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.

Avoiding The Irish Haircut

It seems that if you look into any property bubble you'll see the hollow remains of a British bank. Which explains George Osborne's offer of a direct loan from the UK to the Irish government.

It has been made clear by the German government recently that the holders of Irish bonds must take a 'haircut' - a reduction in the value of their bonds - to share the pain in the event that any European money is used to bail out Ireland or its banks.

To the extent that European money involves the European Financial Stability Fund, then the UK would be on the hook for £7bn. Chickenfeed, you say, compared to our own bail-out costs to date, though a sizeable sum in the scheme of recent budget cuts.

But that's not all that's at stake, because the usual suspects filled their boots with about £140bn of Irish assets, according to Channel 4 news tonight, of which RBS and Lloyds share about £80bn. So these positions don't need to take much of a haircut to exceed the UK's £7bn exposure via the ESFS.

Hence George's anxiety to avoid Ireland's trip to the Brussels barber.

What next? British banks were said to be 'tight-lipped' about the exposure to the PIGS. I'd say that's more like "white-knuckled" by now.

Image from Gals Rock.

Buried!

Has a week gone already?! The distinct lack of posts has been due to my being buried by business-as-usual, plus:

• Consultations on the implementation of the new E-money directive by both the Treasury and the FSA;
• The latest edition of the EC's Consumer Markets Scoreboard;
• Excellent discussions on where bankers and social thinkers disagree and agree;
• All the other great stuff that I tweeted or retweeted, to which I may yet find the time to return; and
• Last but not least, agreeing the topic for discussion at the inaugural meeting of the SCL Junior Lawyers' Group on 20 January 2011 - be there!

Have a great weekend!

Image from PubSub.

Strength in Diversity

Following the discussion on the concept of a Social Finance Association, it was interesting to read the guest post on Zopa's blog by Rob Garcia, Senior Director of Product Strategy at Lending Club, attempting to classify types of social finance as 'crowdfunding', 'microfinance' or 'peer-to-peer lending or investing'.

Having had to spend far too long studying the distinctions between US and UK regulation in this area, I must respectfully disagree that 'crowdfunding' necessarily involves 'pooling' or a lack of nexus between 'funder' and 'fundee'. Similarly, any of these models should be capable of operation on either a for-profit or not-for-profit basis, or for any purpose, social or otherwise. The essence should be that each facilitator enables people - rather than the facilitator itself - to determine the allocation of their own funds directly to other people, businesses or projects, whether the businesses or projects are operated for-profit, social purposes or otherwise). In other words, people remain in day-to-day control of the management of their money, not the facilitator.

While precise distinctions between the various different social finance models may be important at one level, and a diverse range of business models is certainly good sign for the strength of the sector, the sector must also be ready to differentiate itself from traditional financial institutions and models - unless it wants to be regulated in the same way.

Social finance models were vital alternatives before the global financial crisis, let alone now and for the foreseeable future while traditional institutions adjust to new capital and regulatory constraints. But the existing regulatory framework makes it painfully slow and expensive to launch social finance platforms. To help foster confident innovation and competition, and enable the new sector to flourish quickly enough to provide much needed funding, financial regulators should clarify what is permissible within or outside the scope of regulation.

Image from the Trade Association Forum.

Long Now

The Long Now Foundation "was established in 01996 to creatively foster long-term thinking and responsibility in the framework of the next 10,000 years." It has three main projects - "to construct a timepiece that will operate with minimum human intervention for 10,000 years... to preserve all languages that have a high likelihood of extinction over the period from 2000 to 2100... and to propose and keep track of bets on long-term events and stimulate discussion about the future."

The foundation also conducts "Seminars About Long-term Thinking". In fact, there's a Long Now "Meet-up" in London tonight, and Chris Skinner of the Financial Services Club recently compiled a great collection of blog posts, SIBOS discussions and comments in a document called "Introducing Long Finance".

It's quite liberating to think in terms of a 10,000 year framework, though one could get bogged down in the best way to go about it. I'm not sure it matters whether one thinks about how the world will be in the year 10,000 or 12,010 and what we might do today to ensure there actually is one, or whether you roll forward 10,000 years only to look back at what might then be considered to have been the big problems of today. In any case, it's at least a very different perspective on human existence to the one I was taught.

Of course, we already tend to this sort of analysis when we talk about landing our grandchildren with financial and environmental problems, but that's not very far in the future, and most of our institutions seem pressured for one reason or another to focus on the very short term.

For what they're worth, my own thoughts - partly reflected in earlier posts and partly in response to "Introducing Long Finance" (ILF) - are these:

1. It is critical to bear in mind that almost all significant events in history are Black Swans - surprise events that have a huge impact and which we rationalise by hindsight. As a result we should maximise our exposure to the upside of such events, and minimise our exposure to the downside (see The Black Swan).
2. We should focus on the total cost of our activities, rather than merely their immediate market 'price' - i.e. not only the retail price of petrol at the pump or the spread between savings and lending rates, but the cost of subsidies and cross-subsidies paid to each of participants in the supply chain.
3. It doesn't seem worthwhile to get too caught up in debating the rate at which certain energy sources are 'running out', when it seems likely that it will come as a surprise that they have, in fact, run out or at least become unaffordable (see above). Given the implications of running out of energy on a mass scale, any degree of scarcity is reason enough to create viable, sustainable alternative energy sources now. Otherwise we are exposing ourselves to the massive downside associated with a surprise event. This is the sort of thinking that led the Dutch government to spend €450 million building the Maeslant barrier, for example (page 6, ILF).
4. Education and health are more critical to our survival - and therefore of greater social importance - than the accumulation of wealth. But we have a tendency to let the accumulation of wealth dominate our activities from time to time. And then we get burned, either by military conflict or economic hardship (read in The Ascent of Money). We should therefore incentivise the pursuit of knowledge and good health above the accumulation of wealth. The process of accumulation of wealth should also be harnessed in favour of education and public health.
5. Migration will remain a very significant source of conflict, since population imbalances - whether caused by social policies like China's one-child policy or declining population - must result in significant relocation of people, whether peacefully or by conquest.
6. I agree that "commodities, capabilities, processes and capital" are key drivers of international tension (page 20, "Introducing Long Finance"). But I don't believe the long term issue is one of which nation will be the next global superpower. In fact, the trend may be towards the devolution of national power into regional and local power (see comment on page 26, ILF), Scotland and Wales being examples close to home, and commodities etc are not evenly distributed within most countries. So the economic challenge becomes one of matching regional/local strengths, weaknesses, opportunities and threats in terms of commodities, capabilities, processes and capital (labour included). Hans Rosling's analysis of regional human development, the rise of the "Cheetah Generation" in sub-Saharan Africa and the aid-investment dichotomy illustrated by China's involvement in that region are illustrative of this trend. Issues of fairness, inequality (page 32, ILF) and the total cost of our activities (#2 above) arise to be resolved in this context. The ideas of Bernard Lietaer and the Japanese currency of ‘fureai kippu’, that enables families to exchange time and duties in support of each others' parents and grandparents (pp 37-40, ILF) are also attractive here.
7. A focus on the eradication of "poverty" (see page 30, ILF) seems a futile as an end in itself. It should be a bi-product of prioritising education and public health over the accumulation of wealth, as well as meeting the challenges arising out of regional/local economics and migration, as discussed above.
8. Industries naturally concentrate and fragment, while customer dissatisfaction and the competitive activities of players normally considered to be in other markets play a role. This dynamic has played out in the past decade via the Web 2.0 or 'social media' phenomenon in the retail, travel and entertainment industries, for example. I've covered this in the consumer finance context already. And there are signs the markets for audit services and credit risk ratings will be next. So I disagree with Chris's contention that banks have a future as "safe keepers of information", in the way that "Apple’s iTunes, Amazon’s Superstore (it’s no longer books) and Google are all data businesses who use the rich analysis of data as their key resource" (page 46, ILF). I disagree partly because that would buck the social media trend generally, and partly for the very reason that those social media based businesses developed their rich data capability first, and are implicitly more competent in this respect than retail banks (who actually have little such readily accessible data or relevant skills and resources). Instead, the functions associated with retail and commercial 'banking' today are likely to be subsumed and concentrated into other types of businesses more closely aligned with end-to-end retail and commercial processes. Those businesses are in turn likely to fragment to create new types of service provider aligned with the regional/local economic developments, new currency models, shifts in population and so on, discussed above.