Sheikh, Blatter and Mole

Updated 3rd June as events have unfolded regarding the scandal at FIFA.

How game theory, dollars and the efforts of one investigative journalist have brought accountability to FIFA.

As certain individuals, associations and European banks have found out recently, if the money you are handling happens to be in dollars or relates to a US registered entity (or exchange) you fall under the jurisdiction of US law – which potentially extends to any country with an extradition treaty with the States.

Why that is the case is, in part, explained in this article in the Washington Post. Simply put, if you want to do business in the States you accept you can be sued from the States. And ‘business’ may mean just one meeting or transaction.

The implications are quite far reaching, as the scandal revolving around recent World Cup bids and FIFA has demonstrated.

What began with the sole efforts of investigative journalist Andrew Jennings to uncover wrongdoing within FIFA, snowballed after he was contacted by the FBI. You can read a fascinating account of his efforts  here to give the Washington Post their second plug of the day.

The story of how Jennings went fishing for and landed a ‘mole’ within FIFA, is a lesson for any errant organisation who thinks their information is contained.

sheikh blatter and mole
From left – Sheikh Hamad, president of the Qatar FA; Sepp Blatter acting president of FIFA; Andrew Jennings – the man who established the ‘mole’ within FIFA.


 The FBI’s own efforts eventually led the US Department of Justice on the 27th May, to ask the Swiss authorities to arrest seven senior FIFA officials, as well as others, as they continue to investigate ‘bribery, racketeering, money laundering, fraud and other related crimes’. The Swiss launched their own enquiries into the 2018 and 2022 bidding processes at the same time.

In the aftermath, Sheikh Hamad Bin Khalifa Bin Ahmed al Thani, the president of the Qatar Football Association has been forced to defend the integrity of their winning bid to host the 2022 World Cup. He had hoped on the support of the re-elected President of FIFA, Sepp Blatter, but yesterday Blatter resigned for reasons that were not convincing given his euphoria at his re-election the previous Friday.

The speculation is that there is a ‘smoking gun’ – that Blatter himself may be implicated in some way. And the US Department of Justice have made it clear that their investigations are just beginning and they will seek to bolster their pile of evidence through the use of ‘plea bargaining’.

The DoJ hope that those already under suspicion will accept the first-mover immunity, or a lesser charge, that can be given to those who plead guilty and implicate others. So, they are looking for one or more of those already charged to essentially become an informant.

They have already agreed a deal with Chuck Blazer, the former FIFA executive and Mr Blazer has already begun making revelations. A Sky news article has a quote that, among other defendants, there will be, ‘a race to see who will flip on (Blatter) first’.

Whether someone under suspicion would choose to do so relates to an area of decision-making known as ‘game-theory’, to which the late John Nash, the subject of the film ‘A Beautiful Mind’, contributed so much. There comes a tipping point in the plea bargaining process, where an individual finds the benefits to themselves of revealing all, overwhelms the benefits to the group of remaining silent.

What these events will ultimately mean for the Shiekh Hamad’s World Cup in Qatar is not certain – they would, no doubt, pursue significant reparation costs, even if some wrongdoing was found and the event relocated.

As for Blatter, he plans to continue his duties until a replacement is found. Whether that will include travelling to the Women’s World Cup in Canada, given the extradition treaty that exists between Canada and their southern neighbour remains to be seen.

Post his resignation, Blatter was apparently given a ten minute standing ovation by staff at FIFA – I wonder if Andrew Jennings’ mole was among them.

Legal over-reach?

While many of us might be celebrating Blatter’s resignation, the whole process does raise some serious concerns about the reach of US legal jurisdiction.

Hedge fund manager John Hempton writes an excellent blog and here you can read how he views the DoJs actions as undemocratic. I’d point out that Mr Hempton is no apologist for the crimes FIFA is accused of. He spends a lot of his time discovering fraudulent corporate activity and outing those behind it.

And then we have the US extradition request being fought by Navinder Singh Sarao, a futures trader from Hounslow, who is charged with ‘spoofing’ and prompting the so-called US stock index ‘flash-crash’ in November 2010. Bail has been set at £5 million, but in a classic legal ‘catch-22’ he can’t meet it as he is the subject of a US freezing order over all his assets.

I don’t know him at all, but I do know something about the structure of stock index futures markets in the States and Asia and there isn’t the room here to explain everything technical relating to this case. I find the accusation that his activity was especially egregious and that he pushed the first domino that toppled a knowable chain of other dominoes hard to prove – he wasn’t trading at the time and crashes did not occur on other days he was. Regulators would do well to look at those flash trading firms behind the other dominos stacked in the chain – you can read about them here.

And Sarao’s treatment is somewhat harsh, given the lack of success in the States in bringing any sort of accountability against certain high profile individuals.

Large corporations, like some European banks have received enormous fines that I am not arguing against – but when I see Dick Fuld, the former head of Lehman Bros, arguing again this week that he was running a prudent organisation and that what happened was all the government’s fault, with only an grilling in front of a House Oversight Committee as a chastisement, it does not seem fair.

Anyone for 500 euro notes?

Of course, the other implication of all this is that if you do want to earn some illicit income from the bidding process for a worldwide sporting event, don’t do it in the States and don’t do it in dollars.

Europe would seem far better as it has two advantages. Firstly, one wonders if the Eurozone would ever have looked this closely at FIFA. Andrew Jennings certainly doesn’t seem to think so.

And, secondly, rather than dollars there is the 500 euro note – there are apparently 609,908,558 in circulation as at the end of April, according to the European Central Bank’s own website. But, I’ll discuss the impact of these so-called ‘Bin Ladens’ (a nickname given when we knew he existed, but not where) in another post.


Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time, so it is quite possible to get back less than what you put in, depending upon timing;
  • this blog does not constitute financial advice and is provided for general information purposes only.

Pensions Freedoms

pension nest

Since the start of the new financial year, the new pension ‘freedoms’ have come into effect and we have a clear guide to all the ‘major changes’ that I will be happy to send to you if you contact me.

I emphasise ‘major changes’ because there is a lot of additional information, not in the guide, that may be relevant to clients with different amounts and types of pension provision as they seek to benefit from the valuable new rules. And not all of it is that straightforward or easy to assess.

For example, although these changes have arrived in law, they haven’t yet been put into practice with all pension providers – some will choose not provide the full suite of options that are now possible and others are still in transition between the old rules and the new ones.

There are also new types of investments that are now eligible for your pension such as peer-2-peer (p2p) funds – I have blogged about p2p here and here.   And fund management groups are falling over themselves to emphasise ways of managing the risk of different types of assets in your pension. And, while these might look attractive, I have strong reservations about some of them.

There are also some questions about different types of cost.  We still don’t know how the charges for the new flexibility in withdrawing money from your pension will be levied in all instances. Or the extent to which the price and design of annuities will be affected as fewer choose this route for income from their pension.

There are also some important legal issues relating to the new rules and trust law and how that may be affected by current lawsuits relating to divorce and bankruptcy.

And then there are the acronyms!

The pension industry loves an acronym, whether they relate to funds going into a pension, funds coming out or just general regulation. The industry seems to follow a mantra of ‘Always Value Ideas for New And Laudable Acronyms to Use Generously and Habitually’ – or as I prefer to call it ‘’AVIN’ A LAUGH’.

I’ve just had a brief look at the growing database that I maintain to monitor all things pension related, from press articles and conference notes to announcements by HMRC and other relevant bodies – and there are well over 50 different acronyms…so far.  Nor are any of them especially memorable, unlike the new think-tank set up by the governments of Pakistan and China known as ‘Research and Development International’ or RANDI for short.

So, while it is true that for many people with straightforward situations that generic guidance will be sufficient, others will benefit greatly from a full appraisal of their pension provision. And tailored advice can ensure that basic mistakes are avoided and that full advantage is taken of the new rules.


This list is definitely not intended to be exhaustive, but here are a few examples of circumstances where good bespoke advice can make a real difference.


  • The most obvious question that is fundamental to all the others is, ‘when can I afford to retire?’ The answer to this depends on each clients capacity for risk, appropriate investments and creating a plan using methods that I can readily explain to you.
  • Which investments are the most suitable? There are new investment products that are based on matching your risk profile, but great care needs to be taken here. Where investment funds measure risk solely by targeting how volatile an asset is, I have concerns that the funds themselves have little understanding of the important limitations of that approach. A conversation I had with a salesman at a leading fund recently, confirmed that can be the case.
  • Is inheritance important? The new rules have reduced the cost of passing on your pension pot, if you have a defined contribution scheme. There are also ‘family SIPPs’, which offer greater flexibility in growing funds within the scheme, but also how they are allocated between members.
  • Do you have more than one pension scheme, including a final salary scheme? The way in which final salary and defined contribution schemes interact is very important. Care needs to be taken when making and maintaining contributions between the two and working out the lifetime allowance, which restricts the tax free size of your combined funds.
  • Are you thinking of transferring from a guaranteed salary pension to a private plan to access the new freedoms? Leading company pension schemes have seen a dramatic rise in requests for ‘transfer values’ of final salary pension pots. Given the generational lows in interest rates these values can look extremely enticing and have risen recently as trustees of those company schemes seek to manage the rising cost of provision. As yet, these requests haven’t translated into significant switching into private schemes, but I cannot emphasis enough how much care needs to be taken here before such a transfer is made so that the monetary value of what is being foregone is completely understood – particularly if the company scheme is very well funded. In any event, transfers over £30k must be accompanied by independent financial advice. Some company plans will let you ignore that advice if it’s against switching, others won’t. There are specific scenarios where a switch may be justifiable, but only after very careful consideration. I can’t cover everything here, so the best option is to call is you have any concerns.


Please remember:

  • ‘Pension Theft’ is unfortunately a reality. If you are cold-called by unknown companies or advisers offering you something that seems too good to be true, then it probably is – all qualified advisers are listed in the FCA Register;
  • Past performance is no guide or guarantee of future returns;
  • Investment risks apply to all kinds of pensions. Values can rise and fall over time, so it is quite possible to get back less than what you put in, depending upon timing
  • This blog does not constitute financial advice and is provided for general information purposes only.

Blowing More Bubbles

This is my first blog of 2015. My father passed away in early March after a short illness that began before Christmas. Naturally, my family has been the most important consideration during this difficult time and some, less essential, parts of my workload have taken a back seat – and, unfortunately, this blog was one of them. But, it returns now and with renewed gusto – Dad intuitively knew a thing or two about financial decision making and I’m sure he’d approve.

In my last blog I wrote about central banks, asset prices and West Ham. After a three month break, I am still going to write about central banks, asset prices and West Ham.

Then I talked about central banks ‘blowing bubbles’ and noted that :

‘By historical measures both government bonds and equities are very expensive and although in the leading economies they are relatively stable there are signs of fissures elsewhere – especially in certain currencies and commodities.

I see the message repeated often in the world of financial advice that stability, as measured by volatility, means low risk – but that can change and change abruptly. And a general lack of understanding of the limitations of this methodology is partly why banks got in such a mess in the first place.’

Within a couple of weeks we had example of what can go wrong. And it specifically related to a financial dam bursting due to the actions of central banks.

The dam in this case was a commitment by the Swiss National Bank to peg the Swiss franc to the euro almost three years earlier. This was done to protect Swiss exporters from a rising Swiss franc that made their exports more expensive. But, in order to maintain such a peg, especially in the face of rising demand for the Swiss franc from within the Eurozone, the Swiss central bank had to do the opposite and sell their currency to buy euros.

And buy euros they did…and amassed a record pile of 495 billion Swiss francs worth of foreign currencies – almost 80% of Swiss national production. Which is simply enormous and when it became clear that the Eurozone was about to embark on its own program of quantitative easing, which would likely lead to another bout of demand for francs from Europe, the Swiss central bank decided they could not maintain the peg and removed it.

Following the announcement, the franc appreciated by 40% against the euro at one point, before settling at the end of the day with a 25% gain. What had been a stable relationship had shifted to a new plane in a move that traditional risk management implies is impossible.

While a central bank may temporarily ‘peg’ exchange rates, over the long term this is extremely difficult– especially if you are also attempting to fix interest rates with quatitative easing as many now are. It also explains how one country’s policies can be exported to other nations whether those nations want it or not.

Alpari lose their shirts.
Alpari lose their shirts.

Some of the fall out from the Swiss change of heart did not occur for a couple of days, when it then became clear that a couple of retail currency trading firms would fail – including West Ham’s shirt sponsor, Alpari.  They simply did not require of themselves or their clients enough of a financial buffer to cover such a move. They might argue that it was unprecedented, but in a world where governments are seeking to fix the rates at which they can borrow by printing money, one place where economic strain can show is in foreign exchange (fx) rates.

And these retail fx trading firms and their customers were highly leveraged. Lehman Bros, the epicentre of the financial crisis failed with leverage finally revealed as 30 times capital. These firms offered their clients leverage ratios over 100 – which is barely enough to handle daily trading noise and shines a very poor light on their business model.

So, my position remains the same – we need to be especially careful when managing risk at the moment. And I’ll keep a wary eye out for more signs of strain. I mentioned ‘fissures’ in currencies and commodities in my last blog and that remains my focus.

I also hope that I’ve given you an appreciation of how hard it is to trade currencies as a retail investor.

In the world of financial advice there is hardly any focus on currencies or commodities, but I mention both in our ‘product guide’. And I wrote the following regarding currencies –

‘please beware the glut of adverts out there from companies suggesting you can get rich quick trading currencies on a very short term basis. It’s very unlikely you’ll master the vagaries of short term foreign exchange movements, however seductive the marketing material may be.’

I can’t predict imminent movements in markets, but I can note elevated levels of risk that others either don’t see or choose to ignore. And part of that is discussing what is reasonable, and it is simply not likely that you’ll make a regular income from trading foreign exchange. I should know, I managed currency risk as part of other strategies for a long time and was paid in Yen for eight years.

If you are tempted by the hype, just ask the company seeking your business what percentage of their customers make money over a year? That should focus your mind a bit.

Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time, so it is quite possible to get back less than what you put in, depending upon timing;
  • this blog does not constitute financial advice and is provided for general information purposes only.

Blowing Bubbles

Well, I’ve managed to survive another Christmas silly season where I managed to disregard most of the lessons in good decision making that I’ve taken care to explain in a series of blogs over the past year.

The first ever blog I posted was about the benefits of delaying gratification, but as I’ve added about seven pounds in weight in the past three weeks, it’s safe to say that I have ignored that one.

In February I wrote a post called ‘making your mind up’ that explained a whole range of emotional biases that affect our ability to act rationally and make informed decisions. But then I received a present for Christmas that demonstrates one life choice that is anything but informed – I got a ticket to see my team, West Ham, play Arsenal in the league.

There aren’t many choices that you make at primary school, that convention states you cannot change for life, but your choice of football team is one of them. And remarkably, since then, the only time my loyalty was sorely tested was when as a nine year old I suffered at school the Monday after a 6-1 drubbing by the same Arsenal. Arsenal fans can view the carnage here.

Fortunately, for the current game the West Ham team are a little more robust – and were even above Arsenal in the league….at the start of the game. And the cost for a front row seat in a tired East Stand? £75.

Now £75 is what you’d pay to see the latest West End musical, but at a football match you are expected to do the singing yourself. You also don’t know whether you are paying to see a comedy, tragedy or thriller.

As it turned out, one of the linesmen was a comic, West Ham’s early disallowed goal a tragedy and the game a thriller as we lost 1-2 to the old foe. But then, I am demonstrating those biases again.. time to get back to the day job.

The West Ham bubble machine in full flow...
The West Ham bubble machine in full flow…



Central Banks Blowing Bubbles

Being in the front row at West Ham I got to see the bubble making machine in all its glory.

On a more serious note the Central Banks around the world have their own more serious version called QE (quantitative easing) or simply ‘money printing’.

QE  by certain central banks began in earnest in the teeth of the financial crisis and you might think that printing money, albeit digitally, out of thin air would be very damaging to the credibility of the money in all our pockets.

And normally it would, but in this case the central banks were using the created money to buy assets, especially their own government bonds in order to bring stability and order to markets.

At the height of the crisis it also became clear that many leading financial institutions were under threat and that they could not be dismantled in an orderly fashion and the existence of QE money provided reassurance these institutions would not fail and their underlying assets could be supported.

It was the right decision, but we must remember that it was a right decision after some very poor ones by the same central banks that encouraged the excesses in the first place.

But it is one thing to print money to bring temporary support for asset prices, it is quite another to pursue the same policy further to raise the price of all asset classes, including equities, in the belief that this will encourage self-fulfilling economic activity.

This is the opposite of the normal relationship and the problem was eloquently described by Jim Grant, a financial journalist, who I have followed for almost thrity years. In a recent speech he explained, ‘we have entertained the fantasy that high asset prices made for prosperity, rather than the other way around’.

And this is where we are now. By historical measures both government bonds and equities are very expensive and although in the leading economies they are relatively stable there are signs of fissures elsewhere – especially in certain currencies and commodities.

I see the message repeated often in the world of financial advice that stability, as measured by volatility, means low risk – but that can change and change abruptly. And a general lack of understanding of the limitations of this methodology is partly why banks got in such a mess in the first place.

What this means is that, when working with clients, extra care must be taken with the level of risk being undertaken – whether looking at a client’s own attitude to risk or the risk inherent in certain assets and products.

And with the new pension rules due this year and an accompanying list of new product offerings including peer-to-peer loans, I will certainly aim to keep our clients as informed as possible.

While a prosperous New Year is great, we are after a prosperous long term.


Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time, so it is quite possible to get back less than what you put in, depending upon timing

Two Not So New Year’s Resolutions

It seems both I and the Financial Stability Board have made new resolutions, albeit a bit late in the year.

In my case the resolution is quite a simple one – when leaving your car at the garage to have a new tyre fitted, make sure that you have ejected the cassette from the deck before handing over the keys to the mechanic.

Your first thought is probably, how come he still has a car old enough to have a cassette deck? Well these Volvos refuse to rust and back when I bought it in ’98 you got a cassette deck with your FM/AM radio and cd player.

The day before my trip to the garage I’d taken my daughter back to university. And for a bit of fun I’d found an old cassette that we last played years ago on long journeys to entertain her and her sister. It’s called ‘Disney’s Silly Songs’, and it includes such classics as, ‘There’s A Hole In The Bottom Of The Sea’, ‘When I See An Elephant Fly’ and that mind-melting masterpiece, ‘I’m My Own Grandpa’.

And we did find it very entertaining. Although, it’s rather worrying how you can remember both the words and the order of the tracks of an old children’s cassette, but can’t remember sometimes why you opened a fridge door.

The following day, on my trip to the garage, I thought I’d give the cassette one last sentimental play before storing it forever in a drawer.

As I arrived at the garage I was able to pull straight into one of the bays. Engine off, I handed the keys to a nice Polish gentleman and left to run a few errands around town to kill 15 minutes.

When I returned, the car had been moved so they could service a different one and as I paid the mechanic he thanked me and said in his thick accent, ‘Hey, by the way – nice tunes!’. And then I realised my mistake. This is what he was listening to as he moved the car – sing along:


Resolution solution?


Mark Carney
Mark Carney hopes to have found a ‘resolution solution’. Image from FSB website.

I have to admit that the Financial Stability Board’s own resolution announcement is somewhat more important than my own.

The FSB is an international body, chaired by Mark Carney the Bank of England Governor and yesterday it unveiled proposals for ending ‘Too Big To Fail’ banks. And those proposals are largely concerned with a process known as ‘resolution’.

Resolution is a means by which an institution can be orderly wound down and it is absolutely fundamental to the correct functioning of an economy. It should provide a protective legal framework within which losses can be calculated and correctly attributed to those who have assumed risk by taking a stake or lending money to a company i.e its shareholders first, then other grades of debt holders. It should also place severe restrictions on the boards of the affected companies e.g. in relation to their own remuneration.

And the key word in that last paragraph was ‘orderly’, because in the years leading up to the crisis the balance sheets of many financial institutions had become far too complex and crucially far too large in relation to their assets to be ‘resolved’ in an orderly fashion.

Initially, when severe signs of stress started to appear at smaller institutions, resolution was avoided by governments allowing takeovers by larger banks that otherwise would not be allowed under competition rules.  Some are still the subject of shareholder litigation today e.g. Lloyds takeover of HBOS.

Too big to fail

But when Lehman Bros., one of the larger financial institutions approached bankruptcy its balance sheet was so large, international, complex and leveraged other suitors for the company would only consider taking it on with heavy government guarantees. And they weren’t forthcoming as the US authorities wanted to avoid creating ‘moral hazard’ by rewarding those who had failed in their fiduciary duty.

At the time the US had a good record of orderly resolution of several failing institutions, but it was immediately clear that winding down Lehman would not be a straightforward process. Nor would it be for similar institutions which were now also rumoured to be on the brink of failure.

What Lehman had demonstrated was that troubled large financial institutions, where even their own board could not quantify all their risk, could only exist at that time with government support. And if they failed there’d be chaos – they had become ‘too big to fail’. So governments began to support other financial institutions in a variety of ways.

I won’t go into the nature of all that government and taxpayer support, but not all of it was about injecting and lending cheap funds. Some of it was about supporting the prices of those assets held by banks using policies including quantitative easing. As a transfer of wealth, some of that activity in the early months of the crisis was frankly obscene.

So, yesterday’s announcement by the Financial Stability Board is very welcome. If implemented properly it will form a vital part of the necessary reforms to banking that include transparency, counterparty risk and remuneration.

It isn’t an absolute guarantee, but it does require banks to maintain a ‘living will’ that essentially shows a true reflection of their assets and liabilities in the event of death.

And that ‘will’ should make it very clear that those who have liabilities with the bank in question are to form an orderly queue to meet their obligations, with shareholders at the front and depositors at the very rear (above the £85k limit).

A ‘Total Loss Absorbancy Capacity’ (TLAC) measure for each bank should also demonstrate how well that queue is being maintained. And new products such as CoCo bonds, that I wrote about here, are part of that overall process.

The exact details of the TLAC are, of course, complicated, but if you can get your head around the lyrics to ‘I’m My Own Grandpa’ you’ll have no problem understanding, at least, some of them.


Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time, so it is quite possible to get back less than what you put in, depending upon timing

Peering into Peer to Peer Lending – part two

I apologise again for the length of these last two posts, but these will soon be eligible ISA investments and advice is unregulated at present. In due course, I’ll produce a more comprehensive guide – if you are interested just email me.

I mentioned in my last blog that I certainly have admiration for those who are responsible for getting the peer-to-peer (p2p) industry in the UK to where it is today. Over £500 million in loans were matched in the first half of this year and it is now regulated by the Financial Conduct Authority.

And there are plans to make p2p loans allowable investments for ISAs from April of next year. The latest consultation, containing 24 questions, was announced by the Treasury on Friday and the delay in this post is in part due to waiting for its release.

Much of this nascent industry’s growth is put down to its positive image as an alternative to traditional banking. And while that may be a real cause-celebre for a lot of lenders and borrowers matched in this way, they are also benefitting from a rather fundamental thing – price. Borrowers are paying less interest and lenders are receiving more.

But, lenders are also taking on two significant types of risk, credit risk and liquidity risk. Depositors in a bank may earn less for similar time frames and there may be certain access restrictions, but within the FSCS limit of £85,000 they know they are getting their money back.

Both of the leading p2p companies, Zopa and RateSetter, look to mitigate credit risk, the risk that borrowers default on their loans, by offering protection funds. These are pools of money, funded by fees paid by borrowers that aim to meet in full the costs of expected defaults according to each company’s own risk models.

And to date they have. Both Zopa’s Safeguard Fund and RateSetter’s Provision Fund have 100% records – in other words, all default losses to date have been met by the capital buffers in their respective funds. Zopa has even lowered the level of contributions as its overall rates of default have been so low – it claims to have the lowest default rate, including the high street banks, although I do not know if they are strictly comparing like for like.


I mentioned in my last blog what they’ve got right, but what could go wrong?

Well the main concern has to be that these products and their protection funds have only been operating over a short time frame economically – RateSetter was established in 2010 and although Zopa is several years older, it’s Safeguard Fund is only a year old. The corresponding period also happens to have been one of the most benign environments for consumer lending.

And there is a danger that in such an environment confidence in their own credit risk models becomes self-reinforcing. Rather than creating a larger loss buffer that might work better over a full economic cycle, it could be they are set at a level that suggests near term default rates are the best indicator of future ones.

At present, it looks as though Zopa’s buffer is set about 1.5% of loans outstanding. But, during the financial crisis, albeit with a far smaller loan book, their website shows a default rate of 5%. Of course, they may have improved their risk analysis since then and it’s important to appreciate those conditions are viewed by many as a once in a lifetime extreme event.

But it wasn’t an extreme event in terms of the level of interest rates in the UK, and I know Zopa haven’t used consumer lending data from before they were established in their risk analysis, because I asked their CEO, Giles Andrews this summer at a FT conference.

We are also still in the midst of a false environment where interest rates are at generational lows due to central bank intervention. They would like to roll that back gently, but they may not get that wish given recent volatility.

As a comparison commercial banks are required to hold buffers of nearer 10% against potential loan losses over a full economic cycle. But, and it is a big but, loans extended by banks are somewhat different because banks are allowed to use leverage i.e. lend more money than they have in deposits or other assets. They also have a broader range of lending from short term retail loans to long term commercial mortgages.


Understanding liquidity risk

The second major concern is liquidity – the ability to get quick access to your money by selling your loans to another investor. Both p2p providers have plans in place to enable lenders to do this for a fee – in Zopa’s case 1%. And it all sounds very straightforward and, at present, I am sure it is.

But your ability to sell your loan on to someone else, depends on there being another willing lender. If the market interest rates for the type of loans you are holding have risen you will have to pay the balance in interest to the new holder of those loans. And the availability of other willing lenders may be affected by a variety of things, such a sudden increase in default rates, interest rates in general or a loss of confidence due to problems at another p2p provider.

So, there are no guarantees to return money within a given time frame, even though at present it may work well. And this liquidity in what is known as the ‘secondary market’ in p2p loans is at the centre of a lot of the questions about their eligibility for ISAs – all other eligible investments have established secondary markets i.e they can be bought and sold relatively easily.


The market is evolving.

What began as a matchmaking service for individual lenders to meet individual borrowers has begun to change. New institutional lenders are now being catered for that are looking for packages of bespoke loans. This is particularly true in the States, where the FT reports that the two leading p2p firms Lending Club and Prosper are each about to package loans so that they can be sold as a single security, complete with a credit rating.

This has all sorts of implications, but as far a retail investors are concerned the regulator needs to ensure that they are not being disadvantaged as what is effectively a marketplace in these loans develops

What's good for love is good for finance. Behavioural techniques used to match couples will be adapted to match lenders and borrowers.
What’s good for love is good for finance. Behavioural techniques used to match couples will be adapted to match lenders and borrowers.

If you think this is all sounds very corporate and far removed from the original ethos of the p2p business model. I’d note that a new p2p company in the US called Payoff has just hired Galen Buckwalter, the brain behind the compatibility matching engine for eHarmony, the dating website (hat tip to the FT for that snippet). He’ll be introducing a bit of behavioural science into their loan assessments, no doubt based on the lessons of love. Aww.


Apparently money does grow on trees

I am already way, way over my allotted blog word limit, but I want to emphasise that I am not against p2p lending at all. Any regulated competition for high street banks is welcome. And there are other parts of Europe, especially Italy, where the traditional banking credit lines are broken and new sources of credit for their small and medium sized firms and consumers are really needed.

I just want to emphasise that while returns from this type of lending are very seductive, particularly as they can be structured to pay out in the same style as a plain annuity. And you need to be aware of risks, especially as the current p2p investment environment is so welcoming – by the companies themselves, the government and the FCA.

And it’s worth noting that, while these firms are now regulated by the FCA, under the current regulatory regime, not all regulation is the same. The provision of advice to lenders/savers on entering into a peer-to-peer loan is not a regulated activity.

Here’s Zopa suggesting money can grow on trees.

For clients interesting in learning more, please feel free to contact me for more comprehensive analysis. The information contained in this blog draws, in part, on information gained during the excellent FT sponsored Camp Alphaville event this summer.

Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time, so it is quite possible to get back less than what you put in, depending upon timing

Peering into Peer to Peer Lending

This is the first of two posts that are going to be long on detail and short on humour,  but the subject matter is important and I don’t think it’s been covered very well for retail investors unless you happen to read the FT on a regular basis.

This year is setting up to be a transformative year for peer-to-peer lending (p2p) – an area of finance that began matching individual lenders and borrowers using the advantages of the internet.

It now has its own body, The Peer-to-Peer Finance Association, which announced at the end of July that UK lending platforms had arranged over £500 million in new loans in the first half of the year. And, after much lobbying from the p2p industry, it became regulated by the FCA on the 1st April.

But the biggest impetus for growth was highlighted by Giles Andrews, Chief Executive of one of the market leaders, Zopa. In a Reuters article he noted, “The peer-to-peer industry is growing faster than ever and we’re looking forward to offering new products like ISAs in the near future”. He was referring to the Spring Budget when it was announced that p2p loans would be eligible investments for ISAs from April next year, although the exact structure has yet to be announced.

Zopa pioneered the model for p2p in 2004 by providing the original platform where personal savers could be matched with personal borrowers. In doing so, by cutting out banks, both savers and borrowers could get better rates. But there is naturally a concern about the risk of default involved in this direct funding model, especially as these are personal loans and they are unsecured (not guaranteed against an asset).

If you are making unsecured loans, your first defence is that you know enough about the borrower and that you are the getting the right rate of interest. But Zopa does more than screen borrowers for their chance of default, it also allows loans to be split between many borrowers to spread risk. And an internet based platform is ideal for bringing all those factors together.

It also means you can tailor pools of loans with different risk profiles for lenders with different appetites for risk. And this was the dominant model until 2010 when a competitor called RateSetter was launched.

It offered simplicity and an additional way to help manage risk to reassure lenders further. It charges borrowers a small fee that together add up to what it calls its Provision Fund to meet the likely costs of default. And since launch that fund has been sufficient to meet any losses.

RateSetter also looks more like a saving site. And now so does Zopa, which since May of last year has its own default protection fund called Safeguard. Again, it has met all its default claims so far. Both companies explicitly state that loans/savings are not covered by the Financial Services Compensation Scheme, but they are doing their best to give you peace of mind with this part of their overall offering.

So what to make of this relatively new and rapidly growing part of the investment landscape?

Well, I first have to state my admiration for those involved in getting these companies to where they are now. There have been some small failures at other companies, but these two are well established, regulated and growing. I should also point out that there are other p2p companies specialising in areas other than retail loans – one called Funding Circle has a successful model lending to smaller businesses.

They are all, no doubt, benefitting from a general desire to move away from banks. But I think that does them a disservice. Their main attractiveness is price and the nature of their service – lenders and borrowers are getting better rates.

And the p2p industry clearly wants to bring this to as broad a market as possible. Hence the innovations by RateSetter to look more savings friendly, which have been mirrored by Zopa. Both their headline returns of just over 5% look enticing, especially if put in an ISA. And the ISA development is important, because outside of an ISA tax is charged on the interest earned and default losses, if there are any, aren’t deductible from those earnings.

But, as ever, there are several important things to consider. Some are to do with risk and some to do with how the market develops.

Clearly the main point is that funds are not covered by the Financial Services Compensation Scheme, but I’ll cover the other substantial points in my next blog. And it’ll be a bit different to the marketing information found on the p2p company websites.

In finance we love growth, but if you see one of these growing in your garden don't smoke it.
In finance we love growth, but if you see one of these growing in your garden don’t smoke it.

All this talk of rapid growth is reminding me that I need to remove a rather large weed from outside our bedroom window that my wife and I thought we’d let develop as we’d never seen anything like it before. It turns out to be a plant called Jameson weed or ‘datura strarmonium’ to give it its proper name. Apparently, it is a powerful hallucinogen and deliriant. And I thought our chickens that share the same area were just getting paranoid.

Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time,  so it is quite possible to get back less than what you put in, depending upon timing

Are CoCos Nuts?

I was going to write about peer-to-peer loans this week, but instead I am going to concentrate on another new type of investment that offers high headline rates of interest.  They are known as CoCos and this week the Financial Conduct Authority used a new tool in its armoury to effectively ban their sale to retail investors.

Any resemblance between myself and this coconut is purely coincidental.
Any resemblance between myself and this coconut is purely coincidental.

The ban states that contingent convertible instruments, to give CoCos their full name, are ‘risky and highly complex instruments’. And indeed they are and I certainly welcome this pre-emptive ban. If a product can’t reasonably be understood by a private retail investor or, frankly, those advising them then clearly trading in it should be restricted to those with far more experience.

But I thought I’d give you a bit of insight into what they are and why they exist. And it’s not a story about financial recklessness, quite the opposite. They are a tool intended to aid financial stability – although with billions now in existence, that has yet to be tested.

One of the great realisations of the recent crisis was that some financial institutions were ‘too big to fail’. In other words, they had become so large and so complex that if they became troubled, that trouble would quickly spread to other financial institutions and threaten the whole financial system. I have written in previous blogs about a ‘network effect’ and this made the financial sector especially vulnerable.

And the poster child of this problem was an investment bank called Lehman Bros. When it failed in 2008 it set off waves of destructive ripples through the balance sheets of other financial institutions that were more severe than regulators in the States or elsewhere expected.

They had hoped that through a process known as ‘resolution’, the bankruptcy of Lehman could actually be orderly and give confidence to the rest of the market. And it’s true to say with other failing banks this did work, such as Washington Mutual. But with Lehman, which had a large and highly leveraged international operation, it patently did not.

And that realisation meant that regulators around the world knew that, given the resolution process was so inadequate, that they would have to keep their major financial institutions alive – even if that meant providing them with vast tax payer funded loans.

Now you don’t need me to tell you how unpopular those bailouts were and remain. And institutions, such as the Bank of England have been looking at ways ever since to improve that process of resolution so that if a bank gets into trouble it can be resolved in a more orderly fashion – and without resorting to the national purse.

To do that it wants to insure that, not only do banks have sufficient capital as a buffer against losses, but also that those who provide that capital via loans (bonds) and equity (shares) know that if that buffer gets depleted they are first in line to meet those losses – not depositors, not those who have lent the bank money that is secured against an asset for example and not tax payers.

So how do CoCos make this process more orderly? Well, the buffer I mentioned above is officially known as Tier 1 capital and a loan to a bank that helps meet this buffer has very little protection in the event that a bank needs to use the loan to meet losses.

What then normally happens is that there is a long drawn out process where the lenders meet with the bank to see how much of their money they will get back and only when it becomes clear it will be very little will lenders reluctantly accept shares in the bank as compensation for losing the value of their loans – known as a debt for equity swap.

Now, long drawn out processes are not good for market confidence or stability. Investors like certainty and this is why the Bank of England has championed the development of CoCos, because they have this whole process already built in.

If you own a CoCo loan with a bank, you already know that if the Tier 1 capital is threatened your loan will be converted to shares in the bank. The Lloyds Bank CoCos convert if the Tier 1 capital falls to 5%. And from the Bank of England’s perspective, they have control over this simplified process as they are responsible for announcing the conversion has been triggered.

It also ensures that at exactly the time that a troubled bank needs the benefit of swapping a loan for shares it is able to do so. You could call it repayment insurance for the original loan.

One of the proponents for these types of convertible loans or bonds is Andrew Haldane, the Executive Director for Financial Stablility at the Bank of England. He laid out the case for their use in banking and other areas in a speech titled ‘Debt Hangover’ in 2010.

I got to hear him speak on the more recent topic of ‘This Market’s Nut’s’ at Camp Alphaville, which I mentioned in my last blog. He was one of several speakers on the topic and it was not his choice of title, but there was clearly awareness that all this liquidity central banks have created, coupled with a low interest rate environment have led to a chase for high interest rate investments – whatever the risk profile.

And I suspect this is also in part where this ban has come from. Not only do the Bank of England and the FCA want to avoid poorly informed investors holding such products at this time, but if the Bank of England ever pulls the conversion trigger on one of these loans they do not want to be dealing with a bunch of retail investors claiming they never understood the risks.

Far better to be dealing with experienced investors, used to valuing other complicated hybrid investments such as convertible bonds – my own specialist area for several years.

And even where investments are allowed it’s important to know their limitations or know someone who does. And this whole series of blogs is designed to help you do that. It’s so easy to get over confident as I have mentioned before.

My wife and I still have the emotional scars from the time, given a background in art, I offered to apply her makeup for her. I was hoping for the subtle look of Coco Chanel, but she got the more distinct appearance of Coco the Clown. The pictures are here.

But that’s enough cocos for one day!

Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time,  so it is quite possible to get back less than what you put in, depending upon timing

Sex & Drugs & GDP

On a trip to the coast a fortnight ago, I went inside a café to order a couple of ice-cream cones. Ahead of me in the queue was a father, who was looking a little stressed. He was waiting for a few burgers and hotdogs for his family and it was taking a little longer than expected.

He wasn’t the only one who was a little tense. The staff were feeling the heat of the kitchen as well – and I was wondering how I managed to get on the wrong queue again. His order did finally arrive and everything seemed to relax a bit as the lady behind the counter entered his order into the digital till.

In anticipation, the dad stood there with a twenty pound note in his hand and I doubt he expected much change. However, the final total on the till suggested he had under-clubbed it a bit. The price for some soft drinks and a few burgers and hotdogs? £26,000.

A bit pricey for a few burgers and drinks.
A bit pricey for a few burgers and drinks.


He quite calmly said, ‘I wasn’t thinking of spending that much’. And from the back of the kitchen came a distant voice, ‘has the till gone wrong again?’

They settled on an amount nearer £15 and my own bill was a more moderate £3.20 as we resorted to the old analogue system of a notepad to record the trade and cash to pay for it.

I mention it because, for a fleeting moment there, the Gross Domestic Product (GDP) of the UK was artificially raised by approximately £25,985.

I am jesting, of course, but last week we learned that the Office for National Statistics will attempt to add the oldest industry in the economy to their quarterly estimate of how the economy is faring. From September, as part of other changes that will lift GDP by 2.3%, they will include the value of drugs and prostitution.

It’s important to emphasise the word ‘estimate’. GDP figures are reported and debated in the media as though they are factual, but they are subject to revisions as some parts of the economy are far harder to assess than others and not all the data arrives at the same time.

In this case, the Office for National Statistics kindly give us a separate Excel spreadsheet that shows us their assumptions. In total, it amounts to £9.7 billion, based on 2009 prices, or approximately 0.7% of the then GDP – and it breaks down as follows:

Prostitution        £5.27 billion        54%

Drugs                  £4.43 billion        46%

In the case of prostitution they reached that number by estimating there are 60,879 prostitutes in the UK – each with 25 clients a week paying £67.16. If £67.16 seems ridiculously precise, it’s an old figure of £50 adjusted for inflation. Take off costs of £44 million, which were borrowed from a Dutch estimate and you get the final figure.

And for the drugs industry, cocaine in its various forms represents 71% of the total (42% crack, 29% powder). Those numbers allow for the cost of importing it, so the sales figures are even higher with cocaine accounting for 77% of the grim total.

So why are they attempting to do this?

Ostensibly it is to meet European Union rules to establish common practice among member countries. The Dutch, for example, have reported parts of these figures for years as prostitution and certain drugs as are legal. However, the overall changes are also in line with international guidance from the likes of the US and Australia.

It’s hard to argue with the idea of trying to measure all areas of the economy and some countries have a lot of work to do. In April the IMF endorsed a near doubling of Nigeria’s GDP to $510 billion as new industires were added and prices updated. As the Economist newspaper pointed out, the new numbers aren’t fiddled, it’s the old numbers that were wonky.

So what’s most important is that the numbers as a whole are regarded as credible. And the numbers of two countries stand out as being questionable.

The government of Greece, endorsed by some economists, justified higher levels of national debt before the recent crisis due to the estimated size of its black economy. At the time, as now, it wasn’t even collecting normal levels of tax on its legitimate one. We know how that one turned out.

And then there’s China, where the GDP figures miraculously meet official annual targets near 7%, despite the sheer scale and complexity of their calculation. Mathematically, continuous growth of 7% is a notable number – it means the economy is doubling in size every ten years. And if an economy of that size is really growing at that rate, they are more likely to bump into problems – especially rising levels of debt.

Michael Pettis, a professor of finance at Peking University, whose blog we have followed for some time, now makes the case that it can’t continue that way – the country needs to rebalance towards lower growth nearer 3 or 4%. I’m not sure the investment world fully appreciates that.

I’ll leave the final comment to the lyrics of Ian Drury, from whom we borrowed the title of this blog. He knew a thing or two about simple explanations of complicated subjects. My favourite has to be these two verses about two well known gentlemen from ‘There Ain’t Half Been Some Clever Bastards’ –

Van Gogh did some eyeball pleasers

He must have been a pencil squeezer

He didn’t do the Mona Lisa

That was an Italian geezer.

The next verse isn’t quite as factual, but brilliant nonetheless

Einstein can’t be classed as witless

He claimed atoms were the littlest

When you did a bit of splitting-em-ness

Frighten everybody shitless


Time For A Little Caution

I appreciate that last week’s blog regarding changes to pensions and annuities in the Budget was a little technical and on the long side, but if you managed to gain a little more understanding of how simple annuities (and mortgages) work and why that knowledge will still be very useful, then it was worthwhile.

This week’s blog will definitely be easier on the brain, but I want to look at other changes in the Budget concerning additions to the list of eligible investments that can be made in an ISA. To quote from the Budget itself, ‘ISA eligibility will be extended to peer-to-peer loans…..the government will also explore extending the ISA regime to include debt securities offered by crowdfunding platforms’.

I will be producing a guide to the different classes of investments very soon and that will include some information on peer-to-peer loans and crowdfunding. But for now I want to emphasise a point I made in an earlier blog ‘The Wrong Trousers‘.

Having extra types of investment that offer a yield is fine, but when making an investment you need to be able to read its label and understand it, or know someone who does. Simply because an investment appears to offer a high income, say over 7%, or a tax break or both doesn’t mean it’s a good choice.

And the environment at the moment appears falsely benign as governments continue to print money to buy their own debt (QE) and therefore lower the interest payable on that debt. But the resulting cheap money means there’s a lot of dosh out there seeking out more and more risk for less and less return – and the yields on some junk investments are back to where they were before the financial crisis.

In short, it’s time to exercise a little extra caution, whatever the asset class.

Next week I’ll review Michael Lewis’ latest best seller ‘Flash Boys’ – which is actually a well written book about the development of electronic trading in the States and its implications for markets as a whole. I grant you that isn’t the most natural subject for a best seller, but Sony has apparently aleady acquired the film rights.

The topic is of particular interest to me as I was involved in developing electronic trading in its earliest incarnation in Tokyo. We didn’t have much ‘flash’ speed back then as we had to transfer information via ‘floppy’ disk – and there was far less controversy than now. In any event ‘Floppy Boys’ doesn’t have quite the same ring to it.


Risk note:
Clients are reminded that the values of some kinds of investments can fluctuate over time; that past performance is no guarantee of future returns; and that it is possible to get back less than what you invested, especially in the early years.
This blog is based upon our initial understanding of the Spring 2014 Budget, but proposals may be modified or delayed by legislation.
Please therefore treat this content as general guidance only, and seek personal advice on specific issues.