Back in the comparative financial glory days of the 1940s, economist Joseph Schumpeter coined the term creative destruction, meaning a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”
Schumpeter is former Federal Reserve chairman Alan Greenspans favorite economist. In his autobiography Greenspan states that: It was the dot-com boom of the 1990s that finally gave broad currency to Schumpeters idea of creative destruction.
Greenspan was wrong. Schumpeter implied that the new companies that caused and arose from the previous destruction would be better that before; a form of economic Darwinism. But during the past decade, the creative machinations of quant analysts and asset managers that arouse out of the Big Bang in London and the financial volatility of the 1980s ended up causing almost total destruction. If anything, the dot-com executives of the 1990s, vying for venture capital, seem saintly in their overestimation of the technology industry compared to the CEOs that rose and fell during the past decade.
However the wreckage from the credit crunch is failing to stop financial innovation, and uniquely perhaps one of the most interesting financial products around is also one of the simplest to understand.
Nuclear Power Notes (NPNs) were formulated with the takeover of British Energy by EDF at the end of 2008. For British Energy shareholders, EDF made an initial cash offer of GBP7.74. They also made another offer of GBP7 a share plus one NPN (issued by Barclays Bank). This offer was made to appease shareholders who had a vested interest in the future of British Energy and the nuclear industry.
The notes, or contingent value rights instruments (CVRs) pay out on a yearly basis over a ten-year period. The payments come down to two factors, the net metered output of British Energys nuclear fleet, and various UK wholesale power prices referenced from third parties.
This enables shareholders to retain an exposure to wholesale power prices and to the output of British Energys existing nuclear fleet through the NPNs.
The notes are traded on Plus Markets, the London based stock exchange for small and mid-cap stocks. Paul Haddock, Head of Capital Markets at Plus, called the NPNs: A hybrid between an equity and a debt security, but traded just like an equity. What made these notes especially novel is that both Barclays, the issuer, and EDF, the ultimate guarantor of the notes, must issue information that could affect the price of the notes separately. Two separate information sources that have a direct relationship with the asset is not only novel, but of benefit to the investor.
This is genuine product innovation from the financial services sector in a time where new acronyms often strike fear into the heart of the investors. Some journalists have likened the CVRs to stub equity, but this is misleading. Classic stub equity takes the form of shares in a company that is to own part of the target after the acquisition. The NPN is about exposure to a market, not ownership.
As there is little left to destroy, coining the NPNs a 21st century example of creative destruction would be lazy. But these NPNs are a prime example of innovation using market forces. 520 million notes were issued, showing that investors are not only happy to welcome new methods of investing, but also, if explained to them, then they are happy to take up an investment opportunity.
More importantly, it gives the shareholder a choice and encourages investor participation. By increasing the choices available to a shareholder, not only are you increasing the responsibility of the shareholder, but also helping them understand the risk in relying on shares for a permanent form of income or pension.
People have forgotten that shares are a form of exposure, and with exposure comes risk. By giving someone the choice to expose themselves to risk, in this case the risk that nuclear power may or may not grow as a source of power in the UK, responsibility is shifted back to the shareholder.
Also, the link to CEO remuneration packages is obvious. Until the shareholder takes an active interest in their holdings, the disconnect between employees and executives will resurface once the CEO witch hunt is over.
The highly paid executives of the past decade had every right to be paid as much as they were, if not more, only because the shareholders and passive market participants failed to pay enough attention to their portfolios, myself included. It seemed better to let CEOs get paid a fortune, if it means that I can rely on constantly rising share prices. The CEOs thought so too.
There is nothing creative about the Savonarola-esque salary slashing that is taking place. The only way that the enraged investor will stop people getting paid so much in the future is if they take more responsibility for their investments, and the companies they invest in. This could be the most creative act of the credit crisis.