Controlling the Game: Protecting Football Through Financial Regulation
In November 2021, Tracey Crouch MP published the long-awaited independent report around improving governance and financial sustainability in English football. The proposal could have substantial implications for how football is governed in England and may also lead to governance changes in other sports. While the report covered a range of topics, from player welfare to tests for owners and directors, this article (written by Alasdair Malcolm) will seek to analyse some of the key proposals for changes to financial regulation within the game.
The Fan-Led Review looked to consider five key factors with regards to financial regulation:
· Ensuring long-term financial stability
· Avoiding monopolisation of leagues
· International competitiveness
· Minimising burdens on clubs or an expensive system
· Ensuring compatibility with other rules.
The current position
Football is currently responsible for regulating itself, and despite regulation in place to restrict spending across domestic and European football, we are still seeing football clubs going into administration. The Fan-Led Review proposes to introduce an Independent Regulator of English Football (IREF) which would be responsible for governing football. Its task would be similar to the regulators which govern other industries in our country, such as Ofcom as the communications regulator. There is logic which suggests that if effective, IREF could prevent conflicts of interest which arise at the moment and prevent regulatory change.
At present, the Premier League is made up of 20 clubs and each club gets one vote, with a minimum of 14 votes required for all rule changes and major commercial contracts. This immediately fails to consider that the 20 clubs in the English top-flight have different interests and therefore are unlikely to vote for new regulation which may adversely impact their competitive position. For example, Manchester City, Premier League champions in three of the last five seasons, will have starkly different priorities to Norwich City, who themselves have alternated between the first and second tier of English football for the last four years. When voting for regulation which may increase the competition at the top of the Premier League, for example to increase the distribution of television revenues further down the Premier League, Manchester City may naturally seek to vote against any such change, where Norwich City may wish to vote for this due to where they sit in the table and the benefits that may bring.
The Premier League currently has its Profitability & Sustainability Regulations (PSR), which dictate that any club competing in it are limited to making a maximum adjusted loss of £15m over a three-year period. This is increased to up to £105m for the assessment period if the additional £30m per season is covered by the owners through a cash injection. For the Championship, the cap is £39m, and for those who have spent time in both divisions in the prior three years, this limit is tailored accordingly. There are types of expenditure which are excluded, such as investing in women’s football or youth development. At present, clubs themselves are responsible for monitoring their own situation, and therefore the rules are acting as a punitive measure rather than giving any assistance to prevent unsustainable expenditure. Breaches to the rules may lead to points deductions, fines and transfer bans which only exacerbates the issue if clubs consequently struggle to compete and lose broadcasting and commercial revenues.
Premier League clubs participating in UEFA competition must additionally comply with UEFA’s Financial Fair Play (FFP) rules, which are stricter than that of the Premier League. FFP rules look to ensure that clubs are balancing their books. UEFA permits its clubs to have an ‘acceptable deviation’ from breaking-even over a three-year assessment period, i.e., a maximum permitted adjusted loss, of €5m. This increases to €30m if the remaining is covered through a cash injection by the owner(s). Similar to the Premier League rules, the adjusted figure excludes several categories of expenditure.
In August 2020, the English Football League’s League One and League Two clubs voted for the introduction of Squad Salary Caps (SSC), which were to be £2.5m and £1.5m respectively, in its maiden season (2020/21). However, this was withdrawn following arbitrary action from the Professional Footballers’ Association. Therefore, League One and League Two are left with their Salary Cost Management Protocol (SCMP) which restricts spending on player wages to a percentage of club turnover. League One clubs can spend 60% of their turnover on player wages, whilst the cap in League Two was set at 55%. Clubs forecasting to spend within 5% of the figure will be monitored closely by the EFL. However, there are no restrictions on transfer fees.
Across the variety of retrospective financial regulation in place now, there is a failure to force clubs to act sustainably and minimal focus on preventing, rather than punishing, overspending. For clubs trying to achieve promotion into England’s top-flight, they can financially gamble until the point of financial ruin before the rules kick in. Further, we have seen examples where clubs are able to circumnavigate the rules by artificially creating large cash inflows to offset their losses. The current regulations do not mandate owner accountability. Owners can commit the club to grossly overspending and then leave the club in financial ruins. More must be done to protect the bedrock of so many communities in this country.
(Image taken from Goal.com via Twitter)
Over the last 20 years, we have seen wages in football rise exponentially. With the increased revenues coming into football, and the Premier League in particular, players are agreeing contracts which, in some cases, are in excess of £300,000 per week. There has been an increased focus on players who are seen to be running their contracts down to secure a very lucrative deal elsewhere. For their new club, there is no transfer fee to pay if a player signs for them at the end of a contract under the Bosman Rule, but this gives players more power in negotiating a contract. Salaries increasing at the higher ends of English football has a domino effect further down the pyramid, as clubs without the same resources feel obliged to pay similar salaries to attract similar talent, in a bid to remain competitive. The result is that salaries across all divisions are dragged up. The Coronavirus pandemic has failed to slow this growth, but more must be done to prevent clubs overspending.
The Premier League and Championship currently do not have a soft salary cap similar to that in place in League One and League Two. In the 2018/19 season, the last full season prior to the pandemic, Manchester United and Manchester City had the greatest wages expenditure in English football, of £332m and £315m respectively. However, this level of spending only amounted to 53% of Manchester United’s revenue, and 59% of Manchester City’s. The problems come when Premier League clubs are relegated and their broadcasting revenues in particular fall considerably, and they are still committed to paying Premier League wages to their players.
A soft salary cap may assist in promoting sustainability if clubs stick to it, although this is difficult if clubs are relegated from one division to another, where the cap on wages as a proportion of turnover differs. Further, it entrenches the dominance of the richest clubs as their on-field success will lead to more prize money and greater sponsorship deals. The clubs attracting the most revenues at the moment will be able to reinforce their position and continue to pay the same wages, while clubs wishing to challenge these elite clubs will be restricted and must grow organically. While this is good for sustainability, it hampers competition and may reduce the interest in investing in the Premier League.
Alternatively, a fixed salary cap may aid competitive mix as it only requires an assessment of costs. This would mean that ambitious clubs further down the pyramid wishing to challenge the elite could, in theory, fund the same level of player wages, although they would need to find the resources to do so if they are not achieving the same level of revenues as clubs near the top, unless they had an owner willing to inject endless cash into the club which is not sustainable. For the clubs playing in European competition, there may be a competitive disadvantage internationally, as other countries may not bring in the same caps. The European Commission has suggested that such a cap would be anti-competitive. In recent years, English clubs have performed excellently in the Champions League, and therefore a hard salary cap is unlikely to be supported by the Premier League elite.
Football is not the first sport to consider salary caps as a way to financially regulate. Major League Baseball (MLB) introduced a hard cap with a luxury tax in 1997. This luxury tax, known as Competitive Balance Tax (CBT) is payable by teams which exceed the salary thresholds. The threshold in the 2021 season was $210m, and the tax rate on the amount exceeding this threshold is 20% for the first season. For two and three or more consecutive seasons, this rate rises to 30% and 50% respectively, of the overspend. There are further surtaxes payable if the breach of the threshold exceeds $20m. CBT is collected and 50% of this is distributed to teams that did not exceed the threshold in that year. This therefore increases their revenues and gives other clubs more financial resources they can use to compete. This tax seeks to deter teams from exceeding the salary cap, although if clubs can afford to pay the tax, they are able to continue to exceed the salary limits and enforce their competitive advantage. However, being subject to CBT and performing successfully on the field do not necessarily correlate. In 2015, none of the teams that went over the tax threshold won a playoff series.
Bringing a luxury tax element into English football would allow the richest clubs to become more dominant, as many of the elite clubs have financial resources to be able to afford a luxury tax and continue to dominate on the pitch. The benefit would come if these funds are distributed to clubs across the football pyramid, as this would help these clubs to stay afloat. However, if alternative and more rigorous financial regulation was introduced, these lower tier clubs would run more sustainably, and therefore may not require this additional income. Further, owners who choose to continue to spend, despite the tax, undermine long-term sustainability as they raise the competitive bar for other clubs wishing to compete. We may arrive at a situation where half of the Premier League clubs are simply paying the luxury tax to allow them to compete.
The Review recommended that all new player contracts include clauses for promotion and relegation. This would allow player salaries to be tailored to the new division the club finds itself in, which would consider the changes in forecasted commercial and broadcast revenues. This improvement would allow clubs to adjust player contracts more easily as part of bringing their expenditure in line with their revenues for the season they are playing in.
There are legal considerations for any form of salary cap to consider. A Europe-wide salary cap is likely to bring a restriction of the freedom of action of clubs and players by prohibiting them from negotiating and contractually fixing higher salaries. This may contravene the competition law provisions detailed within Article 101 of the Treaty on Functioning of the European Union (TFEU), to which UEFA is bound. Alternatively, if salary caps were introduced in only the English game, we risk losing our best talent to other clubs across Europe and failing to remain competitive in European competition. Further, a salary cap in English football would hinder the free movement of workers (Art. 45, TFEU). The European Court of Justice (ECJ) ruled in the Bernard case, that football was an economic activity and therefore a violation of European law was able to be found as there was “an irregular limitation of the free movement of workers”. The cap may render it economically unattractive for a player to move to another club if the cap is already exhausted at this club, or clubs may also reject a player due to this limit. Although this legislation may appear to prevent any form of salary cap in European football, there may be a justification for such a salary cap if there is an overriding reason in the general interest, for example economic sustainability, and the cap can be classified as suitable, necessary, and proportionate for achieving this purpose.
Capital and liquidity requirements
The Review proposed a licence requirement for clubs to have “adequate financial and non-financial resources” to meet their committed spending and foreseeable risks. This would involve clubs holding sufficient capital to absorb losses or respond to shocks and meet their obligations on-time. Clubs will need to demonstrate adequate cash and cannot pull this out of the business.
The process may require significant administration costs by IREF, as it would involve clubs submitting a filing setting out their planned income versus expenditure and a business plan for their upcoming plans. Further, IREF would want to see the risks which have been considered by the club and a plan for managing these risks. Where IREF deems the filing to be too optimistic, they will have the power to impose remedial solutions, including increasing capital held in the club.
The idea of capital and liquidity requirements are logical in the light of clubs going bankrupt as a result of misjudging their forecasted expenditure. The forward-looking approach will aim to challenge this forecasting and ensure that enough financial resources are available and, critically, unable to be withdrawn. However, some Premier League clubs have argued that they should not be required to go through the additional administration in submitting these filings and having them examined because of other clubs’ historic failures.
As part of the capital and liquidity requirement, the capital held by clubs can come from normal business operations or from a subsidy from the owners. The owners would be required, in effect, to put the cash into an escrow account. This secures the capital for the club and prevents the owner from removing it for other purposes. However, it may not promote sustainable competition across the game. Those clubs with particularly wealthy owners may be able to inject cash into the club and appear very financially resilient, although this will come at a cost for other clubs hoping to compete.
It is proposed that IREF would have the authority to prevent owner subsidies where it has objectively assessed that these will destabilise the sustainability of the wider league. Although, it is unclear how this would be able to work in football alongside competition law. Experience from banking regulation shows that creating a model to ‘objectively’ determine the impact of owner subsidies on the financial stability of the broader market would be very challenging. Further, we risk preventing our elite clubs from being able to compete internationally in European competition, where similar owner subsidies may be permitted.
Real-time financial monitoring and transition plans
One of the Fan-Led Review suggestions is to implement real-time financial monitoring. This would allow IREF to review regular filings by the clubs and examine forecasts to identify any potential issues and address these at an early stage. The current regulations are retrospective and do not look to reduce future spending. Examining club accounts in real-time would allow clubs to amend their budgets and business plans to be more sustainable. IREF would have the power to force a club to take remedial action to improve its financial situation and prevent this from becoming any worse, for example through a transfer ban.
As a last resort, clubs will also be required to have a transition plan which will be an agreed series of actions to undertake, triggered by certain financial markers to ensure the stability of a club while a new owner is identified. This will involve a realistic assessment of how financial and non-financial resources will be maintained at a club.
These approaches allow IREF to intervene in advance of financial collapse, which is not currently possible. We have seen clubs fall foul of financial regulations in England, but they were not helped by a third-party to mitigate the risk of the club ceasing to exist. IREF being established would allow governance to be in place which monitors clubs in real-time and this would allow more proactive measures to be implemented which may prevent clubs from facing the same fate as Bury and Macclesfield Town.
While financial monitoring and transition plans cannot alone prevent clubs from overspending, they will be appropriate mechanisms to identify issues early which can be mitigated. The transition plans would be able to help preserve a club which is failing financially and give a longer period for a new owner to be found which may save the club.
The idea for an Independent Regulator in football has been challenged, as we often see regulators in essential services, such as the energy market. However, their role in these markets is not to guarantee that no firm ever faces financial difficulty. Instead, the focus is on ensuring the orderly winding up of firms and the seamless transfer of customers. Within football, fans do not change their allegiance to a club like choosing a new energy supplier. The role in football would look to promote financial sustainability and preserve these clubs. This is a different regulatory role as to the independent regulators we see operating elsewhere in England. Introducing enhanced regulation may lead to improvements in transparency and financial discipline, but if clubs do find their financial sustainability under threat, IREF may struggle to provide any support without simply injecting cash. This would thereby result in IREF propping up clubs who are not run well. While one can appreciate the wish list of regulation creating financial stability across the football pyramid, it is challenging to see how it would achieve this in practice.
Whilst the proposals all wish to promote financial sustainability within English football, there is much more to consider which may be adversely affected by the regulations which have been recommended. Firstly, the salary cap options which have been raised are all inappropriate in their own ways and may be incompatible with European law. The soft cap fails to protect clubs who are relegated from one division to another, whilst the hard cap may prevent healthy competition in our game and clubs rising through the pyramid. Though the luxury tax would deter some clubs from going over the salary cap, in reality we will see the real elite cement their competitive advantage as they can afford this tax. It is not guaranteed to promote sustainability. A luxury tax would be very administratively burdensome for IREF, as it would require calculating the tax and running the system.
However, clubs are the foundation of communities and therefore some regulation must be developed to protect the future of these clubs. We have seen the social impact of the bankruptcy of Bury and Macclesfield Town. The capital and liquidity requirements would see capital set aside for the future operations and plans of the clubs. Requiring owners to part with their capital before embarking on ambitious business plans would help to stop a sudden withdrawal of funding, although it is unclear if IREF is required for this.
The proposed capital and liquidity requirements would allow English clubs to remain competitive in Europe too, by allowing an uncapped amount of investment into clubs provided this is injected by owners in advance. However, there must be a balance between competing in Europe and avoiding raising the competitive bar in our own leagues to a level where challenger clubs cannot be sustainable.
English football, and in particular the Premier League, has been successful in attracting investment, generating greater revenues, and increasing its global fanbase. From this perspective, it is not a failing market and may not require an independent regulator. However, some of the proposals in the Fan-Led Review would certainly see improved financial transparency and look to move from the retrospective Financial Fair Play and Profitability and Sustainability rules, to a more forward-thinking approach to football finances, with clubs taking greater consideration for their future business plans and expenditure. This will bring great benefit for clubs and fans alike but may not alone be able to achieve financial sustainability across the beautiful game.
This article was written by Consultant, Alasdair Malcolm.