What Happens if Southampton is Relegated in 2016?

I know that is a pretty strange question.  This season is going so well.  Why would I worry about being relegated next season?  Actually, I am not particularly worried about Southampton being relegated next season.  What I am concerned about is the recent changes to the Financial Fair Play (FFP) rules in the Championship and how they will affect the three teams relegated in 2016 and subsequent years as well as the Competitive balance in the Championship.

To put it simply, the new rules discriminate heavily in favor of teams with rich owners who have just been relegated from the Premier League.  Of course, football has always discriminated in favor of rich owners and relegated teams have always had some advantages.  FFP has just changed that universal truth somewhat to discriminate in favor of established teams over upstart teams with rich owners.  However, the new rules go way overboard in favoring recently relegated teams.

The new Championship FFP rules are explained on the Football League’s web site here.  The rules have regularized the Championship’s FFP rules with the Premier League’s FFP rules.  This undoubtedly seemed like a good idea, but it could be devastating to the competitive balance of the Championship and lead to some teams digging themselves into a FFP hole out of which they cannot easily get.  I will explain.

I don’t want to completely rehash the FFP rules in effect in the Premier League.  I have discussed them several times and a complete discussion is available at the Financial Fair Play web site which is linked in the sidebar.  Basically BPL clubs are evaluated over a rolling three year period and are limited to losses of £105 million.  These losses exclude money spent on “good” things such as facility and stadium improvements and youth programs.  If a club does not have a rich owner willing to put money into the club, the limit is £15 million of losses over three years.  As I discussed in my four part series (part four here), the likely unwillingness of our owner to spend £90 million (plus) of her own money every three years puts us at a competitive disadvantage relative to Manchester City and Chelsea, but likely not much of a disadvantage with respect to anyone else—and Manchester City and Chelsea are also subject to the UEFA FFP rules which restrict owner contributions to under roughly £25 million over three years .

The Championship has now switched from a FFP system which evaluated clubs each year to a three year rolling system like the BPL.  However, instead of a £35 million per year allowed loss, the allowed loss is £13 million.  However, if the owner does not contribute equity to cover the loss, Championship clubs will also be limited to £5 million a year in losses.

So far this approach probably seems quite reasonable—however, a problem arises out of the way the new rules handle relegated teams.   The allowable losses for relegated clubs are calculated on a three year rolling basis based upon the league in which the club was playing each year.  Thus, a club relegated in 2016 is allowed losses of £35 million for 2014-2015, £35 million for 2015-2016, and £13 million for 2016-2017—a total of £78 million over the three year period.  On the other hand, a club that has played in the Championship all three years has an allowable loss of £32 million (not £39 million as you would expect because 2014-2015 is a phase in year with the loss limited to £6 million).

A relegated club which was breaking even in the BPL (admittedly, an unlikely assumption given our rich owner premise) would have the ability to overspend a similarly financially prudent Championship club by £46 million pounds.  Further, the relegated club would have its parachute payment (currently £15 million in the first year) to spend as well so its potential overspend is £61 million.  Given how much just relegated teams want to get back into the BPL, it is likely that at least some owners will spend a large chunk of this money. 

Moreover, this analysis compares the relegated team to a fiscally prudent Championship club—such clubs are few and far between.  The Financial Fair Play web site discussed the Championship clubs likely to be facing penalties based upon their recent financial losses and it is not a pretty picture.  See here.    Of the 21 Championship clubs which were not recently relegated BPL teams (to whom the FFP rules did not yet apply) seven are likely or very likely to face FFP penalties while ten are  unlikely or very unlikely to be penalized.  However, only three of the clubs broke even or better in 2012-2013.  If such trends continue, the clubs relegated in 2016 will face a league full of clubs who have already used their allowable losses for the past two years and would be limited to a loss of just £13 million.  Some of the teams may have exceeded the allowable losses and will have to lose even less in 2016-2017.  Some clubs might also be subject to a transfer ban which would certainly not help them to compete.  And, of course, many teams will not have rich owners and will need to break even simply to keep afloat.

The picture is not quite this extreme because the clubs relegated in 2015 would also be receiving parachute payments and would have one year of £35 million allowable losses to work with.  Clubs relegated in 2013 and 2014 would also be receiving parachute payments in lesser amounts.  Nevertheless, this system creates huge advantage for the recently relegated clubs who could easily justify spending lots of money to try to get right back into the BPL.

However, such teams face a major downside should they spend this kind of crazy money.  Suppose a club relegated in 2016 shoots for an immediate return to the BPL by taking a loss of £60 million in 2016-2017, but they are still not promoted.  What happens to them?

Assuming they broke even in 2015-2016, they have a total loss of £60 already in the books for the three year period ending in 2018.  Their allowable loss for that three year period is £61 million.  It is hard to imagine that a team that lost £60 million in the previous season could reduce that loss to just £1 million in the next season. 

That is not the only problem, however.  Remember that the losses are only permitted to exceed £15 million in a three year period if the owner chips in equity to cover the losses above that amount.  In my scenario, that would mean that the owner of the relegated team would have contributed £45 million in equity to cover the losses in 2016-2017.  To cover the £1 million additional loss in 2017-2018, the owner would have to contribute another £1 million in equity.  Obviously, this is no big deal.  The real problem arises in 2018-2019 if the club still misses promotion—which is certainly a likely result if they have had to reduce a £60 million loss to a £1 million loss.

In 2018-2019, the club will have been a Championship team for three years.  They no longer have a generous allowed loss of £35 million for a BPL season to work with.  Instead, their allowable three year loss is now £39. However, the club has the £61 million loss over the last two year hanging over their head.  In other words, they must make a profit of £22 million. Has a Championship club ever made a profit of £22 million?

There is also the problem of the allowable size of the equity contribution.  In the Championship the limit is £24 million over three years—yet the owner has already contributed £46 million.  I do not know if a club is permitted to distribute profits to reduce past equity contributions.  If they are, the full £22 million profit would have to be distributed.  (Of course, the cash would not all be available because of taxes.)  If not, the club is stuck in violation of the FFP rules.

A sensible relegated club will realize this and will not take a £60 million loss in their first year back in the Championship.  However, the term “sensible relegated club” may be an oxymoron.   And if they are promoted, the BPL’s more lenient FFP rules would protect them from the consequences of their Championship overspending.

If the club behaves more sensible and take a lesser loss the system still is anticompetitive.  Even a £30 million loss (plus parachute payments) gives the club a tremendous competitive advantage versus its poorer Championship competition.  Of course, even if the recently relegated club elects to take a smaller loss but still fails to get promoted, it will face FFP problems in subsequent years—although not nearly as severe.

On the surface, it makes sense to regularize the Championship and BPL FFP rules.  Upon closer analysis it seems to be a mistake.  The old rules gave relegated teams a one year holiday during which they did not face a transfer ban if they overspent.  However, if they got promoted to the BPL, all clubs were subject to a “tax” proportionate to their one year losses.  (This is the problem QPR and Leicester face next month.)  After that, the clubs were subject to the same rules as everyone else on a year-by-year basis. Since six teams leave the Championship each year, a year-by-year approach seems more sensible.