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http://content.yudu.com/Library/A1w7r3/EntrepreneurCountryM/resources/54.htm

http://www.independent.co.uk/news/business/analysis-and-features/next-big-things-on-the-internet-6284274.html

My initial reaction on Friday morning was of pride – I respect leadership, and, for the first time in a long time, I felt that a British Prime Minister had not crumbled, had not caved in to pressure and had stood his ground for what he believed was right. I like the fact he stood up to “Merkozy” and, from what I was reading of why, I believed he was right. We, the UK, must come to terms and accept that the only thing the rest of the world wants from us, aside from Arms, are our Financial Services. That is where our comparative advantage lies. We account for over 50% of Financial Services activity in Europe. In 2010, the £36 Billion surplus in Financial Services, helped to counter the £98 Billion deficit in Trade and Goods. It directly accounts for 10% of the UK’s GDP, with the likely indirect impact closer to 25-30%. What right do the French and Germans have to erode our core industry? The French have Agriculture, the Germans have Engineering, we rely on financial services to keep our economy ticking, with the benefits of the wealth created trickling down to all corners of society. I don’t condone the current state or management of our banking sector in any way, in fact I am working hard to change it, but the unparalleled skill set we have in finance is undeniable.

However, over the course of the weekend my thinking has changed a little. It appears that Cameron may have made a bit of a faux pas. It seems as though he would have been able to veto any resolutions impacting the city even if he did sign the agreement. It appears he pushed a little too hard and in the wrong way. Continuing to be part of the EU, we now don’t really have a say on future rules that will impact this country. He did not ask for an opt-out of certain clauses, but actually asked for unanimity voting on certain issues related to the city that would currently be resolved by super majority vote. There was no way it would have been supported, particularly and further given the way he apparently presented the demand; a late distribution of a paper documenting the proposal, without any prior attempt to build support through face to face lobbying/discussion with individual stakeholders.

I have serious concerns about the proposal signed on Friday morning – it sets a precedent for a United States of Europe, controlled by the Germans (or maybe the French? – nah) in the aftermath of a euro breakup and, potentially, sovereign defaults. The agreement answered questions that the French and the Germans wanted answering, not the questions that needed to be answered.

I doubt there is much that can be done to stop the redefinition of Europe and the Euro, save the European Bank pumping billions of Euro’s into the system to help cover the interest payments that need to be paid.  See, just like for a business, cashflow is king for an economy too.  Just like in a business, an immediate impact to cashflow can only be made by slashing costs (public spending) while looking for solutions in the mid to long term to increase revenue/growth through sound economic investment and stimulus.

The way I look at it is that European countries have gotten fat and lazy; with the continued lowering of inter-country trade barriers, we are losing more and more of our advantage against the rest of the world, but still like to parade around like Kings. The throne is crumbling. In respect of the UK; I think we, as citizens, over estimate our position: The international demand for UK government debt (gilts) relative to euro debt is alarmingly low and acts as a barometer for foreign sentiment; nobody wants to invest in the UK any more. Across Europe, we have spent way beyond our means and our prospects. We have supported our economy with debt rather than look to grow revenues through innovation and diversification.

The key, for me, to the UK’s future prosperity is in the foundations that Government can create for private business to build new areas of comparative advantage for the country. Entrepreneurs, by their nature, seek out and leverage excellence, nurturing the skills needed to address market opportunities, improving Total Factor Productivity for the nation. Entrepreneurship is fundamental to a country’s competitiveness and growth.

The improved EIS incentives announced in the Autumn Statement are a good start, the push for tech city is another. Indirectly, investment in infrastructure/transportation will also help. Arguably, we, the public need to lend a hand – the approach to risk in the UK hampers our potential; compare to the US, where more are willing to take punts in venture capital, to invest in gambles, to take chances and work hard to help their investments succeed. We sometimes forget that the wealth of this country lies in the hands of a few – starting a business, making it robust, and ensuring success requires CAPITAL. It is only a few that have the capital readily available and those few need to be incentivised to help those less privileged to progress and shape ideas into the businesses that will be the future of this country.

We can’t rely on the government solving all problems – for all the good our democratic political system delivers, it is hampered by a lack of long term planning. Government can never be secure in a lengthy tenure nor of unilateral stakeholder (public) support, and thus focus on short-term policy to deliver impact to win the next general election. Comparing again to business, I remember reading the case study of Jack Welch at GE, who asked outright for his major shareholders to support him through thick and thin, to question and criticise his decisions constructively, but to give him the leeway to shape the company for the long-term.  Bill Gates, Steve Jobs, Michael Dell…there are countless examples of how business leaders, having confidence in their tenure and support, were able to shape competitive advantage and grow world leading organisations.  As for countries, look to Singapore and what it has achieved. More controversially, look at China.

I do not advocate (soft) dictatorship. I do advocate unity. Regardless of individual political sentiment, we have voted them in by majority to lead our country.  I feel privileged to have at this time a bipartisan board running UK Plc; a more representative government with differing opinion – a model of good governance for any company. The Government does need to make tough decisions – they need to turnaround a country. They need a cushion of confidence to be able to do so.  The Government must address critical immediate issues by being harsh; cutting spending, as discussed earlier, is the only way to have an immediate impact. But the UK Government must also be supported and encouraged to build the structure and institutions that will enable entrepreneurship to flourish and drive our economy forward, to ensure we don’t get into this mess again, to ensure we maintain dignity and a place of influence on the world stage. British entrepreneurs, by creating new sources of comparative advantage, will ensure the world continues to needs us.

I won’t bore you with my comments and thoughts on the overall statement, George’s performance or Ed “balls” Balls counter – If you are interested, track my tweets back for the instantaneous reactions. (I will however reiterate one point that is still perplexing me – Ed at one point used the phrase “illiterate fantasy” can somebody please explain that to me????)

I will instead focus on the crux of my loss of sleep for the past few nights, in the hope somebody can prove me wrong and put my mind to rest.

The National Loan Guarantee (NLG) scheme was announced as a measure to provide SMEs with access to cheaper finance – a potential saving of 1% on the cost of borrowing Goerge said. “Great!” I thought. The saving would come about as a result of the UK govt. providing guarantees for borrowing. “Woohoo!” Went my brain.

Then, after a latte and a jog, being the curious fellow I am, I started to delve a little deeper into the proposal, started doing some research on how the scheme would be delivered. This is when neurons started popping in my head.

See, this is what I understand; and it worries me. Hence why I would dearly love for someone to correct what I must obviously have wrong: the NLG benefits the banks with low to almost zero benefit to SMEs.

From what I understand, the NLG scheme will allow BANKS to borrow in the money markets, most likely by issuing bonds, to the tune of £20billion, backed by a government guarantee. I.e. if the BANK goes bankrupt, the govt. will pay out to the owners of the bank debt. As a result of this guarantee, the banks can borrow at lower rates, essentially because they are borrowing under the Govt.’s AAA credit rating. It is then assumed that the banks will pass on the cost saving to SMEs seeking loans. So the SME loans are not actually guaranteed themselves.

Here is the thing – I can’t find any evidence to suggest that the banks MUST use the £20billion they raise to lend to SMEs. This is extremely concerning, and as I said, nagging me to the detriment of my sleep.

If my suspicions are correct and the banks are not obliged to lend the money to SMEs, they will not; for the same reasons they are not lending today. Credit risk and the high (highest) capital charge for lending to SMEs will not change. The opportunity cost of lending to SMEs will continue to incentivise the use of funds in other areas of the bank – lending to larger corps (a shift in capital allocation I identified in a previous post that is clearly apparent in project merlin stats) or, more likely, into their capital markets divisions.

Essentially, without a contract forcing them to lend the money to SMEs, the funding raised under the NLG will be used to bolster liquidity in day to day operations within capital markets, thus further increasing the profitability of this part of the bank, by increasing the scale of the activity that can be carried out. In a similar vein to Quantitative Easing (who holds large quantities of govt debt? The banks. Who processes the transactions for other institutions selling bonds back to the govt. and charge a fee? The banks. What happens when the govt announces a QE programme which runs for several months? The price of the bonds goes up – more profit to…..yes you guessed it, the BANKS), the wool is somewhat being pulled over our eyes; the banks are guaranteed to benefit, SMEs will likely be no better off.

It could be that more detail on the mechanics of the NLG scheme will emerge that subside my concern. It could be, as I have stated I hope, that I have got this completely wrong. I pray it will be so; for the benefit of our economy.

The key recommendation of the paper is the set up of a British Industry and Enterprise Bond scheme. Bonds issued by the government, predominately to institutional and also retail investors, that pay interest based on an underlying pool of securitised SME loans.

The proposal is a good one. The paper addresses the mechanics; rather than the securitisation occurring at the bank level, the Government should purchase the loan portfolio’s from banks then securitise and sell this asset backed bond to investors, providing guarantees beyond a level of default on the underlying portfolio to insure against the catastrophic impact of mass distress/default on the loans. We have seen the consequences of mis-management of these types of assets before –they are part of the family of Asset Based Securities (ABS) that includes Mortgage Backed Securities (MBS).

The paper touches on some of the obvious concerns of such a scheme. Will the scheme stimulate more lending by the banks? Potentially, as it frees up the balance sheet of the banks, compelling them to lend to SMEs as the continued Government purchase of the portfolio will deliver a source of funding for the banking operations – liquidity is one of the biggest concerns of the banks due to the issues in sovereign debt markets, their traditional source of raising cash.

What about Moral Hazard? If the banks know they can offload the loan portfolio to the Government, will they be more gung-ho in their assessment of risk when providing loans to SMEs? NESTA and Mr. Gyimah suggest that the banks be made to buy portions of the bonds themselves, across all tranches of risk (for a detailed description of how securitisation works, I would rather you refer to Wikipedia), thus continuing to be exposed to risk themselves.

The argument is a little weak in reasoning and one of my few criticisms of the report; banks have being doing this for a long time with ABS; it does not work as effectively as one might think. ABS bonds have a considerably higher credit rating than the underlying loans, especially with the Govt guaranteeing against default on those loans, as proposed in the paper. Thus the capital charge for holding the Bond is much much lower, regardless of the tranching that occurs. So, offloading the high risk to Govt, being forced to purchase low risk bond tranches, still promotes hazard and gives more capital for the banks to gamble with.  The government, and thus the tax payer, will bear the brunt of any problems that occur. Fair dues to the authors who state:

“The issue of asymmetric information and the possible passing off of bad loans would be one of the main tasks of the managers of the new entity”.

The paper suggests using Experian to measure the credit worthiness of the underlying loan. Mmmm, I must confess to a little giggle when reading this section. xperian, Equifax and other business data/credit agencies have come in for a great deal of criticism in the press recently around the disparate methodologies and ratings of SME risk. Further, a 3^rd party has no real vested interest (skin in the game) to do a good job, reputational risk aside. I would like see a group of specialists employed by the Government perform the risk assessment, with 3^rd parties, such as Experian being used as auditors of the process. Another one for the managers of the scheme to resolve!

The expansion of securitisation beyond a unilateral Government scheme is discussed with supporting data from an intelligently administered survey through MORI. The suggestion that specialist non bank commercial lending institutions with a trusted reputation in SME lending, be permitted to also issue securitised bonds for investors provides a breadth to the recommendation that is applaudable. Free market forces, supported by the Government, the right processes and market structure, will inevitably lead to a better, more robust product then the Government acting alone.

Credit Easing and the potential establishment of a state controlled bank are considered and dismissed – well thought through and pragmatic arguments are presented that demonstrate the ineffectiveness of either solution to resolve the immediate pains being felt by SMEs while toeing the line of proposed regulation.

The other major proposal of note  is one of “soft” (private sector led) structural reform of the financial sector; looking at new innovations and new models of lending that enable greater competition and/or focus banks on core capabilities (risk management), to better deliver services to consumers. Direct Bond Issuance, championed by Will King of King of Shaves fame, an unexpected but amiable figurehead for SME capital as a result of his “shaving bonds”, is put forward as a solution for larger firms. 

Innovation in financial services is accelerating, the sector is unlikely to look the same in 10 years time. Matching those with Capital to those that need it, leveraging technology, new business models and focusing on specific strands of the financial services value chain, will evolve the industry for the better. Solutions such as Funding Circle (mentioned in the report), our own EuroTRX, MovenBank, Crowdcube, Zopa…will hopefully be the big names we all, business and retail alike, turn to for our financial needs in the future.

The UK’s SMEs have been crying, pleading for a legitimate solution to their lending issues for several years. “Beyond the Banks” presents a well thought through and viable resolution that should give SME’s reason to cheer. Execution is key – Will the government act, and if so, how soon? We wait with baited breath for George Osborne’s statement next Tuesday; fingers crossed that he follows through with some of the report recommendations and provide the spark for the light at the end of the tunnel.

I feel excited by the change that is occuring in financial services – it is good for all, and all for the good. The energy has me dreaming of starting a bank myself, I think I can achieve 20% ROE for any interested investors out there.

1. I employ some currently unemployed bankers (adding value to the economy)

2. We  raise £1 billion of equity

3. We use the £1 billion to buy as much high grade securities as we can (minus set up costs), paying maybe 4-5% coupon.

4. We use the securities as collateral to borrow £9 billion from the BofE at overnight rate of 0.5%.

5. We buy another £9 billion of securities at similar rates as the first batch. At this rate, we are earning at least £400 million per annum.

6. We continuously roll the overnight position with the BofE, pledging more of the security pool in collateral if required on margin calls.

7. We go public. After costs, the bank is earning at least £200 million a year with a high capital ratio (10% equity-to-debt), and the balance sheet will be clean (all low risk securities). Potential valuation of 20-times earnings: £4 billion. We sell 25% of the company for £1 billion.

8. Put the £1 billion raised to good use – go back to Step 3.

9. When market cap hits £10 billion, sell another 10% of the company for £1 billion. Go back to Step 3 again.

10. Expand to US. Fed is lending at 0.25%. Repeat formula. Start focusing on PR and social issues, buy branch networks from defunct banks and start making actual loans to retail and corporate consumers.

11. Exit for a ridiculous valuation. We all win.

I have a specialist who has proven experience of setting up banks. The team is strong. We just need the cash. Anyone interested, please get in touch!

The Q3 2011 Project Merlin figures released today show that the major banks have once again failed to meet their quarterly targets. Banks lent a total of £57.4m to non-financial corporates, with £18.8 billion of that figure going to SMEs. The SME lending target for Q3 was £19 billion.

Some may argue that the numbers still look good – a shortfall of £200m is not too bad. Couple this with the banks’ insistence that demand from SMEs for debt is low and the numbers looks almost rosey.

However, some serious cracks appear when we dig a little deeper, cracks that cast concerning hazards for business on the road to recovery.

The obvious first: the amount lent to SMEs in Q3 is 8.3% less than the previous quarter. Considering seasonality, demand for capital tends to increase in Q3 and Q4, principally as the business machine gets back into gear after the more relaxing summer months, gearing up for year end.  

Proportionately and logically, given the intrinsic incentives of proposed capital adequacy regulation under Basel III and the Vickers report, it is clear that banks are shifting their lending strategy to more reliable credits: larger corporations. The proportion of lending to SMEs as a percentage of total lending in each quarter is Q1:35%, Q2: 38%, Q3: 32%.

Now the crunch: lending numbers reported by the BOE are on a GROSS basis – i.e. inclusive of existing facilities that are rolled over. Considering the onus on stimulating the economy and the widely repeated statement by senior politicians and economists that SMEs are the lifeblood of the stimulus, one would be fair to assume that more new money is being lent each quarter than is expiring as facilities are closed. WRONG.

Simple math: Previous quarter’s lending + new lending – expired lending = current quarter gross lending.

For Q3:     £20.5 billion (Q2 gross to SMEs) + new lending – expired lending = £18.8 billion

                   New lending – expired lending = -£1.7 billion

                   Expired lending exceeds new lending by £1.7 billion!

For clarity: Banks did not make £18.8 billion of NEW money available to SMEs in Q3. In fact, they lent less new money to SMEs then was paid off by SMEs; £1.7 billion less, 9% of total lending for the quarter.

Without question, a reasonable percentage of facilities will have been rolled over. For illustration, let’s assume £10 billion for simplicity, though I hazard a guess that number is far greater. That would mean expired facilities totalled £5.25 billion while new lending equalled £3.55 billion.

Certainly, reduced confidence in growth and the economy as a whole does make SMEs cautious in their ability to service debt. This is further expounded by the perception, recently corroborated by the Federation of Small Business, that banks may pull credit lines at short notice or change the terms of lending agreements. SME facilities will be the first to be impacted should banks need to shore up capital themselves due to issues in other areas of the bank.

The banks are no longer the most effective means for SMEs to access capital. A number of new innovative services are coming to market to help address the pain felt by SMEs. These services seek to positively disrupt the industry by providing more power to and better meet the needs of the SME consumer.  Services such as Funding Circle (www.fundingcircle.com ), MarketInvoice (www.marketinvoice.com ) and Zopa (www.zopa.com , consumer loans), have all made a splash. Recent figures suggest that as much as 10% of consumer lending in the UK may be facilitated by P2P services. Businesses, particularly SMEs should take note.

However, with this first wave of innovation, imperfections are inherent and there is undoubtedly room for further refinement of service to provide the best fit solution for SMEs. We, at EuroTRX, have sought to identify the gaps in order to shape a more robust and sustainable solution for SMEs. We don’t believe alternative loans are the answer. We believe that the predominant need is for working capital, and that an invoice exchange, delivered in the right way, will best fulfil the need.

 Invoice financing in its current guise accounts for less than 5% of business funding in the UK; a criminally low percentage considering the relative benefits of invoice finance to traditional debt finance such as loans and overdrafts. No interest to pay that further impacts cash flow, more effective use of balance sheet assets, inherent security for funders (invoice buyers) thus nurturing more demand, and generally improved financials and ratios for the business borrower (invoice seller). The barrier has always been the complexity of the delivered service, the unnecessarily high cost and the lack of awareness of invoice finance. EuroTRX, when we launch, will change these dynamics for the better, delivering a more transparent, lower cost, sustainable and flexible service to SMEs by connecting them with non-traditional non-banking sources of finance in a user friendly online auction platform. We are determined to deliver the right solution for UK businesses.

I have spent over a year investigating ways to improve SME funding. My belief is that SME needs for cash are primarily driven by working capital requirements.I also believe solutions need to be looked at more wholistically - that the banks need to be provided with the right incentives in order to lend more; solutions that also address key bank issues, such as those related to liquidity, will ultimately be more successful in improving SME funding. The 4 major UK banks control 80% of SME banking, and, though I am a believer that broader participation in the SME funding market from non-banks is fundemental for a robust market, the transition will take time. Any solution must meet an SME’s primary needs of simplicity and ease of access at a reasonable cost. 

The following are my suggestions to help SMEs:

1)   Invoice finance innovation. Support new initiatives that evolve the existing industry business model. Invoice finance is criminally underutilised as a means of funding, primarily due to the complexity of current services and poor distribution and marketing. There is a strong demand from non-traditional financial firms such as hedge funds, private wealth managers, family offices and trade finance funds to take on corporate exposure. These firms have difficulty sourcing corporate assets. A central exchange/market and simple processes will benefit both lenders and borrowers.

2)   Broader criteria to meet Project Merlin targets. Incentivise banks to lend to or invest in third party commercial/trade finance funds (carrying a lower capital charge than SME loans) that are providing financing to SMEs. Permit such an investment to count towards Project Merlin targets.

3)   SME bonds. The focus needs to be on making processes and access as simple as possible. A one stop shop that can structure, market, underwrite, place, report and allow trading of these bonds would be ideal – lowering costs for SMEs and ensuring the broadest participation. The LSE’s ORB caters for Medium size enterprise; Ideally a market for smaller company bonds should also faciliated.

4)   Government loan guarantees. The EFG scheme did not target the right participant in the system. A guarantee scheme that is channelled through a broad base of approved financial institutions, whereby the institutions offer the guarantee, inclusive of defined government terms and credit spread, will deliver better results. Akin to the very successful SBA loan guarantee scheme in the US, the subtleties of this solution will also aid the banks – they will be able to package and sell the guaranteed portion of the SME loan in the secondary market as a sovereign backed security.

5)   More competition in banking sector. We have “free schools”, why not “free banks”? Cut the red tape; make it easier for and provide support to interested parties in setting up local/regional savings and loans associations or banks.