The Paul Gosling Column
Treasury proposals to bring co-operative legislation ‘into the 21st Century’ have been strongly welcomed. But the updating of legislation for co-operatives and other mutuals raises fresh questions about whether the right legal and regulatory framework is in place for social enterprises – whose legislation is not being reviewed.
In July, the Treasury announced its intention to amend the Industrial and Provident Societies Acts – the main legal framework for co-operatives – and the Credit Unions Act. For co-operatives, the most important proposed change is to raise the £20,000 cap on individual, withdrawable, shareholdings in industrial and provident societies, in line with inflation.
The £20,000 limit would be abolished on transferable shares, which could not be withdrawn or redeemed. A person or organisation that wanted to get their money out might have to sell their shares to another member – though this would depend on a society’s rules. The liberalisation could enable co-operative societies to issue financial instruments similar to building socities’ Permanent Interest Bearing Shares (PIBS). The Nationwide alone has more than £1.2bn of issued PIBS.
It is important to recognise the difference involved in shares held in a co-operative or other society operating under IPSA rules, compared with those issued by a company. A shareholder in a company part owns that company. A shareholder of a co-operative society remains a member – in essence the share acts as a loan rather than equity in the business. A member of a society does not get any more say in the control of that society by obtaining more shares.
The lack of appropriate investment in co-ops is widely regarded as the most difficult restraint facing the sector. The Treasury’s papers refer to the particularly damaging impact of the £20,000 investment limit on agricultural co-ops. Cliff Mills – a specialist co-operative sector lawyer – suggests that “the lack of a recognized and distinctive method of funding societies, and the £20,000 limit on any one person holding shares” have been significant factors in the decline of the co-op sector in recent decades.
Various ways round the problem have been considered, not least opening up co-operatives to equity investments – for example, through hybrid structures. However, the use of hybrid structures has been blamed for demutualisations of some co-operative societies in mainland Europe and for others to become semi-detached from the principles and practices of mutuality.
The creation of Community Interest Companies (CICs) was intended to overcome some of these difficulties, at least for social enterprises that might otherwise register under IPSA legislation. However, this column’s recent analysis of the problems of Ealing Community Transport (ECT) (‘Has ECT failed social enterprise sector?’, Co-operative News, 8 July) illustrated the challenges facing CICs and brought to light wider concerns about CIC legislation.
Responding to that article, social enterprise consultant Jim Brown wrote on the Co-operative News website: “The problems encountered by ECT are well known to anyone working in the co-operative and social enterprise sector, which is why Co-operatives UK and Co-operative Action commissioned us, at Baker Brown Associates, to lead a study called ‘Co-operative Capital’ back in 2003 to explore new approaches to equity investment in co-operatives and social enterprises. It is a great pity that we have been unable to engage organisations like ECT in such projects to develop more innovative approaches to the capitalisation problem. We are now working on another publication for Co-operatives UK called, ‘Community investment using Industrial and Provident Society legislation’.
“We have identified over 40 cases where the IPS structure has been used to engage communities as investors. Collectively these enterprise have raised over £48m, with one enterprise raising over £20m. ECT Recycling could have gone down a similar route, encouraging the communities it served not only to recycle, but to invest in recycling.”
Others have also expressed unhappiness with the CIC legislation. There is no suggestion that ECT is demutualising – its motivation is the need to survive – but its sale of a division to a PLC has led to a wider recognition that other CICs might be able to convert into profit-chasing companies. There are also worries that while a CIC has an ‘asset lock’ preventing assets being transferred other than to another socially-oriented project, this might not work in practice. Similarly, some observers wonder whether successful CICs will pay their own senior staff excessive salaries. They point to the fact that, typically, CICs have a limited membership and therefore nothing like the wider structure of accountability that a co-operative society must submit to.
The office of the CIC Regulator – which operates as part of Companies House – admitted to us that it would have difficulty in implementing controls over the asset lock, except where it was tipped-off about any wrongdoing. There are now over two thousand CICs and it is clearly impractical for the regulator to keep a close eye on them all – or probably to investigate those that close.
Cliff Mills says: “I think the key point is that in our sector, we have finely tuned antennae about the issue of exiting mutual status, and can spot a ‘demutualisation’ at ten paces. We have spent quite a few years building statutory and extra-statutory mechanisms for managing this risk. Those who are new to the whole social enterprise world are not tuned into this and many probably neither see the risks nor understand what is going on under the surface. My main interest, from the point of view of the credibility of mutual organisations, is whether CICs are robust, or whether they can be “de-CICed” or whatever you call it, and if so, how, what protection exists, and what the impacts are on the assets protected by the asset lock.”
There is also a worry about the very different forms of legislation and regulation used to govern institutions that claim to have similar objectives. The Treasury has legislative responsibility for credit unions and industrial and provident societies, with the Financial Services Authority regulating them. CICs are forms of companies and as such the Department for Business, Enterprise and Regulatory Reform (BERR) deals with legislation, with the CIC Regulator operating within Companies House.
When we asked the Treasury whether its review of industrial and provident societies and complaints about the CIC legislation was causing it to reconsider the approach to CICs, it, eventually, came back and said this was a matter for BERR. In turn, BERR seemed unaware of any problems and said there was no consideration of a review of the CIC framework. Despite rumours that the CIC Regulator is to conduct its own review of CIC regulation, its office assured us this is not the case.
According to Cliff Mills, the problem with CICs is really about the lack of clarity about what is intended of them. “The CIC looked interesting because it appeared to provide a new type of entity,” he says, “though as it has been implemented, I do not think it is entirely clear whether it is a company – dedicated to providing a return for its investors – or a social enterprise vehicle committed to a social purpose – which many people think it is. The advantages of the industrial and provident societies are that (a) they have been around a long time and people who know about them are broadly clearer about their pros and cons; and (b) we [in the co-operative movement] have done quite a lot of updating to the legislation over recent years which has made them more robust.”
This discussion is not one of mere semantics. A lot hinges both on getting the IPSA legislation working for the benefit of co-operatives, rather than their hindrance, and on ensuring that CIC regulation prevents the notion of social enterprise being ‘ripped-off’. Recently, the Department for Communities and Local Government announced that it was setting-up a unit to encourage local authorities to trade with social enterprises and to assist social enterprises spinning-off from within local government. The Department of Health already has a similar unit, which has helped health staff to move from the public to the third sector.
The last thing either the co-operative or the social enterprise sector needs at this time is any suggestion that weak controls may allow improper personal gain.
The Treasury’s consulation runs until 15 October and its proposals are available on its website, www.hm-treasury.gov.uk/Consultations_and_Legislation/consult_index.cfm.