Is New York losing out to London? McKinsey Global Institute Director Diana Farrell discusses worldwide shifts beyond the trans-Atlantic rivalry
Concerns that New York is losing its place as the world's preeminent financial hub to London have been discussed all the way up to the Chairman of the Federal Reserve. No doubt the rivalry will rumble on—and help ensure customers get a competitive deal in both centers. But other equally seismic shifts in the world's capital markets are taking place, according to the McKinsey Global Institute's third annual update of Mapping the Global Capital Markets.
The creation of the euro has helped make Europe's financial markets a serious new force on the global landscape. By contrast, Asia, despite some notable developments, remains largely fragmented and its markets punch below their weight on the world stage. This only underlines the vast opportunity that will be unleashed once Asian economies fully embrace liberalization in finance.
The Expanding Euro Zone
The euro has come a long way since its inception eight years ago—and so have euro zone markets. With some $30 trillion in assets, euro zone financial markets are still significantly smaller than the $50 trillion found across the Atlantic. But Europe is rapidly closing the gap. In 2005, the latest year of comprehensive data, the euro zone's financial stock soared 21%, to $3.3 trillion. This outpaced U.S. growth of 6.3%, or $3 trillion. Three-quarters of this growth came from equities and private debt securities, indicating how rapidly the euro zone is shifting away from traditional funding by banks.
The euro zone's financial markets now have a value—or financial depth—of more than three times the area's combined gross domestic product. This is still below the depth of financial markets in the U.S. and Britain—with centuries of financial innovation behind them. However, the euro zone's financial depth has increased at twice the pace of either over the past 10 years. As long as financial deepening isn't the result of rising government debt or an equity market bubble—neither of which is the case in the euro zone—this is good news for households and businesses, which gain more choice in investing their savings or raising capital for expansion.
The euro zone is also becoming a larger player in terms of global flows of capital. Within the euro zone, cross-border capital flows—including purchases of equities and debt securities, lending, and foreign direct investment—averaged $1.7 trillion a year between 2001 and 2005. This is much higher than in the pre-euro era. Indeed, 70% of European equities are now held by investors from different countries than the issuer, far higher than the global average of 20%. Capital flows between the euro zone and the rest of the world are now nearly equal to those between the U.S. and the rest of the world. The euro zone is rapidly becoming a leading global capital player.
Fragmented Asian Market
Asia is another story. To be sure, there have been some positive developments. In 2005, Japan's equity market increased in value by $1.5 trillion, the largest gain in the world. And it was no bubble. Growth was due mostly to higher corporate earnings, rather than higher price-earnings valuations. Hong Kong showed the world its intention to become Asia's financial hub, playing host to several of the world's largest initial public offerings last year. There is no doubt that Asia has every potential to raise large sums of capital.
Yet Asia's financial markets remain strikingly isolated from one another. Japan is the world's third-largest financial market with $19.5 trillion in assets. It should be Asia's natural regional hub. Yet its capital ties are overwhelmingly with the U.S., Britain, and Europe, not with its own neighbors. At the end of 2004, it held $1.5 trillion of U.S. and European equities and bonds, but only $29 billion of bonds and equities from other Asian countries. Although Hong Kong and Singapore are slightly more international, the pattern remains true throughout the region. And despite burgeoning trade, growth, and dynamism, Asia has largely remained outside the global financial loop. Some 80% of world capital flows in 2005 were among the U.S., Britain, and the euro zone.
The slow speed of financial innovation and development is hurting Asia. The region has some of the highest savings rates in the world, yet its surplus capital is directed largely to the U.S. Last November, The McKinsey Quarterly surveyed leading global executives and found that 57% of those from China and 42% from India believe development of their countries' financial systems is being slowed by too much regulation. Yes, China is developing quickly and its financial market has $5.1 trillion in assets. Still, more than 70% of these are in bank deposits, and its capital markets are still nascent. One can only imagine Asia's potential if these savings could more easily be invested in the region's rapidly growing economy.
Growth in Latin America
We should not, in mapping the emerging global capital market, forget Latin America. Overall, the region's financial depth is a meager 133% of GDP, far below that of emerging markets in Asia (230%). Still, there are positive signs that change is on the horizon. The region's stock of financial assets jumped from $1.7 trillion in 2002 to more than $3 trillion in 2005. Its equity markets have outperformed emerging markets as a whole by 40% over that period. Brazil and Mexico are playing host to more IPOs. Albeit from a small base, corporate bond markets have grown by 50% since 2002, banking assets by 60%. After decades of recurring financial crises, could it be that Latin America is entering a more stable, dynamic era? The signs are promising—and that would be a seismic shift indeed.