flight to simplicity
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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
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