Alibaba and the battle for financial supremacy: James Saft

March 18, 2014

March 18 (Reuters) – 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 U.S. 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 $15 billion and value the company at
upwards of $150 billion, 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 percent 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 U.S.

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 U.S.

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.

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