Getting There from Here

A Flight to Simplicity

Chris Cook, Institute for Security & Resilience Studies

6 June 2011

“21st Century problems cannot be solved with 20th Century solutions”. Dr Narsi Ghorban

Market 1.0 – decentralised & disconnected

Market 1.0 – physical market presence

Here: Market 2.0 - centralised & connected

Market 2.0 - presence via intermediaries

There: Market 3.0 - decentralised & connected

Market 3.0 - network presence

Here - at Twin Peaks

Peak Credit - financial demand on people

Peak Oil - demand on a finite resource

Peak Credit – intermediary Banks create credit pyramids on their bases of Capital

Credit

Capital

Banks outsourced credit risk

Freeing Capital to support more credit creation

Totally – securitisation and sale of debt to 'shadow bank' investors

Temporarily – Credit Derivatives (CDS - a time-limited guarantee)

Partially – using credit insurance from insurers such as AIG

Radioactive cocktails of all three, like CDOs, structured finance and so on

The Result was a bigger Credit Pyramid than Banks alone could sustain…

Investor Capital

Credit

BankCapital

…and an opaque 'shadow banking system' of Investors holding sliced and diced risk

Investor Capital

Credit

BankCapital

This pyramid of Credit funded the Mother of all Bubbles in US property prices….

…and servicing this credit finally exceeded the financial capacity of the US population

Maybe the end of cheap oil spiked the bubble?

Peak Credit – was the point when the Property Bubble began to deflate

But by now no-one knew where the Risk was

Investor Capital

Credit

BankCapital

Banks started to think, “if this is what our balance sheet looks like…..”

“…what does everyone else’s look like?”

The problem is not shortage of money - liquidity

It is shortage of Capital - solvency

Solvency of Banks is one aspect

Capital

Credit

The other aspect is the solvency of populations

And a secular decline of purchasing power

Loans which cannot be paid, will not be paid

Non-performing loans drain money out of the system...

...threatening a deflationary spiral...

....which requires periodic transfusions

...to avoid Depression

Quantitative Easing – increases quantity of money and prevents deflation

This dilutes the value of money, and causes inflation of financial asset prices

Money will only inflate retail prices if lent or spent into circulation

But at the Zero Bound of 0% dollar interest rates strange things happen

Investors buy anything but dollars whether it carries a return or not

Investors buy Structured Products from Banks and Units in Exchange Traded Funds

The motive is Fear: investors aim to avoid loss, not to make speculative transaction

profit

Financial demand – not consumption – has caused correlated commodity bubbles

Many markets have become financialised and have lost touch with reality

Totally financialised Brent/WTI 2011Semi - financialised Brent/WTI 2009

So Investors have actually created the very inflation they seek to avoid

Getting from Here to There

Unitisation: a Flight to Simplicity

Financing - short term investment in creation of new assets

Funding – long term investment in productive assets

There are conventionally two types of ownership - Public or Private

03/04/10 52

There are two conventional types of investment: Equity and Debt

03/04/10 53

Equity: shares in a Joint Stock Limited Company

03/04/10 54

The 19th Century legal dinosaur...

03/04/10 55

...which makes the Private Sector Private

03/04/10 56

Debt: is typically created by banks as credit and secured eg by mortgages

03/04/10 57

...giving two conflicting claims over the same productive asset

03/04/10 58

But there are new creatures out there

03/04/10 59

Equity vehicles: Trusts, ETFs, ETCs, ETPs, REITs, Master Limited Partnerships (MLPs)

03/04/10 60

Introducing the 21st Century UK Limited Liability Partnership (LLP)

03/04/10 61

A UK LLP is a corporate entity with limited liability

03/04/10 62

...and...errrr...that’s it!...an Open Corporate

03/04/10 63

As far as the UK Tax Man is concerned it is a Partnership

03/04/10 64

Over 68,000 UK LLPs are now in pervasive use for purposes never intended...

03/04/10 65

...even in the Public Sector, where Glasgow has five municipal LLPs

03/04/10 66

Capital Partnership – direct investment in productive assets

03/04/10 67

Embryonic Capital Partnership 2002 (> £1bn)

Capital Partnership LLP10 UK Hotels

Gross Revenues

Hilton GroupCapital User

Consortium LLP Capital Provider

BankProperty

DeveloperHotel

Specialist

% %

%%%

Generic Capital Partnership

CustodianCustodian

Investors

Payment

% %

Use

Managers

Users

Productive assets are held by a Custodian

AssetsAssets CustodianCustodianOwnership

...who safeguards the asset and accounts

AssetsAssets CustodianCustodianOwnership

Investors provide Financial Capital in money, or money’s worth…

CustodianCustodian

Investors

Financial Capital

Managers provide Human Capital of time, expertise and experience....

CustodianCustodian

Investors

HumanCapital

Financial Capital

Managers

Users pay for the use of Capital

CustodianCustodian

Investors

Payment

% %

Use

Managers

Users

Result: Capital Partnership

CustodianCustodian

Investors

Payment

% %

Use

Managers

Users

Capital Partnership reinvents Equity

Equity Shares - % age shares in flows of revenue or production

03/04/10 77

Units – redeemable in payment for use value eg rentals, Kilowatt Hours

Example: “The Art of Flirting” – a film incorporated as an LLP

31/05/10 79

The actors received nth’s of gross revenues

31/05/10 80

I got 5%...and the producer the rest

31/05/10 81

But we needed lights, cameras, pizza, coffee

31/05/10 82

Capital Partners invested £ for 20% of the revenues....

31/05/10 83

...if there are any

31/05/10 84

Art of Flirting Partnership

CustodianCustodian

Financial Capital(Investors)

Financial Capital(Investors)

ViewersViewers

Human Capital(Actors, Producer, Me)

% %

£

31/05/10 85

Albion Trust - a charity providing

affordable office space

31/05/10 86

Due to demand for affordable space they bought the adjacent disused church...

31/05/10 87

...and planned a £4m development

31/05/10 88

But if they borrow, rentals will be unaffordable

31/05/10 89

Solution? An Albion Partnership

CustodianCustodian

InvestorsInvestors

TenantsTenants

Managers

% %

£

31/05/10 90

Unitisation

CustodianCustodian

InvestorsInvestors

UsersUsers

Managers

% Units %

Rental

16/06/10 91

Unitisation – the creation of ownership claims which are value-based

16/06/10 92

Securitisation – the creation of debt claims against third parties which are value-backed

16/06/10 93

Unitisation - changes the quality rather than the quantity of credit: Qualitative Easing

16/06/10 94

Resolution – through Unitisation of rentals

16/06/10 95

Rental Units – undated credits redeemable in payment for occupation

16/06/10 96

Custodian is appointed or incorporated

Houses CustodianCustodian

Affordable (index-linked) rental is set

Custodian

Occupiers

Rental

Proportional Share allocated to Manager

Custodian

Occupiers

Manager

%

Rental

Balance available for unitisation and sale

Custodian

Investors

Occupiers

Managers

% %

Rental

Units are sold to Investors at a discount to the rental value

16/06/10 101

The discount determines the return

16/06/10 102

Debt: £300k pa will fund <£4m debt over 20 years at 5% compound interest

16/06/10 103

Units - £300k (initially) funds £5m @ 6% £10m at 3%; £20m @ 1.5% (index-linked)

16/06/10 104

Investors lend direct to the land – not to the owner

16/06/10 105

Surprise! No compound interest + no principal repayment = drastic cut in funding costs

16/06/10 106

Occupiers - may invest simply by paying rent in advance

16/06/10 107

Receive 'Sweat Equity' Units if they maintain the property themselves

16/06/10 108

Investors – Units are a secure and liquid new asset class

16/06/10 109

Secure – credit default risk in respect of capital becomes liquidity risk

16/06/10 110

Secure - affordability of rental means income is by definition more certain to be paid

16/06/10 111

Liquid – Units in pools are not fragmented by date, rate of return or even issuer

16/06/10 112

Liquid – even if Investors do not buy Units, Occupiers will buy for redemption

16/06/10 113

Intermediaries (eg Banks) – transform from a transaction model to service provision

16/06/10 114

...and need Capital only for operating costs

16/06/10 115

So Back to the Future? A reversion from investment banking to merchant banking?

16/06/10 116

Resolution - exchange of dated land-backed debt for undated land-based credit Units

16/06/10 117

Transition - through Unitisation of energy

16/06/10 118

Energy Pool

CustodianCustodian

InvestorInvestor

UserUser

Energy Energy

Energy

ManagerManager

Units - redeemable in payment for energy

05/04/10 120

Mega Watts: renewables funded by unitising Energy Pool of production.

05/04/10 121

Nega Watt energy savings - the cheapest energy - funded by an Energy Loan in Units

09/03/10 122

Energy Loans in KwH made to properties & repaid via utility bills out of energy saved

09/03/10 123

Funded by investors who invest through buying Units in Energy Pools

09/03/10 124

Energy Loan of £5,00050 Units of 1 Megawatt Hour @ £100 per Unit

09/03/10 125

5,000 Units of 10 Kilowatt Hours @ £1.00 per Unit...and so on

09/03/10 126

Reduced energy bill paid to power supplier for energy consumed

09/03/10 127

Energy loan repaid through buying Units from the Pool at the market price

09/03/10 128

The Coalition's Green Deal faces Jevon's Paradox: how to change behaviour?

09/03/10 129

Unitisation: saving energy is saving money

09/03/10 130

But how do we transition from a carbon economy?

09/03/10 131

Transition through Gas

09/03/10 132

Carbon Levy - initially on gas - funds Energy Pool investment in renewable Mega Watts

09/03/10 133

…and Green Deal investment in Nega Watts

09/03/10 134

An Energy Dividend is paid in Units

09/03/10 135

The outcome is that those with above average carbon fuel use ...

….make a net transfer to those with below average use of carbon fuel

“If you want to keep a cow healthy, you don’t regulate what comes out of it……”

“……you regulate what goes in….”

Energy Pools enable Carbon currency based upon the intrinsic value of energy…

..rather than a market in value-less Units of CO2 emissions, imposed by governments

Capital Partnerships are not Organisations

03/04/10 142

They do not own anything, do anything, employ anyone, or contract with anyone...

03/04/10 143

They are simply framework agreements with cross border application

They transcend borders through associative consensual agreements...

03/04/10 145

...rather than adversarial contracts imposed by national statutes or courts

03/04/10 146

Associative agreements require no legislation

Custodians(National)Custodians(National)

Financial Capital(Money, IP etc)

Financial Capital(Money, IP etc)

UsersUsers

Human Capital(Developers, Operators)

% %

Payment

03/04/10 147

No national or international organisations or hierarchies

Associative agreements enable complementary – not alternative - solutions

So, to get There from Here

Anyone with Air Miles or Storecard Loyalty Points will understand Units

Units – simply direct investment in value created by productive assets

Market 3.0 - networked; decentralised; disintermediated; adaptive....and

Resilient

Getting Started: the low-hanging fruit

Micro - optimal Equity Release

Macro - re-financing existing public assets

Micro - Community Energy

Macro – Global Market in Gas

Thank You

03/04/10 159