BSOG 1.2 Principal purpose of a building society and funding and lending limits

A building society can only be or remain established under the 1986 Act if its purpose, or principal purpose, is making loans which are secured on residential property and funded substantially by the society's members (the principal purpose test) (section 5 of the 1986 Act).

If an established building society no longer meets the principal purpose test, the Authoritymay:

1. (1)

   direct it to submit a restructuring plan designed to ensure that the society will meet the principal purpose test by a certain date and that it will continue to meet that test in the future (section 36 of the 1986 Act);

2. (2)

   direct it to submit to its members for their approval at a meeting the requisite resolutions for a transfer of the societys business to a company (section 36 of the 1986 Act); or

3. (3)

   petition the High Court for the societys winding-up (section 37 of the 1986 Act).

Building societies are subject to lending and funding limits, which help to determine their compliance with the principal purpose test (sections 6 and 7 of the 1986 Act).

1Section 7 of the 1986 Act provides that at least 50% of the funds (excluding those qualifying as own funds) of a society (or, if appropriate, of the societys group) must be raised in the form of shares held by individual members of the society (excluding share accounts held by individuals as bare trustees for corporate bodies).

When the Authorityassesses a building society's compliance with the principal purpose test, it takes into account:

1. (1)

   whether the society is meeting, and is expected to continue to meet, its lending and funding limits (sections 6 and 7 of the 1986 Act);

2. (2)

   the actual and projected proportion of the societys gross income that is, or is expected to be, derived from activities that are related to the making of loans secured on residential property. (Income from the societys property related insurance and valuation services might be regarded as related to the making of loans secured on residential property, but income from the society's motor insurance business (if any) would not); and

3. (3)

   all other relevant quantitative and qualitative factors.

The Authorityexpects societies to draw up their corporate and other business plans so as to provide reasonable assurance that they will comply with the principal purpose test and their other obligations under the 1986 Act.

In particular, societies should ensure that any programme of securitisation does not threaten compliance either with the principal purpose, or with the lending or funding nature limits. Sections 6(3) and 7(3) of the 1986 Act respectively make clear that only items included in total assets or total liabilities in a societys accounts count towards the nature limits. The adoption of International Accounting Standards by some societies changed the accounting treatment of securitised assets for those societies from 1 January 2005. The Building Societies Act 1986 (Modification of the Lending Limit and Funding Limit Calculations) Order 2004 (S.I. 2004/3200) amended the 1986 Act so that securitised assets and related liabilities may continue to be excluded from nature limit calculations, regardless of how they are included in the accounts of a society. Therefore societies which use International Accounting Standards to prepare their accounts will not be disadvantaged in relation to the nature limits.

1Section 9A prohibits a society or its subsidiary undertakings (subject to certain defined exemptions) from:

1. (1)

   acting as a market maker in securities, commodities, or currencies;

2. (2)

   trading in commodities or currencies; or

3. (3)

   entering into any transactions involving derivative investments.

1Section 9A contains definitions of the above terms, and societies are directed particularly to section 9A(9) for the purposes of compliance monitoring.

1Section 9A also includes a purpose test for entering into derivatives contracts and a safe harbour clause for society counterparties stating that any transaction in contravention of the section 9A prohibitions is not, however, thereby invalid and may be enforced against the society.

1The exemptions in section 9A fall into two broad categories:

1. (1)

   those which allow a society or subsidiary undertaking to provide certain retail services to its customers, including:

   1. (a)

      acting as market maker in currency or securities transactions of less than 100,000;

   2. (b)

      trading in currencies (but not commodities) up to a value of 100,000 per transaction;

   3. (c)

      entering into contracts for differences in respect of customers who wish to hedge exposures arising from their own loans or deposits with the society or a connected undertaking; or

   4. (d)

      acting as market maker or entering into derivative investments in its capacity as manager of a collective investment scheme; and

2. (2)

   those which allow a society or subsidiary undertaking to use derivative investments in order to limit the extent to which it, or a connected undertaking, will be affected by changes in interest rates, exchange rates, any index of retail prices, any index of residential property prices, any index of the prices of securities, or the creditworthiness of any borrower(s).

1The Treasury may, by negative resolution order, amend the 100,000 transaction limit and may add factors to, or remove factors from, the list in BSOG 1.2.10G (2). The factor relating to credit worthiness was added to the original list in section 9A(4)(b) by the Building Societies (Restricted Transactions) Order 2001 (SI 2001/1826). The Treasury may, by affirmative resolution order, make more significant amendments to section 9A.

1Boards should have procedures and controls to ensure that use of section 9A exemptions by their society (and subsidiary undertakings, if any) is within the law. The exemptions permitting transactions of up to 100,000 (as market-maker in currency or securities transactions, or trading currencies) may not be abused by artificially breaking up larger transactions into a number of smaller amounts falling within the 100,000 ceiling (section 9A(8) is the relevant anti-avoidance provision). Compliance with the 1986 Act may be assisted by specifying the purposes and circumstances in which hedging transactions may be undertaken, or derivatives used, both in the financial risk management policy documents and in the internal arrangements for delegation, identifying the specific authority in section 9A. Whatever the hedging policies adopted, and however the control and authorisation arrangements are organised, it is important that they should be accurately and fully documented.