Co-op Fortnight Law Lecture 7.00pm 03.07.13 Holyoake House

This is the planned outline for my lecture on 3rd July:

"Ian will be outlining current legal issues around the co-operative and community benefit society structure. He will deal with recent developments in co-operative and community benefit society law and changes likely to be seen in the next 12 to 18 months. They include the proposed new Co-operative and Community Benefit Societies Act, the entry into force of the Co-operative and Community Benefit Societies and Credit Unions Act 2010, the application of the administration procedure to insolvent societies, the new registration system for societies under the Financial Services Act 2012 and the new FCA guidance expected in late 2013 or early 2014. He will also examine some issues around share capital in societies."

I'm honoured to be giving the Ian Pyper Memorial Lecture (kindly sponsored by DWF LLP for the UK Society for Co-operative Studies) at 7.00pm on 3rd July at Holyoake House, home of Co-operatives UK for Co-ops Fortnight. For free food in advance come at 6.30.pm......

Co-op Bank Capital: The Plan to List the Bank

This morning, the Co-op Bank announced its plan to deal with the problems acquired with the Britannia Building Society and how it intends to meet the Basel III requirements for increased capital for banks. The plan has been agreed by the Banking regulator. The PRA has agreed that the bank needs £1.5billion in capital and has approved the current plan by the bank and the Co-op Group to achieve this.

Once the plan is carried out, the Bank will no longer be a wholly owned subsidiary of the Co-op Group but will be a Stock Exchange Listed Company with ordinary shareholders. The plan is that the majority of ordinary shares will still be held by the Co-operative Group.

Lets look at the detail of the plan and think about its implications. The full text of the plan is available on the Co-op Group's website. An interview with Euan Sutherland is available on Youtube as well. The main features of the plan seem to be as follows.

The Plan

It has been agreed that the Bank needs £1.5 billion in Common Equity Tier 1 capital. For the meaning of "Common Equity Tier 1 Capital", see Basel Committee on Banking Supervision, "Basel III: A global regulatory framework for more resilient banks and banking systems", December 2010, revised June 2011 at pp 13-17.

£1 billion is to be contributed in 2013 and a further £0.5 billion in 2014. The first £1 billion will come from an "Exchange Offer" to be launched in October 2013. The holders of "target securities" i.e. preference shares, subordinated bonds and subordinated notes in the Bank will be offered the chance to swap those securities for a mixture of senior but unsecured debt securities in the Group, plus possibly similar securities in the bank, AND ordinary shares in the bank. See pp 6-7 of Co-op Bank Plan Full Statement 17.06.13 for a list of the securities involved and their ranking.

The exact mixture offered to those security holders will vary according to the ranking of the securities that they hold

"more junior ranking Target Securityholders are likely to be offered a substantially greater proportion of Bank Shares relative to the Group Instrument. The most senior ranking Target Securityholders are expected to be offered the substantial proportion of the Group Instrument."

Preference shareholders will get the highest proportion of shares and holders of Notes the highest proportion of debt securities (pp 6-7).

The target securities in the Exchange Offer will be redeemed below the bank's book value (p3 of the Co-op Bank Plan Full Statement 17.06.13). That is the contribution of those security holders to solving the bank's capital shortfall. For "small retail investors", the Bank is considering both "alternative options" and "the provision of independent financial advice" (p4 Co-op Bank Plan Full Statement 17.06.13).

The Co-op Group's contribution as part of the Exchange Offer is that the proceeds from issuing its senior but unsecured debt securities will be used indirectly to finance its own subscription to additional ordinary shares in the bank while Co-op Group will meet the interest and principal payments on that debt from its own resources.

Part of the £0.5 billion to be raised for the Bank in 2014 will be found by the Co-op Group. It will be made up of  the proceeds from the sale of  Co-operative Life Assurance and Asset Management - agreed but subject to regulatory approval - and  from the sale of Co-operative General Insurance by the Group. In addition, the Bank will embark on a cost saving programme and the sale of non-core Bank assets.

The bank will focus in future on serving retail customers and small businesses rather than larger corporate and commercial customers with complex requirements.

The Effects?

So, what does this mean?

• The detailed proportion of the bank's ordinary shares that will be held by minority shareholders rather than the Group will not be known until the detailed Exchange Offer ("Equity Swap") is made in October and the response of Target Security holders is known.
• There has been a genuine effort to develop an "equitable" solution to the problem.
• The existing outside investors in the Bank make a contribution by getting a new bundle of ordinary shares and debt securities which do not reflect the book value of the bank.
• So, watch out for a short term reduction in the credit rating of the "target securities" subject to the Equity Swap and of the bank's senior issuer credit rating - p5 Co-op Bank Plan Full Statement 17.06.13.
• The Co-op Group raises funds based on its own credit worthiness and invests in ordinary shares in the bank as well as investing the proceeds of the sale of the insurance businesses.
• The bank employees and management participate in cost cutting and a refocus of the business.
• The Co-op group avoids selling other profitable businesses to bail out the Bank
• The requirements of UKLA and the Disclosure and Transparency, Prospectus and Listing Rules as they apply to Ordinary Shares will impose a level of transparency and accountability on the management of the Bank and, indirectly, of the Group that will be healthy and useful to Co-op Directors and members.

All in all, this looks like a reasonable and proportionate plan to deal with the serious problems that emerged earlier this year and to clean up the mess.

Using the bank's PLC status to come up with a solution looks like the least of the evils. However, we must hope that any slippery slope towards reduced Co-op Group control of the Bank is avoided.

Capital: The old Co-op conundrum re-emerges....

Andrew Bibby has published an interesting and thoughtful analysis in the Guardian of the issues currently faced by the Co-op Bank in the wider context of the problems faced by many co-ops in raising capital.

He outlines the interesting recommendations of Mark Hayes in a recent report for Co-operatives UK for the use of transferable shares in co-ops and the establishment of a secondary market in those shares. He also points to the difficulties faced in agricultural and other co-ops who have gone down the path of using equity capital while trying to maintain their co-operative identity.

Andrew points out that the Co-op Bank is a PLC owned by the Co-op group and comments that:

"Interestingly, the Co-op Group already has the legal powers to issue transferable shares to its members in the form of what its rule book calls Member Investor Shares. Were the Co-op Group to pursue this idea, it would create a major new financial instrument for cooperatives to develop further. Behind the scenes, recent lobbying by the co-operative banking sector has aimed to ensure that transferable shares of this kind are recognised under Basel III Tier 1 rules as core capital."

This is a good point and the availability of transferable shares could be helpful. The problem will always be the existence of a market in shares of this kind and so the ease (or difficulty) with which they can be sold when people holding them want cash them in.

If the Basel III Tier 1 rules are tweaked to allow such shares to count, it seems unlikely that shares issued by the group would be directly relevant. They are not the bank's capital.

However, the ability for the Group to raise more capital by a share issue might assist in plugging the hole in the bank, if the funds were then invested in the bank as further equity held by the Group in the bank. That would count because it was equity. When the shares were issued, it would have to be made very clear to those taking them that the purpose was to support the bank.

As I remarked in my long post on the bank last month:

"For co-operatives registered as industrial and provident societies capital raises difficult legal and regulatory issues.

Shares classified as withdrawable give the holder an exit possibility as the society can pay the money back and cancel the shares. This is contrary to the usual rule that corporate bodies (e.g. companies) are not permitted to buy back their own shares without special procedures and safeguards for creditors and remaining shareholders. However, apart from withdrawable shares held by other societies, only up to £20,000 worth of those shares can be held by any person (individual or company).

Non-withdrawable shares in societies are not subject to any limit on the value of a holding but they probably cannot be bought back by the society at all under the governing common law rule in Trevor v Whitworth. This is unfair to societies as companies, as long as they follow certain procedures and provide some safeguards, can buy back their own shares out of profits available for distribution or, in the case of private companies, even from capital not so available.

Primary legislation is needed to deal with this issue and to put societies in the same position as companies in that respect. If that were passed, it would significantly ease the position of all co-operative societies, including the Co-operative Group."

There is no doubt that an expansion of the range of shares that societies can issue to  include redeemable shares that are not subject to the holding limit on withdrawable shares but that do offer an exit route subject to appropriate safeguards for creditors would be very helpful.

Local, Loved and Trusted…. with Legal Support? 7.00pm 03.07.13 Holyoake House

I'm honoured to be talking about recent and imminent legal developments and Co-ops at the Ian Pyper Memorial Lecture (kindly sponsored by DWF LLP for the UK Society for Co-operative Studies) at 7.00pm on 3rd July at Holyoake House, home of Co-operatives UK for Co-ops Fortnight. For free food in advance come at 6.30.pm......

Further information from Richard Bickle - richardbickle@cooptel.net