In brief - Australian mutual banks can now use an additional statutory tool to raise capital to facilitate growth opportunities, improve business infrastructure and increase their competitiveness.
The Treasury Laws Amendment (Mutual Reforms) Act 2019(Cth) (Act) which came into effect from 6 April 2019, provides all eligible mutual entities (companies limited by shares, companies limited by guarantee and companies limited by shares and guarantee) with the capacity to amend their constitution to include a power to issue a bespoke capital instrument known as a 'mutual capital instrument' (MCI).
By including a power in its constitution to issue a MCI (within the scope of the parameters allowed under the Act) a mutual can access a broader range of capital raising and investment options without risking its mutual structure, or status.
Currently, mutual entities that are registered as companies limited by shares or companies limited by shares and guarantee, have an implicit power to issue shares and therefore the power to issue MCIs. However, in the absence of the amendments in the Act, if they undertake some capital transactions there is a risk that it will 'trip up' a demutualisation.
In addition, section 124 of the Corporations Act prevents mutual companies limited by guarantee from issuing shares.
Mutual entities that are registered as one of these three types referred to above, will be eligible to issue MCIs if they are:
- a public company
- do not have voting shares (other than MCIs) quoted on a prescribed financial market, and
- are not a registered entity within the meaning of the Australian Charities and Not-for-profits Commission Act 2012.
Once an eligible mutual entity issues a MCI it will become a 'MCI mutual entity'.
Conditions of MCI power in constitution
To be take advantage of the MCI capital raising option contemplated by the Act, the Constitution of an eligible mutual entity must provide:
- that it intends to be a MCI mutual entity for the purposes of the Corporations Act
- that all MCIs it issues must be fully paid
- that dividends in respect of MCIs are non-cumulative
- a description of the rights attached to MCIs with respect to participation in surplus assets and profits, and
- that debts owed to a holder of a MCI by way of a divided are to rank ahead of all other debts owed to members in a winding up but rank below all other debts.
What is a mutual entity?
Prior to the legislative amendment under the Act, the provisions in Part 5 of Schedule 4 of the Corporations Act gave rise to a potential demutualisation where a mutual entity undertook certain capital transactions and hence the entity risked losing its mutual status.
To address this issue, the Act introduces a new definition of 'mutual entity'. The demutualisation provisions will only apply to proposed constitutional amendments that would result in a mutual entity ceasing to fall within the new definition of 'mutual entity'.
A mutual entity is defined by reference to its constitution which must provide that:
"a person has no more than one vote at a general meeting of the company for each capacity in which the person is a member of the company".
If the constitution of a mutual entity provides for joint members, proxy voting or a person otherwise voting in their capacity as another's representative, this provision does not prevent a company from falling within the definition of 'mutual entity'.
Once a mutual entity becomes an MCI mutual entity, resolutions that would result in the entity ceasing to be an MCI mutual entity will not have any effect unless the resolution provides for all MCIs on issue to be cancelled. Thus a mutual entity that issues MCIs is not able to demutualise without first dealing with any MCIs on issue.
In addition, mutual entities cannot be demutualised, except by court order, for as long as MCIs remain on foot.
If a mutual has demutalisation provisions in its current constitution it is likely that those provisions will be based on the legislation prior to the changes introduced by the Act. These may require a legal review, particularly where the introduction of a MCI power is contemplated.
A share must meet a range of conditions in order to constitute a MCI
Importantly, a MCI mutual entity is not required to treat the holders of a MCI in the same way that it treats its members who do not hold MCIs. Holders of MCIs are limited to one vote regardless of the number of MCIs the holder owns.
The rights attaching to a MCI can only be varied by either:
- a special resolution of all members holding the same class of MCIs, or
- obtaining written consent of 75% of the holders of the class of MCI.
The existing requirements for entities to obtain shareholder approval for share capital reductions, share buybacks and the provision of financial assistance relating to the acquisition of the entity's shares will be modified for MCI mutual entities so that approval is required from all members of the entity.
Adoption of MCIs by mutual entities
To facilitate the adoption of MCIs, the Act has introduced a special standardised procedure in Part 2B.8, Division 3 of the Corporations Act.
An eligible mutual entity can utlise the streamlined process, which applies for a limited period of three years from the commencement of the Act (on 6 April 2019), to amend its constitution to issue MCIs. However, the resolution to amend the constitution must pass within three attempts during that period.
The special procedure will only apply if certain conditions are satisfied, including:
- the proposed constitutional amendments are limited to the types specified in the Act, no other matters are to be dealt with in the resolution and the resolution will not result in the mutual entity ceasing to be a mutual entity;
- the proposed constitutional amendments must be passed by a 75% majority of the votes cast by members present at the meeting (including by proxy) and entitled to vote on the resolution, by a deadline of 6 April 2022 (being a period of 3 years from the commencement of the Act).
Therefore member engagement is an important factor in implementing the MCI framework.
Under complementary amendments to tax legislation:
- an entity's 'mutual' status for tax purposes will not be affected by the issue MCIs, paying dividends or profits in respect of issued MCIs and the creation of members who hold MCIs
- the power to issue MCIs does not displace the principle of mutuality, which provides a tax exemption for mutual receipts from members
- the tax treatment of Tier 2 Capital notes convertible into mutual equity interests (MEIs) (being a type of MCI) is aligned with the equivalent instruments issued by other authorised deposit-taking institutions.
APRA has indicated that the issue by an authorised deposit-taking institution (ADI) of an instrument that converts to MEIs has additional considerations, compared to the issue of an instrument that converts to ordinary shares.
An ADI needs to ensure that the terms of the instrument, the MEIs and its Constitution align with, and meet the requirements of Prudential Standard APS 111. These additional considerations also apply to direct issuance of MEIs.
The prudential requirements provide that an ADI issuing a MEI, or an instrument that converts to an MEI, will require legal advice to confirm whether or not any modifications to its constitution, or others aspects of the issuance, would have the effect that the ADI would cease to be a mutual ADI and therefore be ineligible to issue MEIs.
The Hammond Report (Reforms for Cooperatives, Mutuals and Member-owned Firms on 31 July 2017) made recommendations aimed at reducing barriers to enable mutual banks (and cooperatives) to invest, innovate, grow and compete.
For a mutual bank (as well as other prudentially-regulated mutual entities) a MCI capital-raising option may support targeted business growth or assist to build scale and efficiency for investment in technology infratructure.
In addition, this alternative capital option provides an opportunity to source a new class of investors with complementary interests to those of existing members.
However, the prudential capital limits on the inclusion of MCIs in common equity Tier 1 capital imposed by APRA will influence the adoption of the MCI framework.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.