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.

Changes for Co-ops and Bencoms from April 1st

Among co-ops, the Financial Services Act 2012 will have the biggest impact on credit unions. Most of their regulation moves to the Prudential Regulation Authority on 1st April 2013 - see my last post.

However, other industrial and provident societies may see some changes on or after 1st April 2013. That may happen for two reasons:

• the move of the registration role to the Financial Conduct Authority (FCA) on 1st April 2013 and
• the implementation (whenever that happens) of section 1 of the Co-operative and Community Benefit Societies and Credit Unions Act 2010.

Clearer Regulatory Role for the FCA and nature of Its Guidance

In general, the draft Mutual Societies Order simply transfers the functions of registering societies under the Industrial and Provident Societies Act 1965 to the FCA with a possible role for the PRA where necessary -see Schedules 2 to 4 of the Draft Order. However, Schedule 1 of the Draft Order makes two interesting changes.

Paragraph 4(1) of the Schedule provides:

"The FCA must maintain arrangements designed to enable it to determine whether persons are complying with requirements imposed on them by or under the mutuals legislation"

That imposes a legal duty on the FCA to have systems in place to police whether or not people (and societies) are complying with  requirements imposed on them by or under the "mutuals legislation". That expression includes the Industrial and Provident Societies Acts - see   para 1 of Schedule 1 of the Draft Order and section 50(2) of the Financial Services Act 2012 (which was the old clause 47(2) when the Draft order was written).

One of the requirements imposed on every society "by or under" that legislation is that, while they are registered, they should be either a bona fide co-operative or a community benefit society.

So, if the Mutuals Order is enacted as drafted, there will be an explicit legal duty for the FCA to "maintain arrangements" to make sure that is the case. That requires systems to ensure that on registration and while registered societies comply with those requirements so that, if they don't, their registration can be cancelled under the mutuals legislation.

Resources will have to be found by the FCA to operate that system and there will no longer be any ambiguity about their role. They are a registrar of co-operatives and bencoms and that involves more  scrutiny than is needed to register a non-CIC company and keep it on the register.

So how will the FCA decide who meets those requirements? They already publish some guidance together with the application form for registration - see pages 8-9 here. They have already taken legal advice and consulted on the advice and its suggested guidance and work continues on that.

While the content of future Guidance will be subject to further work and more consultation, the Draft Order makes it clear beyond doubt that FCA Guidance about mutuals is Guidance under the amended Financial Services and Markets Act 2000 and not just information provided under the mutuals legislation -see paragraph 2(2)(f) of the Draft Order and section 139A of FSMA 2000 to substituted in the 2000 Act by section 24(1) of the Financial Services Act 2012.

This does not impose the full panoply of formal consultation applicable to Guidance given to regulated persons in the financial services sector. But it does give the Guidance a more formal status than the present brief note to an application form. Interestingly, it also places beyond doubt the power of the FCA to pay other persons or organisations to give the guidance on its behalf - see new section 139A(2) of the amended FSMA 2000.

This means that the role of the FCA as the UK body making sure the society structure is only used by bona fide co-operatives or bencoms will have a firmer legal footing from 1st April 2013. It is  legally required carry out that function effectively.

Implementation of ss 1 and 2 of the 2010 Act

It is not clear when this will happen. It ought to happen by 1st April 2013. When it does, two important changes will be put in place.

One is that societies will formally, legally and for all purposes be known as co-operative or community benefit societies and not industrial and provident societies. Section 2 of the Act will achieve that.

The other is that any society which is registered will be registered formally and officially as EITHER a co-operative or a bencom.

Up to now, as long as a society met the criteria for one of these categories, it would be registered and there was room for some uncertainty or ambiguity about which category it was in at the time. Section 1 of the 2010 Act will amend industrial and provident society legislation with effect from the time of the amendment to make the basis of registration in one category or the other clear.

This, like the more formal legal status of Guidance on the criteria for these categories, makes clarity about the nature and role of the organisation vital.

Both of these developments bolster the role of the FCA as registrar and assist in protecting the "brand". The registration of phoney co-operatives or bencoms should be harder. Continued compliance with the registration conditions to avoid cancellation of registration is just as important.

Finally, when will this happen? In March this year, the Law Commission plans to provide a "draft Co-operative and Public (sic) Benefit Societies Bill to HMT" - see page 11 of this business plan. Will the 2010 Bill's implementation have to wait until parliament passes that new consolidating Bill?

Surely, it makes much more sense for sections 1 and 2 of the 2010 Act to be effective  on 1st April 2013 to coincide with the implementation of the Financial Services Act 2012 and a Mutual Societies Order made under it?