Tuesday 28th August 2012
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New Zealand's Takeovers Panel wants changes to securities law to require disclosure of long equity derivative positions because of the risk they could be used as part of a strategy to build an undisclosed stake in a company in the run-up to a takeover bid.
The panel has called for submissions on a consultation paper: Disclosure of Equity Derivative Positions by Oct. 5, giving its preferred option as requiring disclosure of derivative positions on the same terms as current substantial security holder rules.
A holder of a 'long derivative' benefits from an increase in the value of the underlying security. Such instruments are typically written by investment banks or brokerages for their clients and the 'writer' typically hedges their position by acquiring a corresponding number of the underlying securities or entering a matching short derivative position.
When the derivative is unwound, the writer has "a strong incentive to unwind any hedge position" and typically does this by selling the hedge securities to the holder of the derivative at maturity, the paper says. Underlining that practice, the writer is "incentivised to ensure good client relations and repeat business."
"Even if the hedge shares are not sold to the derivative holder, the fact that the writer buys the underlying shares as a hedge removes them from the market and may bring about a reduction in the free float of the company, which in turn influences the control or potential control of the company," the report says.
That means the derivative holder "can effectively acquire the ability to build a stake in a code company without disclosure, and can facilitate trading positions that may otherwise be difficult to achieve," it says.
The move follows proposed legislation in Australia requiring mandatory controls of certain over-the-counter derivatives and guidance from the Australian Takeovers Panel that it expects disclosure of all long derivative positions over a threshold of 5 percent when a company is under offer.
New Zealand's panel has no evidence of whether a problem exists with the current lack of disclosure though it cites a case taken by Guinness Peat Group against Perry Corporation highlighting the limitations of current disclosure rules under the substantial security holder regime.
In that case Perry had made the correct substantial security holder notices in relation to shares held in Rubicon, which in turn owned 17.6 percent of Fletcher Challenge Forests, but didn't disclose derivative positions or corresponding hedge positions held by Deutsche Bank and UBS in Rubicon shares.
Perry was able to unwind its equity swap contracts with Deutsche and UBS, which were settled via the sale of 36 million Rubicon shares to Perry. That resulted in Perry holding 15.98 percent of Rubicon, becoming a major shareholder for the purposes of voting on a Rubicon proposal to sell its Fletcher Forests shares.
Guinness Peat, which owned 19.87 percent of Rubicon and opposed the Fletcher Forests sale, was unsuccessful in challenging Perry's lack of disclosure of its relevant interest in the hedge shares.
The Takeovers Panel report puts out three options for discussion:
1) Keeping the status quo until such time as the panel gets evidence that equity derivatives are having a negative impact on takeovers.
2) Amend the code to require long equity positions to be disclosed by parties to a takeover transaction, or
3) Amend the substantial security holder disclosure rules and the code, its preferred position.
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