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.