong Kong and Singapore gradually evolved into regional financial centers from the 1960s. In mid and late 1960s, international banks began to search for centers in Asia to make Asiandollar transactions, attempting to make them the time-zone extension of the fast-growing Eurodollar market. At that time, Japan's economy was still in the internal-oriented phase, so Hong Kong and Singapore became the natural options.

 

Hong Kong is located east of the mouth of the Pearl River in Southeastern China, consisting of Lantau Island and more than 230 surrounding islands. After the Opium War between China and Great Britain, Hong Kong had been under British colonial reign for years, following the Western industrial revolution as well as Western culture. Such elements, together with the proper geographical location, have made Hong Kong a major entrepot-trade center in the Asian and Pacific areas in 1960s. In 1976, the Hong Kong government lifted the restriction on bank licensing and adopted a series of measures for financial liberalization, thus attracting far more foreign banks to Hong Kong and contributing to the development of Hong Kong as a regional financial center. The year of 1979 was another turning point for the progress of Hong Kong's financial market. The reform and opening-up policy of mainland China turned Hong Kong into a gateway for the mainland towards the outside world, further consolidating its position as an important international financial center in Asia. Hong Kong has become an important fund allocation center in the Asian and Pacific area, as sovereignty and consortium borrowers from Japan, Taiwan and Korea conducted active credit activities there.

 

Situated in the southern tip of the Malay Peninsula, Singapore occupies a strategic place between the Pacific and the Indian Oceans. Singapore has long been renowned as the "Gibraltar of the East" and the "Far East Crossroads", for it is a must-go for ships from Europe, Mediterranean Sea, West Asia, and South Asia to the Far East. Since the founding of the country in 1965, the Singapore government has made great endeavours to develop the financial sector into a pillar industry of economic growth. Since 1968, Singapore has offered special supervision and taxation treatment for Asian Currency Units (ACUs) set up internally in commercial banks, aiming to enhance the development of the Asiandollar market which can match the Eurodollar market and offer offshore banking services. After 1969, branches of City Bank, OCBC, and Standard Chartered Bank in Singapore were all granted the go-ahead to operate ACUs. Since the 1980s, Singapore has further increased the limitations on foreign holdings in Singapore banks. With encouragement from the government, a large amount of foreign financial institutions entered the market, and all types of financial tools underwent constant innovation and were widely applied in the Singaporean financial market. Consequently the Asiandollar market saw great development in Singapore. Singapore's money, securities, FX, offshore financial and financial derivative markets all developed into international financial markets quickly, and Singapore, accordingly, became an international financial center in the Asian and Pacific area.

 

2.General rules and fundamental conditions of the formation and development of an international financial center

In defining general rules and fundamental conditions for forming and developing an international financial center, many research institutions and experts in the world have made analyses and summaries, including the Capital Market Development Research Institute in Frankfurt University of Germany (IFK,1990), a research team led by Belgian economist Abraham (J.P.Abraham, 1993), Bindemann of the Energy Research Institute of Oxford (Kirsten Bindemann,1999), and Kaufman, economist of the Chicago Reserve Bank (Kaufman,2001). With reference to these researches as well as the historical process of the formation and development of international financial centers, this paper summarizes the rules and conditions of the formation and development of international financial centers as follows.

 

First, international financial centers are always located in communications hubs, which are often places in trading lines. The reason why port cities can become financial centers lies in the fact that commerce and finance industry needed to overcome the problems of distance in the past. Companies operating in commerce and trade centers must make huge settlement, so these places are suitable for developing regional or international settlement centers.

 

Second, international financial centers all enjoy a long and glorious history of finance. The geographical advantage brought financial activities to these port cities in early times. And the influx of financial institutions and talents helps to change the location advantage into historical and cultural merits. Major international financial centers in the world all boast a long history of financial development. New York became the biggest financial and commercial center in the US in as early as 1810. London began to develop its financial industry with the emergence of capitalism in the 16th century. The longer the history of a financial center, the more financial institutions and professionals it attracts. When the economic scale is large enough, every financial institution will try to establish its own position there.

 

Third, government promotion carries a big weight in the formation and development of international financial centers. Generally speaking, the shaping of financial centers takes two forms. One is a natural evolvement based on economic and international trade growth. The other is a government-driven mode based on policy promotion, that is, even though economic progress is yet to reach certain levels, the government seizes some opportunity in the development and restructuring of international financial markets, and, through policy plans, creates favourable political, financial, supervisory and institutional environments in a particular city or area for the prosperous development of international financial activities, thus establishing an international financial center in a comparatively short period through hypernormal development. This is a common mode for most emerging international financial centers. Singapore is a case in point. It is worth noting that the role of government promotion cannot be neglected even for financial centers that evolve naturally. For instance, the resumption and consolidation of the status of a global financial center by London is closely related to the financial freedom reforms and policy promotion of the British government. In particular, in the early phase of a financial center's formation, government is especially necessary to offer a competitive policy and institutional environment, which can encourage financial institutions to make decisions of entry and, accordingly, accelerate the aggregation of financial centers and push the center to the level of self-strengthening and sustainable development.

 

Besides geography, culture and policy promotion, international financial centers also necessitate the following basic conditions:

 

-- A strong and prosperous economic base. Including a large-scale economic hinterland as well as fast economic and trade growth, which can ensure that the hinterland can provide the financial center with huge demand for and supply of funds.

 

-- A stable and harmonious policy and political environment. The importance of maintaining a sound macroeconomic policy and stable social political environment is self-evident in promoting the development of an international financial center. Unstable economic policies and social and political environment will undoubtedly threaten the smooth and orderly flow of international capital.

 

-- A developed and complete financial system. A large financial market with a developed system and wide range of products can ensure the economy of scale and professional efficiency of a financial center.

 

-- An open and free economic system. Highly market and export-oriented economy, a free flow of production elements and products, active business activities, and efficient, transparent and fair business rules can guarantee that the elements and products entering a financial center can reach an effective allocation and utilization.

 

-- Proper legal supervision. Complete supervision rules and clear clauses, proper supervision and fair management cannot only attract funds, but also safeguard sound financial order.

 

-- Flexible and innovative government administration. In the process of forming financial centers, government's strategic orientation is of supreme significance to a city's healthy development. Under a national unified policy framework, if a city can offer a more favourable policy and institutional environment than other cities, it will be a powerful incentive for the construction of a financial center. Flexible and facilitating government administration also includes low-tax policies that can cut the costs of financial activities.

 

-- Advanced supporting infrastructure services, including sophisticated and friendly communications services, as well as a developed and sound financial intermediary service.

 

-- High-quality financial expertise. There must be well-structured financial and finance-related accounting, legal and scientific professionals of a large volume and at a high level.

 

-- Formidable financial innovation capabilities. Facing changes in economic and scientific progress, financial centers should have the capability of constant innovation in financial technology, institution and products. Innovative capability is the guarantee for financial centers to make supernormal profits.

 

Shanghai's current conditions for building an international financial center

First, Shanghai enjoys advantages in geography and communications. Shanghai is located halfway down China's mainland coastline, where the Yangtze River empties into the sea. It is at the center of the big triangle by which China links to Northeastern Asia and Southeastern Asia. Shanghai is where the East-West Yangtze shipping line meets the North-South line by sea. It is easy to go to China's Southern and Northern coast as well as all the oceans of the world, Shanghai also enjoys a navigable inland waterways network including the Yangtze River Valley, Tai Lake Valley and rivers in Jiangsu, Zhejiang and Anhui provinces. The estuary seaport of Shanghai boasts superior natural conditions with the transportation lines ramified around the city. In recent years, Shanghai has accelerated its construction of major infrastructures, which are of multiple functions and form a network. The construction of "three ports and two nets" has made phased progress, and the city's aggregation and radiation function has been strengthened considerably. Shanghai has made significant breakthroughs in building an international shipping center: the container throughput of Shanghai Port ranked third in the world, cargo throughput ranked first in the world, and the first phase of the Yangshan Deepwater Port project was finished and put into operation. The construction is in full swing for the Shanghai aviation hub, rail traffic network and urban freeway network. Such major means of transportation as the Maglev Line and the first phase of the Pudong railway have been completed one after another. The achievement of Shanghai in building an international shipping and trading center, together with the target of becoming a financial center, support each other for the city's grand goal to become an international economic and financial center.

Second, Shanghai has a brilliant financial history. As mentioned before, Shanghai stood out as a financial center from as early as the 1930s. At that time, Shanghai was the focus of financial leaders. 35 banks had their headquarters in Shanghai among the 43 members of the Shanghai Banking Association. Whilst sipping coffee, these banking tycoons decided the lending rate and the exchange rate and then phoned all over the country as the basis for informing local markets. Shanghai's magnet attracted 27 foreign banks in 1936, which exceeded the 11 foreign banks in Tokyo, 13 in Bombay and 17 in Hong Kong. Shanghai's financial industry exerted a marked influence on the international finance industry. In 1933 the overseas Chinese leaders in Singapore, worried that the squeezing of the local Hefeng Bank might spread to the other two banks owned by Chinese in Singapore (China Merchants Bank and the Overseas Chinese Bank), asked the Bank of China in Shanghai for support. When the Bank of China announced "limitless aid", the volatility was controlled immediately. Shanghai is the center of China's bullion, FX and securities markets, as well as the hub of currency issuing. In 1933 the Shanghai banking sector recorded a stock of silver worth over 456 million yuan. Such a scale and turnover, "though unmatchable compared with London or New York, exceeded that of France, India and Japan", and far surpassed Paris, Tokyo, Osaka and Bombay.

 

Third, Shanghai is a national manufacturing base and the engine of the Yangtze Delta. Since 1992, Shanghai has registered a double-digital economic growth for 14 years on end. Shanghai's economy has formed a new pattern of industrial structure of "tertiary, secondary, and primary". The modern service industry developed quickly and its scale in downtown area has been extending constantly. In 2005, the added value of the tertiary industry downtown accounted for 75%. More importantly, Shanghai's economic hinterland, the Yangtze Delta Area is the most developed and vigorous economic zone in China, receiving the most of advanced technology transfers in the country. As the engine of the Delta, Shanghai grasped the opportunity of the quickening of world manufacturing into China, and the strong economic power laid a sound foundation for Shanghai to build an international financial center.

 

Fourth, Shanghai is in the forefront of China's reforms and opening up to the outside world. Shanghai's export-oriented and free economy outperformed other parts of China and the people's standard of living also leads the country. At present, a comprehensive supporting reform is being piloted in Pudong. With initiatives from state-owned, foreign, and private sectors, Shanghai is making strides towards becoming a modern city with higher vigor, larger freedom and deeper harmony with international best practice.

 

Under the strategic leadership of the CPC Central Committee, Shanghai has achieved remarkable success in building an international financial center. As of end-2005, Shanghai's financial market witnessed 35 trillion yuan worth of transactions. Including 5 trillion yuan worth of securities trade accounting for 79% of the total in the country, 6.5 trillion of futures trade accounting for 49%, 23.2 trillion yuan in the interbank market, and 116.8 billion yuan in the gold market. The FX market has expanded its scale by degrees, growing into the major pricing market of RMB exchange rate formation. Shanghai is the home to 610 financial institutions, including 231 banking institutions, 110 securities institutions, and 269 insurance agencies. Financial assets amounted to 3.2 trillion yuan, 9% of the overall total in China. Shanghai is the leading city in terms of hosting foreign financial institutions. Over 300 foreign financial institutions including such giants as Citibank, Bank of America and UBS have set-up their China headquarters or branches in Shanghai. Shanghai has become a domestic financial center with its comparatively complete financial market systems, large numbers of financial institutions and talents and strong radiating ability, which are all offering a preliminary base to propel Shanghai to becoming an international financial center. (To be continued)

 

Source: CHINAMONEY Journal