Alert

Who does this affect?

Participants in the equity derivatives market, institutional investors, hedge funds, listed companies, investment banks.

What do you need to do?

Consider whether any existing positions or positions soon to be taken need to be disclosed. If you regularly take derivative positions, put systems in place to deal with their disclosure. If you are planning a takeover or other control transaction, understand the need for disclosure of any derivative positions you may have or be planning.

Author
Alison Lansley  
Partner

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Alison Lansley  
Partner
T +61 3 9643 4187

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Sydney
Tony Bancroft  
Tim Bednall  
Peter Cook  
Scott Farrell  
David Friedlander  
Greg Golding  
Meredith Paynter  
Jason Watts  

Melbourne
Alison Lansley  
Stephen Minns  
Craig Semple  

Perth
Nigel Hunt  

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The long-awaited Equity Derivatives Guidance Note was released by the Takeovers Panel on 11 April 2008. Disclosure of positions taken in equity derivatives is now expected in “control” situations, by “takers” who have a combined long and physical position exceeding 5% of the underlying stock.

Purpose of the Guidance Note

The purpose of the Guidance Note is to explain when and how the Panel expects disclosure to be made of positions taken in equity derivatives.

As explained in our September 2007 Alert on this topic, the Panel has been concerned for some time that the use and disclosure of equity derivatives in Australia in the takeovers context needs to be addressed in order to ensure greater transparency.

The Panel is not alone in this concern. The UK’s Takeover Panel requires contracts for difference (CfDs) to be disclosed during a takeover where the interest in CfDs, together with any interest in the relevant securities themselves, equates to 1% or more. And both the Australian and UK governments are examining what additional disclosure of derivative positions in equities should be required in their respective markets.

In which circumstances do equity derivatives contracts need to be disclosed?

The Panel’s main focus is to require disclosure in circumstances where there is a “control transaction”.

The Panel has defined “control transaction” as a transaction which affects or is likely to affect:

• control or potential control of a company, or
• the acquisition or proposed acquisition of a substantial interest in a company.

While this working definition may be broad and somewhat vague, it is derived from and consistent with the first limb of Panel’s jurisdiction to make declarations of unacceptable circumstances under s657A(2)of the Corporations Act.

The Panel considers that a “control transaction” has commenced when one of three things occurs:

• a proposal likely to affect control or potential control is announced
• a substantial interest is acquired, or
• a proposed acquisition of a substantial interest is announced.

We expect that there will be circumstances in which it will be difficult to apply these general guidelines, some of which are discussed below. However, it is important to note that the timing of disclosure may be dictated by the interest of the party concerned in the particular control transaction - ie:

• for parties disinterested in the control transaction, there will be no disclosure requirement until the transaction or proposed transaction is in the public domain, at which point disclosure will generally be a prudent course
• for parties interested in the control transaction, it is likely that present market practice will continue, so that combined long and physical positions above 5% are disclosed as soon as they are acquired.

What is a proposal likely to affect control?

Clearly, if a takeover bid or merger by scheme of arrangement is announced, everyone knows that a “control transaction” has commenced.

Less clear are the following circumstances:

• A major shareholder of a listed company announces that it will move to remove a majority of the directors of the company.
• A listed company is facing financial challenges, although not insolvency, and announces that it is seeking expressions of interest for new equity investors or joint ventures.

There are numerous other examples of circumstances where it will not necessarily be clear whether, and if so when, a “control transaction” has commenced.

When does an acquisition of a substantial interest occur?

This is also difficult to answer. The Guidance Note uses the example of 3% as part of a creeping acquisition. Other examples are likely to include the following:

• A company is planning to bid for another company and acquires equity derivatives equal to a stake of, say, 5% before it announces the bid.
• A company has been the subject of takeover rumours for some time. A person other than the likely bidder(s) acquires equity derivatives equal to a “blocking stake” of, say, 10%, before any bid is announced.

Perhaps the most difficult question left open by the Guidance Note is whether an institutional portfolio holding of long derivatives exceeding 5% of the underlying stock requires disclosure.

What types of equity derivatives require disclosure?

The Panel says that it expects disclosure of all “long” positions (defined as either a long equity derivative position or a relevant interest in securities or a combination of both), whether hedged or unhedged, exceeding 5% of the underlying stock, alone or in combination with physical holdings.

The Panel excludes, however:

• index derivatives, and
• derivatives over a broadly-based basket of securities.

Who must make the disclosure?

Responsibility for disclosure rests with the “taker”, but not the “writer” or “market maker”, of the derivative unless there are circumstances which mean that the contract is not on an arm’s length basis. This is on the basis that the taker is most likely to be the party interested in control.

The Panel describes a “market maker” as a writer of equity derivatives who holds an Australian Financial Services Licence (or its equivalent in another jurisdiction) and provides arm's length, professional, intermediary services. The Panel will, however, consider the taker to be the market maker under an equity derivative that specifically hedges another equity derivative it has written (ie back-to-back equity derivative on essentially identical terms).

The taker of the derivative may also have a relevant interest in the physical securities underlying the contract, in which case a substantial holding notice will also be required if the combined position exceeds 5%. Short positions may not be netted against long or physical positions when making this calculation.

What details must be disclosed?

The Panel includes a list of the details it expects to be disclosed:

• identity of the taker (but not the writer)
• relevant security
• price (including reference price, strike price, option price etc as appropriate)
• entry date
• number of securities to which the derivative relates
• type of derivative (e.g. contract for difference, cash settled put or call option)
• any material changes to information previously disclosed to the market
• long equity derivative positions held by the taker and its associates, its relevant interests and its associates’ relevant interests (and the identity of all associates referred to)
• short equity derivative positions that offset physical positions

• short positions of more than 1% that have been acquired after a long position is disclosed, whether by notice or substantial holding notice (ie, the taker should update its disclosure with reference to the short position).

The Panel does not expect ISDA terms to be included in the disclosure.

How must disclosure occur?

If a substantial holding notice is lodged, then the disclosure can occur via a note annexed to the notice.

Otherwise, the Panel suggests that a written notice be sent to the company concerned (with the company disclosing the notice to the ASX).

When is disclosure required?

The Panel expects the timetable for lodging substantial holding notices to be met, which is:

• within 2 business days of the taker “becoming aware” of its position
• in a takeover bid period, by 9:30am on the next trading day.

Further notices may need to be sent for multi-staged derivatives.

When do the new disclosure obligations commence?

Effectively, now. However, the Panel says that, for the next 6 months, it will “bear in mind” in any application before it that disclosure systems may need to be changed, particularly in large organisations which do a lot of derivatives business.

However, the Panel also says that the taker of a derivative is likely to be aware of its position - suggesting that new derivative positions taken where there is a “control transaction” must be disclosed from now on.

As far as currently undisclosed positions are concerned, the Panel recognises that disclosures may cause the taker some commercial disadvantage. But it goes on to say that, if such a matter comes before it in the next 6 months, it will also consider the steps the person concerned has taken to minimise adverse effects on the efficient, competitive and informed market for the relevant securities in the intervening period.

How will these disclosure issues start to apply in practice?

We see some practical problems, especially around when a control transaction can be said to commence. Some clarification on disclosure of large institutional portfolio holdings may also be required.

We also foresee some issues arising between takers (usually investors) and writers (usually investment banks). What happens if the taker and the writer disagree on the need for disclosure?