FCA draft guidance ‘threatens community shares and retail co-ops’

Proposals on share capital, set out in Financial Conduct Authority (FCA) draft guidance, could shut down the market for community shares and damage the co-operative movement’s best established businesses, co-operators say. 

Dave Boyle, director of the Community Shares Company, says the FCA’s proposal to limit interest on co-operative society capital at base rate or below has ‘devastating potential’. “The base rate is currently 0.5%,” he says. “They’re saying that capital in a co-op or bencom [community benefit society] will always lose you money. If you want to make money, go to a capitalist company.

“This essentially turns co-ops into charities as far as capital is concerned. I hope they’re not going to shut down the market for community shares.”

He says interest levels should be considered on a sector by sector basis. Dave Hollings, director of Co-operative and Mutual Solutions (CMS), agrees. “The FCA’s proposals around savings accounts and commercial rates are not what the law and co-operative principles say,” he says.

“Interest should be ‘the amount needed to attract and retain capital’. This is a practical test which will vary from sector to sector; community shares in general, community renewables, worker co-ops, agricultural co-ops.”

Mr Hollings questions the FCA’s premises. “It says societies rarely issue more than a nominal member share,” he says. “It would be interesting to know on what data the FCA bases this.

“Historically, the most common forms of society were retail consumer co-operatives and agricultural co-operatives, both of which have variable share capital. At present, the most common form of society registered is a community benefit society for the purposes of raising share capital.

“It’s quite possible that a majority of societies registered since the 1852 act have had more than nominal share capital. Such societies are certainly not rare.”

He adds that some of the FCA’s proposals are contradictory. It says “financial returns should generally be set at levels that do not exceed the return on savings accounts”, that interest rates should be “fixed”, that “the rate should not exceed commercial borrowing rates” and that returns should never be more than is “sufficient to attract capital”.

“There is, to CMS’ knowledge, no evidence backing the FCA’s statement,” Mr Hollings says. “It’s also strangely at odds with the ruling by the Regulator of Community Interest Companies which came into force on 1 October.”

The regulator removed the 20% cap on share dividends and capped total dividends at 35% of distributable profits.

CMS is submitting analysis of the 33 community share issues it has completed to the FCA. All 33 have offered between 2% and 6% interest, with most offering between 3% and 5%.

The majority, 23, raised the planned amount of capital in the original timeframe, seven did not stick to the original timeframe but were able to fill the gap and three failed to raise the capital. “This indicates that the interest rate on our share issues is just about what is needed to attract and retain capital,” Mr Hollings says.

Co-operative Business Consultants’s (CBC’s) response to the consultation will also focus on community shares. Martin Meteyard of CBC says: “It appears that the consultation has been provoked at least in part by the recent packaging of some community share issues primarily as investment opportunities. Ian Adderley [of the FCA] gave examples and highlighted the FCA’s concerns about this in a presentation to the Society for Co-operative Studies conference in October 2013.

“Emphasising financial returns does raise a question over why co-operative and community benefit societies should be exempt from the provisions of the Financial Services and Markets Act 2000 in offering shares to the public. However, these cases appear almost exclusively to involve renewable energy undertakings, and it seems unnecessary to drag everyone else into the arena.

“There’s a real danger that the baby could be thrown out with the bathwater, particularly with the suggestion that ‘financial return should generally be set at levels that do not exceed the return on savings accounts’.”

He adds that although the guidance says “any decision to pay a higher rate should be justifiable in the context of the risk of the project”, which appears to offer a get-out clause, in reality all co-ops and bencoms involve an element of risk exceeding that of a deposit in a savings account.

“This is stated in every single prospectus I’ve seen,” Mr Meteyard says. “The return therefore needs to reflect that added risk while remaining at a sensible level.

“Some of the most successful community share issues have involved a ‘rescue’ of a local pub, village shop or ferry service, where the suggested financial return has been relatively low but speed has been of the essence, which would not be possible if the FCA were to require prior submission of such offers for vetting as suggested in [paragraph] 6.34.

“There will be arguments that in major undertakings requiring large amounts of capital, such as renewables, a high rate of financial return is necessary ‘to attract and retain capital’. This raises the question of linking such share issues more systematically to networks of ethical investors who are hopefully just as interested in community benefit as a financial return on their investment. This is something the co-operative movement would do well to address.”

Dave Hollings adds that the proposals will also affect retail societies: “One of the FCA’s stated aims is to protect retail investors in society shares, but their proposals would actually put such investors at greater risk,” he says. “A lower interest rate would reduce that amount of share capital which could be raised which would mean societies being more reliant on debt. This would increase the gearing on societies in the most vulnerable early years of trading, thereby increasing the chances of a failure of the business.

“Overall this reflects a fundamental misunderstanding of the way that share capital benefits a society. If a society’s activities are funded by members’ share capital, then it’s funded by people who either benefit from the society’s services and/or are in agreement with the society’s objects.

“If the society has to rely on external loan finance then it’s funded by people who have no real interest in the co-operative or the society’s objects. We’ve seen where that can lead with the Co-operative Bank. In an ideal world, which we’re not in, the capital of a society should entirely come from members’ shares.

“The FCA’s argument is that people investing in a society should not make any personal gain. We’re in a topsy turvey world where Mrs Smith putting in £500 of her own money at 4% return to save her local shop is unethical, whereas paying 8% interest on a loan to a commercial bank is wholly ethical.”

Mr Boyle says: “The FCA proposes a fundamentalist view. Do they realise the impact this will have on the entire sector? Traditionally societies funded capital from members instead of debt. Under these proposals no society will be able to fund itself with member equity; it will have to fund itself with debt.

“There’s already a rule that says a society can pay no more interest than is necessary to attract investment. What’s wrong with that rule? We’ve already got a regulatory process and a self regulatory process in the Community Shares Unit.

“It’s legitimate to say we don’t want to see super profits,” he adds. “Why not just have a blanket clause which says you can’t pay more than 7.5% above the base rate?”