Mutual capital in the UK and beyond. Mutuals’ Forum ’10 4 November 2010. Jeremy Palmer. Head of Financial Policy, BSA. Introduction. Overview of BSA’s UK experience in fighting for recognition of mutual capital instruments
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They give a different answer to two basic questions…
For whose benefit is the entity in business ?
Who benefits from the entity’s surplus ?
In a PLC, the answer to both is : the shareholder who provides equity capital
In a mutual or cooperative, the answer to both is : the customer-member
Back to basics…..
Extract from Report of the ICA Commission on Co-operative Principles (1966)
….and revealed that starting levels were too low.
So a major plank of “regulatory repair” is…
…to require higher levels, and higher “quality” of capital
But what does high “quality” really mean ?
Capital for mutuals –
Why such a problem now ?
..and protects depositors by assuring a bank’s resilience
Capital not the sole mitigant, nor the answer to everything…..….but still very important
Mutuals and cooperatives agree that capital is very important…..
….…which is why we retain surplus to build reserves instead of over-distributing dividends or bonuses like the PLC banks
What is Capital for ?
In a simple company = reserves plus ordinary shares (“core tier 1”)
But ordinary equity may be expensive or unavailable….
….so supplementary capital – prefs, hybrids and sub. debt widely used in banking
But these exotic hybrids proved not much use – in the crisis…..
…so banks now made to hold much more core tier 1
What counts as Capital ?
Based on the “basic ownership” concept which only works in the capitalist model
Let’s go back to the two basic questions…..
Basel in effect says mutuals/coops can only issue core tier 1 if the capital providers get all the benefits of the enterprise
To apply this to mutuals at all is a category error
Why the ordinary share
can’t work for mutuals
We note that the eligibility criteria for Core Tier 1 capital [outlined in Annex IV] are fundamentally inconsistent with the nature of member shares in cooperative banks (notably,criteria 2, 3, 5, and 8). ……Not all of these criteria are essential to assuring the loss absorption capacity of capital, and most cooperatives have large accumulated reserves that provide a sound buffer against losses.
The Basel error
First new instrument – PIBS – introduced in 1991
“Core tier 1” now requires stronger loss-absorption features
So we need another instrument – PLADS
Principal Loss Absorbing Deferred Shares
But no compromise on fundamentals – mutuals’ business is run for their members, not to extract profit for capital providers
The principle is : “limited interest on capital”
So PLADS have a limit on distributions
So what do mutuals
use for capital ?
Developed from the insights of the Rochdale Pioneers
Reviewed and updated by the ICA from 1937
Relevant to our argument are Rochdale Principles 3 and 4
Address how the customer-members share in the cooperative’s surplus, and what return the capital provider is entitled to
Where do these principles come from ?
Democratic Control (O M O V)
Distribution of the surplus to the members in proportion to their transactions
Limited Interest on Capital.
…….from the 1937 ICA report
Limited interest on capital
The ICA looked ahead in 1966
PLADS will have discretionary distributions, not a contractual coupon, to ensure flexibility
PLADS will have a shadow reserve ledger to demonstrate loss absorbency
Distributions will be capped at a stated percentage to prevent alienation of surplus from the members
So how will PLADS work ?
Will need listing and secondary market
Designed to provide a fair, stable return for the risk taken– like an income or utility stock
COB issues for sale into retail market
PLADS probably suit high net worth end, like PIBS
Could be v important for smaller societies
Similar instrument – CCQS –designed for CFS / Cooperative Bank
So how will PLADS work ?
European authorities recognise the mutual / cooperative issue on core capital
MEPs sympathetic and active
Need to get this confirmed in Directive text
More work with institutional investors
More work on retail COB issues
More work on secondary market