Flight to Simplicity

Getting There from Here A Flight to Simplicity Chris Cook, Institute for Security & Resilience Studies 6 June 2011

“ 21 st 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

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 Bank Capital

… and an opaque 'shadow banking system' of Investors holding sliced and diced risk Investor Capital Credit Bank Capital

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 Bank Capital

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

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 2011 Semi - financialised Brent/WTI 2009

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

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

There are two conventional types of investment: Equity and Debt 03/04/10

Equity: shares in a Joint Stock Limited Company 03/04/10

The 19 th Century legal dinosaur... 03/04/10

...which makes the Private Sector Private 03/04/10

Debt: is typically created by banks as credit and secured eg by mortgages 03/04/10

...giving two conflicting claims over the same productive asset 03/04/10

But there are new creatures out there 03/04/10

Equity vehicles: Trusts, ETFs, ETCs, ETPs, REITs, Master Limited Partnerships (MLPs) 03/04/10

Introducing the 21 st Century UK Limited Liability Partnership (LLP) 03/04/10

A UK LLP is a corporate entity with limited liability 03/04/10

...and...errrr...that’s it!...an Open Corporate 03/04/10

As far as the UK Tax Man is concerned it is a Partnership 03/04/10

Over 68,000 UK LLPs are now in pervasive use for purposes never intended... 03/04/10

...even in the Public Sector, where Glasgow has five municipal LLPs 03/04/10

Capital Partnership – direct investment in productive assets 03/04/10

Embryonic Capital Partnership 2002 ( > £1bn) Capital Partnership LLP 10 UK Hotels Gross Revenues Hilton Group Capital User Consortium LLP Capital Provider Bank Property Developer Hotel Specialist % % % % %

Generic Capital Partnership Custodian Investors Payment % % Use Managers Users

Productive assets are held by a Custodian Assets Custodian Ownership

...who safeguards the asset and accounts Assets Custodian Ownership

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

Managers provide Human Capital of time, expertise and experience.... Custodian Investors Human Capital Financial Capital Managers

Users pay for the use of Capital Custodian Investors Payment % % Use Managers Users

Result: Capital Partnership Custodian Investors Payment % % Use Managers Users

Capital Partnership reinvents Equity

Equity Shares - % age shares in flows of revenue or production 03/04/10

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

The actors received nth’s of gross revenues 31/05/10

I got 5%...and the producer the rest 31/05/10

But we needed lights, cameras, pizza, coffee 31/05/10

Capital Partners invested £ for 20% of the revenues.... 31/05/10

Art of Flirting Partnership Custodian Financial Capital (Investors) Viewers % % £ 31/05/10 Human Capital (Actors, Producer, Me)

Albion Trust - a charity providing affordable office space 31/05/10

Due to demand for affordable space they bought the adjacent disused church... 31/05/10

...and planned a £4m development 31/05/10

But if they borrow, rentals will be unaffordable 31/05/10

Solution? An Albion Partnership Custodian Investors Tenants % % £ 31/05/10 Managers

Unitisation Custodian Investors Users % Units % Rental 16/06/10 Managers

Unitisation – the creation of ownership claims which are value-based 16/06/10

Securitisation – the creation of debt claims against third parties which are value-backed 16/06/10

Unitisation - changes the quality rather than the quantity of credit: Qualitative Easing 16/06/10

Resolution – through Unitisation of rentals 16/06/10

Rental Units – undated credits redeemable in payment for occupation 16/06/10

Custodian is appointed or incorporated Custodian Houses

Affordable (index-linked) rental is set Rental Custodian Occupiers

Proportional Share allocated to Manager % Rental Custodian Occupiers Manager

Balance available for unitisation and sale % % Rental Custodian Investors Occupiers Managers

Units are sold to Investors at a discount to the rental value 16/06/10

The discount determines the return 16/06/10

Debt : £300k pa will fund <£4m debt over 20 years at 5% compound interest 16/06/10

Units - £300k (initially) funds £5m @ 6% £10m at 3%; £20m @ 1.5% (index-linked) 16/06/10

Investors lend direct to the land – not to the owner 16/06/10

Surprise! No compound interest + no principal repayment = drastic cut in funding costs 16/06/10

Occupiers - may invest simply by paying rent in advance 16/06/10

Receive 'Sweat Equity' Units if they maintain the property themselves 16/06/10

Investors – Units are a secure and liquid new asset class 16/06/10

Secure – credit default risk in respect of capital becomes liquidity risk 16/06/10

Secure - affordability of rental means income is by definition more certain to be paid 16/06/10

Liquid – Units in pools are not fragmented by date, rate of return or even issuer 16/06/10

Liquid – even if Investors do not buy Units, Occupiers will buy for redemption 16/06/10

Intermediaries (eg Banks) – transform from a transaction model to service provision 16/06/10

...and need Capital only for operating costs 16/06/10

So Back to the Future? A reversion from investment banking to merchant banking? 16/06/10

Resolution - exchange of dated land-backed debt for undated land-based credit Units 16/06/10

Transition - through Unitisation of energy 16/06/10

Energy Pool Custodian Investor User Energy Energy Energy Manager

Units - redeemable in payment for energy 05/04/10

Mega Watts : renewables funded by unitising Energy Pool of production. 05/04/10

Nega Watt energy savings - the cheapest energy - funded by an Energy Loan in Units 09/03/10

Energy Loans in KwH made to properties & repaid via utility bills out of energy saved 09/03/10

Funded by investors who invest through buying Units in Energy Pools 09/03/10

Energy Loan of £5,000 50 Units of 1 Megawatt Hour @ £100 per Unit 09/03/10

5,000 Units of 10 Kilowatt Hours @ £1.00 per Unit...and so on 09/03/10

Reduced energy bill paid to power supplier for energy consumed 09/03/10

Energy loan repaid through buying Units from the Pool at the market price 09/03/10

The Coalition's Green Deal faces Jevon's Paradox: how to change behaviour? 09/03/10

Unitisation: saving energy is saving money 09/03/10

But how do we transition from a carbon economy? 09/03/10

Transition through Gas 09/03/10

Carbon Levy - initially on gas - funds Energy Pool investment in renewable Mega Watts 09/03/10

… and Green Deal investment in Nega Watts 09/03/10

An Energy Dividend is paid in Units 09/03/10

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

They do not own anything, do anything, employ anyone, or contract with anyone... 03/04/10

They are simply framework agreements with cross border application

They transcend borders through associative consensual agreements... 03/04/10

...rather than adversarial contracts imposed by national statutes or courts 03/04/10

Associative agreements require no legislation Custodians (National) Financial Capital (Money, IP etc) Users % % Payment 03/04/10 Human Capital ( Developers, Operators)

No national or international organisations or hierarchies

Associative agreements enable complementary – not alternative - solutions

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

Macro – Global Market in Gas

Flight to Simplicity

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