Open Agentic AI And True Personalisation

Sixteen years on from my own initial posts on the subject of a personal assistant that can privately find and buy stuff for you on the web, and we have 'open agentic AI'. But are you really any closer to the automated selection and purchase of your own personalised products without needlessly surrendering your privacy or otherwise becoming the victim? Should this latest iteration of open generative AI be autonomously making and executing decisions on your behalf? 

What is Agentic AI?

An 'agentic' AI is an evolution of generative AI beyond a chatbot. It receives your data and relies on pattern matching to generate, select and execute one of a number of potential pre-programmed actions without human guidance, then 'learns' from the result (as NVIDIA, the leading AI chip maker, explains). 

A 'virtual assistant' that can find, buy and play music, for example, is a form of agentic AI (since it uses AI in its processes), but the ambition involves a wider range of tasks and more process automation and autonomy (if not end-to-end). 

You'll see a sleight-of-hand in the marketing language (like NVIDA's) as developers start projecting 'perception', 'understanding' and 'reasoning' on their agentic AIs, but computers don't actually do any of those human things. 

It's certainly a compelling idea to apply this to automating various highly complex, tedious consumer 'workflows' that have lots of different parameters - like buying a car, perhaps (or booking a bloody rail ticket in the UK!). 

Wearing my legal hat, I also see myriad interesting challenges (which I'd be delighted to discuss, of course!), some of which are mentioned here, but not all...

Some challenges

The main problem with using an 'agentic AI' in a consumer context is the involvement of a large language model and generative AI where there is a significant (e.g. economic, medical and/or legal) consequence for the user (as opposed to a chatbot or information-only scenario (though that can also be problematic). Currently, the household or device based virtual assistants are carrying out fairly mundane tasks, and you could probably get a refund if it bought you the wrong song, for example, if that really bothered you. Buying the wrong car would likely be a different matter.

There may also be confusion about the concept of 'agency' here. The word 'agentic' is used to mean that the AI has 'agency' in the sense it can operate without human guidance. That AI is not necessarily anyone's legal 'agent' (more below) and is trained on generic training data (subject to privacy, copyright consents/licensing), which these days is itself synthetic - generated by an AI. So, agentic AIs are not hosted exclusively by or on behalf of the specific consumer and do not specifically cater to a single end-customer's personalised needs in terms of the data it holds/processes and how it deals with suppliers. It does not 'know' you or 'understand' anyone, let alone you.  

Of course, that is consistent with how consumer markets work: products have generally been developed to suit the supplier's requirements in terms of profitability and so on, rather than any individual customer's needs. Having assembled what the supplier believes to be a profitable product by reference to an ideal customer profile in a given context, the supplier's systems and marketing/advertising arrangements seek out customers for the product who are 'scored' on the extent to which they fit that 'profile' and context. This also preserves 'information asymmetry' in favour of the supplier, who knows far more about its product and customers than you know about the supplier or the product. In an insurance context, for example, that will mean an ideal customer will pay a high premium but find it unnecessary, too hard or impossible to make a claim on the policy. For a loan, the lender will be looking for a higher risk customer who will end up paying more in additional interest and default fees than lower risk customers. But all this is only probabilistic, since human physiology may be 'normally distributed' but human behaviour is not.

So using an agentic AI in this context would not improve your position or relationship with your suppliers, particularly if the supplier is the owner/operator of the agentic AI. The fact that Open AI has offered its 'Operator' agentic AI to its pro-customers (who already pay a subscription of $200 a month!) begs the question whether Open AI really intends rocking this boat, or whether it's really a platform for suppliers like Facebook or Google search in the online advertising world. 

It's also an open question - and a matter for contract or regulation - as to whether the AI is anyone's legal 'agent' (which it could be if the AI were deployed by an actual agent or fiduciary of the customer, such as a consumer credit broker). 

Generative AI also has a set of inherent risks. Not only do they fail to 'understand' data, but to a greater or lesser degree they are also inaccurate, biased and randomly hallucinate rubbish (not to mention the enormous costs in energy/water, capital and computing; the opportunity cost of diverting such resources from other service/infrastructure requirements; and other the 'externalities' or socioeconomic consequences that are being ignored and not factored into soaring Big Tech stock prices - a bubble likely to burst soon). It may also not be possible to explain how the AI arrives at its conclusions (or, in the case of an agentic AI, why it selected a particular product, or executed a specific task, rather than another). Simply overlaying a right to human intervention by either customer or supplier would not guarantee a better outcome on theses issues (due to lack of explainability, in particular). A human should be able to explain why and how the AI's decision was reached and be able to re-take the decision. And, unfortunately, we are seeing less and less improvement in each of these inherent risk areas with each version of generative AIs.

All this means that agentic AI should not be used to fully automate decisions or choices that have any significant impact on an individual consumer (such as buying a car or obtaining a loan or a pension product).  

An Alternative... Your Own Personal Agent

What feels like a century ago, in 2009, I wondered whether the 'semantic web' would spell the end of price comparison websites. I was tired of seeing their expensive TV ads - paid for out of the intermediary's huge share of the gross price of the product. I thought: "If suppliers would only publish their product data in semantic format, a 'widget' on my own computer could scan their datafeeds and identify the product that's right for me, based on my personal profile and other parameters I specify". 

By 2013, I was calling that 'widget' an Open Data Spider and attempted to explain it further in an article for SCL on the wider tech themes of Midata, Open Data and Big Data tools (and elsewhere with the concept of 'monetising you'). I thought then - and still think now - that: 

"a combination of Midata, Open Data and Big Data tools seems likely to liberate us from the tyranny of the 'customer profile' and reputational 'scores', and allow us instead to establish direct connections with trusted products and suppliers based on much deeper knowledge of our own circumstances."

Personalised assistants are evolving to some degree, in the form of 'personal [online] data stores' (like MyDex or Solid); as well as 'digital wallets' or payment apps that sit on smartphones and other digital devices and can be used to store transaction data, tickets, boarding passes and other evidence of actual purchases. The former are being integrated in specific scenarios like recruitment and healthcare; while the latter tend to be usable only within checkout processes. None seems to be playing a more extensive role in pre-evaluating your personal requirements, then seeking, selecting and purchasing a suitable product for you from a range of potential suppliers (as opposed to a product that a supplier has created for its version of an 'ideal' customer that you seem to fit to some degree). 

Whether the providers of existing personal data stores and digital wallets will be prepared to extend their functionality to include more process automation for consumers may also depend on the willingness of suppliers to surrender some of their information advantage and adapt their systems (or AIs) to respond to and adapt products according to actual consumer requests/demand.

Equally, the digital 'gatekeepers' such as search providers and social media platforms will want to protect their own advertising revenue and other fees currently paid by suppliers who rely on them for targeting 'ideal' customers. Whether they can 'switch sides' to act for consumers and preserve/grow this revenue flow remains to be seen.

Overall, if I were a betting man, I'd wager that open agentic AI won't really change the fundamental relationship between suppliers, intermediaries and consumers, and that consumers will remain the targets (victims) for whatever suppliers and intermediaries dream up for them next...

I'd love to be corrected!

A Strange Speech From The Governor

The Governor of the Bank of England has a key leadership role in the UK financial system, so it's important to understand his vision for Britain's new role in the wider world. Hence my interest in his strange speech on the "future of financial services".

Mis-selling Brexit

The British Parliament has finally had the chance to scrutinise the new UK-Japan trade deal that has been trumpeted for so long by Brexidiot Truss. Unsurprisingly, two committees found that the difference between the new deal and the terms available to the UK under the EU-Japan deal are not as extensive as the Secretary of State for International Trade had claimed. An opposition MP found that the government's own figures show the UK will be worse off than under EU terms.

The House of Commons International Trade Committee, did find some extra items on digital services and data (precedent-setting for future agreements) and financial services (including a ban on the need to store financial data in the host country).

The House of Lords International Agreements Sub-Committee pointed out that "exaggerating the gains ... courts unjustified scepticism about what is a respectable ... agreement". 

UK-Japan deal also depends on a trade agreement between the UK and the EU because, for example, "to secure existing trilateral trade flows between the EU, UK and Japan, the UK and EU would need to extend cumulation to Japan through their own trade agreement". 

The Committees want more effective scrutiny of future free trade agreements that are not based on existing EU arrangements, which are likely to be more controversial. 

Meanwhile, Emily Thornberry revealed the results of Opposition efforts to get to the bottom of the economic value of the UK-Japan deal relative to the UK's terms under the EU- Japan deal:

Yesterday in the House, I confronted Liz Truss with her own Department’s report on the question she’s repeatedly refused to answer: what’s the difference, in pounds and pence, between her Japan deal and the EU-Japan deal it replaces? She didn’t look happy. pic.twitter.com/PKuiYYlNnI

— Emily Thornberry (@EmilyThornberry) November 26, 2020

 

A European View of Brexit: Three Sources of Opportunities

Ironically, I was asked to give a European view of Brexit for an online conference this morning. I say, ironically, because it was in my role as an Irish lawyer for an Irish law firm, yet speaking from London as someone who's also qualified as an English solicitor and who left Sydney in 1994 as a 29 year old barrister. I guess that makes me one of Theresa May’s ‘citizens of nowhere’. At any rate, here's a summary of my view - which I tried to couch in terms of opportunities from a European standpoint.

How to view Brexit

I see Brexit as a set of international sanctions self-imposed by voters for emotional reasons - whether perceived 'lack of sovereignty', feeling 'left behind by globalisation', xenophobia or nostalgia. The hard facts never mattered. Trading rights to fish in UK waters to EU countries may have 'sent a shudder' through the House of Commons from a symbolic, nationalistic standpoint but fishing is the UK's smallest industry, employing 24,000 people and exporting 80% of its catch to the EU to help feed 400m people, as opposed to the UK's 65m.

And the hard reality is that the UK helped build the EU trade bloc, including advocating its expansion to 28 members; and contributing significantly to many of its rules, like EU financial services regulation and, ironically, anti-money laundering regulation. So I have little sympathy with the idea that Britain could legitimately expect the EU suddenly to change how it does deals with third countries just because Britain used to be a member state.

Opportunities?

Brexit may be a mess of the UK's own making, but every mess provides an opportunity for someone to clean up.

Looking for opportunities in this context is a bit like the final scene in "The Life of Brian". A lot of terrible things happen in that scene, including mass-suicide out of 'solidarity' with the poor unfortunates being crucified. But it's important to remember that the scene ends with everyone singing “Always look on the bright side of life”.  

To continue the idea that Brexit is a set of self-imposed sanctions, the opportunities really boil down to 'sanction-busting' – finding workarounds for the many problems Brexit creates. Aside from the potential for speculators and other 'disaster capitalists' to make money, there are three sources for these opportunities:

Any form of Brexit means ‘no deal’ for services: 

The end of Brexit transition period in December means the end of free movement of services from the UK into the EU (and the free movement of the labour needed to deliver them), as well as the end of mutual recognition of professional qualifications, licences and various types of certificates (e.g. veterinary, eIDAS identity certificates and so on).

That's a significant problem because services account for 80% of the UK economy, 80% of UK jobs and a third of UK exports, 40% of which go to EEA countries. 

This means UK firms need to set up EEA hubs, which will bring know-how, jobs and tax revenues to their new home countries. Ireland has a great opportunity here, being the only principally English speaking, common law country left in the EEA with a visa-free Common Travel Area for British and Irish workers. That's why I got my own practising certificate in Ireland and added a consultancy with an Irish law firm, since my UK practising certificate and legal qualifications won't be recognised in the EU after Brexit transition ends.

The perceived mishandling of Covid19 by the UK government compared to others (not to mention a trend toward xenophobic policy measures and right wing culture) might also feed into people’s sense of where is best to live, as could a trend toward remote-working as opposed to treating cities like London as essential hubs.

Britain is a consultant/client state:

Successive British governments have been relaxed about the sale of British businesses to foreign buyers, to the point where there aren’t really many major British-owned businesses anymore, and there seem likely be even fewer in future. 

In fact, Britain has evolved not only into an 80% service economy but also a consultant state - a sort of UK Consulting PLC. It majors in financial services, international dispute resolution, artificial intelligence, computing, construction, engineering and lots of other services (not to mention tax avoidance and money laundering) without actually owning the factories, output, buildings or in many cases even the land on which they're built. 

At the same time the British government apparently sees the job of serving its own citizens as something to be outsourced to private service providers. So the government operates like a procurement platform, paying service providers vast sums of tax money to deliver public services in remarkably autonomous fashion, while extracting taxes from the service providers' public sector income (as a kind of referral commission), as well as the taxes on the revenue from UK Consulting PLC. 

Needless to say, there are all sorts of opportunities for EU/UK service providers to import and export services using local UK/EU entities and locally qualified personnel, subject to dual qualifications and nationality/visas for those who need to move between.

Friction at the borders

There will be problems and delays at the UK borders, regardless of any deal or no deal. So Ireland, for example, is busy figuring out how to get its goods in and out by increased ferry services to and from the EU, and is planning how to open up markets beyond the UK. 

On both sides of the borders, customers who import from the EU into the UK or vice versa want to avoid 'customs risk'. That means the exporting suppliers must have a local entity/office in the EU/UK that takes on the responsibility and the liability for ensuring goods are delivered to importers. 

In each case, both European and British businesses can assist each other in embracing these challenges as opportunities, even if the ultimate result is a transfer of British business activity to the EU and a British economy that is smaller and produces less than if Britain had remained a member of the trade bloc.

You see, I told you there'd be opportunities!

 

The Cat Is Out Of The Bag: The EU Bars UK Financial Outsourcing

A key EU financial authority has asked EU regulators to be strict on UK firms seeking to escape the impact of Brexit. The concern is that having lost their EU passporting rights, desperate Brits will try to get authorised in Europe but continue to rely on UK managers and operations. 

"UK-based market participants may seek to relocate entities, activities or functions to the EU27 in order to maintain access to EU financial markets. In this context, these market participants may seek to minimise the transfer of the effective performance of those activities or functions in the EU27, i.e. by relying on the outsourcing or delegation of certain activities or functions to UK-based entities, including affiliates. It is therefore necessary to ensure that the conditions for authorisation as well as for outsourcing and delegation do not generate supervisory arbitrage risks."

ESMA even proposes a Cat o' nine tails set of 9 "principles" to prevent UK firms making the best of Brexit: 

1. No automatic recognition of existing financial firm authorisations;
2. Authorisation processes by the EU27 should be "rigorous and efficient";
3. Regulators must verify the objective reasons for relocation;
4. Regulators should avoid "letterbox" entities in the EU27 - the EU firm must perform substantial activities;
5. Outsourcing and delegation to third countries (like the UK) is only possible under strict conditions;
6. Substantive decision-making must occur in the EU, especially over outsourced activities;
7. There must be sound local governance of EU entities, by resident directors/senior managers;
8. Regulators must have the resources and data to effectively supervise and enforce EU law. 
9. ESMA is watching and will co-ordinate to ensure adequate and consistent supervision. 

Of course, the UK could retaliate with red tape of its own. Brexit is also a challenge for 8,008 EEA firms that hold 23,532 passports (about 3 each) to cover their UK offerings.

There's No Single Market For Consumer Finance: What Next?

Perhaps it's not what the European Commission intended, but its green paper on retail financial services is a great explanation of why there is so little cross-border activity in consumer finance: 3% for payment cards, current accounts and mortgages; 5% for loans (less than 1% between Eurozone countries!) and only 3% of gross insurance premiums. For a very long list of reasons, it's just not practicable for most retail financial services providers to operate across EU borders, as the EC has known since at least 2007. Could it be time, therefore, to scale back EU requirements for firms that only focus on their national market, so consumers have a clear choice between national and genuinely cross-border suppliers and products?

The Commission concedes that its vast, confetti-like attempt to harmonise EU financial regulation  has proved futile in catalysing a single retail finance market, yet it continues to ask what more can be done.

One issue in particular that the Commission is huffing and puffing about is 'geo-blocking', the use of technology to identify and block or re-direct consumers based in certain countries.

But the Commission's own findings are that few players have the resources to focus on cross-border markets. Suppliers who do target multiple countries typically use separate local operating entities to deal with all the problems listed in the green paper, so they don't even properly qualify as 'cross'-border. At any rate, how can you force a Spanish motor insurer to sell policies to Germans if it simply can't afford to administer claims in Germany? How would that be in the policyholders' interests? Even assuming the focus solely on Spanish customers is the supplier's own choice, rather than due to some legal restriction, wouldn't requiring the firm to deal with Germans or Swedish consumers put it at risk of going bust, leaving the whole market to a few big players who can afford to serve customers everywhere?

In its response to the green paper, the UK's Financial Conduct Authority quite rightly urges caution on the economic impact of more (futile) regulation, as well as careful analysis of consumer needs and behaviour before churning it out. The FCA points out that existing regulation must be allowed to 'bed-in' before assessing its real impact; and the Commission needs to consider that EU consumers are not some amorphous clump of flesh waiting eagerly for Greek insurance policies homogeneous, but diverse in their needs and behaviours - so a 'one-size-fits-all' approach won't be universally acceptable and risks crushing local financial services that are working well.

The FCA hints at the idea of a range of EU-approved products that might be provided by any EEA firm to any EEA consumer in a standard way, though this still begs the question whether the providers are able to manage this operationally. 

I guess it's possible that those able to target cross-border markets would benefit from some kind of voluntary EU-cross-border safe harbour scheme that enables them to adopt the same approach to marketing, contracts, customer service, complaints handling and enforcement and so on throughout their target market(s). It could even be very a attractive product in some national markets that are currently under-served or where consumers are being fleeced.

But that's more or less what the current regime allows, yet few firms are bothering to do it: the whole point is that we know it is futile to impose a cross-border scheme on firms and consumers who just want to focus on their own national, regional or local market.

Which begs the question: rather than add more regulation, why not allow member states to scale back EU requirements for firms that wish to remain nationally focused? This would allow further differentiation between national and cross-border suppliers and products, presenting consumers with a clearer choice to make.

The Beginning of The End of Consumer "Banking"

Funny to see a story from John Gapper in the FT this morning, saying technology will hurt retail banks but not kill them, only a few pages before First Direct admits it mis-sold complex investment products to consumers.  While I agree that innovation doesn't 'kill' anything, and must co-exist with what it is replacing, John seems to have a misplaced faith in retail banks' ability to maintain their direct relationships with consumers.  Banks are steadily being relegated to the back-office of retail finance.

 

John may be right to point out that banks lose money on the limited activity of offering current accounts, and possibly even savings account functionality, so that these are not attractive areas in themselves for technology businesses to enter. But of course you can't view those 'products' in isolation. They are just part of the 'bait and switch' routine that banks operate to persuade people to part with their money so the banks can earn far more from using those funds for their own ends.

To understand what the tech companies are doing, you have to consider how much money the banks make out of the end-to-end activity of robbing investors/depositors of yield while fleecing borrowers with expensive loans - and making everyone pay a lot for slow-cycle payment processing. 

 

It is wrong to say that technology companies are merely playing at the edges of 'banking' by offering payment services and person-to-person loans. This is all part of the strategy for disrupting the 'banking' sleight of hand.

 

Tech companies know that if they can provide a decent, transparent consumer experience to savers/investors on the one hand, and those who need the funds on the other, then they are in a position to cut the cost of moving money between the two. In fact, the money may not even have to move at all: the important issue is who is entitled to it, and whether it is available. 

 

You don't need a bank to keep the data and transaction records that tells you who owns the funds. It's all just data, as Marc Andreessen is quoted as saying. 

 

And it's far safer to separate the transaction processing and record-keeping function from the cash, which should be held separately from the processor's own funds. That's how e-money institutions, payment institutions, P2P lending and crowd-investment firms are set up...  They may rely on segregated commercial bank accounts for holding that cash, but the banks who provide those accounts have no control at all over which consumers own the money in them, or what those consumers choose to do with it amongst themselves.

 

In the EU, the regulatory support for such new business models began in earnest in Europe in 2000, with the advent of the first E-money Directive, and has snowballed with the Payment Services Directive in 2007, a new EMD in 2009 and the proposed revamp of the PSD. There are now hundreds of these payment institutions in the UK alone. And it's no coincidence that the UK has led the way in both creating and regulating P2P lending and crowd-investment platforms.

 

All of this spells the beginning of the end for consumer 'banking'.

 

 

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)."

Banks Can't Even Be Bothered For The Rich

Oh those poor, poor bankers. Now, we're told by Spear's, that the new 'retail distribution' rules have made their lives so complicated they even have to stop fleecing servicing wealthy customers. Bernie Madoff must be relieved to have got out before the well ran dry.

Ironically, for a magazine that bills itself as "the essential resource for high net worths", Spear's argues the bankers' case. The article seeks to persuade wealthy readers to stop being so demanding if they wish to avoid being 'managed out' by private bankers who find them too costly to serve. In particular, customers must stop expecting services aligned to their needs and behave in a way that suits the banks: 

• agree what the banker will do for you up front, then wait for the quarterly reports and limit any discussion to those times instead of pestering for more frequent advice;

• don't change your instructions (the banks already chew through 3% of your return by making 'adjustments' to your portfolio, so don't make it worse); and

• behave as if you're part of a team - cut your banker some slack when he is slow to realise gains or avert losses and, most importantly, recommend him to your friends (bankers just love the bandwagon effect).

Puzzling, until you realise where Spear's probably gets most of its advertising revenue.

Definitely a sign that yet another area of the financial services market is ripe for innovation by facilitators.

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.

Gasp! UK Bank Enables Mobile Money Transfers!

The comments under the Guardian's piece on Barclay's mobile money transfer app tell you everything you need to know about the pace of innovation amongst UK retail banks ;-)

Image from JISC infoNET.

Facilitators and Institutions Defined

The distinction between 'facilitators' and 'institutions' is a theme that has emerged quite strongly in this blog and is discussed in Chapter 2 of Lipstick On a Pig. In essence, I've defined "facilitators" as organisations that exist to solve their customers' problems; and "institutions" as organisations that exist to solve their own problems at their customers' expense.

To be more specific, I've extracted the following characteristics that I believe mark an organisation as being one or the other. Broadly, these characteristics group into themes of alignment, openness, adaptability, transparency and responsibility.

So, a 'facilitator' is organised to solve its customers’ problems, operates openly, adapts well to changing circumstances, is committed to transparency and takes responsibility for the impact of its activities on the wider community and society.

I update this post from time to time and am interested in any comments you may have.

Facilitators:

 Alignment

• exist to solve problems that their customers encounter day-to-day as part of wider end-to-end activities (i.e. customers don't 'pay' or 'bank', they make a payment as a single step in a much longer purchase process);

• don't presume to 'own' the relationship with people who use their products, and see customers as the controllers of that relationship;

• accurately define real problems, assess their real scale, identify root causes and implement proportionate, efficient solutions;

• view the world through the eyes and experiences of people who use their products;

Openness

• are prepared to work with complimentary businesses to support their users' end-to-end activities (including linking to material produced by others);

• seek feedback, welcome input and criticism;

• interact well with users in open forums;

• are 'free-rider tolerant';

Adaptability

• are highly adaptable and responsive to criticism; 

• allow ideas to develop from staff and users bottom-up, generating passion and connection amongst them;

• see uniqueness, change and adaptability as a source of competitive advantage;

Transparency

• work to simplify their products and users' experience;

• their terms and communications are clear, fair and not misleading;

Responsibility

• seek to make the world a better place in which to live, addressing the impact of their activities on the wider world.

Institutions:

Alignment

• Exist to solve their own problems at the expense of 'their customers';

• View the world through the lens of their own products (whether goods or services), rather than the activities in which users are engaged when acquiring or using those products;

• Regard themselves as controlling the relationship with users. 

 Openness

• Resist criticism and change – believing that their own processes, judgement and publicity should prevail;

• Impose their own views on staff and 'their' customers, top-down;

• Interact poorly with users (if at all) in open forums, experiencing 'vicious cycles' of adverse publicity; 

•  Are 'free-rider resistant';

• Mandate the use of their own add-on services, even where these are inferior those available from third parties; 

 Adaptability

• See running with the herd, or 'fast-following' as a source of competitive advantage;

• Demand that 'their' customers must become more capable if their products or experiences are to improve; 

Transparency

• Deliberately adopt complex pricing, conditions and 'pressure' techniques in their sales and marketing activities;

• Rely on cross-subsidies to distort the attractiveness of new products;

• Their terms and communications tend to be unduly complex and legalistic;

Responsibility

• Avoid addressing the impact of their activities on the wider world.

ID Theft Insurance: Bonfire Of The Gullible

I guess it started out as a reasonable idea - provide card customers with comfort that someone else will help if your credit card is stolen and your card issuer let's you down.

But your card issuer isn't allowed to let you down, unless you do that yourself through fraud or negligence - in which case why would an insurer help? Slow as they are, it's very much in the legal and financial interests of card issuers to invest in anti-fraud protection. And they're usually 'first-on-the-scene' in a card fraud scenario, as you'll be aware if you've ever been called to confirm you weren't standing at a point of sale in both Brazil and Bulgaria in the past few hours.

If you're an ID theft policyholder and you don't agree, are you are among the 0.5% who've actually made a claim?

Cue the FSA probe into CPP, purveyor of fine ID theft protection at £80 a year. The investigation was prompted by Which? who have campaigned against this rort for some time. A glance at the fund managers who backed the IPO tells you all you need to know. Those people have no right to complain. Either they knew the drill or they were gullible enough to think this product had a real future.

As for the attitude of the card issuers: the FT cites at least one analyst's view that:

"You could argue that half the companies on the high street shouldn't exist because the things they sell are vulgar, tasteless or tacky... Which may be true, but it's irrelevant. The point is, there's demand there."

Demand or gullibility?

Sunlight On Pensions

Good to see Michael O'Higgins, the new Chair of the UK Pensions Regulator making a splash in his first interview. He's quoted in Tuesday's FT as saying providers should be obliged to compare their returns against their fees and other charges, including brokerage and dealing costs.

He admits transparency is key to building public trust in pensions, implying there isn't much.

Add that level of transparency to the focus on improving administration and record-keeping, and we should see some more pension scandals come to light in 2011.

What fun!

Next job: fill the black hole.

Open-Loop Time Banks?

I spent Monday partly examining the practicalities of treating time as a currency at BarCampBank4.

In essence, 'time banks' for social care are no different to other closed-loop 'alternative' currencies ranging from loyalty schemes to gift card and store card programmes. Hureai Kippu, the Japanese system for earning the right to senior care by caring for senior citizens yourself, is often cited in this context. That specific model, which involves a nationwide clearing system for care credits, is being considered by various local authorities in the UK, though Age UK is among those who question its utility.

But we've had UK time-banking schemes since the '90s, e.g. TimeBank, TimebankingUK and Local Exchange Trading Systems or Schemes (LETS), the mutual aid barter network. The difference is explained here. So I it's clear there is something worthwhile that can be achieved by trading units of time to solve underfunded problems like personalised social care in its many forms.

However, we need to be cautious about 'open loop' time banks, even though this may bring welcome liquidity and funding to support an aging population with a giant pension deficit. There's a range of practicalities that stand in the way of time - or loyalty points, for that matter - becoming a 'real' or open-loop, freely negotiable currency or E-money. I'll cover these briefly below. But a more fundamental point is that I'm not even sure that opening up such currencies would add any utility to what's already feasible with any real currency, unless the underlying E-money system is somehow cheaper and more cost effective in moving money or other resources to where they are needed. And there are of course plenty of E-money systems that did not need to go to the trouble of creating a new currency to get going.

Other than funding the business itself, perhaps the main practical challenges to time banks becoming open-loop are achieving 'critical mass', enabling immediate redemption in cash, and tax. Issues of trust, privacy, data protection and so on seem secondary and surmountable so long as the upside to participating and disclosing information outweighs any perceived downside.

Achieving a 'critical mass' of people that will ensure adequate supply and demand for the type of time in question is an awesome challenge that deserves a post in itself.

The requirement for users to be able to redeem the time they have 'earned' or 'acquired' in cash at any time would go hand-in-hand with the need to be authorised as an E-money issuer, and to comply with various capital and prudential requirements, including safeguarding the cash corresponding to the outstanding time. Redemption in cash and safeguarding would seem to defeat the purpose of a time bank, founded as it is on the notion that participants deal only in time.

Finally, we are obliged to pay income tax on our earnings, as well as indirect taxes on sales of goods and services. And governments tend not to accept payment in anything other than their own national currency. While in a closed-loop UK time-bank for charitable purposes tax is not an issue, as soon as you enable redemption for cash or goods and services, tax would come into play.

For these reasons, I think time banks are very useful in allocating resources within a specific community, network or scenario, but not as an open-loop currency - at least not without substantial changes to the regulatory and tax framework.