To understand why New York capturing the title of world’s greatest financial center is no cause for celebration, look no further than the Alibaba IPO.
Chinese e-commerce company Alibaba announced its intention to list its shares in the US rather than Hong Kong, a decision driven in significant part by regulatory arbitrage, just hours after the Big Apple captured the top spot for the first time in a survey of global financial capitals.
The battle to be top financial center is a bit like hosting the Olympics: the winner always loses but the athletes (or bankers) do well out of the deal.
New York topped London for the first time in a ranking of financial centers, according to the Global Financial Centres Index compiled by London-based consultancy Z/Yen, with Hong Kong, which lost out on the Alibaba IPO, in third place.
While clearly New York offers deep capital markets and expertise, it seems one point was key in taking Alibaba halfway round the world to list its shares: Hong Kong would not countenance its executive-serving corporate structure.
At issue is a provision which will allow a small group of Alibaba insiders to retain the right to appoint the board despite owning a small minority of shares, a structure permitted in the U.S. but not by Hong Kong.
“We wish to thank those in Hong Kong who have supported Alibaba Group. We respect the viewpoints and policies of Hong Kong and will continue to pay close attention to and support the process of innovation and development of Hong Kong,” the company said. “Should circumstances permit in the future, we will be constructive toward extending our public status in the China capital market in order to share our growth with the people of China.”
In other words “if ever the temptation to get a bit more investment banking business for Hong Kong overcomes your scruples, let us know.”
And quite a bit of investment banking business it will be, too. The offering may total US$15bn and value the company at upwards of US$150bn, making it the most significant such deal since Facebook listed two years ago.
Hong Kong regulators last year rejected Alibaba’s plans for an IPO there with a shareholder structure that would allow a small group of top managers and founders to nominate and control the board, while holding only around 13% of the company’s shares.
Alibaba’s cave
Be in no doubt, while Alibaba may well make investors who aren’t interested in exerting control over the company a lot of money, history is littered with examples of dual-share-class companies abusing their true owners.
It is easy to see why. Without the right to appoint board members or exert other forms of control, investors can only vote with their feet. That leaves executives free to pursue self-serving policies, be they for reasons of self-enrichment, self-aggrandizement or caprice.
That brings us back to the competition to be the world’s leading financial center, one New York seems to be winning, at least for now. Financial centers wax and wane for a complex set of reasons but three factors stand out: regulation, the financial strength of the host government and local wealth. All three involve a complex balance of weighing risk against reward but in all three instances it is very easy to increase your financial sector at the expense of consumers and tax payers.
Much is made, by the way, of the importance of a local talent pool, but in a business which offers outsized rewards, talent follows the money. Just ask a hedge fund manager in Zurich on a cold and oh-so-quiet Friday night.
In terms of regulation, on the point of dual shareholding at least, Hong Kong seems to be doing a better job of protecting investors than New York and the US.
If the great financial crisis demonstrated anything, it is that while the benefits of a large financial sector are highly concentrated at the top, the downside is much more equally allocated should banks fail or fall into danger. That’s because host governments quite literally backstop their financial industries, and can rack up huge liabilities in the process.
London’s fall from the top spot is not therefore bad news, especially considering that its banking industry’s assets compared to the size of its economy are much larger than are those of the US.
There is also the larger point that beyond a certain level, financial industry growth seems to have a tendency to distort the host economy. Think of all the British, American and Chinese math and science talent which has been squandered writing financial algorithms rather than inventing and building useful things.
There is treasure, it seems, in Alibaba’s cave, but considerable danger as well.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)