THE RACE TO GET AHEAD Credit Unions Caught In The Crosswinds of Change

Introduction Canada’s credit union System1 is in the midst of its largest evolution in more than 50 years. By the time the decade is out, there will be fewer credit unions, with some operating under federal jurisdiction. Provincial Centrals and strategic suppliers will perform different functions than they do today. A new national trade organization will tie the country’s credit unions together and everything from how credit unions process payments to the products and services offered will have significantly evolved.

With this uncertainty comes great opportunity: credit unions will be larger, financially stronger and better capitalized. Niche credit unions will find new ways to work together on both operational and strategic initiatives. And more Canadians will be choosing to live their financial lives cooperatively.

What isn’t known today are the details of how this market will evolve and what the end form will be. While the System is faced with a number of known external pressures, without a central decision maker leading the process, outcomes cannot be reasonably predicted. The uncertainty, however, is not grounds for inaction. Individual credit unions’ ability to operate effectively and continue to serve the interests of their members will be determined in large measure by how well they prepare themselves to adapt to the new normal of System collaboration.

Because structural decisions will be made at the credit union level, first-movers, acting in the best interests of their members, will collectively determine the industry’s new course. Fast-followers will be ready to react swiftly to the shifting landscape, benefiting their members and further entrenching the changes. However, those players who remain content with a wait-and-see approach will risk getting caught offside and will find themselves reacting defensively to their peers’ moves.

While these internal and external pressures have been present for some time, a series of December 2016 deadlines imposed by the federal government are likely to act as a trigger for larger change. Credit unions across the country have a small window to prepare their strategies to maximize benefits for their members and contribute to building a stronger national System.

The drivers of change are coming from multiple directions. Like all enterprises, credit unions must deal with both external forces (such as changing regulations, competition and consumer preferences) and internal forces (such as staffing, operational effectiveness and changing technology). What makes credit unions unique is a third category of forces–the System. When the System is structured effectively, cooperation amongst cooperatives allows credit unions to be far more effective than if they were independent. How these forces ultimately interact will shape the arena in which credit unions, Centrals, strategic partners and suppliers make their decisions.

Crosswinds of Change

Baseline Pressures The baseline pressures on the System are well known. Regulatory requirements continue to grow and demand more resources. In Canada, this trend includes FATCA compliance and a recent push to improve the effectiveness of FINTRAC’s anti-money laundering program. Internationally, even as the Basel III Accord is being finalized and implemented, regulators are at work on a set of additional controls and requirements, including a possible increase in the risk-based capital ratio.

The Big Five banks have upped their game considerably in recent years, differentiating services and launching social responsibility initiatives that speak to the values of many individuals and communities. This heightened competition comes as members expect new services and features, such as mobile banking and contactless payments, while at the same time demanding mortgages with rock-bottom rates. Deploying digital wallets and other emerging technologies, meanwhile, will test the resource capabilities of many credit unions.

These and other pressures are contributing to consolidation across the System. There are about half as many credit unions today as there were 12 years ago, and the trend is leading the System to bifurcate into a small number of large, well-capitalized financial institutions and a collection of niche organizations. They are also forcing credit unions of all sizes to operate more efficiently and nimbly in order to compete.

Credit unions are impacted by external, internal and System pressures, each of which are interrelated

Ability to Influence

H

igh

L

ow

Varies

Credit Union Operations

External Pressures

• Economic• Competitive• Political • Regulatory• Member needs

Internal Pressures

• Products & services• Channel growth• Cost controls• Talent shortages• Technology• Risk management

System Pressures• Shared services delivery• Fair pricing• Cost controls• Vertical &

horizontal integration• Locus of decision making

*Please note the above infographic is an example and for illustrative purposes only.

Federal Inflection PointsThe credit union System also faces several inflection points, in many cases spurred by changes being made in Ottawa. In 2010, the federal government opened the door for the creation of federal credit unions by introducing amendments to the Bank Act2. The move was part of the government’s strategy to increase competition by creating a “second tier” of Canadian banks and to lead the biggest credit unions into the sturdier federal oversight System. It also aimed to address concerns expressed by some large credit unions that they could not compete fairly with banks while under the jurisdiction of the provinces. Some cooperatives, for example, are unable to provide certain financial services that are not authorized under provincial laws.

In 2012, the federal government introduced a series of regulations that built upon the initial changes to the Bank Act3. These included rules allowing a federal credit union to become shareholder-owned rather than member-owned, disclosure requirements regarding the issuance of equity and stipulations on a federal credit union’s participation in the governance matters of the Canadian Payments Association.

These measures brought greater clarity to the process of creating a federal credit union. But the most significant changes occurred in December 2014, when the federal government’s budget implementation bill received Royal assent4. Bill C-43 streamlined the process for amalgamating two or more cooperatives into a single national operation and it ensured credit unions moving to the federal arena would have sufficient time in which to separate their insurance operations from their deposit-taking activities.

The effects of Bill C-43 will reach every credit union in the System, regardless of whether they are considering going national. The proposed legislation included major changes to the federal regulatory regime, as well as structural changes to the credit union System.

Under Bill C-43, which repeals parts of the Cooperative Credit Associations Act, provincial governments will become exclusively responsible for oversight of the provincial Centrals, and the federal Office of the Superintendent of Financial Institutions (OSFI) will cease to share that role. While the details are still very much in flux, it appears likely that the Bank of Canada will limit its range of emergency support unless provinces agree to indemnify the central bank for any losses that may occur.

Bill C-43 also amends the Canada Payments Act to change the governance structure of the Canadian Payments Association, which may make representation on the board more complicated for credit unions. All of Bill C-43’s changes are due to take effect in December 2016, according to the timeline the government provided in late 2014.

So why are these backend issues so important to credit unions? With OSFI due to hand sole oversight of the Centrals over to the provinces, each province is currently looking at new legislation and /or regulations to manage their expanded responsibilities. It’s not just the fact they will be responsible for oversight of the Centrals. The provinces will also need to explicitly backstop liquidity and payment transactions. With some credit unions having cross agreements with counterparts in other provinces, and some of the Centrals managing liquidity and payments in multiple jurisdictions, governments may be resistant to providing interprovincial guarantees. The net effect could be a weakening of the national System in favour of single-province solutions.

i) The Federal OptionThe ability of today’s credit unions to go federal will almost certainly accelerate consolidation in the System. With additional clarity on the new federal and provincial rules, it is likely mergers will bring one or more players to the national arena.

While the Caisses Populaires Acadiennes5 was the first cooperative to announce its intention to seek a federal charter, the System is waiting for the first move of a large credit union. The first large federal cooperative bank may grow from a merger among two of the ten largest players in the country or it could come through the solo efforts of a large or middle-sized organization. There is even a chance one of the first national credit unions will be seeded by a European cooperative setting up a deposit-taking shop in Canada.

One or more national players may steadily vacuum up a disproportionate share of the Systems’ assets and strain the notion of shared System resources. The largest credit unions may increase (or potentially decrease) their degree of collaboration with each other. These partnerships could create stronger leverage when negotiating with third-party providers outside the System. They might lead to the development of shared services arrangements that bypass the provincial Centrals or traditional service providers, with profound implications for niche players who rely on economies of scale.

ii) Central OverhaulsCentrals will be under tremendous pressure to offer their current slate of services, cost-effectively, when only some of their members need them. Centrals could also find it difficult and may no longer have the bench strength to provide value-added services to these credit unions as size, expertise and complexity increases. Conversely, small- to mid-sized credit unions could see a narrower range of services available to them from the Centrals as the market for these services decreases, a scenario that would likely force smaller players to merge or to look at new ways to operate.

In response to the consolidation among credit unions, Centrals themselves might renew their attempts to consolidate. Alternatively, they could increase collaboration with one another and centralize service delivery across national centres of excellence. Each Central will also need to work with their members to determine what services they can provide cost-effectively.

iii) New CollaborationsCredit unions across the country are finding new and innovative ways to work together. From shared core banking replacements to shared service organizations, credit unions of all sizes are bypassing traditional consensus models in favour of coalitions of the willing. This trend is expected to accelerate, providing new opportunities and efficiencies for participants and greater uncertainty for those relying on more traditional structures.

iv) New RegulationsAt the same time as they face supplier issues, the smallest credit unions may be looking at tougher regulations designed by the provinces to place greater oversight on organizations deemed to carry the greatest risk.

With provincial budgets tightening across the country, it would be hard for any government to justify the expense of cleaning up a failed financial institution. Provincial governments will look for ways to reduce their risks, and the smallest players in the most niche markets may find themselves in regulators’ sights.

Possible Outcomes Affecting Operations

Managing Change

i) Consolidation QuestionsThe likely emergence of federal credit unions, as well as a related new wave of consolidation, should have every credit union determining which side of a deal it wants to be on. Large and medium-sized organizations should be weighing possible acquisitions and determining whether they need to focus on local expansion, a bigger provincial presence or a place in the national arena. This is also the time to be asking yourself whether demutualization is a long-term goal. Should your credit union merge and is the board ready to respond quickly to any offers it may receive from a peer? For a large or middle-sized cooperative, does it make sense to move up to the federal level?

Niche credit unions will want to understand how they are going to keep pace with changing demands and expectations in a bifurcated market that disrupts traditional supply partnerships. How, for instance, will they introduce new products and services cost effectively? Does the answer lie in the development of a new operating model? Does it make sense, for example, to share a back office with other small credit unions and use the Central for the basic mandated services? Alternatively, a smaller cooperative may decide that it needs to grow through acquisition.

Two critical questions tied to the M&A scenario are whether a credit union’s staff is ready for such change and whether the board of directors has formulated a plan in advance of an acquisition target presenting itself, or an acquirer coming knocking. Staff readiness involves not only having people prepared for change, but also having the right skills in place, such as leadership. Proper governance demands having a proactive board that has done its homework.

In all likelihood, when an M&A situation presents itself, a board will have little time to evaluate options and respond in a way that best reflects the cooperative members’ interests. Instead, the board will need to have worked out in advance how to get the most value out of any deal. Do you know how your cooperative is performing next to its closest peers, for example? Who are your reliable independent advisors to guide you through the process? And even more fundamentally, does the board have the proper set of skills and experience to handle M&A?

Individual credit unions have little ability to control either the external or System forces that are at play. Likewise, boards of directors and executives have limited visibility on how the events will play out, particularly as provincial regulatory changes remain in development. Smart leaders will construct a framework to understand how the System as a whole may respond to these baseline pressures and structural triggers. The framework will gauge the variety of motivations at work and potential responses within the System, from individual peers to Central and strategic System partners. It will also outline the desired outcomes in each scenario from the perspective of the organization and enable leaders to assess the changes and develop the appropriate reactions. With a properly built framework, the leadership of each individual credit union will have the right process in place to answer the key questions attached to each scenario.

Each credit union must decide which of their functions should be insourced, outsourced

or System-sourced

Credit UnionSourcing Decisions

National Trade Association

• Advocacy• Federal lobbying• Training

In House

• Core products• Wealth management

products• Technology & operations• Human resources• Marketing

System / 3rd Party Suppliers

• Credit card• Insurance products• Core banking System• Web & mobile banking

Central• Shared liquidity• Provincial lobbying• Payments clearing

Other Credit Unions• Research

& Development• Syndication

*Please note the above infographic is an example and for illustrative purposes only.

Managing Change

ii) Central QuestionsShifting structures and evolving Centrals will force credit unions to re-assess the most efficient way to source backend and frontend services. For the smaller cooperatives, if access to services is threatened, they will need to consider whether to partner with a larger player or an external supplier. Some credit unions may even have difficulty finding commercial replacements for services that the Centrals may be required to discontinue. In this scenario, understanding in advance how much control you are willing to give up to gain access to these services will be critical.

iii) Regulation QuestionsIn the new regulatory environment, does a credit union want to be under provincial or federal jurisdiction? For a large or middle-sized credit union, does access to a broader market, for example, justify the resources necessary to meet tougher federal standards? What will the financial costs be of oversight and compliance? For a smaller cooperative, is the organization sufficiently resourced and efficient to survive a greater regulatory burden from the province?

All credit unions need to include System evolution in their enterprise strategies. To assess your readiness, consider the following questions:

1. To what extent do I rely on cooperative structures to control operating costs and offer innovative products and services?

2. Will I be able to execute my strategy if these cooperative structures are scaled back dramatically, eliminated or moved to a different organization?

3. What would I need to do differently if the largest credit union in my province went federal?

4. Do my members need me to be a leader or a fast-follower on System evolution?

5. To what extent are the board and management aligned on these issues?

1 “System” in this document refers to the formal organizations and informal structures tying together credit unions affiliated with the Credit Union Central of Canada / Canadian Credit Union Association.

2 Budget 2010: Leading the Way on Jobs and Growth, Department of Finance Canada, March 4th 2010, p.118.

3Canada Gazette Part II. Vol. 146, No. 26, December 19, 2012.

4 A second Act to implement certain provisions of the budget tabled in Parliament on February 11, 2014 and other measures. Assented to 16th December 2014, Bill C-43.

5 New Brunswick credit union first to move toward federal charter, as most remain reluctant. National Post, April 2, 2015.

It is perhaps ironic that a traditional strength of the credit union System–independence and local decision making–threatens to become a significant weakness for managing change. While there are a multitude of venues for consultation and discussion, the System lacks a central leadership voice at a time when change is being forced upon it. That means each leader must step up to make the right decisions for their organization, and to do that requires having a strategy for each of the different System scenarios in advance.

As a leader, it’s critical to anticipate how these scenarios could impact your organization. Your members expect you to take on a leadership role, advocate for your needs and perhaps try to influence bigger players. For fast-followers, the key is to understand how the System is evolving so you can enact your own contingencies and position your organization for the best possible outcomes. A failure to take any action in advance of the changes will risk putting the best interests of your credit union and its members in the hands of other parties.

The credit union System is evolving. What worked over the last half century is not what is needed now. By working together in the best interests of their respective members, credit unions can ensure that a renewed System will provide the support necessary to build a solid foundation for the next 50 years.

Conclusion

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Visit us at MNP.ca/crosswinds

Annette Kuckartz, CPA, CANational Credit Union LeaderT: 306.664.8327E: annette.kuckartz@mnp.ca

Doug Macdonald, MBA, PMPNational Credit Union Consulting LeaderT: 416.515.5087E: doug.macdonald@mnp.ca

David Baxter, MBA, PMP, CIPMFinancial Services ConsultingT: 778.374.2162E: david.baxter@mnp.ca