Asset-based Finance a Capital
The worlds markets in financial Capital are built
upon the Twin Peaks of Equity and
Debt often also characterised as Investment
Asset-based Finance, by which I mean investment
in an asset-owning legal entity, is fundamentally different
from the familiar Deficit-based Finance, meaning
Credit or time to pay which arises in the context
a transaction between buyer and seller with delayed
payment (ie trade credit); or
a loan created by a Credit Institution
such as a Bank or Building Society.
Where credit is secured by a claim over assets such as
a mortgage, I refer to it as Deficit-based but
At this point it is worthy of note that 97% of the money
in circulation in the UK consists of such credit which has
been monetised two thirds of which is based
upon mortgage loans. ie the UK monetary system is Deficit-based,
but for the most part asset (property)-backed.
Existing Asset-Based Finance
The pre-eminent mechanism for asset-based finance is the
Joint Stock Limited Liability Company where
investors in shares issued by the Company have an absolute
and permanent legal claim over the assets and revenues contained
within its legal wrapper.
The flaws of this structure have been well documented and
are essentially twofold. Firstly, there is the conflict
of interest between the shareholders and all other stakeholders,
often described as the externalisation of costs.
We are all familiar with the rhetoric of shareholder
value, cost-cutting and of course Corporate
Social Responsibility that flows from this.
Secondly, there is the Principal/ Agency problem
which is that of the relationship between the Shareholder
owners and their agents the Directors and other managers
who are often prone to favour their own interests at the
expense of the shareholders.
We have seen in recent years the development of another
type of legal wrapper for assets based upon
the law of Trusts. This body of law is not based
upon statute but has developed over hundreds of years through
decisions by judges. Essentially a Trustee owns
the relevant assets and revenues flowing from them on behalf
of a Beneficiary.
Through the concept of the Unit Trust and the
Investment Trust investors have been able to
invest in assets typically bundles of investments
More recently we may observe in Canada principally
due to the existence of a favourable tax regime the
emergence of Income Trusts or Royalty
Trusts typically invested in oil and gas utilities
and providing a stream of revenues based upon oil and gas
production. These Income Trusts are hugely successful, particularly
as an asset class for long-term investment by Pension funds.
We also see in the hugely successful business model of
the Australian Macquarie Bank the advantages of acquiring
assets using deficit-based financing and then refinancing
them using asset-based financing through Investment Trusts.
Like Companies, Trusts also have flaws, being costly and
complex to set up and to amend and also complex in terms
of taxation. However, the principal problems are the management
issues arising out of the restrictions of the Trustee/ Beneficiary
relationship and the conflicts of interest inherent in the
use of external managers /advisers.
finance through Partnership
There is in fact another possibility based upon the utilisation
of a new type of legal wrapper based upon partnership
The first example of an Open Corporate or Corporate
Partnership is the new UK Limited Liability Partnership
introduced on 6 April 2001. Confusingly, despite the name
an LLP is not legally a partnership but is in fact
like a Company -a corporate body with a continuing legal
existence independent of its Members. Also like a Limited
Company an LLP has the benefit of limitation of liability,
so that members cannot lose more than they invest.
In taxation terms an LLP is tax transparent
in other words as far as the Inland Revenue is concerned
it is not taxed in its own right, but revenues pass straight
through it to the Members who are then taxed individually.
Crucially, in an LLP it is possible for other stakeholders
beyond the Investors to be Members. This quality of open-ness
combined with infinite flexibility (since the LLP Member
agreement is not prescribed and need not even be in writing)
may mean that an LLP is an optimal vehicle for investment
allowing the problems of existing legal vehicles to be transcended.
We may achieve this - notwithstanding Treasury-inspired
restrictions upon Investment LLPs generally
and Property Investment LLPs in particular
through a Capital Partnership which has
three or four Members.
a Trustee member who owns the asset
essentially as a custodian in accordance with Aims and Objectives
expressed in the LLP agreement.
an Investor or Capital Provider
member who invests money or moneys worth in assets
into the partnership;
an Occupier or Capital User
a Managing member ((optional).
The Capital User pays a Capital Rental to the
Investor and/or Manager consisting of a share in the revenues
produced by the assets in question. This Rental is not paid
for a defined term but is paid for as long as the capital
is used. Any rentals paid before the due date automatically
The outcome of a Capital Partnership is Co-ownership
between the Investor and the user of the Investment. The
asset itself need never be sold again remaining in
Trust - although the Investors, Investment Users and Managers
(if any) may change in accordance with the LLP agreement.
This essentially comprises an entirely new property right,
since the property relationship between an investor and
an asset is being encapsulated in a radically simple new
way without the conflicts in existing property law between
the absolute rights of an owner and the temporary
rights of a property user.
Open Capital: In terms of financial capital, we
see a new Open form of Capital which
is neither Equity nor Debt, as we know them, but something
new and arguably optimal.
A transaction entered into in late 2002 by the Hilton Hotel
Group serves as an example of a prototype Capital
Partnership. The Hilton Hotel Group (the Occupier)
invested a portfolio of ten hotels in a Capital Partnership
LLP and development finance of some £350m was invested
by another LLP linking three Investor Members who receive
for 27 years a share of the gross revenues from these hotels.
So if the Hilton Group has a good year, so do the Investors.
Proportional shares (nths) in
such asset-owning LLPs constitute an entirely new
asset class not dissimilar to units in a unit trust, but
simpler, tax transparent, and arguably optimal in the way
that stakeholders interests are aligned.
The possibilities of asset-based finance as
a technique are not limited to the private sector. There
is no reason why public assets such as new schools
and hospitals -should not be financed by pension investors
interested in a secure index-linked revenue stream using
In fact it brings in to question the Public Sector
Borrowing Requirement since demonstrably borrowing
is not involved. In addition to pension funding the asset
class may also attract the huge amounts of petrodollars
in the Middle East looking for Islamically sound investment
In the housing sector we see the possibility of a new Fifth
Option Co-ownership by tenants
in affordable/social housing financed by pension investment
in property on land retained in trust for the community.