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Case Study Background Briefing for both Coursework 1 and 2
Students are required to read this background briefing as it provides a summary of events that has led to Co-Operative Bank making and Exchange Offer in June 2013. It is „LIVE? and under consideration and the prognosis is that an agreement will be reached in the fourth quarter of 2013. In addition, primary materials are provided as further and better particulars on blackboard. Both assessments therefore require thorough reading of all the materials prior to students undertaking Coursework 1 and 2.
Following the global financial crisis, banks have been under a legal obligation to meet stricter capital rules. A key part of bank regulation is to make sure that firms operating in the industry are prudently managed. The aim is to protect the firms themselves, their customers and the economy, by establishing rules to make sure that these institutions hold enough capital to ensure continuation of a safe and efficient market and able to withstand any foreseeable problems.
The main international effort to establish rules around capital requirements has been the Basel Accords, published by the Basel Committee on Banking Supervision housed at the Bank for International Settlements. This sets a framework on how banks and depository institutions must calculate their capital. In 1988, the Committee decided to introduce a capital measurement system commonly referred to as Basel I. This framework has been replaced by a significantly more complex capital adequacy framework commonly known as Basel II. Basel III is being implemented on a piecemeal basis with liquidity coverage ratio being phased in, with a 60 per cent threshold by 2015 gradually increased to a 100 per cent requirement by 2019.
According to the European Banking Authority report published on 25th September 2013, most EU banks are on track to meet the Basel III requirements ahead of schedule.
In the UK, statutory powers for banking regulations rest with the Prudential Regulation Authority (PRA) which determines the level of capital that banks need to have in relation to their lending. PRA which became responsible for the prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms on the 1 April 2013 was created under the Financial Services Act 2012 and is part of the Bank of England.
In a speech on 28 August 2013, Mark Carney, Governor of the Bank of England, confirmed that the Prudential Regulation Authority (PRA) Board will implement the June 2013 recommendation of the Financial Policy Committee (FPC) regarding the amount of liquidity held by banks and building societies.
Governor Carney said:
“for major banks and building societies meeting the minimum 7% capital threshold, the Bank of England will reduce the level of required liquid asset holdings. The effect will be to lower total required holdings by £90 billion, once all eight major banks and building societies meet the capital threshold. That will help to underpin the supply of credit, since every pound currently held in liquid assets is a pound that could be lent to the real economy.”
Last month (September 2013) saw Barclays Bank, UK?s second largest bank by assets, launching a rights issue to meet its capital requirements, namely to plug a 13 billion pounds capital shortfall. The plan was to raise 5.8 billion pounds in the stock sale to meet the PRA?s requirement of a 3 percent leverage ratio (to force the bank to hold 3 pounds of equity for every 100 pounds of assets).
Despite the costs associated with the rights issue coming in at 130 million pounds, the bank had decided to raise around half the money from a rights issue – or share sale – because this was an established method whereas ‘co-cos’, a hybrid mix of share and bond was a new and untested market.
Investors generally dislike rights issues because they are forced to cough up more money or face having their stake in a company diluted. As a result investors were invited to buy one new share for every four they already owned at 40 percent less than the closing price the day before the offer. Barclays is also shrinking assets by as much as 80 billion pounds to 1.5 trillion pounds and selling 2 billion pounds of loss-absorbing securities.
By the close of play last week (Friday 4 October 2013) investors bought 94.6 percent of the shares in its rights offering, leaving the banks managing the sale to sell about 472 million pounds ($761 million) of stock. There are at least 14 banks involved in the process.
The Barclays right issue is the largest by a British bank since the height of the financial crisis, when all the country?s biggest lenders were forced to raise more money from shareholders. In comparison, Lloyds Banking Group Plc had to raise 13.5 billion pounds in 2009.
It is indeed the biggest by Barclays, which raised billions of pounds from Middle Eastern investors to avoid taking a taxpayer bail-out a few years ago.
Barclays said the only way to avoid a rights issue would have been to reduce its £1.5 trillion balance sheet (the size of the UK economy) by nearly a third, or £427 billion. It concluded that would have been damaging to the business and the country as well as risky to undertake in such a short space of time. Of course there still remains a huge gap in Barclays? capital despite the rights issue and it remains to be seen how it intends to bridge that gap over 2014- 2015.
Barclays Bank is by no means alone in coming up with various capital raising initiatives through restructuring.
On 17 June 2013, the Co-operative Bank (Co-Op) announced that it required additional capital to satisfy regulatory requirements imposed by the PRA. The format chosen for its restructuring was a „bail in? (a debt haircut) of its subordinated bondholders to contribute to the restructuring.
In a letter to the Chair of the Treasury Select Committee dated 30 August 2013, Chief Executive of the Co-Operative Bank wrote that there had been no formal correspondence received from PRA before the letter of 14 June 2013 setting out capital requirements using Basel III definitions whilst conceding that informal discussions may have taken place prior to his appointment as Chief Executive of the bank on 28 May 2013. The announcement of the 17 June 2013 was therefore a serious reflection of the bank?s desire to meet its capital obligations.
The Bank needs additional aggregate Common Equity Tier 1 capital of £1.5 billion (Tier 1 Gap) by 2015, comprising:
£1 billion to be contributed in 2013; and
£500 million to be contributed in 2014.
The 1.5 billion pounds capital shortfall is to be bridged via an Exchange Offer to those holding target securities. The Exchange Offer was to be effected by October 2013 but the process is currently being stalled as negotiation takes place between the bank and its bondholders.
The Co-operative Bank is currently a 100% owned subsidiary of the Co-operative Group, which owns a number of businesses in the retail and financial services sectors. It is primarily a retail bank but also has some corporate business in the SME sector. The Co-operative Group is a mutual society owned by around six million individual members and about 80 local co-operative societies. Profits are used to expand its business and are from time to time distributed to members.
According to the Fitch Agency Rating notice dated 29 August 2013, the substantial losses announced by the Co-Operative Group for the first quarter of 2013 (as per interim financial information for the 26 weeks ending 6 July 2013 by the Co-Op Group amounting to 709 million pounds) were primarily driven by loan impairment charges relating to legacy commercial real estate loans assumed by the Co-Op bank when it took over Britannia Building Society in 2009. The controversy relating to whether in actual fact most of the losses could be attributed to Britannia Building Society purchase was finally resolved by Andrew Bailey who is the Chief Executive of PRA in his written submissions to the Treasury Select Committee.
These charges reduced the bank’s core Tier 1 ratio to 4.9% (FY12: 8.8%) and fully loaded Basel III Common Equity Tier 1 ratio to 3.2% at H113. Separately, the UK Prudential Regulation Authority announced the same day that the Co-op’s results do not affect its assessment that the bank has a capital shortfall of GBP1.5bn relative to its end-2013 7% core equity capital (after adjustments) requirement for major UK banks.
This is not the first time the Co-Operative Bank sought to bridge the capital requirement gap. Indeed, in 2011 it proposed similar scheme to the Financial Services Authority (FSA) (predecessor body to PRA) but FSA sought to delay such a plan until “there was greater visibility about the possible outcome” over the bank?s then intention to buy 632 branches from Lloyds Banking Group Plc. 18 months down the road, PRA Chief Executive confirmed that the initial plan proposed by the bank was rejected because it was inadequate. This current Exchange Offer therefore represents a new plan made by the new management.
UPDATE AS OF OCTOBER 2013 by Robert Peston, BBC News
AS STATED ALREADY ABOVE Co-op Group’s original plan involved it putting in
£1bn of the capital needed by Co-op Bank, with bondholders and owners of preference shares contributing the remaining £500m.
Under this proposal, Co-op Bank would have been floated on the London Stock Exchange, but Co-op Group would have retained control of it with a 70% stake.
This deal cannot go ahead without the agreement of the bondholders and owners of preference shares, and they’ve told Co-op Group they reject it.
The most important opposition to what Co-op Group wanted came from owners of 43% of “lower-tier-two-capital” bonds – or lenders to the bank with greater rights over Co- op Bank’s assets than other bondholders.
The leaders of these opponents were a couple of hedge funds, Silver Point and Aurelius, advised by investment bank Moelis.
These hedge funds favoured a plan in which their bonds would be converted largely into Co-op Bank shares, which would give the bondholders ownership and control of the bank. Under this alternative rescue, the banks would still be listed on the London Stock Exchange.
The hedge funds are getting their way.
Under a revised rescue plan, it is the bondholders – which also include insurers and pension funds – which would end up controlling Co-op Bank.
Under any new rescue deal, Co-op Group would retain a stake, but it would be less than the 50% necessary for Co-op Group to boss the bank.
Institutional investors, led by hedge funds, would collectively be the majority owners.
This conversion of Co-op Bank into just another bank owned by professional investors has the potential to fundamentally alter the bank’s ethos and culture,
Meanwhile it is hoped that the structure of the new deal will placate another group unhappy with Co-op Group’s original proposals, namely thousands of individuals who invested in the bank’s preference shares and perpetual subordinated bonds.
Under the Co-op Group’s rescue plan, holders of these perpetual subordinated bonds and preference shares would have received ordinary shares in the new bank in exchange for their bonds and preference shares – because that was the conventional way of forcing a financial sacrifice on investors very low down the food chain of creditors (the perpetual subordinated bonds and preference shares have less claim on Co-op Bank’s assets than the lower-tier-2-capital holders).
This would have caused considerable hardship for many of these individuals, because their existing Co-op Bank investments pay a handsome income, whereas the new Co-op Bank shares would probably pay little or no income for many years.
So there has been a public campaign against what Co-op Group was proposing by these small investors, co-ordinated by Mark Taber.
Co-op Group has been insisting it has been trying to protect the interests of the retail investors. And it looks as though they have won some kind of victory, because the revised rescue deal will – breaking with convention – offer them income-paying bonds.
Meanwhile the hedge funds and lower-tier-2-capital owners will receive mainly shares, because they want direct ownership of a bank that they believe can be restored to health and turned into a valuable business over three to five years.
The hedge funds and other institutional investors are also expected to invest tens of millions of pounds of their own money in Co-op Bank, to boost its capital and reinforce their control of the bank.
If no rescue can be agreed voluntarily, control of the bank would temporarily be seized by the Bank of England, under a process called resolution.
The Bank would then protect the interests of depositors by forcing big losses on Co-op Group and obliging the bank’s bondholders to convert their loans to the bank into loss- absorbing shares on terms regarded by the Bank of England as fair.
Co-Operative Bank Exchange Offer
As part of the plan, an Exchange Offer has been made to investors in the Bank?s subordinated capital securities (which comprise subordinated notes, bonds and preference shares). No senior unsecured bonds of Group or Bank are being targeted in the Exchange Offer – only subordinated capital securities issued by Bank.
The terms of the Exchange Offer as it currently stands are:
Broadly, there will be an offer to exchange existing Bank subordinated capital securities for a combination of (a) a fixed income instrument issued by the Group, and (b) new ordinary shares in the Bank.
The fixed income instrument will be used by the Group to finance, indirectly, its subscription for additional ordinary shares in the Bank. In addition to the issue of ordinary shares, capital
will also be generated for the Bank through the Exchange Offer as a result of redeeming the Bank subordinated capital securities below the Bank’s current book value.
The Co-Operative Group will be making a substantial fresh contribution of up to £1 billion through its subscription for new ordinary shares in the Bank using the proceeds of (a) the Group?s issuance of a fixed income instrument in the Exchange Offer, and (b) the sale of the Group?s insurance assets. The Group?s equity stake in the Bank following the successful implementation of the Exchange Offer will come only as a direct result of its planned substantial contribution of up to £1 billion of fresh capital.
ADDITIONAL MATERIAL PROVIDED (on blackboard):
• Co-Operative Bank?s Capital Position and Plan dated 17 June 2013
• Co-Operative Group Interim Report 2013
• Co-Operative Bank Interim Financial Report 2013
• Co-Operative Bank Bond Issue Prospectus dated 29 July 2009 following acquisition of Britannia Building Society
• Co-Operative Bank Additional Regulatory Disclosures 2013 (NOTE: These Additional Regulatory Disclosures are in accordance with requirements defined by the Prudential Regulation Authority (PRA), and provide interim Basel III CRD IV capital resources and leverage ratio disclosures. These disclosures have been completed according to the final Capital Requirements Directive (CRD IV) published within the Official Journal of the European Union on 26 June 2013, along with the FSA’s public statement ??�CRD IV transitional provisions on capital resources’.)
• Letter from the Chief Executive of Co-Operative Bank to Chair of the Treasury Select Committee dated 30 August 2013
This is the first piece of coursework in the module.
MAXIMUM 2,400 WORDS (excludes footnotes, references, bibliography and attachments, graphs, images and addendums)
Hand-in Deadline: Week beginning 9am Monday
Hand-in Process: Through Blackboard TurnitIn only. The first page of the coursework must be the completed assignment feedback form which is made available to students within the module assignment folder and at the end of this handbook.
ADDITIONAL MATERIAL PROVIDED (See list above and on Blackboard)
Referencing: Students must utilise OSCOLA.
Holders of the securities which will be subject to the Exchange Offer (the “Target Securities”) range from major corporates and other large organisations, including registered providers and local authorities, through SMEs and charities, to individual retail investors.
The Bank cannot compel bondholders to accept the Exchange Offer. Further, proposals by the Bank which penalise bondholders who fail to accept – for example by redeeming their bonds for nominal consideration will be susceptible to challenge in court.
However, the Bank may offer inducements for participation – e.g. cash payments to holders who consent. Furthermore, the Bank may use “sticks” to incentivise participation, from suspending payments under the existing bonds, to forms of compulsory restructuring which would leave holders worse off than under the Exchange Offer.
In light of the fact that any holder of a Target Security face losses, with reference to the offer contained in the Co-Operative Bank?s announcement of the 17 June 2013 and the above statement, critically examine the following cases and consider whether the offer as it stands satisfies the rationale behind judgments made by Mr Justice Briggs and Mr Justice Hamblen respectively in:
• Assenagon Asset Management S.A. v Irish Bank Resolution Corporation (formerly Anglo Irish Bank Corporation Ltd)  EWHC 2090 (Ch)
• Azevedo and Another v Importacao, Exportaacao E Industria De Oleos Ltda and others  EWHC 1849 (Comm).
please use the oscola style reference
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