When a financial journalist describes somebody as ‘an eminent City figure’, he probably means what he says. The man is perhaps a senior member of the banking establishment. If a journalist describes somebody as ‘the controversial City financier’, he’s probably coming as close as he dares within the libel laws to calling him a financial spiv!
But what exactly is this ‘City’ which harbours these characters and many more? It is, of course, a geographical area on the east side of Central London, often described as the Square Mile. But ‘The City’ is more often used as a convenient blanket term for the commercial institutions at the heart of Britain’s financial system. They do not necessarily operate within the square mile of the City of London, though a surprising number of them do. They provide the financial services that oil the wheels of industry and trade. They are not, however, concerned only with serving Britain’s domestic economy. Much of the City’s activity relates to international finance, trade and securities dealing, and many of the financial institutions that operate there are foreign owned. One of the more common criticisms of the City is that it is too remote from Britain’s own productive industries. Whereas some parts of the City have always been international in outlook, the big change of the last 20 years is the internationalization of even the most traditional domestic institutions such as the London Stock Exchange. However, in looking at the City institutions we will be concentrating first and foremost on pinning down their importance to Britain’s own economy.
The City is a major source of invisible earnings for Britain’s balance of payments. Financial services generated net overseas earnings of almost £32 billion in 1998.
To put into context what we read about the City, we need some idea of the relative importance of different institutions and the sums of money involved. What follows in this chapter is an outline of the main domestic investment flows and the bodies that handle them. Some of these figures (together with other markets not covered here) are described in more detail in the chapters devoted to them.
The City provides the mechanisms that channel money to where it can be put to work. The main external source of new long-term investment funds for business and government is the savings of private individuals, and in Britain these savings are channelled mainly through the large financial institutions: primarily the pension funds and life assurance companies. These two types of institution between them had almost £62 billion of new money to invest in 1999. They invest funds in companies by buying shares. By buying gilt-edged securities they supply much of the money the government borrows (in the years when it does need to borrow). The London Stock Exchange provides the main mechanism for these institutional funds to find their way into company securities and government and company bonds, and the financial institutions are the London Stock Exchange’s largest clients (see Chapter 6).
The financial institutions also invest in commercial property and in overseas securities and property, and put money to work short term in the money markets.
A third type of investment institution is significant in the equity market: the unit trust. Unit trusts pool the money of individual investors to provide a spread of risk by investing in a range of shares, mainly via the stockmarket. Investment trusts perform a somewhat similar function, but there are important structural differences between the two types of trust (see Chapter 21).
The building societies also act as a funnel for the savings of individuals but the money they take goes primarily into providing mortgages for homebuyers. However, a proportion of their funds is invested in government securities via the stockmarket, where it can readily be turned into cash if needed. Building societies are less of a force nowadays, when many of the biggest have turned themselves into banks or been acquired by banks (see below).
The other major domestic source of external funds for business is the banking system and the money markets (see Chapter 15). The banks’ main sources of funds are shorter term – the money of individuals and companies deposited with them (retail deposits) plus the wholesale funds they borrow in the money markets. The banks lend money in one form or another. The high-street banks in Britain do not, as in some other countries, invest in company shares to any significant extent. But they act as arrangers of finance as well as lenders by organizing and guaranteeing issues of various types of short-term IOU by companies. The banks also invest in government securities via the stock exchange. And they are the main participants in the foreign exchange or forex markets. Some of the banks are directly involved in the stock exchange through securities houses they own. The big banks are very active in buying and selling derivative financial products. Finally, they often deal quite actively in various financial markets on their own account in an attempt to boost their income.
A third source of finance for business and governments is the eurocurrency market or euromarket, also known as the international market. Here the sources of funds were originally the deposits of currencies held outside their country of origin, in banks round the world. These days, however, this distinction has become a little unreal and the market is defined more in terms of its trading and issuing techniques, its structure and its international character. The users are borrowers round the world (in spite of the name, this market does not deal solely with deposits held in Europe). London is the main centre of this market, but Britain is neither the main supplier nor the main user of eurocurrency funds (see Chapter 17). The international market saw enormous growth in the late 1990s.
The London Stock Exchange, the banking and money markets and the euromarkets are the main markets for investment funds. But the City contains many other markets which provide services for business.
There is a range of markets concerned with the management of risk, in which investors or businesses can either hedge (protect themselves) against the risks inherent in their operations or opt for high risks and high rewards by betting on movements in prices and interest rates. These are increasingly referred to as the derivatives markets. They include the traded options market and the financial futures market (which are now amalgamated) and a range of commodities futures markets. The foreign exchange market also comes within this category as a medium for hedging currency risks.
There is another aspect of risk management: a market in insurance. This divides into two parts: insurance provided by insurance companies (the company market) and the international insurance market operated under the aegis of Lloyd’s of London, though the distinction between the two is less rigid than it once was.
Occupational pension schemes – pension schemes provided by companies or industries for their employees – had (at end-1998) investments valued at some £699 billion and invested some £8 billion of new money in 1999. The contributions that companies and individuals pay into these schemes are invested in a fund to provide the pensions at the end of the day. Some pension funds manage their own investments – the biggest run into many billions of pounds. Others farm out the investment management, often to investment banks (see Chapter 6). Others are insured schemes where payments are made to an insurance company which contracts to provide the pensions.
Because life assurance companies provide pensions as well as life assurance, the distinction between the two types of investment is a little blurred and life assurance funds include a pensions element. The larger life assurance companies have also become more diversified investment management groups, offering unit trusts and other financial services. Life assurance is mainly a savings business as opposed to general insurance which provides cover against fire, theft and similar risks. The life assurance companies had (in 1998) existing investments of about £776 billion in their long-term funds and invested some £55 billion of new money in 1999.
Both the pension funds and life assurance companies are vehicles for contractual savings: money coming in under long-term savings schemes which can safely be invested for the long term because the savers have contracted to make regular payments.
Unit trusts cannot rely on the same regular inflow of funds, though part of the money they receive comes from regular savings plans. Investors tend to pile into unit trusts when the stockmarket is buoyant and may even withdraw funds when it takes a turn for the worse. But, overall, they have still shown strong growth in recent years, particular as investors could hold unit trust units in a personal equity plan – PEP – or ISA (see Chapter 21) and receive tax advantages. At end-1999 unit trusts held total funds of £254 billion, having invested a further £19 billion during the year. They are often operated by large investment management groups which market a range of savings products and services. Investment trusts were considerably smaller, with total funds of around £77 billion early in the year 2000.
The pension funds, life assurance companies and unit trusts between them own around half of all listed shares in British companies, and the first two have large holdings of gilt-edged securities.
Life assurance and unit trusts are sold direct by the organizations that provide them, but are also extensively marketed through financial intermediaries who operate on commission. These include insurance brokers and independent financial advisers. Accountants, solicitors, bank managers, building societies and stockbrokers may also sell these investment products.
The building societies at end-1999 had outstanding loans of some £129 billion, mainly mortgage loans to homebuyers. Their possible range of activities is now wider than in the past and the larger ones are allowed to offer a range of services including cheque accounts, personal loans, estate agency services and a variety of financial and savings products. But building societies are, regrettably, a declining force in the financial arena. Hitherto they have been mutual organizations – owned in theory by the people who deposit money with them and borrow from them – but the larger ones now have the option to become companies owned by shareholders or to acquire banking status. The Abbey National was the first to convert into a bank and launch on the stockmarket, and other major societies have either taken this course or allowed themselves to be taken over by banks. Since a building society’s savers and borrowers normally receive a windfall payment in cash or shares when the society abandons its mutual status, short-term greed probably dictates that the mutual building society movement will contract still further.
At end-1999 banks in Britain had total deposits from UK residents of around £724 billion, of which £636 billion was in sterling. The bulk of this money is with the major clearing banks such as Barclays and Lloyds TSB, whose traditional deposit-taking and lending services are familiar enough. These are the banks whose branches you see in the high street and which are, indeed, also known as high-street banks or retail banks. Some of the clearing banks flirted in recent years with the world of the stock exchange via the acquisition of broking or, in some cases, marketmaking businesses, but with very mixed success and earlier grandiose plans were often watered down or abandoned.
Very different from the traditional clearing banks are the investment banks or merchant banks. Twenty years ago you would have used the term ‘merchant bank’, but many of Britain’s traditional independent merchant banks with well-known names such as Kleinwort Benson and Warburgs have now been taken over by foreign banks and become part of much larger organizations. At the same time, foreign financial institutions have set up shop in London, with the American brokerage houses and investment banks particularly prominent.
Investment banks or merchant banks do not have a great deal of contact with the general public, except perhaps as fund managers and vendors of investment products. Nor do they necessarily have large-scale funds of their own even though they may nowadays have the backing of larger institutions. Their expertise lies in arranging finance, not necessarily in providing it. They are dealmakers whose corporate finance arms advise companies on stockmarket launches, capital raising, takeovers and on takeover defences. They may be active as marketmakers and dealers in the stockmarket and the eurobond market and many of them have a large fund management business – much pension fund investment is in practice managed by investment banks. The larger ones are global in their activities and outlook.
London is host to a wide range of foreign banks – around 550 at the last count – many of which were attracted by London’s position as centre of the euromarkets though some of the larger ones also do significant domestic banking business in Britain and may be involved in stock exchange business.
Britain’s domestic stock exchange is one of the world’s largest, ranking after those of the United States and Japan. At end-1999 the total market value of listed ordinary shares in UK companies was £1,820 billion, while UK government securities listed on the exchange had a value of £333 billion. In 1999 some £14 billion was raised by the first-time sale of shares in new and existing companies on the stockmarket. London Stock Exchange members may operate as dealers or marketmakers, acting as principals and putting their own money at risk, or they may confine themselves to the role of agency broker. Agency brokerage is the business of executing share trades for investors in return for a commission. Marketmaking in gilt-edged securities is undertaken by primary dealers known as gilt-edged marketmakers. There were 40 equity marketmakers in the main market of the domestic stock exchange at the end of 1999 and 16 gilt-edged marketmakers.
Most of the major London marketmakers and brokers are now owned by UK or foreign banks or other financial institutions and in some cases several firms have been brought together to form major securities houses which undertake all kinds of securities business. A number of major foreign banks and securities houses are now also active in the British market. Many of Britain’s smaller brokers and country brokers remain independent, though some have got together into larger groupings. In recent years there has been growth in execution-only brokers, who provide a no-frills, relatively cheap share dealing service for the public and Internet brokers (who provide share-dealing facilities via the Internet) were becoming more established in Britain. They are already well established in the United States.
Most of the larger stock exchange businesses employ numbers of investment analysts who produce research into companies and other investment topics as a service to clients.
By no means all investment in Britain passes through the stock exchange. An enormous growth area in recent years has been the provision of finance for businesses whose shares are not traded (or not yet traded) on the exchange. This can take the form of finance for business start-ups, development finance for growing private companies and finance for operations such as management buy-outs. Venture capital groups are the businesses that provide or arrange this kind of finance in return for a share stake. Some of these venture capital groups are stockmarket-listed companies in their own right. Others may be offshoots of other financial groupings such as banks, insurance companies or pension funds.
The components of the other markets are described in the chapters devoted to them. But among the City figures encountered in the financial pages there is also a range of professional firms without which the City could not function: notably, accountants, actuaries, lawyers and chartered surveyors.
Accountants are a vital link in the financial chain, if only because they audit the accounts of companies (see Chapter 3). Their services are particularly vital in the preparation of a prospectus when shares are marketed (sold to a range of investors) for the first time. Audit and tax work is the traditional mainstay of the accountant, with liquidation work – winding up companies that have gone to the wall – as a specialist sideline for some of them. But the major international firms which number their employees in tens of thousands worldwide have pushed fast into areas which overlap with other established interests: corporate finance and all manner of management advisory services. Link-ups with firms of commercial lawyers are also being pursued.
Consulting actuaries are the firms that advise on the highly complex business of pension funding and pension fund performance and they crop up with some regularity when pension topics are discussed. This is in addition to the actuary’s original function of assessing mortality risks, valuing life assurance assets and liabilities, and deciding on bonuses.
Commercial lawyers: few documents in the investment world can safely be prepared without the advice of a commercial lawyer, and the City boasts a dozen or so major firms specializing in commercial work.
Surveyors and estate agents act as intermediaries in the market in investment properties. But they do a great deal besides. Valuations of a company’s properties may be needed in a new issue or takeover document. They will certainly be needed when finance is to be secured on properties. The chartered surveyor frequently helps to arrange finance for development of properties. He manages property investment portfolios for numerous institutions and is one of the main sources of information on conditions in both the property investment market and the letting market (see Chapter 20). But change is again in the air. Most of the largest firms have relatively recently surrendered their autonomy and are now part of larger international real estate and financial groupings.
Perhaps the financial public relations agencies should also rank as one of the City’s back-up services. Many have a significant client list among stockmarket-listed companies. The reader of the financial press is not necessarily aware of their presence, but much of the routine information from companies – profit announcements and the like – reaches the journalist in the form of a press release on the paper of one of these agencies. They perform a more active role in publicizing the virtues of companies coming to the stockmarket, in helping to present the case for an aggressor or a defendant in a takeover bid, and generally in ensuring that information which could be good for the share price of a client company does not remain hidden under a bushel.
Finally, there are the regulators whose job is to supervise these diverse bodies and interests and ensure that they remain on the straight and narrow. The main regulator is now the Financial Services Authority. Since the regulatory system is complex, and currently undergoing significant change, we will deal with this topic where it crops up, and in a distinct chapter, towards the end of the book (Chapter 22).
Most of the organizations mentioned in this chapter, or their professional bodies or trade associations, now have websites where further details and contact information are provided. These are listed in Chapter 23. For further information on the City and its components try first the Corporation of London-City of London website at www.cityoflondon.gov.uk/. This provides background and links to the main organizations operating in the City of London. Statistical and research material is available at the BI (British Invisibles) site at www.bi.org.uk/. At the Bank of England site at www.bankofengland.co.uk/ you can find and download free The City Handbook of City organizations with their addresses and contact details (this is not available in printed form).