Memorandum submitted by Ignacity (DFoB
43)
DAIRY FARMERS OF BRITAIN INQUIRY
STRENGTHENING THE
ABILITY OF
COOPERATIVES TO
RAISE CAPITAL
1. The evidence session from First Milk
on 3 February became almost a seminar on enabling cooperatives
to raise capital.
2. One valuable idea was that farmer members
who had invested money should be enabled to trade that asset,
thus avoiding the need for the cooperative to find money to make
a repayment. This would be increasingly important if the amount
that farmer members could invest were to increase.
3. This would involve the creation of a
new form of commercial paper. This note considers some of the
obstacles that might arise and how they could be overcome.
4. The commercial paper would be a debenture
of some kind. Its holder would be entitled to (a) repayment at
some point (eg 2020) or in some circumstances (sale or merger
of the cooperative) and (b) payment of income.
5. It is hard to see how the income could
be other than of a fixed sum (say 5%) or just possibly a fixed
sum plus an amount to compensate for inflation—like an index
linked Treasury bond—eg RPI +2%. A dividend system, dependent
on annual declarations, is almost certainly impractical.
6. Such a debenture would be an investment
under the Regulated Activities Order. While there may be some
individuals who would buy such paper, the FSA regulatory requirements,
and in particular the role of the Financial Ombudsman Service,
make it unlikely that Financial Advisers would be willing to recommend
such investments to clients unless the interest rate was high—and
that of course would defeat the object of the exercise.
7. There would be much less difficulty in
commercial entities (banks, OEICs, investment trusts etc) buying
such paper. We have made enquiries and, provided that there was
sufficient paper available, there would be no difficulty in finding
capital to create a regulated entity that could buy such paper.
So in time there could be a competitive market that would in principle
mean that the interest payable by cooperatives would be low.
8. However it is unlikely that simply making
it lawful for such paper to be created, issued to farmer members
in lieu of cash repayment of sums they have invested and be tradable
by them will produce anything of value. There are a series of
steps that would need to be taken for a market to develop.
9. First, the annual returns and other information
on cooperatives are currently held by the FSA under arrangements
that make it inaccessible to analysts and researchers. It essential
that information on all cooperatives is accessible at a low cost.
The only way in which a market in such paper can become large
enough to be commercially attractive and not be destroyed by high
unit operating costs is for a number of cooperatives to issue
paper and that paper will only be acceptable if their accounts
are publicly available. At present they are in theory but not
in reality.
10. Second there will have to be a crackdown
on accounting which conveys a rather more rosy impression of affairs
than the underlying reality. For example, while First Milk includes
in its cost of sales in the P&L all the money that is retained
for investment from the monthly milk cheque (and this is plainly
the right approach as that money is money transferred to and invested
in the cooperative by members) Milk Link uses the cash sum paid
to members, so it deflates its cost of sales and inflates the
bottom line. Although I am sure that somebody could find some
words in an accounting standard to allow this, if one takes the
view that the overriding concern is "true and fair"
it must be a wrong approach as it is tantamount to Milk Link treating
money that is transferred to its individual members (and on which
they pay income tax) as retained as part of its own assets. Milk
Link does indicate in the notes what is happening but I do not
regard that as mending the problem with the total picture presented
in the main pages of the accounts. Indeed, most people who looked
at the First Milk and Milk Link accounts would be misled into
thinking that Milk Link was achieving a substantially lower cost
of sales and hence higher operating profit than First Milk when
the main difference is caused by differences in accounting. Another
example is in the treatment of intangibles—First Milk has
very little on its balance sheet, Milk Link a great deal. (The
FSA requires authorised firms to exclude intangibles from their
assets when calculating whether they meet capital adequacy requirements,
which should tell us something about how easily these intangibles
vanish in a crisis.) If intangibles are a large part of a co-operative's
assets, then any paper backed by the assets of the cooperative
will be regarded as more risky than if the assets were exclusively
tangible unless very convincing reasons are provided for believing
that these intangibles can be realised at anything close to the
value on the balance sheet. A further complication is that once
paper becomes traded on a market, the law on market abuse severely
restricts private briefings. And there is an interesting question
over re-valuation of assets—Milk Link's balance sheet is
significantly improved by a big revaluation last year. That would
cause concern in valuing any paper—again it may be possible
to provide an explanation, but there are regulatory obstacles
to disclosure of information not put in published accounts If
there were already a vigorous market in such paper, analysts would
notice these features and doubtless demand higher interest on
Milk Link paper to compensate both for the weaker balance sheet
and for a profit and loss account that overstates the actualité.
Confidence would scarcely be enhanced by a rather generous executive
bonus policy (First Milk it should be noted paid no bonus last
year.) So if we had a well established market in cooperative paper,
one might be tempted to leave the matter to the market—and
the members; farmers would doubtless know how to deal with the
management that had just cost them rather a lot in extra interest.
But when trying to establish a market, differences in accounting
that materially alter "the bottom line" are liable to
damage the credibility of the whole sector—so a crackdown
on reporting standards is necessary and urgent. The FSA really
should be capable of dealing with this quite effectively—they
show little mercy to those in authorised firms who massage reports,
so if there are clear rules that force uniform presentation of
accounts the FSA can be trusted to enforce them. I appreciate
that these accounts are signed off by one of the largest firms
of accountants in the country. However auditors are appointed
by the firms they audit, and directors have much influence over
the appointment. For a number of years, I worked in the consulting
division of an accounting firm, and we regularly had to resist
pressure from audit partners. On one occasion, we were replaced
by employees of the audit division on a report commissioned by
the Bank of England when our draft report stated that the bank
in question did not have adequate controls. (We were proved right—eighteen
months later a rogue trader caused nearly £100 million losses.)
When Spicers was taken over by one of the giants, those consultants
who had been conspicuous by their refusal to bow to Baal found
their main clients were assigned to others and then made redundant.
I hope that the Committee will not be impressed by the fact that
a big auditor has signed off the accounts. Big accountants are
proficient in finding ways to present accounts that suit their
clients.
11. Third, there is a need to look at the
tax treatment both of retentions and of interest payments that
are retained. The former was discussed before the Committee on
3 February. If cooperatives issue paper on which interest is payable,
and paid when the paper is held by an outsider, then there is
going to be a problem if farmer members are not able to roll up
the interest inside the cooperative without acquiring a liability
to income tax. The Committee might wish to suggest that the Chancellor
of the Exchequer considers the possibility of a tax regime in
which income tax is only payable when money is received by the
farmer member or former farmer member, that is taxing at the point
of spending. There is a useful literature on Expenditure Tax that
the HMRC advisers to the Chancellor might review—the late
Lord Kaldor wrote a book on this in the 1960s, quoting Hobbes:
For what reason is there that he which laboureth much and, sparing
the fruits of his labour, consumeth little should be more charged
than he that, living idly, getteth little and spendeth all he
gets; seeing the one hath no more protection from the Commonwealth
than the other? But when the impositions are laid upon those things
which men consume, every man payeth equally for what he useth;
nor is the Commonwealth defrauded by the luxurious waste of private
men.— (Leviathan, Chapter 30) These ideas were fruitfully
developed in the Select Committee on a Wealth Tax of 1974-75:
see draft Report proposed by Rt Hon Maurice Macmillan MP. So there
is a good theoretical background available to the Chancellor and
HMRC to develop a tax regime that would not kill the market in
cooperative paper at the outset.
12. In principle there is no reason why
there should not in a few years be a lively market in traded cooperative
paper—and that would undoubtedly enable investment projects;
and it would also lead to analysts focusing their attention on
the management of the sector. Despite occasional disastrous failures
to recognise incompetent and even fraudulent conduct, and we can
all think of some recent horrors, the great growth of wealth since
1700 suggests that most of the time if information is available
and the tax regime is not too oppressive funds flow towards investment
opportunities which are more often than not successful in generating
productive capacity and jobs.
IGNACITY
February 2010
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