Credit Where It's Due

Having spent the past seven years banging on about the changes needed to democratise the financial system, it's only fitting that my last post for 2014 should give a little credit to the authorities for making some very significant changes this year.

The FCA published its rules to specifically regulate peer-to-peer lending in February, and its rules on crowd-investment in March. At the same time, the Chancellor announced the expansion of the ISA scheme to include peer-to-peer loans. In the Autumn Statement, he announced that consumers who lend to other consumers and sole traders through P2P platforms will be able to offset any losses against interest received. And there will be a consultation on expanding the ISA scheme to encourage crowd-investing in bonds and other debt securities.

We are still at the start of a long journey. The rules could be simpler and the EU could yet muddy the waters if the UK position is not well represented. But if you'd asked me in 2007 whether so much would be achieved by 2014 - particularly on the ISA front - I'd have been optimistic (naturally) but expecting the worst. Yet in 2015 we'll have both the regulatory 'blessing' and the incentives necessary to enable people with surplus cash to get it directly to creditworthy consumers and small businesses who needed it, instead of leaving the money tied up in low yield bank deposits or having it eaten away by fees in managed investment funds. 

Perhaps this is partly why 2014 also saw the bank bosses' swagger and bravado turn to panic. The trends which are combining to democratise the financial system have not only revealed that the stuffed shirts are powerless to stem the flow of fines for corrupt practices on virtually every front, but those trends have also produced competition from the banks' very own customers. 

Hell, even their auditors are finally coming under scrutiny!

But let's not get carried away. While crowdfunding is growing at over 150% a year, the crowd will probably produce 'only' about £5bn of funding in 2015, based on Nesta figures and assuming a boost from the ISA changes. 

So, while we've come along way since Bobby "Dazzler" Diamond infamously suggested that the time for bankers' remorse was over if the UK was to recover, we will still have a small business funding gap next year - eight years after the financial meltdown. In fact, in many ways the financial system is in worse shape now than in 2007, with less competition and appalling inefficiency in banking, vast public sector debt, a larger 'shadow banking' sector than every before (depending on how you measure it), and many key economies around the world suffering low/no growth. Events such as those in Russia, Greece and the Eurozone are applying further pressure to a system that is still broken. In these circumstances we remain terribly vulnerable to financial shocks. 

Still, the UK government deserves plenty of credit for the changes announced to date. Whether they have come early enough to help us through the next storm remains to be seen, but at least the national funding solution now lies substantially in our own hands. 

If we don't take the opportunity to crowdfund the recovery, we will only have ourselves to blame.

Good News For #FinTech And #Crowdfunding in Autumn Statement

The government has announced bad debt relief for lending through P2P platforms; a consultation on whether to extend ISA eligibility to crowd-investing in debt securities and an intention to review some rules that add unnecessary costs for institutional lending through P2P platforms.

Individuals lending through P2P platforms to offset any losses from loans which go bad against other P2P income. It will be effective from April 2016 and will allow individuals to make a self-assessment claim for relief on losses incurred from April 2015.

The government will also consult on the introduction of a withholding regime for personal income tax to apply across all P2P lending platforms from April 2017. This will help many individuals to resolve their tax liability without them having to file for Self Assessment.

The government will call for evidence on how APIs could be used in banking to enable financial technology companies to develop innovative solutions to allow customers compare banks and financial products.

From January 2015, the majority of card acquirers will offer a new service for small businesses to receive the funds from debit and credit card transactions much more quickly. Two acquirers will not meet this commitment, and the government will ask the Payment Systems Regulator (PSR) to examine whether small businesses are being disadvantaged as a result.

The government will allow gains that are eligible for Entrepreneurs’ Relief (ER) and deferred into investment under the Enterprise Investment Scheme (EIS) or Social Investment Tax Relief (SITR) to benefit from ER when the gain is realised. The government will also increase the annual investment limit for SITR to £5 million per annum, up to a total of £15 million per organisation, from April 2015 and will also consult further on a new relief for indirect investment in social enterprises.

To better target the tax reliefs, the government will exclude all companies substantially benefiting from other government support for the generation of renewable energy from also benefiting from tax-advantaged venture capital schemes, with the exception of community energy generation undertaken by qualifying organisations. The government will also make it easier for qualifying investors and companies to use the tax-advantaged venture capital schemes by launching a new digital process in 2016.

We Need Let The Crowd into Financial Services

What a difference a year makes. At an industry event yesterday none other than Nicola Horlick, a well-known fund manager, confirmed her faith in crowdfunding as way of people putting money directly into the lifeblood of the economy, at a time when bank finance for small businesses is limited. Her own film finance vehicle raised £150,000 by issuing shares within weeks of an initial discussion with Seedrs CEO, Jeff Lynn, about how the crowd might help. A year ago, she wouldn't have given it a moment's thought. 

Of course, Nicola was referring to equity crowd-investing, which is the latest type of crowdfunding to burst into life. People have been donating to each other's projects via online marketplaces for nearly a decade and lending to each other online since 2005. Even the UK government is lending along side savers on peer-to-peer lending platforms. 

But these 'direct finance' marketplaces are no longer simply challenging a dozy bunch of retail banks. The addition of crowd-investing in shares and bonds is a direct assault on the sophisticated world of venture capital, private equity and boutique investment banking. 

Silicon Roundabout has launched a rocket attack on Mayfair.

This trend has raised a few bushy eyebrows down at Canary Wharf, where the paint is still wet on the signage at the hastily re-named Financial Services Conduct Authority. Not everyone at the FCA is excited by the prospect of just anyone being able to put a tenner into a business run by Nicola Horlick. In fact, the 'hawks' down there seem to believe that ordinary folk should content themselves with a low interest savings account, a lottery ticket and a flutter on the nags between visits to the nearest pub. If you can't afford to lose a grand, say the hawks, then you've hit the economic buffers. The banks can enjoy the use of your savings for free, while the government enjoys the betting taxes and the excise on your beer and cigarettes.

And we wonder why the poor get poorer.

You might also wonder, as I did yesterday, how 'the government' might explain to the same person who is banned from buying a share in the local bakery why he is still be free to blow £10 on a drug-fuelled quadruped at a racetrack, or donate it to a band that might go triple platinum and never have to share a penny of the upside with those who backed them.

But that's where you're reminded that the government never puts itself in the citizen's shoes; and there's really no such thing as 'the government' anyway. Just individual civil servants at separate desks in separate buildings, each looking at his or her own policy patch and waiting to be told what to do. Collaboration is not a creature common to Whitehall. In that world, no one at, say, the Treasury snatches up the phone to share a bold new vision for driving economic growth from the bottom-up with the folks over at Culture Media and Sport, or Business Innovation and Skills or Communities and Local Government. 

Or do they...?

At least those in Parliament, bless them, did collaborate in response to the ongoing financial shambles. Julia Groves of the UK Crowd Funding Association quoted some choice words on alternative finance from the report of the Parliamentary Commission on Banking Standards, and I've set out the full quote below (as I have previously). Julia also put it very nicely in her own words: "Wealth is not a skillset." We need to let the crowd into financial services, and we need to keep the 'crowd' in crowdfunding. Let's hope this time the following message permeates all the way to the remaining hawks at Canary Wharf.

"57. Peer-to-peer and crowdfunding platforms have the potential to improve the UK retail banking market as both a source of competition to mainstream banks as well as an alternative to them. Furthermore, it could bring important consumer benefits by increasing the range of asset classes to which consumers have access. This access should not be restricted to high net worth individuals but, subject to consumer protections, should be available to all. The emergence of such firms could increase competition and choice for lenders, borrowers, consumers and investors. (Paragraph 350)

58. Alternative providers such as peer-to-peer lenders are soon to come under FCA regulation, as could crowdfunding platforms. The industry has asked for such regulation and believes that it will increase confidence and trust in their products and services. The FCA has little expertise in this area and the FSA's track record towards unorthodox business models was a cause for concern. Regulation of alternative providers must be appropriate and proportionate and must not create regulatory barriers to entry or growth. The industry recognises that regulation can be of benefit to it, arguing for consumer protection based on transparency. This is a lower threshold than many other parts of the industry and should be accompanied by a clear statement of the risks to consumers and their responsibilities. (Paragraph 356)

59. The Commission recommends that the Treasury examine the tax arrangements and incentives in place for peer-to-peer lenders and crowdfunding firms compared with their competitors. A level playing field between mainstream banks and investment firms and alternative providers is required. (Paragraph 359)."

Labour Is Still Pushing Financial Capitalism

When Gordon Brown (remember him?) repeatedly proclaimed the "end of boom and bust" he was declaring his belief - along with that of his fellow group-thinkers - that capitalism had found a way to become sustainable. But his support for unbridled growth in everything from investment banking to the Private Finance Initiative eventually revealed he was hooked on financial capitalism, rather than the 'real' capitalism of employment and productivity. Look at how ISAs, for example, have become a drain on the 'real economy'.

Ed Milliband has been trying to repair Labour's image with some lipstick apologies here and there, but old habits die hard.

Recently, the party released "An Enterprising Nation", a report by its Small Business Taskforce. To be fair, there are some good insights into the problems faced by small business, as you would expect from the membership of the taskforce. But, surprisingly, the report contains no proposals for short term solutions, or even medium term solutions. One suspects that either the collective intelligence had already fed all those ideas into the government, or the left wing political establishment doesn't grasp the need to foster an environment in which new businesses can start and thrive today.

Academic as they may be, perhaps the worst of Labour's long term ideas is that of a US-style Small Business Administration. It's an idea I first heard from them in November 2011. And as I pointed out then, the SBA programme had already gained a somewhat unhealthy reputation through David Einhorn's book "Fooling Some of the People All of the Time." Heavy application of the Labour lipstick has now branded this idea the "Spark Umbrella" (a nod to the many local German savings banks, or sparkassen, to which this programme actually bears no resemblance).

Basically, the idea is to saddle the UK with 20 lending vehicles, or "Sparks", funded with £10m of public money (naturally) and £90m drawn, no doubt, from the traditional City suspects. Each Spark would fund its lending to local businesses by selling the loans to the "Spark Umbrella" which would in turn finance the loan purchases by issuing bonds to investors eager to package those bonds into  another set of bonds to sell to... anyone stupid game enough to buy them.

Sound familiar? 

The only way not to end up carrying the can for this, would be to emigrate.

But the UK already has an artificial, publicly subsidised channel for small business lending that limits innovation and competition in the retail financial markets. It's run by the UK's major banks. So we don't need another publicly guaranteed channel to crowd-out sustainable private alternatives. 

I mean, who would start a local lending business knowing that the government was about to launch a publicly funded competitor?

The government should foster an environment in which the private sector can generate alternative finance options, not simply create markets that are ultimately underwritten by the taxpayer.

The fundamental flaw in the Spark Umbrella is its reliance on securitisation (or vertical credit intermediation) to try to overcome the riskier nature of small business lending. That model is hugely expensive in terms of issuing and underwriting bonds that are prone to being mis-priced, particularly in riskier markets, as we have seen. It also creates huge scope for moral hazhard, and traditional financial institutions, intermediaries and speculators are likely to be the only potential winners - as Einhorn's book reveals. There is certainly no guarantee that the loans to small businesses will be competitive with other potential alternatives.

Anyone pointing to the US for solutions also has to understand that, like Germany, it enjoys a much more varied set of small business funding options than the UK, as Breedon reported. So it's possible that the SBA won't have crowded-out US private finance businesses in the way that Spark Umbrella would in our bank-dominated market. 

It's also worth noting that Spark Umbrella is purely debt focused, whereas only 3% of UK small businesses finance themselves by issuing shares.  

Of course, we already have a rapidly growing set of alternative financial services platforms that are beginning to solve the problems that the Spark Umbrella will not. Peer-to-peer lending and crowd-investing provide finance to borrowers and entrepreneurs in small amounts directly from many people at competitive rates from the outset, using both debt and equity finance. There is no need to create new markets for these platforms to grow. However, the government has been dragging its heels on the removal of regulatory barriers and perverse incentives, and that does represent an opportunity for opposition parties. 

True, the government has directed some of the Business Finance Partnership funds through peer-to-peer finance platforms. But that funding goes directly into the businesses who borrow - not through countless intermediaries in the financial markets. Labour needs to recognise the difference.

Horizontal vs vertical credit intermediation from Simon Deane-Johns

'Bank' of Dave Goes P2P

I've hugely enjoyed the documentary series tracing Dave Fishwick's valiant efforts to start a small community 'bank' in Burnley high street. 

I say 'bank' because, while it made for good television to say so, Dave didn't necessarily mean "bank" in regulatory terms. His goal was to enable local people to lend to other local people and businesses without profiting unduly. He rightly thought that's what banks are supposed to do, so he was determined to call himself a 'bank' to make the point. And his good-humoured, optimistic crusade has certainly rammed the point home.

While Dave also didn't necessarily set out to launch a peer-to-peer lending marketplace, his path to launch was eerily familiar to those who have done so. The FSA wouldn't speak to us either, prior to the launch of Zopa in March 2005, but was all too keen to discuss the detail afterwards. Fortunately we'd done our homework and didn't have to stop taking money. At least that made for good TV in Dave's case.

Since 2005 a dozen other management teams have also threaded their way through the regulatory maze to directly link savers and borrowers, or investors and entrepreneurs, via online 'P2P' lending or crowd-investing markeplaces. And it's good to see that Dave's journey has led him to adopt the peer-to-peer model on the high street. He may be facing the bricks-and-mortar problems that the online models solve, but at least he's shown there is very real demand for innovation amongst people who still manage their finances by walking around. And the benefits to the 200 local borrowers who are paying a net 5% to local savers are undeniable.

Unfortunately, there are still unnecessary difficulties in structuring these businesses, regardless of whether they facilitate loans or investments in shares or debt. The sources of that uncertainty were summarised here in January 2012, here in February 2012, here in June 2012 and here in July 2012. Industry CEOs and others met policy and regulatory officials to discuss these difficulties at a summit in December 2012, and again last month (as summarised here). The salient points were also explained again in my submission to the Parliamentary Commission on Banking Standards.

However, while it's clear there is plenty of shared frustration and many officials have been supportive in discussions, there is worryingly little sign of actual regulatory change.

We need a lot more war stories like Dave's.

My Legal Alter Ego Has Been At It Again

Image from Parliament.uk

This time he's made a submission 

To the Banking Standards Commission.

He's a poet and he didn't know it.

Towards A Diverse, Sustainable Financial System

It's not every day you get to brainstorm ways to bring diversity and sustainability to Britain's ailing financial system amidst a broad cross-section of officials, economists, entrepreneurs, think-tanks, technology suppliers and advisers. And yesterday's Finance Innovation Lab workshop was a golden opportunity to do just that.

While the Lab will report the output in due course, I thought I'd share a summary of my notes from the breakout sessions in which I participated. These looked at regulatory barriers and lack of financial awareness. Others explored the unfair advantages enjoyed by estalished providers and ways to encourage innovation. We operated under the Chatham House Rule, hence the absence of names or affiliations.

The UK financial system is neither diverse nor sustainable. 

There is plenty of evidence that the UK's financial system is suffering from a lack of innovation and competition, and is unsustainable in its current form. Rates of market entry and exit are low, relative to other industries. Few customers switch and customer trust is lowest for financial services on several leading surveys. The unit cost of intermediation remains high in financial services compared to other retail markets, while management and staff have reaped the benefits of any increased operational efficiencies (even while legacy systems remain prevalent). Banks rely on a huge back-book of deposits on which they pay little or no interest to finance loans to fund trading in financial assets rather than loans to productive businesses. After all, a single giant property loan does more to grow the bank's numbers than lending the same amount of money to thousands of small firms. 

Regulatory barriers

 

Against this background, we concluded that the current regulatory framework, including subsidies and incentives, is essentially designed to both protect the 'financial system' and 'customers' - i.e. to minimise the risk that consumers and small businesses, in particular, will be mis-sold 'products' by unscrupulous suppliers. 

In effect, however, that framework obliges policy officials (Treasury) and regulators (FSA) protect the system as it is, rather than to ensure that it evolves to encourage and accommodate innovation in line with customer requirements. That's because the framework and those who police it are organised in silos according to existing product types and types of suppliers, and not according to types of customers' and their day-to-day activities. 

The customer protection regime mirrors this approach, being organised according to limited sets of product types and types of suppliers, as well as types of promotional and business activities in which suppliers are engaged (not their customers). As a result, the impact of regulation, complaints and potential for changes are all viewed through the lens of existing products and firms, and any actual changes reinforce those lines of distinction. 

The perverse nature of this can be seen in the fact that, if I want to allocate £100 to a project that I'd like to support, it's easiest for me to donate the money, a bit more complex if I want the money repaid with interest (as a loan), very complex if I want to be able to freely trade that right to be repaid with interest (a bond) and the most complex thing of all is to receive an equity share in the project. This discourages diversification and the search for opportunities to get a decent return on surplus cash; and limits the availability of funding to new businesses, on which most new jobs depend.

Hard-wiring the markets according to types of products, suppliers and ways of dealing with them also artificially limits the number and range of suppliers, product types, and the corresponding markets. In addition, taxpayer guarantees and subsidies in the form of savings and pension incentives are aligned with existing regulated suppliers and product types. Therefore, the regulations and incentives work together to enable the suppliers in the regulated markets to charge higher fees, make higher margins, reward staff more generously and pay more for marketing - resulting in less innovation and competition.

The overall result is a financial system that is not designed to evolve in line with the requirements of consumers, small businesses or even big business. It is designed to suit incumbent suppliers - those who play well with the system, regulators and policy officials. Yet there is no single set of policy officals or regulators tasked with understanding how the regulations, subsidies and incentives actually work together as a whole or whether they distort any aspects of the financial system within or outside the regulated areas.

A broad range of solutions were suggested, as you can imagine, and the Lab will report on these shortly, and include them in a submission to the Parliamentary Commission on Banking Standards. However, suggestions included: 

• creating a Parliamentary Select Committee to focus on encouraging financial innovation;

• limits on market share by product type;

• controls on gross leverage; 

•  separate banks' credit creation process from financial intermediation (the process of allocating that credit);

• central bank guidance to banks on how much to lend productive firms;

• levelling the playing field on subsidies and tax incentives/allowances;

• a target of 200 new local banks by 2016;

• publishing details of national banks' regional/local banking activity;

• making it easier to get low risk financial businesses authorised;

• publishing the amount of the subsidies to major banks and oblige them to set aside a proportion of their subsidy for future crises;

• treating payments systems and credit reference data as utilities (i.e. public goods).

Lack of financial awareness

The scale of financial mis-selling across many different types of products and lack of diversification by investors suggests a widespread lack of understanding of financial services. This was seen to be caused by a lack of financial education, on the one hand; and by product complexity on the other. In turn, product complexity is driven by both regulatory complexity and an unwillingness to invest the extra effort required to simplify products and better align them with customer requirements.

The lack of financial education is essentially a failing of our education system. Yet there is little faith that the Department for Education accepts any responsibility for delivering a sound financial education. It's also clear that no other government department sees this as part of its mission. Rather, financial education seems to be a specialist area confined to universities and business schools or professional bodies. It was felt that this will only change with a determined effort by the Department for Education to measure financial 'literacy', collect best practice for teaching it and including those measures in the national curriculum. Measures of success would include improvements in financial literacy exam results, fewer complaints to the Financial Omudsman Service and improved diversification amongst savers and investors.

Removing product complexity requires a commitment to reducing regulatory complexity, the removal of the regulatory barriers to innovation and competition discussed above, as well as incentives that drive both simpler products and diversification, rather than the concentration of funds into a few regulated asset classes.

In short, more pragmatism and less politics should go a long way.

Evidence From Non-bankers On Banking Standards

Here's what some of the non-banks have to say about banking standards (from 17:52).

Careful What You Incentivise

Two things seem to be choking the flow of money to people and small businesses in the UK: broken regulation and perverse incentives. Yet there's a tendency to focus more on regulation, and to only see the obvious incentives - like bankers bonuses. Some innovative self-regulation in retail finance has been welcomed by the UK government, and banking reform creeps ahead. But all this could prove futile if problems with incentives are not also addressed. To fix those, we need to look below the surface at the more fundamental incentives at play in the financial system. In particular, we need to understand the extent to which the likes of ISA schemes and pension investment rules are limiting competition and innovation in financial services and inhibiting economic growth. I've summarised some recent debate on this below, and added some comments on the government's latest defence of the ISA scheme. I'd welcome your thoughts.

Some of the perverse incentives have been outlined to government by tax colleagues previously (in Annex 3 to this document). In essence, the contention has been that certain tax relief selectively favours banks and the suppliers of regulated investments to the detriment of innovation and competition. In particular, the tax free ISA system funnels ordinary people's savings into UK bank deposits on a vast scale, which the banks then fail to lend. This effectively discourages and inhibits those same people from diversifying, one alternative being to extend finance directly to other creditworthy people and businesses through peer-to-peer platforms. As a result, it's been suggested that the ISA system should be extended to cover such direct finance. Indeed, in his response to the Red Tape Challenge, Mark Littlewood, Director-General of the Institute of Economic Affairs and a 'Sector Champion' said:

"...it is surely worth noting that the present format and definition of the ISA wrap may have raised “barrier to entry” problems for new financial products and it may be beneficial to review these to stimulate innovation in the sector."

But the impact on innovation is merely the tip of the iceberg. It's the impact on the wider economy that must be understood.

There is overwhelming evidence that the UK's small businesses are cash-starved. They represent 99.9% of all UK enterprises and are responsible for 60% of private sector employment. Their output is critical to the UK's economic growth, which has stalled. Yet they face a funding gap of £26bn - £52bn over the next 5 years. Critically, the four banks which control 90% of the small business finance market are lending less and less to them. This is a red flag. You might think from their enormous market share that these banks would consider small business lending to be very important and a retreat from that market unwise. But, as the economist Richard Werner has pointed out, the reality is that only about 10% of the overall credit issued by our banks goes to productive firms. The other 90% goes to fund deals involving financial assets which don't count towards economic growth figures. So for these banks small business lending is actually a sideshow. They clearly make their money elsewhere.

Yet the ISA scheme had lured savings and investments of £391bn from UK adults by the April 2012, half of which is in cash deposits in these same banks. And they pay nothing for it - a paltry 0.41% in interest after 'teaser rates' expire, according to a 'super complaint' by Consumer Focus in 2010. 

In other words, the government appears to be incentivising workers to plough their savings into banks which virtually ignore the sector on which most of those same workers depend for their income. 

Contrast this with the position in Germany, where 70% of the banking sector comprises hundreds of small, locally-controlled banks who provide 40% of all loans to SMEs.  In an ironic twist, the UK government now sees peer-to-peer platforms as a similar conduit for a new German-style government-directed lending programme. But it appears never to have openly considered that the limited scope of the ISA scheme is part of the problem. 

In March, the goverment defended the narrow scope of the ISA scheme for the reasons extracted here. In September, the government gave a different response (see p. 13 here). In the hope of sparking wider debate on the issues, I've set out the current defence of the status quo below (my additions/comments in square brackets). I welcome any comments.

"HM Treasury believes that there is not a strong enough case for [making bad debt relief available to P2P lenders], as creating an exception would add complexity to the tax system and is difficult to justify when other [unspecified] forms of investment do not qualify for bad debt relief. Moreover, the current tax treatment of P2P investors is not necessarily a barrier to further expansion, as witnessed by the impressive growth in the industry in recent years.

...HM Treasury does not believe that P2P loans are suitable for inclusion in ISAs. The risk profile of P2P lending is too high [compared to what? cash ISAs? stocks and shares ISAs?], and it is unlikely that the platform can satisfy some of the [unspecified] features essential to the operation of ISAs.

Consumers tend to view ISAs as a relatively safe and simple investment vehicle [this fails to distinguish between cash ISAs and stocks/shares ISAs. And are they safe?]. ISA investments are thought of as relatively low-risk, and consumers should be able to get access to their funds whenever they wish. This is less likely to be the case with P2P lending than with existing ISA Qualifying Investments [this could be cured by permitting secondary markets in P2P loans]. 

Similarly, existing Regulations require ISAs to be operated through an ISA Manager [regulations could include P2P platforms], who invests through persons or firms who are authorised by the FSA, and thus have access to the FSCS [this does not mean you can't lose the principal in your stocks/shares ISAs, or stop banks paying 0.41% interest on cash ISAs]. As far as we are aware, current P2P lending platforms are not conducive to the ISA Manager role, are not regulated by the FSA, and do not offer Financial Services Compensation Scheme (FSCS) protection [any or all of which could be changed by regulation].

Finally, in order to be included in an ISA, P2P loans will require to be listed as a Qualifying Investment. Qualifying Investments are identified generically. It would be extremely difficult to restrict a generic description such as “loan” only to loans made via P2P lending platforms [but none of the qualifying investments are so generic, being limited by reference to 'banks', 'building societies', 'recognised stock exchanges' etc., so why not by reference to 'P2P platforms'?]. Exclusion from the ISA wrapper does not make this type of lending exceptional; rather, it puts it on the same footing as investment in stocks and shares issued by unlisted companies [how are these activities equivalent?]."

Crowdfunding Politics And The Public Sector

In Lipstick on a Pig, I looked at why facilitators will triumph over institutions in the markets for retail financial services. I'm now working on the next book in the series that will demonstrate similar outcomes in the public sector. Political parties, unions, government departments, churches and the European Commission are all in the frame. Do they exist to solve citizens' problems, or to solve their own problems at citizens' expense?  

Thanks partly to the Leveson Inquiry and a vengeful Rupert Murdoch, we're building a great picture of self-interest, greed and fear of transparency in key parts of the UK public sector. Riding hard on the heels of Horsegate - which perhaps typifies the alleged link between politics, journalists and police - we've of course had the allegation that Peter Cruddas, former Conservative Party Treasurer, claimed that a donation of at least £200,000 would get you to dinners with David Cameron and George Osborne, as well as the opportunity to get your policy concerns fed into the "policy committee at number 10." Cruddas claimed "my job is to get the donors in front of the Prime Minister." The Tories say "No donation was ever accepted or even formally considered by the Conservative Party" on the cruddy basis that Cruddas was suggesting (my italics). Cruddas has resigned. 

You might also consider that the Cruddas Affair has overtones of the 'Cash for Honours' allegations. And clearly politics is Big Business because campaigning, in particular, is expensive.  The UK's political parties spent over £30m on the 2010 general election (down from over £40m in 2005). And that's nothing compared to the estimated $6bn that will be spent by candidates trying to win the coming US election (as opposed to $5bn last time around).

But let's not confuse the activities of the party officials with those of party MPs and Peers who are acting in their capacity as UK government ministers. The party people can't speak for the government. The Cruddas Affair, like the Cash for Honours idea, smacks more of a lame attempt at positioning the allure of political influence as bait on the real - and less controversial - hook: the chance to hobnob with other wealthy donors in a grand setting. You could equate the plight of anyone who climbs aboard that bizarre bandwagon to investors in Madoff's ponzi scheme or 'stupid Germans from Dusseldorf' who offered insurance against sub-prime mortgage defaults. The truth is you may not need to pay any money at all to get policy suggestions into a committee at number 10, depending on the quality of the suggestion. And the sort of people who could afford large cash donations could also simply pay lobbying firms to push their pet policies around Whitehall and Westminster to greater effect. They might even simply buy lunch.  

All of which tends to suggest that the managers of political parties have little genuine interest in policy at all, let alone solving the problems of ordinary people, and are instead merely preoccupied with choosing socially attractive candidates and wealthy fools to pay for their election. 

But enough sunlight appears to have shone into this murky world for the political leaders, at least, to realise that offering to pimp the PM or sell a peerage won't really bring in the dosh. Nervously, they are casting around for an alternative. As recently noted in the Guardian, all three UK political parties last year dismissed recommendations by the oxymoronic Committee on Standards in Public Life to limit political donations to £10,000 per donor per year, require union members to opt-in to their subscriptions being used to fund the Labour Party, to provide £3 of public funding per vote, and to allow tax incentives for small donations. Now Labour have suddenly suggested that a cap of £5,000 would be sufficient, while the Tories want a cap of £50,000 - which happens to double as a membership 'fee' for their clubby "Leader's Group" though "50 City donors" gave them more than that in the year to June 2011 (isn't it notable that these figures are stale by time of publication?). 

In other words, the major parties lack confidence that an open, transparent appeal to ordinary citizens will yield the necessary war chest. Could this be because they don't believe their policy offering is compelling enough to persuade enough citizens to part with just a few pounds each...?

This myopia has parallels with the political approach to the UK bank lending crisis. Even when 'welcoming' the evidence that ordinary people are directly funding each other's personal and business plans, the politicians still cling to the notion that Big Money will eventually pull through. As a result, they refuse to make the formal changes to the tax and regulatory framework necessary to level the playing field for non-banks, implying that this whole mass-collaboration thing is somehow just a sideshow. 

Of course, as discussed in Lipstick, the same malady affected many other 'institutions' who've lost out to 'facilitators' whose primary focus is solving others' problems instead of their own.  Just ask the ad agencies whether they think their clients find Google and Facebook more compelling recipients of advertising expenditure than the traditional media.

Refreshingly, some officials like the Bank of England's financial stability director, Andy Haldane, concur:

"In the UK companies such as Zopa, Funding Circle and Crowdcube are developing this model. At present, these companies are tiny. But so, a decade and a half ago, was Google."

And none other than the current UK Chancellor said in 2007:

“With all these profound changes – the Google-isation of the world’s information, the creation of on-line networks bigger than whole populations, the ability of new technology to harness the wisdom of crowds and the rise of user-generated content – we are seeing the democratisation of the means of production, distribution and exchange. … People… are the masters now.”

On April Fools Day, I suggested that smokers and drinkers might target the excise duty they pay on beer and cigarettes at specifichealth services. I wasn't being entirely facetious. There's no reason why a majority of voters shouldn't find it compelling to direct specific elements of their taxes or savings to specific public services, projects or even political parties. But enabling that to happen would require a little more ministerial interest in granting formal regulatory status to direct finance platforms. 

Will the lure of campaign crowdfunding prove too tempting to resist further? The Tories could offer dinner with Cameron at the Olympic Stadium.

 

Government Support For P2P

The authorities tend to view people sharing content as 'piracy', but fortunately when it comes to money the UK government thinks sharing is a great idea.

I've covered the Breedon Taskforce report, and the Government's response over on The Fine Print. But the most significant points for ordinary people with surplus cash and those who need it are:

• the government's support for self-regulation of peer-to-peer finance; and

• the ISA scheme remains closed to new assets, despite recommendations that it be extended.

Don't Just Move Your Money: Spread It, Recycle It.

Great to see the MoveYourMoney campaign up and running - certainly a step up from the calls for futile mass withdrawals in 2010. But there are two significant gaps in the message.

Firstly: why should we move our money?

We don't need to 'save'. That's not really an activitiy in itself. And it's only one side of a much bigger story. Where do our deposits go?

As a society, our financial challenge is to get surplus cash from those who have it to creditworthy people and businesses who need it. Quickly and cheaply. At the rate that's right for both parties.

Our financial institutions don't enable this right now. They pay very little to interest to savers. They keep too much of the interest that borrowers pay. They use this 'margin' to cover losses from their own poor investments. 

So we've had to invent direct finance services that cut the cost of connecting savers and borrowers - meaning higher returns on savings and cheaper borrowing costs. As each borrower repays, you can re-lend your money to others. Think of it as financial recycling. The banks still play a role - the operators of these new services recycle the money through segregated business bank accounts - but they don't get to use your money the same way as if you opened your own personal savings account.

But this brings us to the second gap in the MoveYourMoney campaign. We shouldn't move our money to just one place. We need to put our eggs in lots of baskets -  we need to diversify more. There are many other baskets for your eggs than those listed.

Yet we are incentivised by government not to diversify. Most of us only get basic tax breaks (e.g. ISAs) for putting our small amounts of savings in the bank or building society (or in regulated stocks and shares).  This not only discourages us from using more efficient services, but also protects banks and building societies (and managed investment funds) from competition. Worse, it encourages us to put all our eggs in a few baskets, so our holdings of surplus funds are not diversified. We're told this is 'safe' to do because at least some of our money is protected by the Financial Services Compensation Scheme. But such insurance does not ultimately make these baskets 'safe' for all of us as a society. It makes these baskets expensive - because as consumers we all pay for the compensation scheme in the end. And we pay again as taxpayers when the highly concentrated risks in the financial system bring it grinding to a halt.

MoveYourMoney may not yet explain the need to get your money quickly and cheaply to creditworthy people and businesses who need funding. Nor adequately explain the need to diversify. But the government is now aware that the regulations and incentives are wrong. And organisations like MoveYourMoney should be helping us to keep the pressure on government so that these problems are actually addressed.

Submission on New Model for Retail Finance

Over on The Fine Print, I've set out both the initial summary and my full submission to the Red Tape Challenge and the BIS Taskforce on Non-bank Finance. I'm very grateful to the colleagues who contributed, as mentioned in the longer document.

Some might say that the alternative finance market is small beer at this point, and it's not worth accommodating them in the regulatory framework. But it's unrealistic to expect alternative business models to thrive amidst the dominance of the banks and while the entire financial system is hard-wired to suit them and other traditional investment vehicles (see the series of articles by Vince Heaney, David Potter and Adriana Nilsson in February's Financial World).

Others might also say that we should wait until the 'winning' business models emerge before figuring out what regulation may need to change. Yet picking winning business ideas is impossible, as Peter Urwin explains in "Self-employment, Small Firms and Enterprise". He has found that, while "entrepreneurship is crucial for economic growth... we have no idea where it will come from - not even in the most general terms."

As a result, the best that we - and government - can do is to ensure "a climate in which enterpreneurship can thrive".

Red Tape in Retail Financial Services

I'm off to Number 10 today, to talk about red tape that's constraining disruptive business models in financial services. In the interests of transparency, I've summarised my thoughts for both the legal community here, as well as below. I'll be submitting a more detailed paper in the coming weeks, both to the Red Tape Challenge and the BIS Taskforce on alternative business finance. I'm interested in any comments you may have.

In its invitation to submit evidence of ‘red tape’ that is inhibiting the developmentof ‘disruptive business models’, the Cabinet Office notes the example of Zopa, “a company that provides a platform for members of the public to lend to each other, who found that financial regulations simply didn’t know how to deal with a business that didn’t conform to an outdated idea of what a lender is…” 

Financial regulation similarly fails to deal with a range of non-bank finance platforms that share some of the key characteristics of Zopa’s person-to-person lending platform. Accordingly, financial regulation is failing to enable the cost efficient flow of surplus funds from ordinary people savers and investors to creditworthy people and businesses who need finance. In particular, the current framework: 

1. generates confusion amongst ordinary people as to the basis on which they may lawfully participate on alternative finance platforms (even though some are licensed by the Office of Fair Trading); 
2. does not make alternative finance products eligible for the usual mechanisms through which ordinary people save and invest, exposing lenders to higher ‘effective tax rates’; 
3. discourages ordinary savers and investors from adequately diversifying their investments; 
4. incentivises ordinary savers and investors to concentrate their money in bank cash deposits, and regulated stocks and shares; 
5. inhibits ordinary savers’ and investors’ from accessing fixed income returns that exceed long term savings rates; 
6. inhibits the development of peer-to-peer funding of other fixed term finance (e.g.mortgages and project/asset finance, and even short term funding of invoices); and
7. protects ‘traditional’ regulated financial services providers from competition. 

These regulatory failings could be resolved by creating a new regulated activity of operating a direct finance platform, for which the best-equipped regulatory authority would be the Financial Services Authority (as replaced by the Financial Conduct Authority). Regulation of the platform would be independent of any regulation that may apply to the type of product offered to participants on the platform (e.g. loans, trade invoices, debentures to finance renewable energy and lending for social projects). Proportionate regulation that obliges platform operators to address operational risks common to all products would also enable economies of scale and sharing of consistent best practice, and leave product providers and other competent regulators to focus solely on product-specific issues (e.g. consumer credit, charitable purposes). 

Similarly, there is no reason why products distributed via these platforms should not also be eligible for the usual mechanisms through which ordinary people save and invest, such as ISAs, pensions and enterprise investment schemes.

Permanent Occupation

Here's an idea. Every city with a financial district should erect a substantial monument to the 'occupations' in the heart of its financial district, to act as a reminder to all who pass by it that all of society is affected by what goes on there.

While I have no objection to the quaint tradition of enshrining 'bulls' and 'bears' in the streets outside our bourses, should animals alone continue to epitomise our financial system?

Image from Technology News.

A New Regulatory Model For Retail Finance

Over on The Fine Print, I see that my professional alter ego has updated his post on a proposed new regulatory model for retail finance, in the light of a late night post on the US Crowdfunding Bill. Those posts, and some feverish work of my own on the Book of the Blog, would appear to explain a slight delay on this particular front, which I'm personally assured will be rectified shortly ;-)

Of "Credit Easing" and P2P Finance

Source: Bank of England

The governments proposal to intervene directly in the corporate and small business funding markets shows how grave it is that lending to UK businesses is shrinking.

But it seems crazy for the taxpayer to prop up zombie banks - subsidising tax-free savings rates that allow banks an average margin of 11% - and then to use more public money to shunt aside nascent private competitors. Surely, the result will be a never-ending spiral of financial dependency on the public purse. 

As NESTA recently reported, there are more innovative ways to finance small business. But the current regulatory framework - ironically designed to protect us from the banks - makes it unduly painful in terms of time and money to start true competitors. Which is why the P2P Finance Association was formed to help inform the move to a new regulatory framework and pave the way for new entrants. Without any of the vast subsidies the banks receive, these new platforms will lend more than £100 million this year to individuals and small businesses - and they already account for over 2% of the UK personal loan market.

So why doesn't the government foster the growth and development of alternative means of finance, rather than use public money to put them at risk?

For instance, why not extend the ISA tax-free cash subsidy to lending via peer-to-peer platforms?

Institutions Don't Need Our Money

Forget the credit crisis, we're in the midst of a deposit crisis. 

In a series of excellent posts citing the NY Feds' work on shadow banking, FT Alphaville explains there are too few of these safe harbours for all the institutional cash that needs them. This is different from the mistaken investments made in toxic "AAA" sub-prime mortgage debt. This is about a shortage of the highest grade bank deposits and government bonds. In fact, the NY Fed reports "that 90 per cent of instutional cash pools are subject to management policies where safety [rather than yield] is the primary objective."

This can turn government bonds and other high grade debt into kind of Giffen Good, which people paradoxically consume more of as the price rises. This can continue to the point that the bond rate becomes negative (as has happened with Swiss debt) and some banks may even charge depositors for depositing cash on which it can no longer make a return.

In turn, this awakens the so-called "Triffin Dilemma", whereby a country that has a reserve currency (like the US) runs a large current account deficit to fuel consumption and provide the rest of the world with liquidity, yet suffers "from the declining value and credibility of any currency which runs a persistent trade deficit - eventually leading to a reluctance of creditors to hold the reserve currency."

All of which suggests that institutions don't need our cash - that perhaps we're better off allocating it directly to those who do need it, like people and SMEs, through 'horizontal credit intermediaries' that don't add unnecessary cost or contribute to the deposit crisis.

Image from CurtisMorley.