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The Co-operative Group on Friday said it remains in talks with the Financial Services Authority and Lloyds Banking Group (LYG) ahead of completing its acquisition of Lloyds' 632-strong retail branch network.

The Co-op was chosen as preferred bidder for the business Dec. 14 over rival NBNK Investments PLC (NBNK.LN). Both offers valued the business at around GBP1.5 billion.

The main issue raised by the FSA centers on governance at the Co-op, which is owned by its members and as such has an unusual mutual structure--in particular the group's boards are made up of members rather than company executives and non-executive directors.

One option on the table would involve making the whole group--which comprises a retail and legal and insurance services as well as a bank network--an FSA-regulated entity. This would likely involve higher capital requirements, possible across the group.

Another possibility would be to ring-fence the bank, which has its own 14-strong board, from the rest of the group.

Lloyds said it will update the market later this month on the talks. Meanwhile, the bank continues to explore a flotation of the business as a backup in case a sale can't be agreed.

The Co-op will provide an update when it reports its annual results March 28. Meanwhile, it said it was continuing in talks with a view to finalizing the acquisition.

"As part of our thorough due-diligence process we are working together with Lloyds Banking Group and the FSA on a range of issues, as you would expect in a deal of this significance. We are making good progress," a spokesman told Dow Jones Newswires.

The spokesman declined to comment on funding for the deal or plans for the integration of the business.

Analysts and industry experts have previously expressed concerns over the ability of the Co-op to absorb a large retail network while it has yet to complete the integration of the Britannia Building Society that it bought in 2009. However, the Co-op spokesman has said that the integration of Britannia was on track and ahead of budget in terms of its annualized costs savings.

- By Marietta Cauchi and Max Colchester, Dow Jones Newswires; +44 207 842 9241; marietta.cauchi@dowjones.com

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