Thursday, 16 July 2009

Global Conflict: Causes and Solutions for Peace.

In this article, we speak to Kristiina Rintakoski, Executive Director of the Crisis Management Initiative (launched by Nobel Prize winner President Martti Ahtisaari) about global conflict, its relationship with economic inequality, climate change and energy. We talk about the dynamics of conflict and crisis situations, and how organisations like CMI are building peace internationally.


Vikas Shah, Thought Economics, July 2009

Perhaps more than at any time in our history, our world is engaged in conflict. From the UK and USA engaged at war in Afghanistan and Iraq, through to insurgencies in Algeria, Burma and Columbia, civil wars in African nations, and conflict between people in China, Iran and Israel, we see that we are in a fragile landscape.

Over the past century, a number of facets of humanities development have contributed to this, including:

Economics: From early colonialism to modern capitalism, our western economic growth has often been at the detriment of other nations where, for example, we have aggressively acquired assets, created trade routes, or leveraged economic scale to source products, assets, and services artificially cheaply. These processes, while creating great wealth and development in Europe and the USA, have exacerbated poverty and economic inequality in many nations, creating a great deal of tension and potential for conflict.

Agriculture and Energy: Our world is hugely dependent on agriculture and energy. Both of these asset classes are in huge demand, with their protection and development becoming serious debate. Population and economic growth also puts huge strains on these assets, as our world comes close to consuming greater than is sustainable.

Technology: While technology has been a huge enabler for global development, it has also made our injustices and inequalities more visible to external and internal participants in any situation.

Climate Change: This is now becoming a real and significant issue with millions worldwide becoming displaced by climatic effects.

Religion, Governance, and Politics: These issues, and their allied topics of human rights, justice, and so forth have historically caused many of the world’s most significant conflicts, and continue to do so as often these issues are the most fundamental in the structure of a society.

So how, then, will humanity move forward to create solutions for conflict?

CMI (The Crisis Management Initiative) was founded in 2000 by its Chairman, President Martti Ahtisaari (Nobel Peace Prize Laureate 2008, and President of Finland 1994-2000). The organisation focuses on issues critical to creating sustainable peace and security, and making strategic contributions to the capacity of local, regional and international actors operating in war-torn and conflict-ridden societies through preventive diplomacy, peace-mediation and state building.

In a privileged interview we spoke to Mrs. Kristiina Rintakoski, executive director of the Crisis Management Initiative, about global conflict, its relationship with economic inequality, climate change and energy. We talk about the dynamics of conflict and crisis situations, and how organisations like CMI are building peace internationally

On Conflict and Peace:

Q: What are the key causes the conflicts we see globally?

[Kristiina Rintakoski] All conflicts are different with their particular history and reasons. I think that inequality within societies and between regions has become a key cause for conflict, exacerbated by rapid information dissemination, as people are (now) more aware of inequalities. Economic, social and environmental trends come together, for example, looking at resource competition and climate change (the latter intensifying the lack of resources, leading to political conflict). State fragility continues to be a key source for internal conflicts, instability and human suffering.

Q: How do you go about reconciling sides who have seemingly irreconcilable differences?

[Kristiina Rintakoski] Our strategy is to try and find elements which can create a common ground, a common agenda, which can then build confidence for sides to work together. Often, a common-agenda comes from issues outside the source of the conflict, such as economic and social well-being, but these areas are ones where all sides have an interest (though, often, it is these areas which have caused the conflict). Another strategy, which we inherited from our Chairman, President Martti Ahtisaari, is to work towards finding practical solutions to political disputes grounded in everyday realities in conflict situations. These strategies can lessen tension between parties to concentrate on solution oriented thinking.

Q: What does it take to create peace? And what is the role of conflict resolution in your overall strategy?

[Kristiina Rintakoski] The fundamental starting point is to acknowledge that outside actors can rarely create peace, local ownership in resolving the conflicts is vital. In one respect, this has become part of our practice of peace building, but fundamentally the role of the people within conflicted societies is critical. You cannot import peace, it is created within society.

There are also a number of key issues that a sustainable peace process has to address. Physical security is often the first priority, creating space for societal developments and processes to take place. Creating rule of law, good governance, and democratic political system take time and patience. Sometimes what comes too late, and does not receive adequate attention is economic recovery, guaranteeing the livelihoods of individuals in a society. Concepts like democracy and human rights will always remain fairly abstract if you cannot feed your family. It is therefore important to ensure that job creation, and protecting livelihoods occurs early on in the process.

Q: How do you work alongside governments, supra-nationals (e.g. UN), and military forces?

[Kristiina Rintakoski] Something which is particular to CMI is that we are not a lobbying organisation, we are, indeed, looking at co-operation with, and working alongside government, military and civilian actors in any situation. It is important to note that these organisations are funding our activities, but not in the sense of “sub-contracting”. Where we can add value to a situation such as peace mediation and state building, we may get funding from governments to carry out specific missions. We also work with policy development and support, for example we are working with the European institutions in creating a mediation capacity for the EU, and similarly we are working with the African union on preventative diplomacy and mediation. We encourage transparency and sharing of information, but it is important to note that there are many places where non-government actors (such as ourselves) do not face the same limitations as government actors do, and thus we can be more flexible. We aim to complement these organisations, acknowledging our relatively small size, but our excellent international network. Together, we create a collective capacity for peace-building.

On Threats:

Q: Are we now at risk of more complex threats? Such as cyberterrorism, financial terrororism, etc?

[Kristiina Rintakoski] We are now living with a great deal of uncertainty, which will increase. It is difficult to look at the relative nature of ‘traditional’ versus ‘novel’ threats, but Cyber-terrorism and Financial-terrorism are certainly part of the picture. What is important to look at is the causes of conflict, the issues of state fragility, injustice and inequality impact EU and Global security, and link strongly with issues like terrorism (giving rise to it not only in conflict areas, but in our society). As a society, though, we have to be prepared for threats we cannot conceive, we must build resilience not just in developed countries, but particularly in conflict areas. We, as nations, must also consider, for example, how climate change and financial crisis affects them [conflicted and developing nations].

On Technology:

Q: How important is technology within your overall strategy? And are there any innovations which you think are going to dramatically affect crisis and conflict management?

[Kristiina Rintakoski] I think technology is under-utilised in peace building and state building, but it is important to keep it in context as a tool. To get the best out of technology, you must have the processes to support it, and often that is the problem, you introduce technology without process, and that doesn’t get anyone very far. Technology should be an enabler to support local and national administration, who may have limited resources. In these contexts, technology builds their capacity to provide services and provide administration, and also increases transparency and accountability within these processes.

Looking at the potential for dramatic changes. From the side of responders, technology is bringing a greater level of interoperability between agencies, but it is a long way from being seamless. Looking at the regions of conflict and development, connectivity plays a big role. In Africa, for example, connectivity is being brought in predominantly from mobile technologies, and this will have a dramatic influence in finding solutions for these countries. Technology is one of the biggest gaps dividing western societies and developing countries, improving this will help provide solutions also in education and state administration.

On The Media:

Q: How do you perceive the media in context of global crisis and conflict?

[Kristiina Rintakoski] It is not black and white, the media can play a hugely positive role, but can also be very harmful. One of the main positives is increased knowledge and visibility of situations, specifically the transmission of human rights violations and other internal issues. This makes it difficult to turn a blind eye or deny knowledge and means that we (as society) have to react if governments are not protecting their citizens; it brings a sense of responsibility. We see this too where, for example, when peace workers are kidnapped, the media pressure can help make things happen. The reporting must, though, be factual and appropriate. There must be a good dialogue between practitioners and the media. For example, looking at our negotiations between the Indonesian government and the Aceh people, “nothing was agreed before everything was agreed”. We limited media comment by parties, protecting our negotiation environment, and preventing any false victories in the process. This is a good example of how sometimes you have to maintain privacy in a situation.

Q: Do you think broader coverage of conflict and crisis is harming resolution expectations?

[Kristiina Rintakoski] You never know how long these processes will take. Our negotiations in Indonesia were relatively short, but often it can take a long time. The media often diverts attention when parties need to be focussed on the actual process. It can often create expectations and momentum which forces parties to break from processes to deal with situations back home defending positions and solving situations, this can be immensely harmful to the process.

On The Wider World:

Q: How are issues like climate change, energy, and growing populations affecting crises and conflict?

[Kristiina Rintakoski] These are huge areas of interest for us, looking at how these issues affect political conflict. Climate change is, in many areas, impacting food availability and the kinds of patterns you would expect to see in society such as land ownership, pastoralism, and so forth. These issues are significant, and it is important that there is increased efforts to understand the connection of conflict and climate trends. This is not only affecting developing countries, but has the ability to intensify global conflict.

Energy issues influence thinking particularly in industrialized countries and is a fundamental issue of national interest. Nations might make compromises to have access to energy, and it can also impact the willingness of nations to intervene, and influence specific policies as part of conflict resolution


What is clear is that there needs to be more understanding of the complexities of conflict, and its specific issues, before we can come close to achieving peace. President Ahtisaari describes, “…the international community has demonstrated its incapacity in resolving conflicts and building sustainable peace in many countries and regions of the world. Meanwhile, new conflicts requiring international intervention may flare up. There has never been such an acute need for the international community to work together to develop innovative solutions and practical responses to these crises. This calls for coordination amongst international actors and a need to find common means and common language and for multi-faceted and multi-disciplinary approaches to problems. No political crisis or conflict can be solved without also seeking to create economic opportunities and employment as means to promote sustainable security.

These economic opportunities and practical solutions must, though, deal with the overwhelming network of issues which interact to create, exacerbate and spread conflicts. Looking at some of the more pertinent factors:

Economic Equality: These issues are of critical importance as economic growth and sustainability are often key drivers to the success of a nation in generating peace and stability. To put it in context, and to give a measure of the level of inequality, of the world’s 6.7billion population (which is growing at a tremendous pace) around 22% live below the poverty line (earning less than $1.25 per day), with 85% living in low to middle income countries (earning under $3,705 GNI per capita). NOTE: The World Bank calculated the GNI of the USA and UK in 2008 were $47,580 and $45,390 respectively.

The recent financial crisis has caused great concern about economic solutions, as funding support to conflicted regions gets cut, and protectionist trade barriers are erected. As President Ahtisaari explains, “The current global financial crisis has increased the risk of major geopolitical instability. Many of the regions and countries most affected by the withdrawal of capital from emerging markets and the collapse of international trade are already fragile, with many only just emerging from years of conflict. Growing inequality between countries and within society exacerbates existing cleavages. The loss of welfare and employment opportunities leads to a loss of hope and faith in the future amongst the vulnerable. This in turn fosters the rise of fundamentalism and violence, and creates breeding-grounds for crime, terrorism and war. We risk losing a generation to this financial crisis. And with globalization and increased interdependence amongst countries, violence in one region will have an impact in another part of the world.

For more detail on this, please refer to our interview in December 2008 with Professor Wim Naudé, (Senior Research Fellow and Project Director of the United Nations University World Institute for Developing Economics Research) who talked about the Economics of Developing Nations in the World Financial Crisis Click To View

Agricultural Sustainability & Climate Change: We currently have almost a billion people in the world hungry, with over five million people dying every year from hunger. Lack of agricultural development is certainly a factor, but climate change is also reducing the viability of land, making it impossible to cultivate high yields of crop without significant investments in irrigation. With booming populations, and increasing demands on agriculture, this has to be addressed. Climate change is also likely to displace many millions of people, predominantly in underdeveloped areas, also leading to a great degree of conflict as already stressed regions struggle to cope with the influx (including the western world).

Example: The Economist (May, 2009) "Rich food importers are acquiring vast tracts of poor countries' farmland. Is this beneficial foreign investment or neocolonialism?" - Click to view

Energy and Resource Security: We are becoming globally more dependent on energy, and we cannot underestimate the fact that ‘western’ societies are becoming dependent on their developing and conflict-heavy neighbours to provide them with oil and natural-resources. This dependency and underlying relationship will have huge impacts over how conflicts are resolved as intervening nations place energy and resource on their agenda.

Example: The Economist (July, 2009) "Foreign oil firms in Iraq" - Click to view

Justice and Human Rights: The level of injustice (in all its forms) and continuing human rights abuses occurring worldwide serve to exacerbate the stress of conflict and bring parties and populations further away from peace.

One of the most interesting factors though, is Technology. This generation, more than any before, are able to communicate globally, instantly, relatively seamlessly. This means that not only are those in conflict regions able to communicate their plight to the world, but it means that we, as a global audience of citizens and organisations can no longer turn a blind eye to what is happening. As the Dalai Lama was quoted as saying, “A wider of more altruistic attitude is very relevant in today's world. If we look at the situation from various angles, such as the complexity and inter-connectedness of the nature of modern existence, then we will gradually notice a change in our outlook, so that when we say 'others' and when we think of others, we will no longer dismiss them as something that is irrelevant to us. We will no longer feel indifferent.” We see this play out ourselves as tens of thousands of individuals, often with no direct link to a conflict will march in cities on behalf of those who are persecuted thousands of miles away.

Along with empowering us (as an audience) to understand conflict, technology has also provided a critical link of support in peace building, Mrs. Rintakoski described, in our interview, “…outside actors can rarely create peace, local ownership of the situation must occur”. We are seeing now that populations themselves, using collaborative and communications technologies are becoming empowered enough to create the momentum required to effectively participate in the conflict resolution and peace building process. The momentum of populations is often the impetus needed, as Dwight Eisenhower observed in the 19th Century, “I like to believe that people in the long run are going to do more to promote peace than our governments. Indeed, I think that people want peace so much that one of these days governments had better get out of the way and let them have it.

Organisations like CMI, who realise that humanity is key, are working hard around the world, taking an innovative approach to brokering peace. They are not trying to cure irreconcilable differences in opinions, they are not trying to undermine the struggles of different sides, but they are finding a common ground which all parties are (in general) interested in, i.e. the well being and conditions of their citizens. It is this process of working towards common goals, which can help broker peace, allowing parties to move forward with a new sense of purpose. We have seen this approach succeed even in our recent history. The troubles in South Africa involved issues which would have been seemingly impossible to reconcile, the cure involved collaboration between parties in hugely sheltered discussions, to work together for a common goal. Nelson Mandela himself observed, “If you want to make peace with your enemy, you have to work with your enemy. Then he becomes your partner.

John F. Kennedy is quoted as saying, “Peace is a daily, a weekly, a monthly process, gradually changing opinions, slowly eroding old barriers, quietly building new structures.” The facts remain peace (for most cases we see) will take not just months, but in many cases, years and generations, as sustainable economies and governance is developed combined with education and a generation who follow with a new shared momentum.

If we are to teach real peace in this world,” said Mahatma Gandhi…and if we are to carry on a real war against war, we shall have to begin with the children.

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Thursday, 2 July 2009

Investing and Trading Illiquid Assets

In this article, we speak to Jeremy Smith, Chief Strategy Officer at SecondMarket, where over 3,000 participants manage over $1 trillion, participating in the world’s largest centralized, independent marketplace and auction platform for illiquid assets from auction rate securities to private company shares, CDO’s, mortgage and asset backed securities.


Vikas Shah, Thought Economics, July 2009

Professor Eugene Fama, in his 1960’s Ph.D. thesis at the University of Chicago Booth Business School hypothesised that, “financial markets are ‘informationally efficient’, or that prices on traded assets (e.g., stocks, bonds, or property) already reflect all known information, and rapidly change to reflect new information”. This ‘efficient market hypothesis’ is now widely disregarded, as in the past quarter-century, our advances in technology allow us to observe that markets are not truly efficient as described by Fama, but are efficient to a greater or lesser degree based on many factors in the market.

Contemporary market thinking focuses a lot of attention on the fields of “behavioural finance” and “behavioural economics” which take inspiration and insight from fields including philosophy, psychology, statistics and neo-classical economics. Hersh Shefrin, in his 2002 paper, “Beyond Greed and Fear: Understanding behavioural finance and the psychology of investing” identified three main themes in understanding behavioural markets

Heuristics: People often make decisions based on approximate rules of thumb, not strictly rational analysis. (Cognitive Biases)

Framing: The way a problem or decision is presented to the decision maker will affect their action. (Information Biases)

Market inefficiencies: There are explanations for observed market outcomes that are contrary to rational expectations and market efficiency. These include mis-pricings, non-rational decision making, and return anomalies.

More recently, these theories have been extended to create the Adaptive Market Hypothesis, which. “Reconciles theories that imply that the markets are efficient with behavioural alternatives, by applying the principles of evolution - competition, adaptation, and natural selection - to financial interactions” (Andrew Lo).

Keeping these theories in the back of our mind, let us turn attention to the concept of Liquidity in a market.

A liquid asset has some or more of the following features. It can be sold rapidly, with minimal loss of value, any time within market hours. The essential characteristic of a liquid market is that there are ready and willing buyers and sellers at all times. Another elegant definition of liquidity is the probability that the next trade is executed at a price equal to the last one. A market may be considered deeply liquid if there are ready and willing buyers and sellers in large quantities. This is related to a market depth, where sometimes orders cannot strongly influence prices.

An illiquid asset is an asset which is not readily saleable due to uncertainty about its value or lacking a market in which it is regularly traded. The mortgage related assets which resulted in the sub-prime mortgage crisis are examples of illiquid assets as their value is not readily determinable despite being secured by real property. Another example is an asset such as large block of stock, the sale of which affects the market value.

The latter case, of illiquid assets, has come to the forefront of market commentary as “uncertainty” (the keyword in the definition) has turned many massively liquid markets suddenly the other way (including inter-bank lending, commercial paper, and more). In many cases, the assets considered are still investment grade, and present opportunities for buyer and seller, but the problems caused by heuristics, framing and inefficiencies in these less liquid markets prevent the structured trading necessary to create efficient operations.

SecondMarket (in their own words) are, “the largest centralized marketplace and auction platform for illiquid assets, such as auction-rate securities, bankruptcy claims, collateralized debt obligations, limited partnership interests, private company securities, residential and commercial mortgage-backed securities, restricted securities and block trades in public companies and whole loans. SecondMarket's online auction platform has 3,000 participants, including global financial institutions, hedge funds, private equity firms, mutual funds, corporations and other institutional and accredited investors that collectively manage over $1 trillion in assets available for investment.

Using an innovative approach, they are aiming to create an efficient market for the trade of these ‘illiquid’ assets, and in a privileged interview, Jeremy Smith (the firms Chief Strategy Officer) talks to us about how they create liquidity and opportunity in these markets.

Q: In your own words, what is second-market and why does it exist?

[Jeremy Smith]: “In the simplest terms, we are an independent marketplace for illiquid assets including, but not limited to, auction rate securities to CDO’s, mortgage backed securities and private company stocks. The key word is “independent”, we are not owned by major buyers or sellers of any of the assets we market, we do not take principal positions to buy or sell assets, we simply provide a market for them to meet. This is an important feature, as in some of the ‘toxic-asset’ markets, one of the biggest problems is that you have market-makers and the market-place acting as the same entity, so for auction rate securities and CDO’s, the banks that connected you with the buyer would buy the asset from you at a discount, and sell to the other party. This provides near instant liquidity, but the problem is for the seller who gets an artificially lowered price. The second problem is more systemic. What happens when the market-makers who are the marketplace go out of business or pull back on their balance sheets? When that happens, the marketplace disappears too. This is a structural flaw where the market-makers and marketplace are the same. If you think of NYSE, CBOE and so forth, you see that you have a marketplace (e.g. NYSE) and a market-maker (e.g. Goldman Sachs), the fact they are different entities keeps the market, to a greater degree, stable.”

Q: How does SecondMarket sit alongside exchanges? And what is the significance of your ‘ecosystem’ approach?

[Jeremy Smith] “The biggest difference, other than legal and regulatory influences, is the types of assets which they, and we, are able and willing to handle. Exchanges are highly automated, with a ‘point, click, execute’ attitude. With these [illiquid assets] you cannot use an automated system; it has to be hybrid to define the necessary efficiency and power. You have to be a market specialist. Of our 125 employees, for example, over 50 are specialists in the specific asset classes they handle, dealing with the unique transaction characteristics for each, and giving “high touch” hand holding, to create liquidity.

Our ecosystem is designed to look at the systemic issues, the transparency if you will. It is a two pronged approach, and is the only way to realistically bring liquidity to these markets. We have an internal transparency team who aggregate and standardise public information and make it available, for free, to buyers and sellers. Not all information is public (e.g. CDO’s) but also, in order to find buyers, you have to provide analytical valuation firepower. Our ecosystem provides all this information, the analytics, research, and valuation systems, to participants on both sides.”

Q: Illiquid assets and instruments have been notoriously hard to price, how does SecondMarket aid in the efficient pricing of these assets and instruments?

[Jeremy Smith] “Transparency is key. The more information you give, the more then bid and ask come together. We provide pricing transparency to buyer and seller showing where similar transactions have happened (or are happening in the case of auctions), bringing pricing into focus.

Another part is education. If we can educate buyers into pricing out there in the market, and why their thinking may not be correct, it also helps us bring liquidity and a narrower bid/ask spread. Improvements in settlement times for established asset classes, for example, restricted securities, which used to take four to six weeks to settle, now take just seven to twelve days, so by definition, we have increased liquidity.

It is, though, important to note that there are controls in these markets, ensuring that sellers, in particular, can control the level of information they give to the market and who can see it. This is essential for certain asset classes”.

Q: Are you seeing any global trends in countries with higher volumes of illiquid assets? And looking at SecondMarket’s site, you have a lot of activity in China, Dubai, Korea etc, how does Asia factor in to your model?

[Jeremy Smith] “I would say, clearly, we see a lot of activity in the USA, closely followed by western Europe. Asia, though, presents an area of great potential, the sheer size of investments held over there gives a medium-term opportunity. Right now, there is not a lot of movement (for economic and cultural reasons) but our efforts there are to penetrate the markets, and ensure we are there when the opportunity develops.”

Turning to sellers of illiquid assets?

Q: Who are the key participants and what are the key advantages to them in participating on SecondMarket?

[Jeremy Smith] “There are marked differences between asset classes. When it comes to auction rate securities and bankruptcy, the bulk of sellers are corporations with bad receivables in a company that went bankrupt (e.g. if company X owed company Y $10,000,000 and went bust, then company Y could sell the debt it is owed). As far as private companies are concerned, usually what you see are employees and early angel investors looking to sell their stakes. Hedge funds and High Net Worth Individuals participate in equity and in other toxic assets where we also have financial institutions and global/regional banks and insurers in the market.

As we discussed above, they have the ability to get better pricing and faster liquidity, and it is because of having these things in a centralised marketplace to aggregate at any time, that the level of participation improves, as does pricing, settlement speed and so forth. “

Turning to the buyers of illiquid assets?

Q: Who are the key participants?

[Jeremy Smith] “As far as buyers are concerned, each asset class is, again, different. The buyers of private company stock may be a venture capitalist, auction rate securities may be a hedge fund, and bankruptcies may be distressed debt buyers. To give you a general sense, around 65% of our buyer base is hedge fund, with the balance split fairly evenly between venture capitalists, pensions and endowments, family offices, global financial institutions, and asset managers.”

Q: Why buy illiquid assets?

[Jeremy Smith] “There are two primary reasons, one being somewhat self serving. Firstly, one unique factor across the majority of investors, is that they are looking for a unique investment opportunity. This [SecondMarket] gives investors access to markets which may have either not been available before, or may have only been available in a small way. Secondly, they [investors] know that they always have a market in which to resell the asset. They may not, previously, have participated because if they invested, they couldn’t easily get out, so they stayed out. Now they can resell these ‘illiquid’ assets, they are more inclined to participate as their risk is somewhat reduced.

Our philosophy is that there should be no such thing as an illiquid asset, there should be “more liquid versus less liquid”, but never illiquid. What we are talking about here is not conducive to environments such as NASDAQ or LSE where billions in liquidity can be created in seconds, but we still aim to provide an adequate level of liquidity.

The complexity and lack of “instant” liquidity also gives these asset classes a higher yield.

It is also important to note that for the asset classes traded, it may not necessarily be the asset which is distressed. In many cases, it is the SELLER of the asset who is distressed, or needs liquidity, the underlying asset itself is fine, but the seller’s own condition creates an opportunity to buy at discount.”

Looking at a few specific markets:

CDO’s and Mortgage Backed Securities

Q: There has been a great deal of negativity directed at these asset classes, how are you seeing investor attitudes here?

[Jeremy Smith] “Seller’s attitudes have been more negative than buyers, simply because they have become upset at carrying assets they don’t want, and can’t get rid of. This is in contrast to the buyers, who see an opportunity and are very excited.

For us as a marketplace, we are seeing a great deal of interest in these assets as buyers, attracted by the high yields (from purchase discount) are also feeling more comfortable trading, as they can resell their assets when they choose, eliminating some elements of risk which had prevented them participating.”

LP Interests & Private Companies:

Q: Interestingly, you also have a market for the ‘vehicles’ used by the VC industry for their investments, along with private company interests directly. Could you tell us more about how these markets work, and what the investor and seller interest and attitude has been like?

[Jeremy Smith] “Most markets are bilateral, insofar as you have a buyer a seller, and that’s it. With LP interests, and private companies, it is a three sided market. You don’t just have a buyer or seller, you have the company (or general partner ‘fund’). So the dynamic really changes because of this characteristic. What we see in terms of attitudes is that private companies and general partners have been reluctant to see these markets form, so we have spent over two years developing our unique ‘private company model’ because of these concerns. The key, we found, was control.

For private companies, for example, we create a micromarket. Typically these companies say, “I’m a private company, private for a reason. I don’t want my shares trading hands between buyers and sellers without me knowing”. The problem is, it already happens. So the choice is, do you want to take control? Or leave the ad-hoc method in place.

In the latter case (ad-hoc) it is useful to note that if employees want to sell shares, they can. Most companies do retain first refusal but in practice (especially at the moment) they don’t want to use capital to buy their own shares back, and would rather invest in market or R&D. The employee therefore calls their accountant, broker, or lawyer who will then sell. Information invariably leaks to the market, and false signals are sent

With our market structure, the company takes control. If you are, for example, linkedin or twitter, you create your own micromarket, you decide who your buyers are (e.g. existing investors? A select group? The whole market), you decide the rules for existing shareholders (how much of their holding can they sell? Do they have a physical value limit? How often can they trade?)

We also, through this model, answer the information problem. By giving control, and privacy, private companies are paradoxically more inclined to release information, as only approved individuals can see it. This creates liquidity and informed bids and in an environment where IPO’s are increasingly difficult, we are seeing many firms opting down our route.

When you have this kind of systemic control, you also get better price stability, which helps fundraising as investors can be more confident in price, transparency, and know they have a market to resell to if required.”

Looking at the future:

Q: How do you see the future for SecondMarket? What ‘markets’ are you bringing on-stream? And what are the key technological innovations you think will have the greatest impact on your business?

[Jeremy Smith] “We currently have around eight markets for illiquid asset classes, with another fifty on our watch-list which we are assessing. In the next twelve months, the marketplaces we have identified in particular include s363 asset sales (a US Bankruptcy asset), private REIT’s, and asset backed securities (including credit card and auto loan securities).

Technology is certainly important to our business, with the regular introduction of add-ons to help analysis and efficiency, but the real crux is the combination of technological and human. Our innovation is predominantly on improving the process and structure of the markets, increasing speed, efficiency, and hence liquidity.”


What we see here is a business model which innovates to tackle the tenets of behavioural finance to create efficiency and opportunity.

By increasing transparency, information, and analysis, SecondMarket have been able to reduce cognitive (heuristic), and framing (information) biases in the market (creating greater participation, and pricing accuracy) and by creating an ecosystem of many thousands of participants, with a great deal of control, they have been able to not only reduce overall risk for participants (almost acting as a pseudo-central counterparty clearing house like LCH.Clearnet) but compensate for the yield, pricing, and rationality anomalies which illiquid markets typically see.

Taking illiquid markets to the extreme, we see companies like “Commercial Intelligence”, who specialise in the recovery of debts from or guaranteed by governments, parastatals or companies in Africa and Asia, here utilising the lack of transparency and liquidity, together with the high perceived level of market-risk, to create high yields and opportunity from highly-illiquid assets.

The more our world becomes interconnected, and the pace of commerce increases, the more we will see that markets ‘behave’ rather than exist, meaning that innovation must take place to ensure continued liquidity and transparency. The lessons of the economic crisis of 08/09 have taught us the importance of these factors, and of the need for continued liquidity, This does signal a change of attitudes in the market, which Geoffrey Moore summarises well describing how “….we were thinking about scale instead of liquidity, ... The correct move now is to redirect the race toward liquidity.

For more information on SecondMarket, visit them online at:

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