Disclosure time for the takeover tacticians who strike by stealth

CFDs have long been the financial instruments of choice for marauders looking to keep a low profile. But enough is enough, says the regulator. By Simon Evans
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The Independent Online

According to the fabled Chinese military tactician Sun Tzu, author of The Art of War: "In conflict, direct confrontation leads to engagement and surprise leads to victory – those who are skilled in producing surprises will win."

In the business world, the use of so-called contracts for difference, more commonly known as CFDs, has become a highly effective weapon in the armoury of companies and investors looking to surprise and snare their prey in some of the biggest corporate takeovers in London.

A CFD is an instrument that allows investors to speculate on the price direction of stocks or indices without having full ownership of the underlying contract. Created in the 1980s, CFDs have the advantage over traditional equities that they do not carry UK stamp duty. Neither are they subject to the disclosure rules forced on equity owners that dictate that the stock market has to be informed once an investor owns 3 per cent of a listed company.

Crucially, investors often put so-called side agreements in place to ensure they get their hands on the underlying shares from a bank of intermediary, which typically holds physical stock to hedge a position, until the open contract terminates. Such agreements have had a dramatic effect on the stock market.

Some of the UK's biggest attempted acquisitions, including Sir Philip Green's ambush of Marks & Spencer and the recent attempted takeover of the London Stock Exchange (LSE), have featured CFDs at their heart, allowing hitherto unknown investors to creep up beneath the radar.

But under proposals unveiled by Britain's financial regulator, those silent assassins looking to use CFDs to win takeover battles or influence a company's board could soon become a thing of the past.

The Financial Services Authority (FSA), the City watchdog, has long had its eye on the nefarious activities of individuals it has suspected of using CFDs for market abuse, but has so far refrained from tightening regulation.

The first and one of the most infamous examples of a firm using CFDs in a high-profile situation came in 1995. Trafalgar House built up a stake in its target Northern Electric through CFDs while it also took synthetic positions in other electricity companies, whose share price it expected to increase on the back of the bid fever. That led the Takeover Panel to broaden rules it had in place requiring bidders to disclose their shareholdings, to include CFDs and other derivatives.

Back in 2003, Shami Ahmed, founder of jeans manufacturer Joe Bloggs, used CFDs when he pursued the high street retailer Moss Bros, building up what was in effect a 5.4 per cent stake in the group. He owned just 0.3 per cent of Moss Bros's actual shares. Grumblings at the time suggested that regulatory change might be on the cards, but nothing happened.

More recently, the American corporate raider Samuel Heyman took centre stage in Nasdaq's battle to win control of the LSE, scooping up around 10 per cent in CFD stock exposure. It allowed him to garner time with the key management players in the tussle.

Mr Heyman is thought to have used similar tactics in getting the management of steel giants Arcelor and Mittal to speak, which ultimately led to Mittal winning a $34bn (£17bn) takeover battle.

So what steps is the regulator taking to curb such behaviour in the future?

On Monday last week, the FSA launched a consultation paper ahead of the introduction of new rules. Keeping the status quo in place is out of the question, which leaves two different options.

The first is lighter in tone and preferred by the FSA. Investors buying CFDs to take an economic exposure to a company would not be allowed to use their stakes to vote at company AGMs and EGMs.

The alternative regime is one that would demand full disclosure of stakes of "economic interests" above 5 per cent – a move that the regulator estimates could cost as much as £50m to set up and run. The Association of British Insurers, which has long campaigned on the issue of disclosure of CFDs, endorses this plan.

The Association of Investment Companies, the trade body for the investment trust world, has also seen some audacious use of CFDs in the past, but is yet to make up its mind which proposal to plump for. Guy Rainbird, its public affairs director, says there are merits in both.

"The full disclosure option is clearly simpler but obviously costs more," says Rainbird. "The lighter option has merits and the wording of 'economic interests' rather than prescriptive rules means it's largely future proof too.

"What we don't want is constant tinkering. The Hong Kong authorities wrote prescriptive rules on CFDs and have had to go back and add additional regulations as investment products have evolved – the rule book is like a Yellow Pages, by all accounts."

On City dealing desks the proposals have received a cautious welcome. Regulation has always been a dirty word in the Square Mile but the measured tones coming from the FSA, coupled with a feeling of resignation that new rules will eventually have to be brought in, means that the news hasn't caused the reverberations it once would have done.

Before the proposals were tabled, hedge fund lobby groups admitted that there was a need for change. Even Colin Kingsnorth, founder of Isle of Man hedge fund Laxey Partners – which once infamously attempted to use a CFD raid to oust John Ritblat, then chief executive at property group British Land – has supported wider disclosure of synthetic stakes, saying: "It's a farce that they are not disclosed."

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