NACUW Conference and AGM

20 October 2011

Jonathan Ellis

Financial Services Authority (FSA)

Legislative Reform Order (LRO)

HM Treasury announced review of credit union law at end of 2006

LRO re-laid in Parliament July 2011HM Treasury officials say it should be:– passed at beginning of November 2011– take effect 2 months later – so beginning

of January 2012

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

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

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

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

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

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

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”

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

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

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)

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

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

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

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)

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

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

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

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

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]

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

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)

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

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

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

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

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

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

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

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

Credit Unions new Sourcebook (CREDS)

Revised CREDS rulesLiquidity

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)

Credit Unions new Sourcebook (CREDS)

Transitional provisions in CREDSCapital 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.

Credit Unions new Sourcebook (CREDS)

Transitional provisions in CREDSProbable outcome

Capital-to-assets ratio – version 1 credit unions30 September 2012 – 1%30 September 2013 – 2%30 September 2014 – 3%

Liquidity ratio – version 2 credit unions30 September 2012 – 6%30 September 2013 – 8%30 September 2014 – 10%

Credit Unions new Sourcebook (CREDS)

Supervisory returns and guidanceSupplementary 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

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

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

NACUW Conference and AGM

20 October 2011

Jonathan Ellis

Financial Services Authority (FSA)