Disclosure of Derivatives Positions During a Bid

New Takeover Panel rules for disclosure of derivatives positions during a bid

Martin Harty, Senior Consultant, Crowell & Moring, London
Originally published in the December 2005 issue

Bids for UK public companies are governed by principles and rules (the Code) developed by the Takeover Panel (the Panel). The Code is designed to ensure fair distribution of the control premium, equality of treatment for all holders of the same class of voting securities, and a transparent market during the course of the bid. One aspect of this requires major players to disclose – publicly – all dealings in relevant securities of the offeree in a cash offer, plus those of the offeror where there is a paper offer or alternative involving relevant securities of the offeror. The offeror and offeree, and their respective associates, clearly have to make such disclosures. But in the interests of enabling the market to see what the significant shareholders are doing – and helping the Panel to detect any collusion between such holders and the parties to the bid – these holders also have to disclose their dealings in relevant securities.

For these purposes "significant" means 1% or more of any class of relevant securities (see above and Code Rule 8.3 – note that the Code uses the term "1% shareholder" rather than "significant shareholder"). Although the Code recognised derivatives (broadly defined to take in most things apart from physically settled options), there was (until the recent changes) no requirement to disclose such positions or dealings as long as the holding of the underlying securities was less than 1%. So you could have had a CFD referenced to, say 8% of the relevant share class, but with no disclosure obligations as long as the holding of underlying securities was less than 1%.

For all practical purposes, a long CFD referenced to relevant securities in a bid, is equivalent to holding those securities. Holders of such CFDs frequently conduct themselves as if they were holding the actual shares and are economically exposed to the result of the bid and its impact on the relevant share prices. Conversely, the counterparty to the long CFD will hedge by buying the relevant securities and holding them in effect to the order of the long counterparty (including voting them as directed and assenting to an offer).

Hedge fund involvement in bids is increasingly significant and is usually effected through CFDs. That made it necessary to revisit the concept of a 1% holder to take account of relevant long CFD positions. The Code hasbeen amended to do precisely this and the relevant changes came into effect on 7 November 2005. Hedge funds (and their advisers), wherever they are based, which take positions in bids subject to the Code, need to have a clear understanding of the new rules and the positive obligations to make disclosures. Failure to make requisite disclosures, or the making of materially inaccurate disclosures, gives rise to the risk of sanctions by the Panel and proceedings for Market Abuse by the FSA.

The new rules

Rule 8.3 of the Code has been amended. It applies during an "offer period". The Disclosure Table on the Panel website lists all companies which are in an offer period, with details of relevant outstanding securities (number in issue plus ISIN). The 1% trigger for public disclosure of dealings has been adapted to cover CFDs in particular. This results from a new definition of "interests in securities" in terms of having a long economic exposure to changes in the price of a security. Short only positions are not included. The definition covers ownership, control (conditional or absolute), and derivatives including CFDs.

Calculating interests: how and when

A holder could have actual shares, options and/or CFDs. There are aggregation rules which set out how to calculate the level of interest. The general rule is that interests in securities means aggregate gross long positions of the various instruments referred to above. So an aggregate gross long holding of 1.5% with a gross short of 0.6% would trigger a disclosure obligation. If a security falls within more than one of the definitions, of "interests in securities", that definition which results in the highest level of interest is applied.

Anti avoidance measures include (1) multiplication factors: if the CFD is valued by reference to a multiple of the number of referenced securities, the same multiple will be used to calculate the number of securities the long CFD holder is interested in. (2) a long holder of a CFD with no stated (or maximum) number of securities is treated as "…interested in the gross number of securities to changes in the price of which he has, or may have, an economic exposure."

Netting of long and short positions will normally be allowed only in narrowly defined circumstances. There are four conditions: the positions must (1) be in respect of the same class of security; (2) in respect of the same investment product; (3) except for the number of securities, the terms of the positions must be the same – eg strike price and exercise period; (4) the counterparty to the positions must be the same.

The time for calculation of interests in securities is midnight (London time). If a person is interested in 1% or more of any class of relevant securities at midnight (London time) on the date of dealing or was so interested at midnight the previous business day (this catches bed and breakfast arrangements), the disclosure obligation arises. Where the obligation arises, disclosure must be made by no later than 3.30 pm (London time) on the business day following the date of the dealings to be disclosed.

What has to be disclosed

Full details of what has to be disclosed are set out in Note 5(a) to Rule 8. The disclosure form (Form 8.3 and, where appropriate, Supplemental Form 8) is available on the Panel website. Points to note are that (1) although short interests will not (unless the netting conditions referred to above apply) be taken into account in determining whether an obligation to disclose has arisen, if there is such an obligation, short positions do have to be disclosed; (2) the general approach is to require details of (a) the dealings which are the subject of the disclosure; (b) the various categories of interest post the dealing which is being reported; (3) the identity of the owner or controller of the interest must be identified – nominee or vehicle companies will not be sufficient. Forms have to be sent electronically or by faxto a Regulatory Information Service (copy to the Panel).

Generally, where a discretionary fund manager makes investment decisions, the relevant securities are treated as controlled by him rather than the investment management client, provided that he actually does make the decision (rather than take instructions). The discretionary fund manager is therefore required to aggregate the holdings in investment accounts over which he has discretion for the purposes of Rule 8.3. Similarly, if the original investment manager subcontracts the relevant investment decisions to a different independent third party manager who then has full discretion, aggregation will apply to the holdings of that manager.

Exemption from public disclosure obligations under Rule 8.3

Rule 8 (3) (d) provides an exemption for market makers and intermediary traders but not the proprietary trading desks of investment banks. The Panel has reviewed these desks in the main investment banks to determine which are within the exemption. It is thought that some of these institutions will be forced into making disclosures for the first time.

Multiple disclosures in respect of the "same" securities

The wider the definition of "interests in securities," the greater the risk is that more than one person is will be "interested" in the same block of shares. If two parties report an interest in these circumstances, there is a risk of confusion. The Panel is aware of this risk but considers it to be small and manageable, since investors will be able to deduce the full picture from the detail required to be included in the disclosures. It will be interesting to see how this works out in practice.

The Panel

Since the Panel is a very unusual regulatory body, it is particularly important to have some understanding of how it operates. Funds and managers with no or little prior knowledge of the Code need to be particularly careful. The Panel covers a narrow and highly specific area – bids and (currently) substantial acquisitions. It has developed great expertise over many years and has a highly experienced permanent staff which is refreshed with investment banking, accountancy and legal secondees from leading firms. From its inception, it has had a succession of highly distinguished chairmen, and included senior representatives from all sides of the industry. The Panel has effective surveillance and enforcement is tight. As the introduction to the Code states, it represents "…the collective opinion of those professionally involved in the field of takeovers as to business standards and as to how fairness to shareholders can be achieved…"

Although the Code does not technically have the force of law, the FSA has endorsed it and the Panel is able to request the FSA to take action against authorised persons in breach of the Code or Panel rulings. Additionally, market abuse proceedings against anyone (whether or not authorised) can arise out of breaches of the Code. Since the Panel enjoys a very high standing, and the serious financial press attaches great importance to the Panel's statements and actions, the potential reputational damage resulting from a breach of the Code is significant.

The Panel focuses on substance rather than form. It is very aware of attempts to circumvent the Code or exploit alleged grey areas. The Panel Executive is available to give guidance and rulings in cases of doubt. It is also familiar with non-contractual understandings and arrangements which can change the characteristics of transactions in an attempt to avoid disclosure obligations.


The new disclosure provisions are likely to affect many hedge fund managers dealing in UK bid stocks, particularly where this is effected through long CFDs. They need to be aware of the relevant new provisions and be able to make the appropriate accurate disclosures on a timely basis. Additionally, they will need to take account of possible "multiple" disclosures in relation to some holdings in assessing the state of the market in such securities.

It is important to note that this disclosure obligation is by no means the only, or necessarily the most important, Code provision that can affect hedge funds. A clear understanding of "acting in concert" and "associate", and the resulting obligations and restrictions is essential. The Panel is also consulting further on what it has called "Control Issues." This relates to implications arising from dealings in derivatives/CFDs referenced to relevant securities and corresponding options, and by persons whose interests (together with associates) are in the 30% – 50% band. Further developments on this subject are likely in the first half of next year.

This is an area with highly developed and effective regulation and a regulator alert to new means of circumvention. Accordingly, those participating in the market need to be aware of the issues and introduce appropriate processes and controls.

Martin Harty is a specialist in regulatory affairs at Crowell & Moring in London. He is a former main board director of Credit Lyonnais Capital Markets and also of Fidelity Brokerage. He was Head of Compliance for Europe at Citibank and then general counsel for its Global Investments business. Amongst other roles, he was the first chairman of the Securities Houses Compliance Officers Group, and has acted as an arbitrator for the UK Securities Regulator.