Optional Annuities Could Mean Working Pensions

Odd that Will Hutton should claim in The Observer, of all places, that making the purchase of pension annuities optional will end in long term social disaster. UK pensions are already a long term social disaster. Hutton himself points out that "400,000 people buy £11bn of annuities every year", yet "the annuity market [has become] overstretched, offering indifferent and often wildly different rates." 

This is because consumers have no choice. There's no competitive pressure at all on the insurance companies or their agents to remove unnecessary middlemen, reduce fees to customers or simplify products. In fact, the Financial Services Consumer Panel recently found that the annuities industry continued to focus on increasing its revenues through product complexity, even when consumers were given the option to shop around. No one in the industry seized the opportunity to make annuities more transparent and better value for the consumer. [Update on 26 March: Legal & General has suggested the market for individual annuities will shrink by 75% - rather endorsing the government decision to make them optional!].

Will Hutton argues that rather than make annuities optional "the response should have been to redesign [the market] and figure out ways it could have offered better rates with smarter investment vehicles". But that seems naive, given the FSCP findings. The industry had that opportunity and declined it. 

It's equally naive to suggest that less demand for annuities will mean losing a valuable opportunity for insurance companies to 'pool the risk' of funding pensions. The industry merely sees risk pooling as a chance to exploit asymmetries of information to line its own pockets. 

The only way for the government to shake up the cosy annuities cartel was to remove the implicit guarantee that everyone would have to buy an annuity. 

Mr Hutton then seeks to set up some kind of moral panic that the 'freedom to buy a Lamborghini' instead of an annuity will result in people simply frittering away their life savings. Not only does this suggest that he'd rather your life savings were placed in the grubby mitts of the annuities industry so they can buy the Lamborghinis, but it also insults the consumers who face the abyss of the annuities market. Their concern clearly arises from the lack of decent returns, not because they're eager to spend the cash on exotic cars.

Finally, Will suggests that the State is entitled to control how you invest your pension money because it allowed you to avoid paying income tax on your pension contributions in the first place. If you agree with that, then presumably you would say the State is entitled to control how you spend every penny of your income that it has allowed you to keep. This of course places a great deal of trust in the State's financial management capabilities that we know from bitter experience is ill-deserved. As a result, it's more likely that citizens will gain greater control over the allocation of 'their' tax contributions, not less (as I've joked about previously). But regardless of whether it's the State or the taxpayer who is in control, neither party wants the State to be saddled with the consequences of an uncompetitive and opaque annuities market. That would only suit the annuities spivs. Again, the only alternative is to expose the market to competition from all manner of transparent savings and investment opportunities. 

Importantly for economic growth, the freedom to avoid annuities opens up the potential for £11bn a year to be invested directly into the productive economy at better returns in much the same way that the new ISA rules will liberate 'dead money' from low yield bank deposits. Not only could we see some pension capital crowd-invested into long term business and infrastructure projects in a way that won't be interrupted by the need to purchase an annuity, but those in draw-down might also consider some 3 to 5 year loans to creditworthy borrowers as a way to generate some additional monthly income.

At Last: ISAs Go To Work

Finally, the last lines of resistance have fallen and the Chancellor has announced that ISAs will go to work: 

"To further increase the choice that ISA savers have about how they invest, ISA eligibility will be extended to peer-to-peer loans, and all restrictions around the maturity dates of securities held within ISAs will be removed. The government will also explore extending the ISA regime to include debt securities offered by crowdfunding platforms."

In addition, from 1 July 2014 ISAs will be reformed into a simpler product, the ‘New ISA’ (NISA), with an overall limit of £15,000 per year. You will be able to hold cash tax-free within your Stocks and Shares NISA (if your provider allows it). And you'll be able to ask NISA providers to switch your money between cash-NISAs and Stocks and Shares NISAs.

As has been pointed out repeatedly, these changes offer a huge boost to the real economy, because savers will be able to lend their 'dead' savings directly to each other and to small firms to help fill the funding gap left by the banks. At the same time, savers will improve the value of their investments, not only by diversifying into a new asset class, but also one that provides a decent return.

In 2012, the Treasury estimated that about 45% of UK adults have an ISA, with a total of £400bn split equally between cash and stocks/shares.  But others had found that cash-ISAs were only earning an average of 0.41% interest (after initial ‘teaser’ rates expire), and 60% of savers never withdraw money from their account. That amounts to £120bn worth of 'dead money', because only £1 in every £10 of bank loans goes to small firms, and we rely on those firms for 60% of new jobs.

Hats off to the government and the Treasury for putting in the work to turn this situation around.

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.

Banks To Repay Cash-ISAs When Teaser Rates Expire?

The government's ISA programme has become a victim of its own success. The Treasury estimates that "around 45%” of UK adults have one or more Individual Savings Accounts. The total amount held is estimated at £400bn, half of which is in either regulated bonds or shares while the other half is held in cash deposits that are being eaten by inflation. 

In 2010, Consumer Focus found that the £158bn which was then held in cash-ISAs was earning an average of only 0.41% interest after initial ‘teaser’ rates expire. They also found that 60 per cent of savers never withdraw money from their account. 

Since then, there has been a campaign to get banks to tell customers when teaser rates expire. But what has been the banks' response?

To cut the 'teaser' rates on cash ISAs (even though the government subsidises lower lending rates).

Meanwhile, the Treasury has also resisted calls to expand the range of assets included in ISAs, which would enable savers to diversify and boost innovation and competition in the retail finance markets, as explained here. 

The implicit message from the government is that consumers only have themselves to blame if they don't move their savings to get the best deal. But the government can't have it both ways. It can't introduce an artificial tax incentive and then ignore the systemic issues that incentive creates. The government should either take responsibility for the behaviour that is driven by its incentives, and re-design them accordingly. Or it should withdraw the incentives.

So, short of opening up the cash-ISA market to real competition, what more can be done to remind people to switch their ISA cash?

The last straw would be for all cash-ISAs to be term deposits which can only last for the duration of the 'teaser' rate. When that rate expires, the cash would have to be paid into the customer's nominated 'ISA holding account', from which it can be re-allocated as the customer sees fit. 

Maybe this will lead to 60% of ISA cash deposits earning no interest at all. But only then could the government really claim that consumers who don't seek out the best return only have themselves to blame.

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.

Kick Out the Kick-out Bond

John Kay has seized upon the 'kickout bond' as an excellent example of how our creaking financial regulatory framework works against consumers.

John focused on the product as offered by RBS and distributed by Barclays Wealth, but even the Skipton Building Society is at it.

It is not possible to do the product any justice by summarising it in plain English. By all means study it yourself. But my reaction, like John Kay's, is to wonder why a retail bank or building society would offer an investment product with apparently massive bonuses when they can borrow money - or attract deposits - by offering very modest savings rates? If they've done their homework, this product should be very, very unlikely to cost them any more. In fact, the structure and layers of intermediaries involved should mean additional revenue based on fee and dealing charges and returns below the trigger for any 'bonus' payments. As Mr Kay says:

"Like so many structured products, these bonds are bought only by people who do not really understand what they are doing."

Why the FSA allows a product of this complexity to be offered to unwitting investors, yet refuses to provide guidance for the launch of simple, transparent, low cost funding platforms is utterly beyond me.

Remember: you're on your own - pay less, diversify more and be contrarian.

The Bull Market in Australian Cattle Stations

Yep, amidst all the bloodletting and mayhem of the credit crunch, there's a bull market in Australian cattle stations - over 30 have been rounded up in the past 6 months. It seems they've been under-capitalised, relative to their potential capacity and projected global beef requirements, and stand to benefit from the decline in available land elsewhere.

Amongst the buyers are The Macquarie Pastoral Fund, Terra Firma (which just bought out the Packer's rural holdings) and Primary Holdings (management pictured on location), which is in the process of tying up with ex-Murdoch man Ken Cowley's iconic RM Williams vehicle.

It's such a significant opportunity that old mate and CEO, Bob Tucker (pictured, seated left), former COO at Man Global Strategies, recently moved from London to Sydney, after securing seed funding from the RAB Special Situations Fund.

I have a little empathy, as Irish ancestors on my mother's side helped open up the area of the Kimberley region in Western Australia that is now the Ord River irrigation area. The history is covered in Mary Durack's book, "Kings in Grass Castles". I see there's even an upcoming tour of the trek the various families took to get out there in the 1880's.

It's still a hard life out there, by all accounts. Nice to see that the humble whiteboard remains an essential tool.