Beyond Globalisation: Russia’s War On Ukraine Marks The End Of An Era Of Easy Growth For IFCs

The Western powers’ economic doctrine of free (albeit rules-based) trade and mobility of labour and capital achieved effective hegemony following the fall of the Berlin Wall; international finance centres grew and developed on the back of this. But what will succeed the globalisation that we’ve seen over recent decades? And what are the implications for the global ‘cross-border facilitation’ industry?

Demise Of A World Order Or Globalisation Reborn?

Larry Fink, chief executive of the world’s largest asset manager, BlackRock, wrote in March to shareholders: “The Russian invasion of Ukraine has put an end to the globalisation we have experienced over the last three decades”[i]. But the late-twentieth century model of economic relations had been waning since the financial crisis of 2007/8, if not before.

World trade was already slowing. It grew at an average annual rate of 13 per cent over the heady two decades to 2007, but had fallen back to below four per cent per annum between 2012 and 2019. Meanwhile, there’s been growing social disquiet. A tide of ‘populist nationalism’ across Western democracies has brought anti-globalisation sentiment into the political mainstream. Donald Trump’s presidential rally cry of taking down ‘the establishment’ spoke to a base that has been largely left behind because of globalisation and international competition. The frustrations of the working class and the ‘squeezed middle’ in high-income countries has seen significant support for populist parties in Hungary, Austria, Switzerland, Denmark and Belgium amongst others in recent years. Even in the Netherlands, France and Germany, politicians seeking to reverse their countries’ internationalist agenda have been close to breaking through at elections. In the United Kingdom, referenda and elections have been won and lost on immigration and sovereignty.

Covid has accelerated the change. Trade between nations was knocked back by lockdowns and controls while the pandemic demonstrated the weakness of institutional cooperation across borders. Multilateral organisations, like the World Health Organisation, proved close to impotent. Individual countries went their own way in response to the emerging public health and economic crisis. The European Union struggled to negotiate a mutually acceptable support mechanism, just as the four administrations of the United Kingdom showed anything other than unity.

The Covid emergency – reinforced more recently by Putin’s war on Ukraine – has highlighted to businesses the fragility of stretching just-in-time supply chains across distant geographies and, to governments, the risks of reliance on foreign supplies. Missiles exploding within earshot of the Polish border provide stark evidence that the twentieth century global architecture has not only failed its central objective of securing peace in Europe but risked global economic stability. We are now well-aware of German and Italian dependence on Russian gas, EMEA reliance on Ukrainian food and the criticality of raw materials and component parts from both countries to the global automobile industry. Globalisation has brought interdependence.

My colleagues, Clare Leckie and Rebecca Munro, set out three broad scenarios for the future beyond current globalisation in an article for the 2022 edition of IFC Economic Report[ii]. Although devised last year before Russia’s military aggression, these scenarios remain salient and reflect the potential for trends to slow or even reverse:

• Weaker internationalism – where pre-pandemic globalisation trends continue, albeit more slowly, and with plenty of political obstacles to navigate.
• New economic nationalism – a partial reversal of globalisation with increased protectionism, less porous borders and more erratic politics.
• The bloc economy – where economic and regulatory integration between countries continues within geo-political blocs, but these different groups diverge.

Each of these present new challenges and opportunities for IFCs, and the global ‘cross-border facilitation’ industry that they host.

An Industry That Has Developed And Grown To Facilitate Globalisation

IFCs have grown through globalisation – and are now home to a sophisticated worldwide ecosystem of lawyers, accountants, corporate governance practitioners, bankers, fund managers and other professionals expert in facilitating cross-border trade, investment and labour mobility. Across the various IFCs (and with a degree of analytical simplicity with which only economists feel comfortable), this industry serves three broad markets.

First, family wealth. The industry helps families and individuals manage and secure their wealth across nations and facilitates their international mobility. Services range from the administration of the estates of ultra-high-net-worth families through succession planning to retail banking services for expats. According to Capgemini, the number of high-net-worth individuals has grown three-fold since the turn of the millennium[iii].

Second, corporate growth – helping firms and institutions carry out business across borders. This can range from mergers, acquisitions and joint ventures to asset purchase, disposal and protection, insurance and access to capital as well as operating in new markets. The Organisation for Economic Co-operation and Development (OECD) report that the number of multinational enterprises has grown by more than a third in ten years while the volume of international trade has more than doubled in two decades[iv]. United Nations’ data suggest that foreign direct investment has grown 50 per cent in real terms in 15 years[v].

Third, portfolio investment – supporting the efficient pooling, deployment and distribution of investment funds and their returns across multiple jurisdictions. This includes the administration and management of funds, trusts, limited liability partnerships and other structures for cross-border property, private equity, venture capital and pension investors among others. Total portfolio investment assets reported in the International Monetary Fund-coordinated survey grew by a compound annual rate of five per cent to more than double its volume in real terms between 2004 and 2019[vi].

The growth in these markets has changed the nature of IFCs and established a global industry independent of specific jurisdictions. The corporate legal sector is now dominated by the multi-office, multi-jurisdiction practices of the ‘Offshore Magic Circle’ firms. Those needing audit, tax and insolvency advice have on-island access to the biggest global accountancy networks and brands. Similarly, many of the corporate service providers and trust companies have grown and consolidated beyond recognition from their island-specific small partnership origins – often with the backing of major investors. Many are now not only multi-jurisdictional but have a presence across continents and oceans and operate around the clock. Vistra, for example, which has grown off the back of substantial private equity investment, now employs over 5,000 professionals in more than 85 offices, and Dutch-listed incorporator Intertrust Group has 4,000 employees across 30 jurisdictions. Once a small company in St Helier, JTC Group has grown from humble St Helier origins to a 1,300-strong team working out of 27 offices, with a listing in the prestigious FTSE250 on the London Stock Exchange.

In this context, and with professional and arm’s length investors, the industry needs to present itself in a commercial, outward-focused and investor-friendly way. But it remains poorly coordinated and fragmented – and especially so in respect of market data and intelligence. If you wanted to find out about the automobile market, you wouldn’t start by looking at data for Detroit or Wolfsburg. But, if you want to understand the cross-border facilitation industry, you have no choice but to trawl the partial and inconsistent data available from each IFC’s statistical office, regulator and other agencies.

We’ve started to do this – to get a picture of the industry as a whole, and to provide an evidence base from which to think about the future.

Figure 1: Index of active offshore companies

Our experimental metrics combine macroeconomic statistics, such as foreign direct investment, with data that we have compiled from multiple sources across jurisdictions, including for example numbers of active companies registered in IFCs. We have constructed indices of the volume of cross-border activity for family wealth, corporate growth and portfolio investment, as well as a composite of the three to reflect the overall industry. These are works in progress and should only be considered indicative at this stage. But they do help to tell the story: the volume of offshore activity has grown since the turn of the century – but rates of growth have been knocked-back since the financial crisis.

Figure 2: Indicative indicies of the volume of cross-border activity

Prepare For Slower Growth As Well As Uncertainty

None of our three scenarios for the future will deliver as much growth in the world economy as would have occurred with unfettered globalisation. Free trade, mobile capital and footloose labour are unambiguously good things for global prosperity; the addition of (or failure to remove) unnecessary costs – in the form of border controls, red tape, tariffs, etc – is not. But, although the scenarios have negative impacts on macroeconomic prospects, their implications for the cross-border facilitation industry are less clear cut.

Figure 3: Illustrative scenario forecasts of the volume of cross-border activity

The weaker internationalism scenario, where globalisation continues more-or-less as before but slower, is the least risky environment for IFCs, but the industry will still need to adapt. Rather than rely on organic volume growth, businesses will need to focus more on increasing the value of their existing client relationships.

A new economic nationalism, where individual nations go their own more-protectionist way, would damage the global economy the most – but may reinvigorate IFCs’ raison d'être and provide a potentially sizeable albeit temporary fillip to their businesses’ revenues. Offshore expertise will be sought after as cross-border transactions become more complex and costly, while the neutrality of IFCs will be increasingly valued by those wanting a locus for their international activity. But the initial boost for the industry will eventually be offset by a much weaker global economy.

Figure 4: Vote in the United Nations to condemn Russia’s aggression against Ukraine

The bloc economy scenario is the least predictable. The war on Ukraine has potentially illuminated (or possibly further confused) the changing global political geography. Europe has been uncharacteristically unified (so far). Finland and Sweden are rethinking their neutrality. The United States has re-engaged with NATO. Japan is reversing almost 80 years of a purely self-defensive military doctrine. In many respects, the Western alliance has proven resilient – if not, strengthened.

In all, 141 countries came together in a historical vote at the United Nations on 2 March to condemn Russia’s actions. But, as the map shows, five voted against the resolution and a further 36 abstained. One General Assembly debate in New York alone does not determine future allegiances or spheres of influence, but this map does hint at what a 21^st century bloc economy might look like. The countries that abstained or voted with Russia currently account for only a quarter of the world’s economy, but they are among those expected to grow the fastest in coming decades.

Figure 5: Forecast growth in countries’ gross domestic product by vote in the United Nations

New World Growth Or Old World Security

In the bloc economy, demand for cross-border facilitation services could remain robust. But IFCs may struggle to keep simultaneous access to increasingly opposed regimes. The divergence of standards and regulations between China and the European Union is already posing the industry tough questions about how to serve both markets. Indeed, a widening divide on tax and transparency between Washington and Brussels is driving a wedge between long-established markets.

The danger in such a regionalised world is that IFCs, in effect, must align to one bloc – at the expense of access to others. In these circumstances, their markets are limited to intra-regional activity, and their growth is constrained to that of their chosen bloc. Although the United Nations’ vote provides one example of how the world might fracture, there are plenty of other plausible ways that the map may be redrawn. But some broad trends are clear. If a bloc economy emerges, the industry potentially faces an uncomfortable choice between chasing growth in ‘new world’ markets such as Asia and Africa, and pocketing revenues from the currently larger, more predictable but slower ‘old world’ markets of North America and Europe.

Globalisation has transformed small islands with finance centres into a sophisticated interconnected global industry. Russia’s invasion of Ukraine marks the end of that period. What comes next is uncertain. Slower overall volume growth is almost inevitable, and businesses will need to focus on increasing the value of their services to flourish. But geopolitics may pose a greater threat, with IFCs potentially having to choose allegiances that will constrain the future path of the industry they host and benefit from.

Footnotes:

[i] Larry Fink’s Chairman's Letter to Shareholders https://www.blackrock.com/corporate/investor-relations/larry-fink-chairmans-letter

[ii] Beyond Tax: Island IFCs Have Been Out Of The Tax Game For Years But May Still Suffer From G20 Shenanigans https://www.ifcreview.com/articles/2022/january/beyond-tax-island-ifcs-have-been-out-of-the-tax-game-for-years-but-may-still-suffer-from-g20-shenanigans/

[iii] World Wealth Report 2021 https://worldwealthreport.com/resources/world-wealth-report-2021/

[iv] Outward activity of multinationals by industrial sector https://stats.oecd.org/Index.aspx?DataSetCode=AMNE_OUT

[v] Foreign direct investment: Inward and outward flows and stock https://unctadstat.unctad.org/wds/TableViewer/tableView.aspx?ReportId=96740

[vi] Coordinated Portfolio Investment Survey https://data.imf.org/?sk=B981B4E3-4E58-467E-9B90-9DE0C3367363

Mark Pragnell
Mark Pragnell, managing director of Pragmatix Advisory, has over 30 years’ experience as a macroeconomist, forecaster and policy consultant. He has worked with a number of IFC governments, promotional bodies and businesses, and has led seminal research to explain and quantify the value of IFCs.