Globalisation, I suggest, is bad news for co-ops and other mutuals.
By creating a huge single market, it favours the giant corporations that have the capital base to market themselves, provide administration and distribute products and services across a wide geography.
Nowhere is this more of an issue than in banking. The impact of the financial crisis was felt by taxpayers through the bailing out of banks that were too big to fail. Yet, at least at this point in time, the big banks have got even bigger. Lloyds was leaned on to rescue Halifax, before the government was forced to rescue it. A major mortgage lender, Northern Rock, went to the wall, significantly reducing competition. In the mutual sector, Nationwide rescued the Dunfermline, Cheshire and Derbyshire building societies.
It has been a similar situation in other countries. In Ireland, the Anglo-Irish Bank, EBS (formerly the Educational Building Society, now part of the Allied Irish Bank) and the Irish Nationwide Building Society have all left the scene, while the National Irish Bank (bought by Danske Bank) has all but left the country.
In the United States, government rescues have led to comparable outcomes. Bank of America took over fellow giant Merrill Lynch, before the merged business was rescued by the US government.
The intention is that the banks will now downsize and competition increase. But this is a slow process that will take decades to complete (if ever). The demerger of TSB from Lloyds does little to make up for the loss in competition from the demise of the independent Halifax. And the logic of the need for giant size to operate in a global market is undiminished.
For the mutual sector, the impact of these factors is multiplied. If the basic requirement to compete is the size of a business’s capitalisation, a mutual is either disadvantaged or destroyed. While Barclays, Lloyds and RBS survived thanks to new capital injections, this option was not available to the Co-op Bank – as (formerly) a plc subsidiary of a mutual – other than through demutualisation.
The Nationwide was also pushed to increase its capital base, but was able to do this through the issuing of Core Capital Deferred Shares – a hybrid financial instrument that is in effect a bond that converts to equity if the institution hits serious trouble. But Nationwide is the only building society that has used CCDSs and the regulator insisted that it could only sell CCDSs to institutional investors.
In a just-issued statement, the Financial Conduct Authority has made clear that CCDSs may only be issued to what are termed ‘sophisticated investors’.
The FCA explained: “Mutual society members tend to represent a cross-section of the public and we expect many will have little or no experience with investments other than deposit-based products.”
What makes matters worse is that CCDSs are not available to mutuals other than building societies – ruling them out for friendly societies, co-ops, community benefit societies and credit unions (and a plc that was owned by a mutual).
And building societies’ traditional means of raising capital, the issuing of permanent interest bearing shares, will no longer be recognised by regulators as a form of loss-bearing capital from 2019.
The understandable demand by regulators for banks to have larger capital cushions to prevent governments in future from having to bail out failed financial institutions has severely hit mutuals. According to a recent report from the all-party parliamentary group for mutuals, this is particularly the case in the UK. The MPs and members of the House of Lords point the finger at the FCA for not doing more to support the mutual sector and for failing to either properly engage or understand the sector.
Definitions of investors as either ‘sophisticated’ or ‘unsophisticated’ are “simplistic and ill conceived”, said the all-party group in its report, whose title asks How can mutuals raise capital without destroying the mutual principle?
The all-party group suggested there is a significant difference in approach between the UK’s two financial services regulators, which is harmful to mutuals. It complained that the FCA seems unsympathetic, lacking in understanding of financial mutuals and reluctant to engage with the group’s inquiry.
But the Prudential Regulation Authority demonstrated a more positive and sympathetic approach.
Andrew Bailey, a senior regulator at the PRA, told the inquiry: “I have a lot of sympathy with your view that people who are members of mutuals should be able to own these [CCDS] instruments. That is what membership means.
“Of course, on the continent … mutuals do issue that type of capital instrument to their members and the building society model does not have that feature to it.”
But Mr Bailey also expressed concern about investors misunderstanding the character of CCDSs and being unwittingly exposed to risk.
A presentation earlier this year at the world credit union conference in Australia by Martin Stewart, the director of banks, building societies and credit unions at the PRA, provides some further clarification.
The global capital regulatory requirements are determined by Basel III, the framework by which global banking regulators come together. In accordance with Basel III, CCDSs need to be permanent instruments that cannot be redeemed, with returns determined annually by an institution’s board of directors, subject to a capped upper limit. Losses by the institution will be absorbed proportionately between the CCDSs and the reserves owned by the institution’s members.
These obligations mean CCDSs are only really suitable for large building societies. Two building societies have instead used ‘Alternative Capital Tier 1 instruments’. Manchester Building Society last year privately placed £18m of Profit Participating Deferred Shares, which have been recognised as Tier 1 capital. And the troubled West Bromwich Building Society issued £50m of Profit Participating Deferred Shares in 2009, converting existing subordinated debt into PPDSs.
But, says the PRA, limits will be imposed on the amount of these alternative instruments that can be issued. Building societies and other financial mutuals will therefore mostly rely on retained profits to strengthen their capital positions.
However, the PRA warns that raising capital by CCDSs and alternative instruments is expensive – CCDSs will normally pay more than 10% per annum to recognise the high risk factor – and the development process is also costly and complex.
It is therefore clear that even where there are solutions to mutuals’ problems in raising capital, mutuals are disadvantaged compared to plc banks. This is very unfair. “The additional capital requirements put particular strain on mutuals, which themselves were not the cause of the financial crisis,” points out the all-party group.
The all-party group made several other telling comments, too. There is a weird paradox in the way the FCA regulates mutuals. It is preventing mutuals from selling CCDSs to members on the grounds that they could be unwittingly misled about the nature of the investments. Yet, points out the all-party group, for the law to allow a non-co-operative financial institution to continue to call itself ‘the Co-operative Bank’ is fundamentally misleading.
It should be stressed that this point was made by a group of politicians containing senior Labour/Co-op Party MPs, including Gareth Thomas, Andy Love, Cathy Jamieson and Adrian Bailey.
“It is damaging to any understanding of corporate diversity and confusing to consumers if the Co-operative Bank maintains its name when it is no longer owned by a co-operative,” concluded the group’s report.
The other, to my mind, really important point made by the all-party group is that mutual institutions fail to maximise their capacity to influence and support each other – and this is because of a lack of joint work operating across the boundaries of different types of mutuals.
This has been a view taken for decades by many of us working in the sector. The report points out that there are much stronger connections across the mutual sector in other parts of Europe.
“UK mutuals do not collaborate together sufficiently,” it says, “and they should make more effort to work together to share services and build strategic alliances in order to strengthen the sector.”
Hear, hear, I say. That is surely the way to strengthen the movement, while not allowing any individual mutual organisation to dominate the sector.
The principles behind co-operative identity, I suggest, include diversity, democracy and pluralism. As we rebuild the movement, this is a really good moment to remember that point.
• This article previously mentioned that efforts by the Ecology Building Society to issue CCDSs to its members were rejected by the Financial Conduct Authority (FCA). The building society has clarified that it has not attempted to issue CCDSs to members and has not been rejected by the FCA. The FCA is currently consulting with the sector to work on the marketing of CCDSs.
In this article
- Adrian Bailey
- Andrew Bailey
- Andy Love
- Building society
- Cathy Jamieson
- Co-operative Bank
- Ecology Building Society
- Financial Conduct Authority
- Gareth Thomas
- House of Lords
- Manchester Building Society
- Martin Stewart
- Prudential Regulation Authority
- United Kingdom
- West Bromwich Building Society
- world credit union
- North America
- United Kingdom
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