Submissionby Chris Cook in January 2004 to the House
of Commons Treasury Sub-Committee on Restoring Confidence
in Long Term Savings
Asset-Based Finance: "Open" Financial Capital
1.1. There have historically been two asset classes available
for long-term savings: Debt and Equity. The former is based
upon obligations issued by Government, Credit Institutions
(ie Banks and Building Societies) or by Corporate borrowers.
These obligations may be backed by assets either directly
or indirectly and this asset class constitutes "Deficit-Based"
1.2. The alternative is to invest in productive Capital
assets either through direct ownership or through shares
in Joint Stock Companies or units in Unit Trusts which own
such assets. Unfortunately we have seen how stock-market
valuation of such assets may lose touch with the underlying
reality of revenue streams generated by these Capital Assets
and this is one of the principal reasons for this Inquiry.
1.3. HM Treasury has identified a requirement for new and
tax transparent vehicles (Real Estate Investment Trusts
- "REIT's" ) for investment in Real Estate both
in the commercial and residential fields and is to consult
on the policy issues. In the meantime, the Miles and Barker
inquiries have focused upon issues relating to long term
financing and availability of residential properties.
1.4. HM Treasury was perhaps unaware of the existence of
a tax-transparent vehicle which has already been utilised
in the Commercial sector in a transaction of some £350m
value and demonstrates a new "Open" form of Asset-Based
1.5. This transaction was an example of an "Open Capital
Partnership" ("OCP") utilising the new (post
6 April 2001) UK Limited Liability Partnership, which, confusingly
is not legally a partnership but is a corporate body with
1.6. This memorandum sets out simple applications for asset-based
financing using the OCP in each of three areas:
Public Investment in infrastructure;
Private Investment in residential properties;
Commercial Investment in Capital assets.
Each of these areas has the potential to give rise to a
separate Pension Asset class ideal for restoring confidence
in long-term savings.
2. The Open Capital Partnership ("OCP")
2.1. An OCP is a "new" (post 6 April 2001) UK
Limited Liability Partnership ("LLP") the purpose
of which is to acquire and develop Capital assets in the
UK or elsewhere.
It has two Members: (a) the "Occupier"- or Capital
User; (b) the "Financier" - or Capital Provider,
and the Occupier has the right of indefinite use of the
Capital for so long as he pays an agreed Rental. To the
extent that an Occupier pays the Rental in advance of the
due date he will also be a Financier.
2.2. The OCP creates a form of "virtual" Ownership
which is neither permanent (eg freehold property) nor temporary
occupation (eg leasehold/tenanted property) but a hybrid.
Moreover, once a Capital asset such as Land and Property
is within an OCP there is no reason why it need ever again
be sold, although Financiers and Occupiers may both change
over time in accordance with the OCP Agreement.
2.3. The OCP was demonstrated in embryo in late 2002 in
a transaction by Hilton Group involving 10 hotels in the
UK. Hilton sold this portfolio for some £350m to an
LLP in which they (the "Occupier") retain 40%
of the "Equity" (ie a proportional share) with
the balance of 60% being owned by a second LLP linking the
3 "Financier" Members. Hilton undertook to pay
for 27 years 28.8% of their gross revenues from these hotels
plus a further £3m pa all subject to a floor of £17.5m
pa or 5%.
2.4. There is no debt, and no mortgage: equally there is
no Freehold/Leasehold "sale and leaseback" either
of which would have given rise to that divergence of interest
between the Financier and the Occupier which is taken for
granted between mortgagor and mortgagee or between freeholder
and leaseholder. The outcome is of a true partnership of
27 year duration, where if Hilton has a good year then so
do the Financiers, and the result is "Asset-based Finance"
of some £350m value initially.
2.5. This transaction illustrates the potential for a new
asset class of proportional "shares"/ partnership
interests (eg one tenth, one thousandth, one millionth)
in asset owning OCP's. These "shares" would be
analogous to the asset class we know as Unit Trusts created
through the operation of a trust law- based legal "wrapper"
around assets and associated revenue flows. The OCP essentially
places a different form of legal "wrapper" around
Capital assets and associated revenue streams.
2.6. This could - in the Commercial example of the Hilton
transaction - take the form of partnership interests in
the LLP of (say) 10m "shares" of £35 value,
each of which would be entitled to a proportionate share
in the Hilton revenue stream for 27 years. Such Shares allow
direct investment in commercial Capital assets and direct
participation in the revenues which flow from these assets:
simple, but radical.
3. Public Investment
3.1. Two scenarios follow: in the first we see a possible
replacement for PFI funding; in the second a mechanism for
funding the Olympic Games without recourse to the London
Council Tax payer.
Education PFI Alternative
3.2. Bloggshire has 10 schools in 5 different boroughs
requiring £20m rebuilding/ refurbishment. Bloggshire
transfers the land to Bloggshire Land Partnership (BLP)
and transfers the school buildings to the Bloggshire Schools
Partnership (BSP) both of whose members are the five boroughs.
BLP becomes a "Financier" Member of Bloggshire
Education LLP while BSP becomes the "Occupier"
Member and agrees to pay a peppercorn rental for an indefinite
term to BLP for the use of the land.
3.3. BSP is divided into 10 million "shares"/
partnership interests each valued at £2.00 initially
and Bloggshire agrees to pay BSP a rental for the use of
the school buildings of £600k pa initially, linked
to inflation and thereby providing a rate of return of 3%
inflation linked. Bloggshire will aim to repay the Capital
over the expected life of the school (say 25 years).
3.4. Bloggshire residents are invited to invest in these
"shares" with priority being given to parents
and with any Government "baby bond" money being
allocated to purchase "shares" on behalf of pupils.
Institutions such as the Teachers' and Bloggshire Employees'
Superannuation schemes are given priority after local residents
to invest, and will underwrite the share issue and provide
Financing the Olympics
3.5. The Olympic Partnership LLP would have two members
initially: the LDA as "Community" Land owner and
an LLP consortium of financiers, developers, builders etc,
and it would acquire necessary Land and build the Olympic
Village and facilities.
3.6. A consortium of occupational pension schemes (Local
Authority, Post Office, Universities, Teachers, Nurses and
so on) would be invited to invest on the basis that they
would be allocated a certain number of the Village properties
after the Olympics for occupation by their young scheme
3.7. These young scheme members would then have the "right
to buy" equity in the properties in which they live
by simply paying in excess of the agreed rental for the
property (see Para 4.2 below). In addition they would pay
a rental to the Community in respect of the Land upon which
the Village is built.
3.8. A substantial proportion of the Village could be dedicated
to "creative" professionals unable to afford London
property or alternatively to "social tenants"
and this group could qualify for a reduced rental through
the waiver of some or all of the Land Rental. In addition,
they too would be able to build up equity in the property
in which they live simply through paying in excess of the
3.9. For the "Financier" Pension Schemes there
is a solid asset-backed income stream. For Occupiers there
is the knowledge that they benefit both directly from any
increase in property value through the Equity they own and
indirectly through the fact that their pension will reflect
any increase in value of the Equity they do not own.
3.10. For the Development partners the proposition is that
they will be paid an agreed proportional share in the future
revenues they have helped create. The beauty of this model
is that the development partners are therefore incentivised
to collaborate to create buildings of the highest possible
quality and durability at the earliest practicable time
and thereby maximise both their return and their ability
to realise it.
4. Private Residential Investment
4.1. The use of the OCP for residential property investment
represents a simple and innovative form of property purchase,
which happens to be Islamically sound in that debt and interest
are not involved. Two examples are given below firstly in
relation to Affordable Housing and secondly in relation
to Equity Release - neither distinguishes Land from the
buildings on the Land.
4.2. A property purchased for £100,000, of which
the Occupier invests £20,000:
the Occupier/Financier receives 20 "shares"
and the Financiers 80 shares at a value of £1k each.
(or 200/800: 2000/8000 etc - it is the 20%/80% proportions
which matter, there being no par or nominal value to these
there is an Exchange of Value: in return for the
use of the Property, the Occupier(s) pays a Rental to the
Financier (s) for the use of the Capital.
so a rent of £6,000 pa is agreed for two years
for the above property: the Occupier pays net £4,800
pa; the Financier receives net £4,800 pa.
After two years, the Occupier wishes to invest £12k
in the Property: at £120k valuation he buys a further
10%; at £96k valuation he purchases 12.5% and so on.
4.3. A property worth £500,000, from which the owner
- a retired teacher - wishes to release equity of £50,000
to supplement her pension.
the Teachers Superannuation Scheme (the Financier)
purchases a 10% share in an OCP which acquires the house,
while the Occupier retains a 90% interest; · a market
rental of £15,000pa initially is agreed for the property
of which the occupier is due to pay the Financier 10% or
for two years the Occupier decides to pay the Rental
in equity rather than cash (ie £3,000 rental due).
The property is revalued at (say) £600,000 and the
Equity shares are adjusted so that the Financier now has
10.5% of the Equity.
4.4. In terms of affordable housing, a young member of
a pension scheme may acquire Equity in his property in three
ways: firstly voluntarily, through paying rental in excess
of that due; secondly, compulsorily, through a mandatory
pension contribution (say) half of which is applied to acquisition
of equity; and finally through his participation in the
scheme itself, which owns the balance of the Capital Asset
for which he pays the rental.
4.5. In relation to Equity Release, the two available options
("Reversions" and "Roll-up" mortgages)
are expensive, disadvantageous or both. The OCP model allows
Pension funds to market to its existing portfolio of pensioners
an entirely new Equity Release product. In doing so a Pension
fund also acquires a pool of investments in UK residential
properties with a rental income and potential capital growth.
4.6. As a footnote a defective equity-sharing model failed
in the late 1990's: the disastrous experience of pensioners
using "Shared Appreciation Mortgages" offered
by Barclays and Bank of Scotland arose out of the fact that
in return for a 25% equity stake, the banks demanded 75%
of the property gains, albeit without demanding any other
return on Capital invested.
4.7. In the OCP Equity Release model the Occupier simply
pays a rental for the Capital he uses, for as long as he
5.1. The development of this new asset class would face
similar challenges to those which faced the nascent unit
trust industry ie taxation issues, regulation, accounting.
It would also be necessary to establish intermediary liquidity
providers, and other service provision.
5.2. One of the key points is taxation, and it should be
noted in particular that the UK LLP is a tax transparent
vehicle which is already customarily in use as such. The
capability of the OCP to allow finance to be raised without
borrowing arguably exposes the REIT as an inferior vehicle
for pension funds to achieve the Asset-based investment
which they seek.
5.3. In terms of regulation, we can see a new and possibly
optimal form of collective investment by essentially "pre-qualified"
investment "clubs" constituted as LLP's.6/ Summary
6.1. There now exists a new and radical mechanism for long
term asset-based investment capable of restoring confidence
in long-term savings whether as part of a pension scheme
6.2. This mechanism is based upon a "new" (post
6 April 2001) Corporate vehicle - the UK Limited Liability
Partnership - which already offers a tax transparent vehicle
for property investment for which the Treasury is beginning
the consultative process in relation another type of entity
- Real Estate Investment Trusts ("REIT's").
6.3. Asset-based financing has already been demonstrated
in use in late 2002 in the UK in a major commercial property
transaction to the value of £350m over a 27 year term
utilising an "Open Capital Partnership" form of
6.4. This paper gives examples of how the OCP is capable
of forming the basis for entire new asset classes in the
fields of public and private residential properties which
provide radical new policy options capable inter alia of:
(a) an equitable new form of PFI;
(b) a financial model where "the Legacy funds the Olympics"
rather than "the Olympics (and the council tax payer
in particular) funding the Legacy";
(c) a new and fair form of "Equity Release";
(d) a new model for affordable housing.
6.5. The OCP literally creates a new form of "Open"
Financial Capital which
is neither Debt nor Equity as we know them but a radical