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Capital Needs of Co-operatives

Volume 639: debated on Wednesday 25 April 2018

I beg to move,

That this House has considered capital needs of co-operatives.

It is a privilege to serve under your chairmanship, Sir David. It is a particular delight to be able to talk co-operatives with the Treasury Minister twice in two days. For those of us who want the co-operative and mutual sector of our economy to double in size, fixing the difficulties that co-operatives have in accessing the capital they need to expand is critical. Co-operatives UK, the co-operative movement’s trade body, has done an excellent job in recent years of championing community shares as one way for local co-operatives to raise significant but comparatively small amounts of capital to grow. Lottery money is currently being used by Co-ops UK’s community share unit to support community shares offers, but more could be done if the Government renewed their previous interest in this area. It would be good for Ministers to explore what else they can do to encourage the further expansion of community shares.

More recently, Co-ops UK, working with retail co-op societies, has begun to explore whether fixed-term withdrawable share capital could be developed, allowing more established societies to raise patient and engaged equity finance from members and non-member investors, up to a £100,000 maximum individual shareholding limit. The Financial Conduct Authority does not always get a good press, but it has been very supportive of that work, and I hope the Minister will encourage the FCA and Co-ops UK to continue to champion that new potential source of capital for many co-operatives. The chief executive of Co-ops UK, Ed Mayo, deserves praise for his skill in getting this work so far down the road.

Other parts of the co-operatives and mutuals sector of our economy—notably building societies, friendly societies and mutual insurers—have been subject to legislative changes permitting them to raise much larger amounts of additional capital. These reforms are yet to apply to the co-operative world.

I thank the hon. Gentleman for allowing me to intervene—I sought his permission to do so beforehand. Does he agree that co-operatives should be allowed to invest in social housing? It is the very essence of what a co-operative seeks to do. Benefits are involved. I gently suggest that the Minister should consider revisiting the ability of co-ops to invest capital funds directly in social housing.

The hon. Gentleman makes an extremely good point. If he can use his not inconsiderable influence on the Minister to support what I will say, we might be able to accelerate the addressing of some of the problems co-ops face in investing in social housing. Unless co-operatives can raise additional capital, they cannot expand or develop to their true potential. At worst, they are at risk of demutualisation, as I will set out. Co-operatives do not issue shares in the same way as investor-owned companies—to do so would mean demutualising—so bigger co-operatives can face considerable difficulties raising additional capital at the level they need. Their growth inevitably is limited and their ability to compete on equal terms is reduced.

In short, legislation is needed to fix this problem—legislation that protects that unique governance model of co-operatives, but allows them to issue permanent investment shares. Such shares could allow consumer co-ops to grow by acquisition and by developing new business offers for their customer members. Football supporter-owned clubs could fund the development of new stadium facilities, grow their businesses, serve their communities and consolidate their income streams. Co-operative-owned energy generators could attract long-term investment to build even more energy infrastructure of the sort we need in this country. A lack of capital limits a co-operative’s growth and ability to develop new services. The growth rate of that co-operative is constrained by its relative inability to add significant capital through retained earnings.

In my constituency, the Headingley Development Trust is doing its second community share offer. It has already managed to raise £232,395 from individuals—I declare an interest as an investor in that share scheme. That money is being matched by £100,000 from the community shares booster programme from Co-ops UK, Locality and Power to Change. The trust can have only £100,000 because of the cap. Energy, community facilities and social care can all be aided by lifting the cap.

My hon. Friend raises a good example of the difficulties that co-operatives face. I pay tribute to his work championing the co-operative he mentioned. He also underlined my point about the good work that Co-ops UK has done in championing community shares. His fundamental point is absolutely spot on: there is a limit to the amount of capital that co-operatives can raise because they do not have the instruments available to them that are available to many of the non-co-operative businesses that operate in our economy.

Like all businesses, co-operatives need to be able to benefit from the economies of scale that are often available only by growing their businesses. They need to gather sufficient capital to serve their members well, to extend services to new members and to expand their services. Without new capital, many co-operatives could be driven into inappropriate corporate forms through demutualisation. Many of us in the co-operative movement can think of many examples where that has already happened. If co-operatives convert to other corporate forms, consumer choice in our economy is reduced and large numbers of consumers would no longer have non-listed, member-owned options in the marketplace. That reduces competitive pressure from the operation of different business models in the same market and adds to systemic risk to the economy.

There is inevitably a limit to the amount of debt that can or should be raised by any business. Mutual shares would present an opportunity for small mutuals to raise funds that they may not be able to raise otherwise, and for larger co-operatives to raise funds that subordinated debt does not provide.

Additional capital helps in a number of ways. It could be used in tactical acquisitions, which would help businesses’ competitiveness. They could also look at local infrastructure development potential. There are a number of examples overseas of similar co-operative share offerings. Examples from Canada, the Netherlands and across the European Union show how mutuals can enlist their members in raising capital through the issue of new deferred shares. In summary, the benefits offered provide evidence that Government support for such a Bill would create a viable new opportunity for mutuals to attract new capital and deliver positive outcomes for mutuals and consumers.

Currently, co-operatives largely have to generate capital for growth internally. They have no shares to sell and hence no access to equity markets. Ongoing capital in co-operatives consists of retained earnings and bank borrowing, with some smaller co-ops also raising withdrawable share capital. The lack of access to reliable capital can be a serious limiting factor on the growth and development of consumer mutuals. How these businesses are constructed means that the introduction of external capital without additional safeguards, such as limits on voting rights and distributions, would water down the mutual purpose of the organisation. The International Co-operative Alliance said that co-operative capital needs to offer

“a financial proposition which provides a return, but without destroying co-operative identity; and which enables people to access their funds when they need them. It also means exploring wider options for access to capital outside traditional membership, but without compromising on member control”.

Consolidation between mutual businesses has been the short-term response to pressure in the past. That has created a small number of firms of critical size that are better able to compete in their markets. Without access to new capital, however, organic growth has remained a difficult challenge. In staying true to their business purpose, customer mutuals are therefore limited by their options to access capital for growth. Some external capital instruments do exist in mutuals. In building societies, more than a billion pounds of deferred shares have been issued. Nationwide building society and Cambridge building society have issued core capital deferred shares. That new capital instrument is designed for mutual building societies and enables them to raise common equity tier 1 capital to supplement retained earnings and diversify their capital base.

The Government supported legislation for mutual insurers and friendly societies to issue deferred shares in 2015, although I note that the restrictive position of Her Majesty’s Revenue and Customs has prevented its full implementation and the relevant orders from being laid before the House. It would be good hear whether the Minister can unlock that particular blockage.

The mechanisms for funding co-operatives are more restricted than those for companies. It is not possible for co-operatives to have equity share capital, as understood in the company law context, because equity ownership is incompatible with the co-operative principles and would therefore be prima facie unregistrable. It is also not possible for societies for the benefit of the community because distributions of income and capital are not permitted.

Co-op societies, like building societies, were historically funded by their member customers, who were required to subscribe a minimum amount of share capital in order to be afforded full membership rights. That might be built up over a period of time, including by leaving undrawn dividends. Subject to the minimum capital requirements, therefore, members were permitted to withdraw funds from their account, and share capital was typically withdrawable. One of the consequences of that was that members’ share capital remained static in value. Although it was risk capital in the sense that it could be lost on insolvency in paying debts owed to creditors, it did not give members an undivided share in the value of the underlying business.

While the co-operative carried on trading, members therefore had no expectation of any entitlement to more than the repayment of their original capital. Their real interest was in the continuity of the existence of their society, providing goods and services to meet their needs. As a direct result of that approach to funding and ownership, any undistributed surplus was retained as reserves and shown as such in the accounts, and although such reserves constituted members’ funds for accounting purposes while the society remained a going concern, they did not belong in a traditional ownership sense to the members. They were more like assets currently being held by the body of members, almost as trustees for the purposes of the society.

An appropriate and sustainable basis of funding is a prerequisite for any business if it is to start up and survive, and the requirements for funding are likely to change or evolve over the life of the business. The restrictions in relation to the funding of co-operatives, which are created by legislation, are therefore fundamental to the future use of the co-operative form, and to the future viability of co-operatives.

I do not expect the Minister to give a guarantee of support today for the new form of investment capital for co-operatives, but I hope he will take time to reflect. Although I appreciate he has committed to meet me on another issue, perhaps he will be willing to meet me with Mutuo, the think-tank in the co-operative world, which has been developing this instrument, and which supported Lord Naseby when he introduced similar measures in 2015 which, as I said, are currently held up as a result of the unfortunate attitude of HMRC.

Another new type of raising capital that I want to put on the table comes from Italy. Worker co-operatives can play a significant part in rejuvenating firms that would otherwise close in places where there is a supportive policy and business infrastructure to facilitate that. It can act as an essential component of a progressive employment policy. Perhaps the best example of this is the so-called Marcora law from Italy, where conversions take place as negotiated employee buy-outs between workers, the exiting owners, the co-operative sector, the nearby local authorities, and bankruptcy courts. Under a legal framework—the Marcora law—an infrastructure of support has been created to assist the worker buy-out of firms. State funding that would otherwise be spent on unemployment benefits is used to finance the new co-operatives. It has been remarkably efficient for the Italian taxpayer. It is estimated that that investment has safeguarded nearly 14,000 jobs in 270 businesses and generated an economic return for the Italian state of almost seven times the capital invested.

The Italian method of creating staff buy-outs is essentially a negotiated conversion and business restructuring mechanism, with a unique set of supportive policies and a financing structure facilitated by a collaborative approach between staff, the co-op sector and the Government. Some resources are provided by the Italian state Treasury. Again, I do not expect the Minister to commit to this measure today, but in due course it would be good to hear his reflections on that example.

Perhaps on another occasion it would be good hear what further steps the Minister will take to try to encourage the expansion of the credit union sector, where capital remains a significant issue. The lack of resources for marketing is probably one of the biggest things holding back that sector’s development.

It is a pleasure to serve under your chairmanship, Sir David—for the first time, I believe. I congratulate the hon. Member for Harrow West (Gareth Thomas) on securing this debate today. I am grateful to him for giving advance notice of the topics that he has brought before the House, which has given me an opportunity to consult my officials. Although I do not anticipate that we will get to final conclusions that will fully satisfy him today, I am very happy to have a meaningful dialogue with him in the Treasury with officials and Mutuo, the think-tank that he mentioned. I acknowledge his long-standing commitment to co-ops as chair of the Co-operative party and chair of the all-party group for mutuals. I take what he has said very seriously.

We have heard today how much the mutuals sector is valued in this country, and we share that enthusiasm in Government. I am aware that the hon. Gentleman, alongside other voices in the sector, proposes the introduction of a new financial instrument that co-operatives could use to raise capital. I also recognise that co-operatives need to be able to raise capital quickly and efficiently, and I appreciate the need for flexibility in capital planning.

The hon. Gentleman knows, as a distinguished former Minister himself, that any new policy needs to be thought through and to receive due consultation, not as a wilful delay but to ensure that it is right. I will ask my officials to explore the proposal further, including through discussion with representatives of the sector. I will gratefully receive any further information that he can provide me with.

The hon. Member for Strangford (Jim Shannon) raised the issue of allowing co-operatives to invest in social housing, and I thank him for that suggestion. Again, I do not have an answer now, but I will be happy to discuss that with officials and to liaise with him over the outcome. The hon. Member for Leeds North West (Alex Sobel) asked about the £100,000 cap on share capital and its potentially being lifted. In 2014 the cap was lifted from £20,000 to £100,000. We will keep that under review, but I acknowledge what he said and we will continue to examine that.

I turn to the mutuals’ deferred shares, which the hon. Member for Harrow West mentioned. The Government recognise the benefits of mutual insurers to consumers and the economy. That is why they supported the passage of the Mutuals’ Deferred Shares Bill, which was originally introduced as a private Member’s Bill in 2015. The Treasury consulted on the technical details of MDS in late 2016. We received representations from a variety of mutual insurers, consultants, and industry groups. It emerged from the consultation and follow-on work that the industry sought to issue MDS that, first, qualified as top-tier capital under relevant prudential regulation, and, secondly, had no ill effect on the tailored taxation regime that applies to mutual insurers. Since the consultation, my officials have been working closely with HMRC and the regulators to investigate whether it is possible to structure MDS to satisfy both requirements. Throughout that process, officials have sought the views of industry and its representatives via correspondence and roundtable meetings.

It has become clear that, if a mutual insurer issues equity that qualifies as top-tier capital, it will breach at least one of the principles of mutuality, found in case law, affecting mutual insurers’ tax treatment. Amending primary legislation to ensure that that did not occur would not be straightforward, and could have many unintended and undesirable consequences. For instance, any proposed exemption could give rise to legal risks in the form of state aid. I am happy to get into the detail of that in conversation with the hon. Member for Harrow West. I am considering the available options, but clearly there is no simple solution. I was drawn to ask officials why this matter did not become apparent during the passage of the Bill. Probably it was because the Bill was passed quickly in the early part of 2015, and the issue did not arise.

I now want to exhaustively examine the issues raised. The hon. Gentleman suggested that the Marcora law would assist worker buy-out of failing firms. I thank him for making me aware of that policy, which sounds worthy of further consideration. Job losses caused by firm failure can have a devastating impact on communities, particularly when those employers account for a high concentration and number of employees in a single community. I would be interested in learning more from the Italian example about how converting to a co-operative structure can avoid job losses while saving taxpayers money.

I would also be keen to see evidence on the implications for productivity. Clearly, a short-term fix that does not address some of the fundamental challenges that exist in a business is something that one would wish to examine. Again, I will ask my officials—they will be very busy—to discuss that with representatives of the co-operative sector in order to understand whether that model could be used in the UK, if not in that precise form then in one derived from the concept.

We must not forget that the Government have shown a demonstrable commitment to supporting the sector, because we are acutely aware of its significance. There are nearly 7,000 co-operatives in Britain today that, together, contribute more than £36 billion to the UK economy. Recognising the value of co-operatives, in February we introduced a measure to bring audit requirements for small properties in line with those for small companies. Properties have a key role to play in social investment. Last year, the Government expanded the social investment tax relief scheme, which provides a tax break to encourage investment in social enterprises for certain co-operative investors. That expansion will allow social enterprises to receive investment of up to £1.5 million under the tax relief, which is a substantial increase from the previous limit.

The Government see the great value in the mutual sector and the contribution it makes to not only our economy, but our communities. That is why we have taken steps to support all mutual structures, from co-operatives to credit unions. Today’s discussion has been fruitful, and I will look to have further such conversations. I thank the hon. Member for Harrow West for his long-standing commitment to co-operatives, and the constructive way in which he has brought this matter to my attention. As a Minister, I am very conscious that one’s time in office can be very short. If there is anything I can do to move this agenda forward, I give him my commitment that I will do so.

Question put and agreed to.

Sitting suspended.