From the very beginning of our work at the P2P Foundation, we were in touch with Chris Cook, who has been working on open capital formats, a kind of peer to peer based market reform, which could be enabled by new methods of corporate governance, such as the UK-based Limited Liability Partnerships.
I’m must admit I still have a difficult time grasping what it is about, but I’m assuming that at least a few of our blog readers have a better understanding of market economics, and I wanted to mention Chris Cook’s work again, as he is involved in work in the sensitive Middle Eastern region.
What follows is first a general explanation of his approach, then the specifics of the proposed Gulf initiative. His work also has an interesting critique of carbon trading, since Kyoto thought as the panacea against global warming. The whole issue is reported here, in the Gulf Research Council’s Research Bulletin.
1. Introduction to Open Capital
Both Debt and Futures contracts require future performance of an obligation at a fixed price. Both result in a multiplication of risk known as â€œgearingâ€ and require risk management through the use of risk capital by a credit intermediary (bank) or risk intermediary (Clearing House) as the case may be.
Such contracts, which rely upon the issue of a claim over value (IOU) by a Bank, or a â€œshort saleâ€ by a seller may be characterised as â€œDeficit-basedâ€ finance. Where a bank loan, or margin, is secured by collateral it may be said to be â€œdeficit-basedâ€ but â€œasset-backedâ€.
Having spent much time in the study of Islamic finance in recent years I have yet to learn how â€œgearingâ€ of any sort may be consistent with Islamic values.
â€œAsset-basedâ€ finance, on the other hand, is based upon investment through ownership of a productive asset and/or itsâ€™ production or revenues in a legal vehicle.
Conventional â€œEquityâ€ finance is based upon ownership using the legal vehicle known as the â€œJoint Stock Limited Liability Companyâ€ or â€œCorporationâ€: however, the emerging use of unconventional legal vehicles is becoming a global phenomenon.
In Canada, for instance, virtually the entire Capital market now consists of two tiers, the first being shares in conventional listed Corporations, and the second being units in Income Trusts, whereby part of a Companyâ€™s gross revenues are committed into Trusts and units sold to investors.
The phenomenal growth of Income Trusts has been due to the appetite of Pension funds for gross revenues before company managements are able to access them: ie pre-distributed corporate revenues.
A similar outcome, but without the tax and management issues and complexities which make trusts so popular with lawyers, is also now possible using LLPâ€™s (or in the US, LLCâ€™s) to create â€œCapital Partnershipsâ€ whereby proportional units or â€œequity sharesâ€ in revenues or production are shared as between providers and users of capital. The outcome will be immediately recognisable to students of Islamic Finance as â€œMusharakahâ€.
The contracts I propose essentially consist of units in a â€œPoolâ€ of commodity production constituted as a fund within a corporate â€œwrapperâ€.
Sellers will sell production into a Pool, and Buyers will buy production from the Pool, and the market price will be based upon an auction process established by reference to actual deliveries â€“ the â€œspotâ€ price.
Investors may buy and sell units in the Pool at any time but do not â€“ by definition – participate in the auction.
The result is a new asset class not dissimilar to â€œExchange Traded Commodityâ€ funds. Producers may both â€œhedgeâ€ sales by selling production forward and receive what is in effect an interest-free loan: likewise consumers may hedge purchases by paying now for future consumption.
For investors the result is a simple new â€“ un-geared, and hence suitable for â€œretailâ€ investors – mechanism for investing in commodities.
The outcome is also of a continuous asset class of commodity â€œunitsâ€, as opposed to a fragmented and continually â€œrollingâ€ series of contracts typically with monthly expiry dates. This will lead to dramatic savings in the transaction costs of holding an investment in commodities over time. If gearing is required units may be bought with borrowed money, or option contracts may be used.”
2. The rationale of a proposed Gulf Clearing Union
“The Iranian OPEC representative informed us that he had advocated for some 20 years the institution of an â€œOPEC Bankâ€ and related financial institutions.
In recent years we have seen proposals for a Gulf â€œSingle Currencyâ€ among OCC states but this appears increasingly remote, particularly now that Kuwait has led the way in leaving the â€œDollar pegâ€, and the dollar appears to be in secular decline in the absence of remedies the US is politically unable to apply.
While some commentators suggest that the Euro may come to replace the Dollar as a global reserve currency, the truth of the matter is that no deficit based currency is sustainable in the long term in a world of finite resources.
What then is an alternative?
Using the market and contract architecture outlined above it is possible to imagine how Gulf States, extending to Iran and Iraq, could commit a proportion of production of both crude oil and LNG to â€œPoolsâ€ the units of which could form a â€œCarbon dollarâ€.
In fact, I believe that it is only through the use of an â€œLNG Poolâ€ in this way that a viable global market in LNG can ever be attained. This is due to the incompatibility between
â€¢ the need for spot cargo trading upon which to base a futures market; and
â€¢ the necessity to tie up production in long term contracts in order to obtain deficit-based infrastructure finance.
The â€œCarbon dollarâ€ would initially be launched â€“ in the same way that the Euro price was â€œfrozenâ€ in relation to all the national currencies of its participant Member states – by calculating the amount of carbon in each form of crude oil, LNG etc a dollar would buy on the launch date, or upon the accession of a new energy source to the Pool. â€œCarbonâ€ Dollars would thereafter diverge from â€œFedâ€ dollars and would thereafter be a new â€œasset-basedâ€ globally â€œfungibleâ€ unit of exchange.
Transactions would be made upon a global market network, which, with the addition of a mutual guarantee would constitute the International Clearing Union which J M Keynes proposed at Bretton Woods in 1944 based upon an abstract â€œValue Unitâ€ he called a â€œBancorâ€.
Why would Banks possibly agree to such a radical structure?
In fact, we simply rephrase the question and ask Banks why they would wish to risk their capital by creating credit based upon it when in fact they may instead act as pure service providers:
(a) managing the bilateral creation of credit among trading counterparties â€“ a classic â€œTrust Bankingâ€ approach;
(b) appraising investments, bringing investors together with investments and providing liquidity â€“a classic â€œInvestment Bankingâ€ service.
So, in this model, Banks would have a future as a service provider rather than as an intermediary, and their interests are entirely aligned with those of other stakeholders as opposed to being in conflict with them.”
3. Proposed International Carbon Trading Union
“The problem with the proposed global markets in â€œCarbonâ€ eg emissions tradingâ€ and carbon offsets is that they are based upon markets in carbon emissions of CO2, as opposed to the carbon content of fuel.
The â€œdeficit basisâ€ of these carbon markets is best understood by an analogy overheard at a gathering of traders â€“ always noted for the dispassionate and objective nature of their judgments:
â€œIf you want to keep a donkey healthy, you donâ€™t regulate what comes out of it, but what goes inâ€.
The Inconvenient Truth of these markets in carbon is that they were invented by trading intermediaries largely for trading intermediaries.
The use of Carbon dollars based upon the carbon in fuel as opposed to that in emissions essentially monetises Carbon, and means that to reduce Carbon use will â€“ literally â€“ be to save money.
There is a window of opportunity for Gulf States to lead the creation not only of a simple oil market architecture which is not dominated by manipulation and speculation by intermediaries, but also a new â€œasset-basedâ€ financial system based upon a â€œCarbon Dollarâ€ value unit.
The use of this architecture in respect of LNG would combine both a new financing mechanism for the massive necessary investment in (and indeed refinancing of) global LNG infrastructure and a resulting new market in homogeneous undated and un-geared LNG â€œunitsâ€ with vast potential.
Since LNG is a new market, without the sensitivities of the existing fragmented and opaque markets in crude oil so evident in the Iran Oil Bourse project, there is scope for development using the new â€œasset-basedâ€ architecture I describe above.
The concepts outlined in this article require an immense amount of research and development, in addition to diplomacy and statesmanship of a high order.
An International Carbon Clearing Union similar to the concept outlined by Keynes at Bretton Woods is both achievable and urgently necessary since no deficit-based financial system is in the long term sustainable in a world of finite resources.”