All Roads Lead To The City Of London

For the city fathers who watch over London's square-mile financial district, it has been a traumatic six months. In March, administrators sold 230-year-old Barings PLC to Dutch-owned Internationale Nederlanden Groep, after Baring suffered $1.4 billion in derivative trading losses. Then, Britain's largest merchant bank, S.G. Warburg Group, in May agreed to become a subsidiary of Swiss Bank Corp., after Morgan Stanley & Co. dumped Warburg at the altar. Now, Kleinwort Benson Group is ready to give up its independence, having entered into merger talks with Germany's Dresdner Bank. As Britain's proud merchant banks fall into the clutches of better-capitalized European rivals, London looks like a big loser.

Look again. London's role is growing, not shrinking, as the preeminent center of Europe's financial services industry. Although the Frankfurt and Paris exchanges are expanding as the German and French securities markets open up, Continental banks are pouring billions into London to tap the pool of talent they need to compete as worldwide investment banks. Their hope is that the combination of British expertise and European deep pockets will put London in a position to challenge New York's global role.

Europe's investment banks are rapidly consolidating to take advantage of an increasingly open market. A European Union directive effective on Jan. 1, 1996, will allow EU investment houses to trade freely across borders, bo matter what country they're domiciled in. In the U.S., meanwhile, the Glass-Steagall Act, prohibiting commercial and investment banking under the same roof, is breaking down, making it easier for European merchant banks to take business away from the big New York investment banks that make up the first tier of the


Since the 1986 Big Bang, when London deregulated financial services by ending fixed commissions and allowing banks, brokerages, and underwriters to merge, independent British firms have slowly disappeared. Today, only five independent merchant banks and a handful of independent brokers are left, but the City of London, as it's known to locals, is home to more than 500 foreign banks. Greater London's financial services industry now employs more than 600,000 people--about equal to the entire population of Frankfurt. And 40% of London's back-office clerks, research analysts, and floor traders have foreign employers.

BIGGEST HUB. London boasts the world's largest center of foreign exchange trading, with some $300 billion in volume daily. It also handles a full three-fourths of the $440 billion Eurobond business. One reason Dresdner wants Kleinwort is that it hopes to use the London bank to bolster its meager presence in the Eurobond market. And London is the world's biggest hub of cross-border equity trading and bank lending. Its futures exchange and institutional fund management businesses are Europe's largest.

Why London? The centripetal forces began building decades ago, when banks had to be near one another because communication was difficult and traders didn't want to be out of the loop for price-sensitive information. In addition, Britain's tradition of openness to foreign investment, its large pool of financial experts, and the liquidity of its foreign exchange, futures, and equity markets have always been magnets for foreign institutions.

Success breeds success. Over the past 10 years, many European companies have grown accustomed to raising capital in London--through equity financing, debt issues, or venture capital. That should accelerate as banks that want to expand their investment banking business can't pass up a presence in London. "Dresdner [possibly] acquiring Kleinwort Benson only makes it more likely that financial services will continue to concentrate here. It's a vote of confidence," says Richard A. Brealey, a professor of finance at the London Business School.

Ever since the Big Bang, many observers have predicted that modern telecommunications and computerized information services would erode the individual powers of New York, Tokyo, and London, as the time zone difference became less relevant and 24-hour trading grew easier. The voices of doom in London got louder when august institutions suffered recurring scandals and missteps, such as the early 1990s collapse of the Bank of Credit & Commerce International and the Robert Maxwell empire. The recent Barings

debacle seemed to confirm their dire predictions.

FITFUL MARCH. But the City's downfall never came. In fact, more financial clout is now concentrated there than ever before. In just the past two weeks, Dresdner, Amsterdam-based ABN-Amro, and Germany's WestDeutsche Landesbank have all announced their intentions to move investment banking operations to London. Their decisions follow a similar move in December by Deutsche Bank, whose 1989 acquisition of Morgan Grenfell & Co. made it one of the first Continental banks to acquire a London merchant bank. Now, Deutsche Bank is using London as its base for building a global investment bank, with its sights set squarely on New York. Japanese and American banks are also making London their European headquarters.

But the City still can't afford to sleep. For one thing, Britain's reluctance to join in the fitful march toward monetary union and a single currency in Europe could threaten its preeminent role in currency trading. And Paris and Frankfurt also want to build financial districts. Both cities' bourses have quicker clearing and settlement systems than the London Stock Exchange does. Both also use computerized screens for their futures exchanges, while London's International Financial Futures & Options Exchange insists on old-fashioned open outcry. Already, London has lost out to Frankfurt in the bidding for the much-coveted European Monetary Institute, which will become the European Union's central bank once monetary union `ccurs, in 1999 at the earliest.

But even the European Union's future central bank will have to execute its monetary policies through currency traders in London, who aren't about to get relocated by their employers. London's masses of foreign exchange traders--at least 100,000 of them--make recruitment and training easy there. And in a new survey by the London Chamber of Commerce, foreign banks named the quality of telecommunications as the No.1 reason for locating in London, just above the skilled workforce.

Despite high-profile mishaps in London, such as the Bank of England's failure to prevent the Barings calamity, the regulatory system is viewed as fairly rigorous, evenhanded, and consistent. And further tightening of the regulatory system is expected soon.

That's why the city fathers aren't crying in their beer over the increasingly non-British character of London's financial service industry. Other European cities hoping to bump London from its perch any time in the next few decades are only indulging their fantasies. A bigger problem is figuring out how to relieve the City's congestion at rush hour.

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