Credit Union Davy Million Euro Windfall ?

News of the Ombudsman ruling in favour of Enfield Credit Union complaint and requirement for Davy to buy back perpetual bonds at face value, appears to set the cat amongst the pigeons. Davy has indicated its intention to appeal the matter to the High Court. The ILCU for its part appears to been blind-sided as it has publically stated that perpetual bonds were appropriate investments for credit unions and has itself invested SPS funds in such bonds. Problems with perpetual bonds were initially highlighted by a risk and compliance consultant in a letter to credit unions. So far the Regulator has not commented on the Ombudman finding. However in a more recent article the Regulator indicated that whereas a product may fall within the terms of the Trustee Investment Order this did not mean that it was suitable for a credit union.

http://www.independent.ie/business/irish/multimillion-windfall-on-the-cards-after-financial-ombudsmans-finding-1272558.html

Whatever the outcome given increasing rising public concern over credit union investments it’s clear that transparent and active regulatory intervention is required to mitigate the investment risk millions of people’s savings are being regularly exposed to.

This is all the more acute in the absence of properly constructed financial safety net of proper regulation, effective prudential supervision and deposit insurance. In particular credit union savers have no statutory rights to compensation in the event of the collapse of their credit union. Additionally governing legislation is defective in not providing the regulator with the powers required to effectively supervise credit unions relegating the regulator to what many consider puppy status of all bark and no bite.

The credit union financial safety net remains highly defective and of itself gives rise to growing concern.

Credit Union Status as Investors
From a MiFiD perspective both the regulator and industry trade body, ILCU consider credit unions as being “retail investors”. However they are a special class of retail investor as the type and weighting of investment instruments they are permitted to invest in are restricted. For example an ordinary person can hold 100% of their investments in one class of instrument …credit unions may not.

But credit union boards and management are expected to have the professional competence to assess and make appropriate investments within the terms of the restrictions laid down by the regulator. This requires the boards and management to possess a professional and not a retail level of investment competence.

It is highly unlikely that a standard provider, brokerage or advisor QFA has the competence or skill necessary to undertake a proper retail investor “know your client assessment” of a credit union as this would require them to be familiar with credit union business and its inherent interest rate and liquidity risks including its ALM requirements. Most product providers would balk at this requirement unless they assess using specially qualified personnel. Furthermore classifying credit unions as restricted retail investors runs counter the accountability and responsibility credit union boards have for credit union safety and soundness. Indeed such “retail” status could dilute the fiduciary responsibility of the board of a financial service firm and provide an all too handy get out of jail card.

One way of dealing with this issue to ensure a product is appropriate for credit union use is for the regulator to require it to be assure as fit for use within the context of its guidelines. This could take the form of an approved form of declaration by the product distributor (provider, broker or advisor) that the product qualifies within the regulatory investment criteria. Or a blanket declaration that it undertakes to ensure that its products are fit for use by credit unions and complies with the investment guideline criteria. Breaches of such declarations would of course expose the distributor to prudential supervision and the administrative sanction regime.

Another solution is for credit unions to employ the expertise required either on their own payroll or through outsource contracts of engagement through which products are assessed for fitness for use. In this case the regulator should issue guidelines on contracts of engagement of regulated investment expertise. This is standard credit union regulatory practice elsewhere. Here the credit union would rely on this expertise to assess the appropriateness of otherwise of the product(s).

This is not a role for a trade body as it would require the entity to be itself regulated and open up the prospect of continuing quasi self-regulation and supervision where all the evidence points to unacceptable agency and moral hazard risks.

Of course it is expected that a credit union has the competence to construct an appropriate portfolio out of “fit for use” products having due regard to a safe and sound asset and liability maturity profile and the ongoing governance and management of interest rate and liquidity risk. Which is of course an altogether different issue.