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the latest source of comment and analysis from the Institute for Security & Resilience Studies at UCL.


Archive for the 'Resilient Markets' Category

Rage Against the Dying of the Light

By Mandeep K Bhandal, on 18 July 2012

ISRS Senior Research Fellow, Chris Cook, argues that the Brent/BFOE crude oil price is the subject of routine manipulation by market participants.

A generation of markets is dying and the era of the Middleman is coming to an end.  The ‘Bezzle’ – as J K Galbraith described financial misbehaviour in a boom, revealed by a bust – is now coming to light.

We now see a wave of popular rage against the freshly revealed manipulation by banks of LIBOR, the London Interbank Offered Rate benchmark for interest rates which is the cornerstone of the money market.

This manipulation in the financial world is being augmented by a groundswell of protest against manipulation taking place in the real world.  Here, the allegation is that the Brent/BFOE (Brent, Forties, Oseberg, Ekofisk) crude oil benchmark price, against which global crude oil prices are set, is the subject of routine manipulation by market participants, particularly investment banks and traders of physical oil.

In both cases, the popular outcry is based upon misconceptions as to what has actually been going on. The good news in the oil market at least is that the manipulation which is being revealed is nowhere near as serious in its effects on the general public as is believed. The bad news is that the true manipulation, as yet still concealed, is far more serious than anyone has yet conceived.

They shoot horses, don’t they?

The current LIBOR pogroms are the regulatory equivalent of flogging a dead horse. The Interbank money market in wholesale lending had a heart attack in 2007 and essentially died in October 2008 with the collapse of Lehman Brothers. The money market is now on life support directly to central banks and to all intents and purposes there is no independent Interbank Market in money and there never will be again.

LIBOR is dead, and the markets are moving on.

The Brent/BFOE crude oil market benchmark, on the other hand, has been in failing health for a long time as the North Sea oil production upon which it is based has been in secular decline. Despite the best efforts of Platts – the Price Reporting Agency who are getting most of the flak – the market is at the point where if it were a horse it would be put down.

Market Manipulation

A regulator friend of mine used to joke that since excessive market manipulation is a US felony, the implication is that there is such a thing as ‘acceptable’ market manipulation. My response was that trading might be defined as ‘acceptable market manipulation’.

While producers desire a stable high price, and consumers desire a stable low price, for a trading intermediary who aims for transaction profit, price stability is Death, and the only bad news is no news at all.

I am not familiar enough with the endemic LIBOR manipulation to say much about the victims and their losses. But I can say that from its inception in the mid-1980s crude oil trading and the associated fun and games in the Brent/BFOE complex of contracts have taken place entirely among consenting adults. The outcome of the routine short term ‘micro’ manipulation by oil market participants has been pretty much a zero sum game between trading intermediaries.

Some of these middlemen are traders of physical oil like Vitol and some of them are the ‘Wall Street Refiner’ traders in investment banks such as Goldman Sachs. There have been no direct effects from these continuing trader games on the man in the street, but there are indirect effects such as the higher cost of energy investment arising out of unnecessarily high market price volatility.

Whenever producers or consumers can gain market power, through some kind of leverage, to either support or suppress prices in the medium and long term, then they will. The history of markets is full of examples of such ‘macro’ market manipulation and while LIBOR is among them, that is only now of historic interest, now that the market is dead.  In crude oil, on the other hand, we are approaching the end of the greatest macro market manipulation in the history of commodity markets, by comparison to which Yasuo Hamanaka’s $2bn manipulation of the copper markets through Sumitomo is a car boot sale.

Cui Bono

Ask yourself who benefits from high oil prices? It’s the producers, stupid. From 2005 onwards a market bubble in crude oil has been deliberately created. This has been achieved opaquely through use of the Prepay funding used by Enron to sell commodities at a discount for cash now, and deliver them later.

Creditors and investors who were unaware of Enron’s ‘off-balance sheet’ liabilities were misled as to the true financial position and were thereby defrauded. Most oil market participants have been similarly misled as to the true position in the oil market through the use of prepays by producers, funded by passive investors.

In simple terms, risk averse investors have lent dollars to producers, and producers have lent oil to investors.  None of the resulting changes of ownership of oil in the physical market were visible to other market participants, and the price has become a completely distorted and financialised bubble as a result.

The bubble first collapsed during the second half of 2008 from $147 to $35 per barrel and it was then re-inflated in 2009 through the use of prepays, facilitated by US investment banks to the benefit of producers.  Oil prices have since been kept pegged as far as possible between levels which: (a) do not endanger US presidential re-election; and (b) enable producer populations to be financially anaesthetised.

A key element in the evolution of this macro manipulation has been that banks as financial intermediaries are no longer capitalised to take risks in the way that they could and did prior to the collapse of the banking system. The outcome has been that market risk – i.e. the risk that the oil price will fall – is no longer held by the banks but has been transferred to passive and risk averse investors.

The motive of passive investors is not the speculative desire of active investors to make a transaction profit, but its very opposite: the desire to avoid loss. So they invest in oil funds in order to offload the risk that the dollar will depreciate in value relative to oil. Unfortunately, they are blithely unaware that they have a massive market risk if the oil price falls in a market ‘bust’, as it did in 2008; has recently been doing; and will continue to do at least until the end of the year. This is a regulatory accident waiting to happen.


The direct ‘Peer to Peer’ connections between producers and consumers which were first demonstrated by the music file-sharing phenomenon Napster have also been evident in the financial markets for some time through Peer to Peer lending businesses such as Zopa, and the new phenomenon of ‘crowd-sourcing’ of investment and donations.

But it is not widely understood that in financial services, the transition of middlemen to a role as service providers managing risk, business platform and direct P2P relationships is actually in the interests of the middlemen themselves. The reason is that when credit or market risk is with end users, then the only capital needed by service providers is the limited amount necessary to cover operating costs.

This is precisely why, since 2008, investment banks starved of capital have been originating and selling the new generations of funds responsible for the bubbles, where the market risk is with the investors, and not the banks. Unfortunately they have also been able to prey upon end users through their privileged ‘asymmetric’ access to markets and market data and through trading such as ‘High Frequency Trading’ (HFT).

Intermediaries are also responsible for short term micro manipulation, but they are not directly guilty of the macro manipulation of markets which has inflated the medium and long term market price because they simply do not have the capital to invest in this way anymore, even if regulators allowed it.

The End Game

Once the current bubbles collapse, which is only a matter of time, I believe that we will see markets evolve to the next ‘adjacent possible’, which will be the widespread – and necessarily transparent – use of direct Peer to Peer relationships through a new generation of market instruments, of which Enron’s Prepay was the first.

This return to what is in fact an ancient form of financing and funding will complete a cycle which began some 300 years ago when modern money and capital markets began with the foundation of the first Central Banks and the wave of Joint Stock Companies which financed and funded the Industrial Revolution.

The challenge of linking national security to economic stability is only just beginning.

By Dan Fox, on 8 March 2012

The following is a news release fron Rt Hon Lord Reid of Cardowan, Chair of ISRS:

The challenge of linking national security to economic stability is only just beginning.

We welcome the call from the Joint Committee on National Security Strategy for the government to better link the on-going economic crises with national security. Those of us committed to resilience have been advocating this for over a decade.

However, there is much still to be done if the Committee’s recommendations are to become workable realities. Bringing together orthodox approaches to economics and security could merely reinforce the groupthink that tends to characterise these policies, rather than improve strategy.

National security is the first duty of government but as an island nation the UK at its best has always dealt with the reality of networks, whether real (such as those of goods or people) or virtual (such as cyberspace or financial trading). National economic security must not be equated with protectionism. Protectionism is no substitute for competitiveness in economics or security.

Historically, combining financial services with manufacture, merchant marine and the Royal Navy made the UK an unprecedented asymmetric power. Cyberspace offers a new environment, and one of great prospects, which both enrich and endanger. In partnership with public, private and academic colleagues, ISRS is developing tools and methods for surviving and thriving in this new environment.

One such example is the practice of Net Assessment: the comparative analysis of economic, social, political, and other factors governing the relative capability of countries and organisations, in order to identify competitive advantages and dangers that deserve the attention of decision-takers.

We are keen to support the significant work that now needs to be done.


For more information: Dan Fox +44 (0) 20 3108 5074.


A stock answer

By Dan Fox, on 9 January 2012

ISRS Senior Research Fellow, Chris Cook, argues for qualitative easing through stock issuance.

For several hundred years, the Exchequer financed and funded English sovereigns by issuing IOUs, in the form of wooden tally sticks (pictures) split into two parts.  Individual creditors were given the Stock as a receipt and as a credit token which was returnable to the Exchequer in payment of taxes: the Exchequer retained the counter-stock or foil to be matched against returned Stock.

13th-century Exchequer "stocks".

By the time the (privately incorporated) Bank of England came along to privatise the money supply in the late 17th century there were at least £17m worth of tallies in issue at a time when the total cost of the operation of the Kingdom was perhaps £2m to £3m per annum.-

From 1660 onwards, the UK began to issue interest-bearing Stock wholesale which met a demand for long term risk free annuity investments.  This Stock paid interest periodically to the holder and became very popular with long term investors, representing the lowest risk and most solid income stream available.  Meanwhile the physical tally stick accounting system gradually fell into disuse as the accounting system became a more secure double-entry book-keeping system.

Several classes of Stock were issued and in 1752 these were consolidated into what became known as Consolidated Stock or Consols.  Further issues were made and in 1888 these were all brought together by (Chancellor) Goschen’s Conversion as the 2.5% Consols which remain in existence to this day.

A Return to Stock

Under professional management of credit managers/service providers, and the accountable supervision of the Bank of England as monetary authority, local Treasury branches could issue, in virtual form, undated Stock which would be redeemable in payment against taxes.

Stock would be issued at a discount – eg a Unit of £1.00 of Stock sold for 90p – and the rate of return depends on the period over which the Stock is returned to the Treasury in payment of taxes.  The very word return alludes to this long forgotten practice of returning Stock to the issuer.

Stock revolutionises long term investment by transforming the risk.  There is no longer a risk that debt and interest will not be paid.  The stockholder may redeem Units against taxation, or may sell Units to other taxpayers/investors.  Even if pure investors will not buy Stock, taxpayers will always buy Stock when the price is below £1.00.

The rate of return depends literally upon the date of return of the Stock to the Treasury or the date of sale: the former depends on the rate and basis of taxation, while the latter depends on liquidity – the ability to sell stock.

Liquidity is transformed: instead of a market in debt fragmented by different rates of interest; repayment dates; and trading platforms, there will be a single wholesale market in Stock, probably through periodic auctions on the Treasury web-site.  The retail market in Stock takes place throughout the nation: Units of Stock in bearer form – Treasury Notes – may simply circulate alongside Bank of England notes as they still do in the US.

Stock also revolutionises Government funding, since massively reduced funding costs enable the issuance of new Stock to create new productive assets – which was precisely the reason why the wiser sovereigns issued Stock in the first place.

Qualitative Easing

The outcome of such 21st Century Stock issuance would be to transform the quality rather than the quantity of UK public credit – a debt/equity swap on a national scale.

Such Qualitative Easing will give a short/medium term breathing space for the transition of the UK economy to a sustainable long term fiscal basis.

But that is another story.




Nondominium: establishing consensus and collaboration for the Caspian nations

By Dan Fox, on 4 October 2011

ISRS Senior Research Fellow, Chris Cook, argues that 21st century problems cannot be solved with 20thcentury solutions.

Wherever the writ of Western nations has run, so have attempts to impose the Rule of Law. But the Rule of Law has never sat well with other nations, particularly East of Suez, where absolute rights and obligations are not the norm, and where consensual agreements are customary. It is said that Napoleon’s experience in Egypt and interest in Islam may have informed the French Napoleonic Code.  In the context of civil law, French jurisprudence distinguishes between contrats de mandat, which are essentially one way agreements mandated by statute or judges, and contrats de société, which are associative, consensual agreements.

Similarly, the joke is that there are as many Sumo wrestlers in the US as there are attorneys in Japan. Anyone who has done business in Japan will know that because trust is assumed, agreements are typically simple and brief. And in Scotland there is, in addition to the existing polar opposite verdicts of Guilty and Not Guilty, a third null or indeterminate verdict of Not Proven.

There are two principal 20th century legal approaches to joint international development of resources:

  • International Law (Convention);
  • and Common Law (Equity).

(A good example of the Common Law approach is in the North Sea, where rights to production from oil and gas fields are now dealt with through the use of a common law ‘Master Deed‘ agreement.  While this is imperfect, it is a great improvement on the complete legal nightmare which preceded it).

There have also been proposals for ‘co-ownership’ between nations. But while Condominium – as it is known – is not unusual, such agreements have typically only been reached in respect of relatively low value bilateral territorial disputes.

Consensual agreement opens up a route to resolving even the most intractable disputes, such as those that arise over the most valuable territories.

The relatively simple – but still intractable – bilateral dispute between Iran and Russia over the Caspian Sea and its resources has, since the end of the USSR, been multiplied by the conflicting claims of what are now five Caspian-littoral nations (including Azerbaijan, Kazakhstan and Turkmenistan).  Their claims relate not just to rights on the surface, but to rights in the sea, and, above all, to the rights to what lies under it.

If a 21st century approach to territorial disputes can resolve this Mare’s Nest, then it can probably resolve anything.

A Caspian Partnership

The proposal is that the littoral Caspian nations should form a Caspian Foundation legal entity, and commit to that entity all existing rights in respect of the use, and the fruits of use (usufruct) of the Caspian Sea, and everything on it, in it or under it.  The Caspian Foundation would act as custodian or steward and the Caspian nations would have agreed governance rights of veto.

The Caspian Foundation agreement would reflect an agreement between the littoral nations jointly or collectively.

The negative or passive veto right of stewardship is very different from conventional property rights of absolute ownership and temporary use under Condominium. Moreover, it does not confer the active power of control held under common law by a Trustee on behalf of beneficiaries, and the legal complexities and management conflicts which go with that status.

The new term – Nondominium – reflects the fact that no country or combination of countries has the power of dominant control over the relevant territory and resources.

The Caspian Foundation would be a subscriber to a Caspian Partnership framework agreement between the nations; investors of money or money’s worth; and a consortium of service providers.

This Caspian Partnership would not be yet another international organisation, with everything that goes with that.  It would not own anything; employ anyone or contract with anyone: it would simply be an associative framework agreement within which Caspian nations self-organise to the common purpose of the sustainable development of the Caspian Sea. Within such a framework agreement a great deal is possible, although expectations may diverge to an extent that even consensual agreement is impossible.

The Caspian Partnership agreement would comprise a master framework agreement within which a myriad of associative agreements between the Caspian littoral nations individually or severally would be registered and evolve organically.

In particular, it is possible to envisage a new ‘pool’ of Caspian oil and gas production which would open up the 21st century direct financing and funding options of Unitisation (ie simply the issue and sale by producers of credits redeemable in payment for gas) which is the key market instrument underpinning the ISRS Resilient Markets initiative.

A Caspian Pool of natural gas production also opens up the possibility of a Caspian ‘balancing point’ spot gas price in just the same way as there is already a virtual national balancing point at which the UK spot natural gas price is set.


Many indigenous peoples, such as American Indians and Australian Aborigines, find it impossible to understand how anyone can own land.  Whereas most religious traditions – including Christianity, Islam, and Judaism – were all founded upon a belief that absolute ownership, particularly of land, is God’s alone, and that a tribute should be paid accordingly, such as a tithe.

It is apt to describe this proposal’s approach to the property relationship as Nondominium. Such a collaborative and consensual legal and financial framework for sustainable development and management of international resources is capable of revolutionising international economic relations.