NACUW Conference and AGM 20 October 2011 Jonathan Ellis Financial Services Authority (FSA)

1. NACUW Conference and AGM 20 October 2011 Jonathan Ellis Financial Services Authority (FSA)

2. Legislative Reform Order (LRO) HM Treasury announced review of credit union law at end of 2006 LRO re-laid in Parliament July 2011 HM Treasury officials say it should be: • passed at beginning of November 2011 • take effect 2 months later – so beginning of January 2012

3. Legislative Reform Order (LRO) The LRO abolishes old “common bond” concept Present: A credit union must adopt one of the “appropriate membership qualifications” from the Act, and that qualification must create a “common bond” among the members Future: The “appropriate membership qualifications” are renamed “common bonds”, and the old “common bond” concept is abolished Effect: It’s a technical question whether a credit union’s rules comply with the legislation, and there’s no subjective judgment to be made about the commitment of members to each other

4. Legislative Reform Order (LRO) Under the LRO, the “common bonds” are the same as the old membership qualifications, and old terms (like “locality”) are not redefined: • following a particular occupation • being employed by a particular employer • residing or being employed in a particular locality • being a member of a bona fide organisation or being “otherwise associated” • any other common bond approved by FSA

5. Legislative Reform Order (LRO) The LRO introduces no new “common bonds” Credit unions are still restricted to the same old ones However, the “otherwise associated” “common bond” now offers more scope to credit unions - as there no longer needs to be a commitment between members

6. Legislative Reform Order (LRO) The LRO allows a credit union to adopt more than one “common bond” for the membership qualification in its rules Present: It’s one “common bond” per credit union (though there can be two in some cases, if “association” is involved) Future: A credit union may adopt several “common bonds” – for example, more than one “occupation” plus more than one “employer

7. Legislative Reform Order (LRO) The LRO allows FSA to accept a statutory declaration from a credit union as sufficient evidence that the “common bond” requirements are met The FSA will generally accept a statutory declaration if the credit union’s membership rule directly follows the wording and structure of the “common bond” requirements in the legislation

8. Legislative Reform Order (LRO) The LRO limits the scope of the “locality” “common bond” If one of a credit union’s “common bonds” involves a connection with a “locality”, the following conditions apply (unless there are “extraordinary circumstances”): • the number of potential members must not exceed 2 million • it must be reasonably practicable for every potential member - to participate in votes - serve on the credit union’s committee - have access to all the credit union’s services This means that a credit union cannot adopt a membership qualification covering more people than it intends, or is able, to service This applies to “membership qualifications” already registered, as well as to new ones

9. Legislative Reform Order (LRO) The LRO allows the FSA to accept a statutory declaration from a credit union as sufficient evidence that the conditions relating to “locality” are met Otherwise, the credit union will need to make a case that “extraordinary circumstances” exist for not complying with them “Extraordinary circumstances” are not defined in the legislation “Extraordinary” suggests that the circumstances will be very unusual, perhaps to allow an emergency transfer of engagements Being in breach of the conditions before the legislation takes effect is unlikely to be seen as “extraordinary circumstances”

10. Legislative Reform Order (LRO) Under the LRO, a person under 18 may enjoy full membership rights in a credit union (shares and loans) unless its registered rules provide to the contrary • If there is no registered rule specifying a minimum age, an individual is eligible for membership, however young, and “juvenile deposits” (deposits by persons too young to be members) are not permitted • The absence of a registered rule does not allow the credit union to exercise discretion about the minimum age • A registered rule may not confer such discretion on the credit union’s board A member under 16 may not be an officer/director, or execute instruments on behalf of the credit union

11. Legislative Reform Order (LRO) Under the current law, a person who ceases to fulfil the qualification for membership (a “non-qualifying member”) may retain membership, but the number of such persons shall not exceed 10 per cent of the total membership The LRO abolishes this limit But if it chooses, a credit union may state in its registered rules that such persons shall not: • be entitled to retain membership, or • exceed a specified percentage of the total membership of the credit union

12. Legislative Reform Order (LRO) Under the LRO, a credit union may amend its registered rules to allow bodies corporate (limited companies, for example) to become members in their own right The LRO creates three categories of “corporate member”: • a body corporate which is a member of the credit union • an individual who is a member of the credit union in his capacity as a partner in a partnership • an individual who is a member of the credit union in his capacity as an officer or member of the governing body of an unincorporated association (earlier versions of the LRO referred to a “trustee” of the association)

13. Legislative Reform Order (LRO) The LRO specifies how “corporate members” must relate to each of the common bonds for individuals For example, in the case of the “locality” common bond, the body corporate, partnership or unincorporated association must have: • a place of business in that “locality” • some other significant connection with that “locality” If a credit union wants to admit “corporate members” under this common bond, its registered rules will have to state whether it is adopting either or both of the above bullet-points If it is adopting the second bullet-point, it will have to set out what it regards as the significant connection with the “locality” The LRO includes similar provisions for the other common bonds A credit union may only make corporates eligible under a bond if it is admitting individuals under that bond

14. Legislative Reform Order (LRO) Under the LRO, the eligibility for membership of a “corporate member” is determined by the eligibility of the body corporate, partnership or unincorporated association – not by the eligibility of an individual acting for them The corporate must be eligible for membership, but the individual doesn’t have to be An eligible individual cannot convert an ineligible corporate into an eligible one A credit union’s rules will need to provide for a transfer of shares and loans whenever a different individual begins acting for the partnership or unincorporated association

15. Legislative Reform Order (LRO) The LRO provides that “corporate members” may not borrow, unless the credit union’s rules provide specifically for this “Corporate members” must not: • make up more than 10% of membership • hold more than 25% of shares (apart from deferred shares) • borrow more than 10% of amount on loan to all members

16. Legislative Reform Order (LRO) The LRO introduces “deferred” shares, which: • count towards capital (when members pay in money for deferred shares, credit union has to transfer that sum to reserves) • are different from other credit union shares in being transferable, but not withdrawable, and carrying no right to borrow • are generally repayable only on winding-up or dissolution of credit union, after all creditors have been repaid They will not be covered by the Financial Services Compensation Scheme (FSCS)

17. Legislative Reform Order (LRO) Interest-bearing shares The LRO allows credit unions to issue interest-bearing shares so long as they have: • registered an amendment of rules to provide for it • submitted to the FSA: - an audited annual return showing reserves of at least £50,000 or 5% of total assets, whichever is greater - a report from its auditor that credit union has satisfied conditions specified by the FSA

18. Legislative Reform Order (LRO) Once the LRO takes effect, FSA will make a direction specifying the conditions that a credit union needs to satisfy if it is to issue interest-bearing shares These are likely to be that the credit union: • operates an accruals-based accounting system • has a business plan based on reasonable assumptions • has in place a system that provides for monitoring performance against the business plan, and making necessary changes

19. Legislative Reform Order (LRO) Under the LRO, a credit union that satisfies the specified conditions may issue interest-bearing shares as well as shares that are eligible for a dividend But each share has to be one or the other – if a share is interest-bearing, it cannot be eligible for a dividend

20. Legislative Reform Order (LRO) The LRO imposes no maximum rate of interest on interest-bearing shares It abolishes the maximum dividend rate on shares - except on winding up, where it remains at 8% - so current members have nothing to gain personally from closure

21. Legislative Reform Order (LRO) “Attachment” of shares - where member’s loan exceeds shareholding Position after the LRO takes effect: • existing loans - no change – shares may be withdrawn at discretion of committee • new loans – loan agreement must deal with “attachment” issue - shares are “attached” if term in loan agreement that shares cannot be withdrawn for duration of loan That term may be varied by mutual agreement, thus “unattaching” shares [High-level rule in CREDS that credit unions need to hold prudent and appropriate levels of liquidity, but no specific rules to reflect differing practices of credit unions in “unattaching” shares]

22. Legislative Reform Order (LRO) The LRO will amend the law on charging for ancillary services (bill-paying, standing orders, advice etc) Current position – credit unions may only charge members on the basis of cost recovery Position under LRO – members joining the credit union after the LRO has taken effect may be subject to a commercial rate, but existing members must remain on no more than on cost recovery

23. Legislative Reform Order (LRO) The LRO amends the law on instruments of dissolution of credit unions With FSA’s agreement, such an instrument may be approved by members attending 2 meetings (like a transfer of engagements) rather than by members’ signatures (three-quarters of total membership)

24. Legislative Reform Order (LRO) The LRO allows credit unions to publish unaudited interim revenue accounts and balance sheets, provided that they are: • marked “unaudited” • accompanied by the latest audited accounts

25. Legislative Reform Order (LRO) Credit unions must provide copies of their registered rules on request Under the LRO, the following fees apply: Members – free (for their first copy) Other applicants – up to £5

26. Legislative Reform Order (LRO) Variation of permissions: LRO gives FSA power to vary credit unions’ permissions to allow them to admit a full range of corporate members The idea is to save credit unions and the FSA the trouble of dealing with individual applications But credit unions can opt out of having their permissions extended by giving notice to FSA before the LRO takes effect FSA proposes to exercise power and vary permissions once the LRO comes into force

27. Credit Unions Regulatory Guide (CURG) CURG will be a guide to the law on credit unions (parliamentary legislation) It will not contain FSA rules or guidance on FSA rules Guidance on the changes made by the LRO will be available by the time the LRO takes effect But guidance on the wider law delayed by transfer of NICUs and split of FSA

28. Credit Unions new Sourcebook (CREDS) CREDS was published • in draft form in Consultation Paper 09/27 in November 2009 • as “near-final rules” in Policy Statement 10/11 in July 2010 No changes of substance are now possible, but there can be minor clarifications and corrections

29. Credit Unions new Sourcebook (CREDS) Differences between new CREDS and old CRED: • new table setting out which parts of main FSA Handbook are relevant to credit unions, but no detailed paraphrases of main handbook • no guidance on credit union legislation – that’s the role of CURG • revised rules on capital and liquidity • consequential changes - resulting from legal changes made by LRO

30. Credit Unions new Sourcebook (CREDS) Revised CREDS rules Start-up funding (or initial capital) - amount needed by credit union to get established Evidential provision • version 1 credit unions - £10,000 (up from £1,000) • version 2 credit unions - £50,000 (up from £5,000) Presumption that those levels of start-up funding are needed, but individual credit union can make case that it doesn’t need so much

31. Credit Unions new Sourcebook (CREDS) Revised CREDS rules Capital Minimum capital-to-assets ratio 3% for version 1 credit unions – rather than the old CRED requirement that ratio should merely be positive

32. Credit Unions new Sourcebook (CREDS) Revised CREDS rules Liquidity Minimum liquidity ratio (percentage of assets held in readily available form) Ratio for version 2 credit unions to be same as ratio for version 1 credit unions • 10%, with dispensation to fall to 5% for single quarters (Currently - 5% minimum liquidity ratio for version 2 credit unions at all times)

33. Credit Unions new Sourcebook (CREDS) Transitional provisions in CREDS Capital and liquidity Near-final rules allowed 3 years to transition. Should we consider that the 3-year period started with the publication of the “near-final rules”, or that it should start with the making of CREDS by the FSA Board? Probably the latter.

34. Credit Unions new Sourcebook (CREDS) Transitional provisions in CREDS Probable outcome Capital-to-assets ratio – version 1 credit unions 30 September 2012 – 1% 30 September 2013 – 2% 30 September 2014 – 3% Liquidity ratio – version 2 credit unions 30 September 2012 – 6% 30 September 2013 – 8% 30 September 2014 – 10%

35. Credit Unions new Sourcebook (CREDS) Supervisory returns and guidance Supplementary sheet The existing returns remain unchanged, but credit unions taking advantage of new LRO powers will need to fill out a supplementary sheet This sheet will analyse aggregate figures on the main return, to show: • corporate members • deferred shares • interest-bearing shares

36. Credit Unions new Sourcebook (CREDS) Supervisory returns Submission period for annual return (CY) and accounts Submission period reduced to six months after financial year-end “Near-final rules” said this wouldn’t apply to returns for financial years ending before 31 July 2011 In final CREDS, this will probably become 31 July 2012 – so it won’t apply to this year’s round of annual returns, but will apply to those we generally start to receive in 2013

37. Credit Unions new Sourcebook (CREDS) Revised CREDS guidance Provisioning for bad and doubtful debts New guidance that credit unions should consider making provisions when loans are 6 and 9 months in arrears

38. NACUW Conference and AGM 20 October 2011 Jonathan Ellis Financial Services Authority (FSA)