FSA moves to make hedge funds disclose CfDs

The UK's financial watchdog has targeted hedge funds for the second time this month, demanding more disclosure for those trying to build anonymous stakes in companies using a complex derivative, in a bid to combat market failure.

The move to force disclosure of contracts for difference (CfDs), which comes just weeks after the regulator brought in disclosure rules for short positions in certain circumstances, will leave some hedge funds "fuming", according to one market expert. CfDs and shorting are tactics predominantly used by hedge fund investors.

The Financial Services Authority outlined plans yesterday for investors to disclose their positions if they have built up more than 3 per cent in a company through CfDs. Under the new rules, investors must disclose a position, whether held through shares or CfDs or a combination. Previously there had been no requirement to disclose any CfDs positions other than when the target was in a takeover process.

Contracts for difference are a way of benefiting from share price movements without owning the stock. The strategy involves borrowing stock, for a fraction of the value, which can then be acquired when the contract is closed out.

There had been calls for greater disclosure as CfDs allow investors to build stakes in companies "at arms length" without disclosing their positions.

The FSA said it was to draw up draft rules to be published in September but took the unusual step of outlining the policy yesterday "because of the importance of the issue, and the significant market interest in it".

It launched a consultation into CfDs last year, closing it on 12 February. It said yesterday that it had received a large number of responses from banks, investors, listed companies and law firms. "The consultation papers ... support our conclusion that enhanced disclosure is needed to address some market failures around access to voting rights, and proposed changes to our regime designed to deliver that," the regulator said.

There were three options when scrutinising CfDs, the regulator said, which was refined to two after it "rejected the do nothing option". It initially proposed a disclosure level of 5 per cent, but following the consultation reduced it to 3 per cent.

The rules will not be in place for 14 months. The FSA will publish the policy statement with feedback on the consultation, with the final rules released next February. These will come into force in September.

The announcement was met with mixed reactions yesterday. Peter Montagnon, the director of investment affairs at the Association of British Insurers, which represents institutional investors, welcomed the move. "This is the right way forward for the market, but we will need to look carefully at the details."

But Andrew Shrimpton, a member of Kinetic Partners and former head of alternative investments supervision at the FSA, called the measures draconian: "Lots of hedge funds will be fuming over this." He said the rules would add extra costs to trading.