Richard S. Grossman

March 27, 2017: In February this year, HSBC, one of the world’s largest banks, decided not to move its headquarters from London to Hong Kong. The revelation that a company is staying put is usually not earth-shattering news. Nonetheless, HSBC’s decision made headlines in Asia, Europe, and the US for three reasons.

First, HSBC is the world’s fifth largest commercial bank; it holds more than $2.5 trillion in assets and is exceeded in size only by four state-owned Chinese banks. Wherever such a financial behemoth decides to hang its hat will have an important impact on that location…and the one it leaves.

Second, and more importantly, the decision highlights the crucial role that a country’s legal and economic institutions play in the health of its financial institutions.

Third, it shows how large banks like HSBC can — and do — use the threat of moving to secure more favourable treatment.

HSBC was established as the Hong Kong and Shanghai Bank almost exactly 151 years ago, opening for business in Hong Kong on March 1865 and in Shanghai a month later. It extended its reach throughout east and south-east Asia for the next three quarters of a century. With the communist take-over of China after World War II, the bank retreated from China and expanded its scale, scope, and geographic reach elsewhere, increasing its presence in the US, where it acquired Marine Midland Bank, and in the UK, where it purchased Midland Bank, one of the big four UK banks.

HSBC has more than a quarter of a million employees; nearly a fifth are located in Hong Kong and Mainland China, just slightly more than the proportion working in the UK.

Nearly half of the firm’s assets are located in the UK, about a third in Asia, and about a sixth in North America. Hence, from a logistical perspective, London and Hong Kong would both seem to be good choices for a headquarters location.

From a purely commercial perspective, however, Hong Kong seems to have the upper hand: the long-run potential growth in less-developed Asia is certainly higher than in Europe. And, in fact, nearly two thirds of HSBC’s pre-tax profits in 2014 came from its Asian business. And yet, there are many reasons HSBC might be wary of decamping to China.

Although Hong Kong has a large and well-run financial system, and its regulators get high marks from the IMF, if HSBC were to get into trouble, the Hong Kong authorities might not have sufficient resources to act as a lender of last resort. In 2012, Hong Kong’s banking sector assets amounted to more than seven times its GDP — HSBC’s balance sheet alone is nine times the size of Hong Kong’s GDP. Finding the resources to bail out a bank that is bigger than the entire economy would pose a substantial challenge.

Further, because Hong Kong is a special administrative region of China with a currency board, and not an independent country with its own central bank, it could not bail out a bank by issuing unlimited amounts of money. Hence, any serious crisis would require China to step in. And, given that China’s economic institutions are neither efficient not transparent, and its commitment to corruption-free rule of law is tenuous, a large multinational institution like HSBC might be wary of putting its future in Beijing’s hands.

HSBC had been officially considering the move to Hong Kong for almost a year before it decided to stay put. As a healthy and relatively profitable bank, the British government was keen for it to remain in London. So keen, in fact, that recent government moves could be interpreted as an attempt to … convince (bribe is such an unpleasant term) HSBC and other multinational banks to remain in London.

Britain’s Chancellor of the Exchequer (i.e., finance minister), George Osborne, made it clear during his Mansion House speech in June 2015, that he was prepared to make life more comfortable for banks to stay in the UK, offering a “new settlement” to Britain’s financial industry. “I want Britain to be the best place for European and global bank HQs. It’s in our national interest to be so.”

And so the government will reduce a special tax that had been imposed on banks in the wake of the financial crisis. He also signaled that the substantial fines that had been imposed on banks for bad behaviour would be used more sparingly: “… simply ratcheting up ever-larger fines that just penalise shareholders, erode capital reserves and diminish the lending potential of the economy is not, in the end, a long term answer.”

The HSBC board, which voted unanimously to keep its headquarters in London, understood that moving to a more economically dynamic Hong Kong would subject it to China’s not-yet-ready-for-prime-time economic institutions. Still, the threat of the move encouraged the British government to make life cozier for its banks.

The Chancellor was taking no chances.

And neither was HSBC.

This article originally appeared in Oxford University Press blog (OUPblog)

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November 29, 2016: Ireland has indicated to a number of large investment banks that it would be hesitant to host large trading operations. The Irish central bank has signalled in talks with banks that they would encounter serious hurdles to gain regulatory approval for these operations, which would involve large sums of money compared to the small size of Ireland’s economy.

The reasoning behind the stance

“A lack of specialised supervisors and the risk of sophisticated investment banking to the state make Irish regulators reluctant to host such banks in Dublin,” said a source who understands the line of thinking of the Irish central bank.

“Our sense is that the appetite in Ireland is not that high for balance sheet banks,” said a source at a global investment bank.

The reluctance is said to stem largely from the unfortunate experience of having gone through a severe banking crash in 2008, which was followed by an international bailout.

Speaking anonymously, a source at a large investment bank with a global presence commented, “Ireland is being very realistic about what it can and what it wants to do. If you’ve come from all the troubles Ireland has, you want to be very careful about taking on risks.”

Meanwhile, yet another banking source said, “Yes, Ireland wants insurers, asset managers, back office functions; but they don’t want big balance sheet risk. They just don’t want to take on that kind of risk and feel that they don’t have the regulatory bandwidth to do that.”

The news comes in spite of the country’s need to attract jobs in the financial sector from London after Brexit.

Likely fallout

What will most likely result from this stand is that Ireland will fail to become a destination of choice for what is considered to be some of the banking industry’s riskiest affairs. The investment banks involved are mostly American, Swiss and British, which are now figuring out how to gain access to the EU after Britain leaves.

The principal concern of these banks is where they can carry out trade which brings many risks and involves large balance sheets, such as the trading and clearance of European securities, euros and other market activities, which come under the purview of EU regulation. Carrying out such trade means the trading models employed must be carefully supervised. Coupled with the scale of such business, this has led to the cautious response from Dublin, say sources.

No blanket policy

However, a spokeswoman for the Irish central bank said that there is no blanket policy in place intended to turn away certain types of business. “The central bank is open to engagement with any firm wishing to obtain an authorisation,” she said.

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