Monday, 23 April 2018

Merger arbitrage in practice: Sand Grove Capital

Given the renewed interest in financial market activity around mergers and acquisitions, I thought it might be interesting to have a look at the regulatory disclosures for one of the funds that has caught my eye lately.

I hadn't heard of Sand Grove Capital until recently, but it ended up taking a sizeable (almost 3% at one point) short position in Melrose Industries in the run-up to the acceptance of its bid for GKN.

There's a similar story in the GVC/Ladbrokes takeover. Here is Sand Grove long Ladbrokes 2.1% on 19th March using CFDs and short GVC 1.87% also using CFDs on the same day. 

And we see the same thing with Tesco/Booker. Here is Sand Grove long Booker 1.17% using CFDs on 7 Feb and short Tesco 0.22% using CFDs on 8 Feb.

Obviously, their main approach is to gain exposure through derivatives. On a quick search I could only find one disclosure - in respect of Revolution Bars - where there was an actual shareholding. This was reduced later, according to reports, when a takeover was rebuffed.


What I couldn't see on the Sand Grove Capital website was a a Stewardship Code statement. Just as a reminder, the FCA Conduct of Business rules say:
firm, other than a venture capital firm, which is managing investments for a professional client that is not a natural person must disclose clearly on its website, or if it does not have a website in another accessible form:
  1. (1) 
    the nature of its commitment to the Financial Reporting Council’s Stewardship Code; or
  1. (2) 
    where it does not commit to the Code, its alternative investment strategy.
I can't see a statement on the website, but, weirdly, you can access a statement via this site which does third party hosting for regulatory disclosures. The Sand Grove statement is here. If you can't be bothered read it, here's the key bit:
The Firm manages event-driven strategies involving a variety of asset classes, global jurisdictions and timeframes, and approaches companies and their managements on a case-by-case basis. Therefore, while the Firm supports the principles of the Code, it does not consider it appropriate to conform to the Code at this time. 
If you stick the second sentence into Google you get a few other hits for hedge funds that coincidentally came up with the same set of words. Spooky.

Wednesday, 18 April 2018

No, Elliott is not Whitbread's largest shareholder

With the Melrose bid for GKN almost complete, our old friends Elliott are back in the news again, this time targeting Whitbread, where it looks like they will be pushing for Costa to be spun off. Cue lots of headlines, many of them identifying Elliott's stake making it Whitbread's "largest shareholder".

Well, now, you see, actually, err.... no.

If you read Elliott's statement carefully, that's not quite what they say. What they actually say is that they have "an economic interest in excess of 6% of the Company". They do not say they hold 6% of Whitbread shares.

There's a very good reason for this - they actually hold 0.01% of Whitbread shares. Here is the RNS statement that shows that they hold just 18,707 shares, but they also have a load of CFDs. Notably Elliott has secured voting rights, so in practice they are going to have real power.

But they are not Whitbread's largest shareholder or anything close to it. And we are doing Elliott's PR work for them if we erroneously describe them as such.

PS - Jim Moore has a good piece on the way that passive institutions allow firms like Elliott to do their thing.

Tuesday, 17 April 2018

ISS and US pension funds vote against ICTSI directors

Proxy advisors and shareholders endorse voting against non-independent ICTSI Directors in line with ITF recommendations

Global proxy advisors and shareholders have recommended voting against the re-election of non-independent Directors of Filipino port operator International Container Terminal Services Inc. (ICTSI) at the company’s upcoming Annual Stockholders’ Meeting on the 19th of April 2018.
Recommendations from the world’s largest proxy advisory service Institutional Shareholder Services (ISS), and the voting decisions of major global shareholders, support significant corporate governance concerns raised by the International Transport Workers’ Federation (ITF) in analysis released last month.
Paddy Crumlin, ITF President and Vice-Chair of the International Trade Union Confederation’s (ITUC) Committee on Workers Capital (CWC) said today: “ISS, the world’s largest proxy advisory service, advised shareholders to vote against the re-election of four current ICTSI Directors, including Directors Stephen A. Paradies and Jon Aboitiz who the ITF recommended shareholders vote against over their alleged contribution to major governance and operational issues at the company, and non-independence.
“ISS identified that ICTSI’s Board does not comply with the Filipino Government’s Securities and Exchange Commission’s Code of Corporate Governance for Publicly-Listed Companies.
“Failures identified include a lack of board independence, a failure to have a separate Chair and CEO, a lack of independent directors on the audit committee, and a lack of independent directors on the corporate governance committee.
“The ISS recommendations again send the message that ICTSI must put in place decent and sustainable governance structures in line with accepted international best-practice in order to avoid major operational issues, including protracted disputes that the ITF has observed across the company’s terminals, and relationships with censured regimes.”
Shareholders including United States pension funds have also publicly disclosed their voting intentions and are opposing the election of the Directors the ITF has highlighted. CalSTRS has disclosed that the fund has voted against the entire Board, including ICTSI Chairman and President, Enrique Razon, while CalPERS, one of the world’s largest pension funds, has voted against all but two members of the Board.
“The vote of the US pension funds is a clear vote for greater Board independence.
“These Directors have failed to ensure that ICTSI’s internal governance structures are strong and enough to avoid major operational issues. Only last week, international unions came together in Melbourne to condemn the company’s ongoing failure to resolve labour issues across their global network, including at their flagship terminal, Victoria International Container Terminal.
“The ITF calls on all ICTSI shareholders to vote in line with recommendations to send a message to ICTSI management that they must urgently make changes to their Board to ensure outcomes that are better for all shareholders,” Crumlin added.
For more information
Luke Menzies, ITF Asia Pacific | +61 433 889 844 |  

Friday, 13 April 2018

IEA report on GKN/Melrose / old Takeover Panel comments

The Institute of Economic Affairs has stuck a report out today on the Melrose bid for GKN. Very broadly it says that there is nothing to get worked up about. Most importantly, a headline message is "leave it to the shareholders"

Interestingly, the report doesn't really look at how the bid got over the line as a technical process. I think this is important, because when you get into the detail it reveals quite a lot that suggesting that this is just about "shareholders" deciding doesn't really clarify.

For example, the report talks about a "vote" on the deal. Yet there was only a vote by Melrose shareholders to authorise the bid, GKN shareholders did not vote. If they had voted that would have raised its own questions, but because GKN shareholders had to accept the Melrose offer or not the dynamics were different.

Also the report does not distinguish between shareholders and other investors, and in particular does not look at how the hedge funds operate. For example:
This brings us to the third type of objection that the takeover has been decided by shareholders – including ‘rapacious hedge funds’ – who just want to make a quick profit regardless of the long-term implications for the business, let alone for the wider economy. This argument doesn’t stack up either. ....It seems odd to complain about ‘rapacious hedge funds’ making a quick profit if they do so by selling back to ‘long-term investors’, especially as they had presumably bought from ‘long-term investors’ who had lost faith in GKN’s management. 

To reiterate, the merger arb funds were largely not shareholders, they held derivatives (primarily CFDs as far as I can see) linked to shares. Hence I do not think they could "accept" the deal themselves, rather the counterparty (a bank) would have done this. Again, if you look at Elliott's carefully-worded statement about the bid it talks about having an "economic interest" in GKN shares, not holding shares, and says it will "support" rather rather "accept" the bid.

The hedge funds by and large don't seem to have bought shares from long-term holders, and so won't be selling back to them either. They built up derivative exposure with the help of banks (who did presumably buy the shares off institutions).

If the IEA does not think the hedge funds were out for a quick buck, let's keep an eye on hedge fund exposure to both companies once the deal is done. What we can see, even since the result was announced, is a further surge in the short position in Melrose on the part of some who are/were also long GKN through derivatives. The publicly disclosed short positions (0.5% and up in the FCA list) are now nearly at 17%. IHS Markit reckons one third of Melrose shares are on loan.

That does not look like a bet on the long-term success of Melrose to me. Rather it looks like an inherently short-term trade intended to take advantage of an expected drop in the share price when it has to cough up for GKN. Exactly what greater purpose this serves I am unclear, but then Adam Smith's hand is invisible.

As to the actual mechanics of how bids work when there is a lot of derivative action, I found this old Takeover Panel paper which sought to deal with these sorts of issues. I've dug out a couple of bits of commentary on what actually happens (some of this was in response to claims that derivative holders don't really have an influence.
First, the Code Committee believes that, notwithstanding the contractual arrangements between them, a counterparty will usually know the derivative investor’s likely wishes and therefore it would be na├»ve to assume that the counterparty (who has no economic interest in any hedge securities it holds but who does have an ongoing client relationship with the investor) will act without having some regard to those wishes. In addition, as indicated in paragraph 3.3 of PCP 2005/1, the Code Committee understands that it is frequently the expectation of a long derivative investor, notwithstanding the terms of the documentation, that his counterparty will ensure that the securities to which the derivative is referenced are available to be voted by the counterparty and/or sold to the investor on closing out the contract. If the counterparty does not hold any such securities (because, for example, its book is balanced by an offsetting short derivative), the investor would normally expect the counterparty to acquire the necessary securities, even if that resulted in a cost to the counterparty.…..the Panel continues to encounter situations where holders of long derivative positions behave as if they were shareholders and, more importantly, situations where investment bank counterparties enquire of investors with long derivative positions as to their preferences in terms of bid outcomes in order that the counterparties may take those preferences into account;
This is pretty much how I thought things work (NB it's an old paper, so perhaps practice has changed a bit). Essentially the huge funds act like shareholders even when they are not, and expect counter parties to help them, perhaps even when this isn't actually in the contract. Now again, you can argue that none of this really matters, and many "free market" types would. But it certainly makes the argument about "leaving it to the shareholders" more complicated. Do we mean "leave it to the counterparties"?

Equally folks on the Left could argue that to the extent that we do leave it shareholders to determine bid outcomes, those "shareholders" should be people who both hold shares and have an economic interest in them (i.e. only having one or the other means you don't qualify).  

Thursday, 12 April 2018

Wolfgang Streeck

Belated realised that I never blogged about How Will Capitalism End by Wolfgang Streeck, which I read some time last year. There are loads of interesting ideas in there, even if don't agree with some of it. Anyway, here's a little excerpt from the introduction:

"[U]nder financialised capitalism the private vice of greed in no longer magically converted into a public virtue - depriving capitalism of even its last, consequentialist moral justification. Stylizing owners and managers of capital as trustees of society has lost any remaining credibility, their much-publicised exercises in philanthropy notwithstanding. A pervasive cynicism has become deeply engrained in the collective common sense, which has come as a matter of course to regard capitalism as nothing but an institutionalised opportunity for the well-connected super-rich to become even richer. Corruption... is considered a fact of life, and so is steadily growing inequality and the monopolisation of political influence by a small self-serving oligarchy and its army of wealth defence specialists. Converting public trust into private cash has become routine and is seen as such, effectively rendering the social order morally defenceless in possible future moments of open contestation. Elite calls for trust and appeals to shared values can no longer be expected to resonate with a populace nursed on materialistic-utilitarian self-descriptions of a society in which everything is and ought to be for sale. Morally defenceless as they have rendered themselves, political and economic elites will require great creativity if things came to a head and they had to mobilise legitimacy for themselves and the social order they represent. One symptom of growing instability of the democratic-capitalist system is the rise of so-called populist parties, of both the Left and the Right, feeding on and fortifying a deeply emotional rejection of existing social elites."  

Saturday, 7 April 2018

Some reasons centrists continue to fail

Simon Wren-Lewis has a good blog up on Social Europe on the mistakes that centrists make. I've been thinking along similar lines, albeit with the aid of other people...!

1. Centrism is failing because is attacking its opponents morally rather than politically.

I'll be honest, I don't have a clear idea what many self-described centrists really believe in beyond the "wrongness" of others. While this may help as a way of forming an identity, I genuinely think this is a problem, not strength. Chantal Mouffe is very good on this:

"[T]he weakening of the discourses  constructing political identities in terms of left and right has not meant the disappearance of the need for a we/they distinction. Such a distinction is still very much alive; however, today it is increasingly established through a moral vocabulary. We could say that the distinction between left and right has been replaced by the one between right and wrong. This indicates that the adversarial model of politics is still with us, but the main difference is that now politics is played out in the moral register, using the vocabulary of good and evil to distinguish between 'we the good democrats' and 'they the evil ones'.
"This can be seen, for instance, in the reactions to the rise of right-wing populist parties, where moral condemnation has generally replaced a properly political type of struggle. Instead of trying to grasp the reasons for the success of right-wing parties, the 'good' democratic parties have often limited themselves to calling for a 'cordon sanitaire' to be established in order to stop what they see as the return of the 'brown plague'.
"To construct a political antagonism in this way is what I call the 'moralisation of politics'. This is something that were can see at work in many different areas nowadays: the inability to formulate the problems facing society in a political way and to envisage political solutions to these problems leads to framing an increasing number of issues in moral terms. This is, of course, not good for democracy because when the opponents are not defined in a political but a moral way, they cannot be seen as adversaries, but only as enemies."
It's hard not to think of the Democrats, and Hillary Clinton in particular, when reading this, though the interview is from 2007. I would also add that centrists also attack political opponents to their left, not just to the right, in moral terms. It is very striking that most of the attacks on Labour are focused on the "wrongness" of Corbyn or McDonnell in moral terms. Even now there is very little attempt to understand why they, and specifically the policies they articulate, are popular.

And finally what sort of message does the discussion, coming primarily from centrists as far as I can seen, of "open" and "closed" approaches to politics send? I am yet to see anyone using this division identify themselves as "closed", nor is there much suggestion that the "open" can learn from the "closed".

2. Centrists can look like populists on policy

It's pretty unenlightening to point this out, but populists simplify and deny complexity. Certain things are obviously "wrong" and the solutions are equally obvious. But centrists can often do this too, and in quite unattractive terms. Whereas populists invoke the people's will (which only they can represent), centrists will tend to invoke the superiority of technocracy - "what matters is what works". The impression is that there is a very narrow channel within which policy can operate. There are "right" ideas and "mad" ones. There is a frequent implication that you have to be pretty stupid to not accept the technocratic position on issues.

Jan-Werner Muller has made this kind of point recently:
"[A]t least as far as the current wave of populism is concerned, I would say that it is the particular approach to the Eurocrisis - for shorthand, technocracy - that is crucial for understanding the present-day rise of populism.
"In a curious way, the two mirror each other. Technocracy holds that there is only one correct policy solution; populism claims that there is only one authentic will of the people... For neither technocrats nor populists is there any need for democratic debate. In a sense both are curiously apolitical. Hence it is plausible to assume that one might pave the way for the other, because each legitimises the belief that there is no real room for disagreement. After all, each holds that there is one correct policy solution and only one authentic popular will respectively."
This really resonates with me. One of the things I found dispiriting about the dog end of the Labour government was the rigidity of much centre-left thinking on policy in my area (capital markets, corporate governance etc). But more recently this has really hit home in respect of foreign policy. It is really something to see the herd instinct of the commentariat whenever there is a conflict or possibility of one. Basically the opposition is expected to outsource its position to that of the government, otherwise it is betraying the country. As if there are only ever obvious and "correct" positions to adopt in foreign policy.

3. Centrists still can't tell us what they got wrong

As I've blogged etc before, one of the biggest problems for centrists is not being able to come up with a good explanation of what was bad in the Blair/Brown/Cameron/Osborne era. The ability of some people to switch directly from Labour to the Tories during that period (Dan Hodges even hilariously named David Cameron "leader of the British left" in one article) shows that they didn't really perceive much difference between what was on offer or believe that much needed changing.

Very broadly, social liberalism plus leaving the economy alone was ok. For many centrists, the financial crisis didn't challenge any beliefs, and hence they were quickly signed up to austerity and cutting public services to pay for private sector failings. When even people like Dominic Cummings identify the impact of the crisis as a major factor in Brexit, you might think that people whose only interest is in "what works" might pay more attention.

Yet even now, despite the rise of Corbyn, Brexit etc they really struggle to articulate what might have gone wrong. And certainly austerity and the excesses of the finance sector do not form a significant part of their analysis. Many clearly believe that the rejection of centrism is what has gone wrong. So the crisis is really that the public have lost the "right" answers that were already obvious, the idiots. In fact, according to one recent piece, the obvious answer to the current crisis can be located back in the 2010 Labour leadership election: David Miliband. Ho hum.

To state the obvious, a mixture of moralising, denial of alternatives and an inability to reflect on failure is perhaps not an attractive mix. Yet barely a day goes past when opponents are not described as morally reprehensible, or implied to be idiots for diverging from obvious policy solutions, all the while giving of a strong whiff of superiority. It's no mystery why they aren't winning.

Wednesday, 4 April 2018

Just a bit more on GKN

Here are a couple of things I noticed over the past few days. Anyone sharing my interest in this should have a read of John Collingridge's great piece looking at the end of the bid process. There are some really interesting nuggets in there.

For example, it appears that both LGIM and Blackrock backed the Melrose bid:

Neither manager has made any public statement as far as I am aware, something I increasingly think is going to have to change in future bid situations. Note the claim that LGIM didn't get back to GKN - I would a bit surprised if this is true. Incidentally, I don't think anyone "voted" their shares, they accepted the bid.

Blackrock's position is obviously also of interest given that this was a big call since Larry Fink's letter to corporates saying don't just think about the money. The other major stakeholder group in GKN - employees - was opposed to this deal along with management. If Blackrock still approved the bid, this gives us an idea of how that guidance may play out in practice.

The other really interesting bit in the article is the suggestion that Melrose was scrabbling around at the last minute to make sure it got over the 50%+ acceptance level:

This suggests that the result was very close indeed. 50m shares out of a total float of 1.72bn is 2.9%. If total acceptances were 52.3% then if these shares had not been pledged Melrose would have been short of the necessary level of acceptances. However, as I blogged previously, the hedge funds didn't largely hold shares, which makes me really curious about this. Was this a question of a bank counterparty having to pony up the shares, or did the hedge fund have to ultimately acquire shares to pledge them? If the latter did this change the expected returns from their trade - if so Melrose owe them one. And a missing 50m shares really narrows the possibles list down - how many hedge funds had a total position of 2.9% (or more)? This deserves more digging.

Finally, it's worth noting the total disclosed short positions in Melrose in the FCA list have gone back UP - over 13%, and some new names in the list (although they could have been sitting under the 0.5% level reported by the FCA). Note several of the positions date from 29th or 30th March - the day of the bid and the day after. Melrose's share price actually went up slightly post the bid result. Anyway, I'll keep an eye on it.


Friday, 30 March 2018

GKN takeover - losing the battle, winning the war

Few things have made me as angry recently as the Melrose takeover bid for GKN. This bid was opposed by a very wide group - workers, unions, GKN customers, Labour, some Tories, the Daily Mail, most of the large long-term GKN shareholders - yet it got over the line because of the support for merger arbitrage funds (or "arbs" as they are known in the City).

I think the labour movement can learn a lot of lessons from GKN, and see this as an area where we can do some fruitful work. If we don't want hedge funds to prevail we have to figure out how to beat them. So here are some of my thoughts.

Two killer facts: the arbs won it, and most arbs were not shareholders 

It's important to be absolutely clear about two things when looking at the Brexit-shaped 52% result in favour of the bid. First, Melrose could not have won without the arbs. Second, many of the arbs were not shareholders. I say we need to be clear about these things, because a lot of the reporting of this bid has failed to grasp these important facts.

On the first point, if hedge funds accounted for 20% to 30% of the control of GKN shares, then this accounts for about 40% to 60% of the support for Melrose. In this bid, compared to other cases, they were not bit players they were absolutely central to Melrose's victory. To repeat: Melrose could not have won without them. They may not even have come close. Melrose was expecting these funds to support it, but I doubt they had an inkling of how much they would need that support (remember they initially set the acceptance level at 90%!). This from the FT today makes the point:

Incidentally, that means that GKN's FD was correct in his claim last weekend (which GKN had to retract on Monday) that the company had the support of most long-only shareholders. Assuming that the figures for hedge fund control of GKN shares are about right - GKN likely had the support of around two thirds of the remainder of the shareholder base.

The second point is just as important. Most of the arbs were not shareholders. When Elliott announced its support for Melrose last Friday this was reported far and wide as backing from GKN's "second largest shareholder". (I believe it was briefed to City journos by Melrose's PR firm in these terms, more below). But as I blogged previously Elliott isn't a shareholder, it holds contracts for difference (CFDs). The same goes for hedge funds like Och Ziff, Sand GroveDavidson Kempner, MelqartMan Group (actually a mix of shares and CFDs in the last case, but more of the latter). The disclosed CFD positions for Elliott and those other five investors alone is over 9.5%. (PS here's an example of what it looks like when an investor does hold shares - they fill in a different part of the box on the form.)

Still not convinced? Look at GKN's list of major shareholders which lists holders with 3%+. Elliot's position was 3.84%, so where is it?

No Elliott, but getting on for 16% held by two US banks. In fact, the big positions in GKN shares held by the banks was one of the things that first revealed that hedge funds were swarming in. The banks are the counter parties that facilitate what the hedge funds do, and it is they, not the hedge funds, that hold the GKN shares. There was a good Lex piece about this earlier in the week but it is paywalled. 

So it's simply not correct that many of the arbs were "shareholders". Their exposure was via derivatives. When I posted a link to Elliott's disclosure on Linkedin and highlighted the fact its interest was through CFDs it got the most traffic of anything I've ever posted on there, and prompted some interesting comments. As mentioned above, I believe that Montfort, the PR firm advising Melrose, briefed journos about Elliot's support for the bid describing them as GKN's second largest shareholder, even though they don't own shares. There is a question in my mind as to whether this counts as an unverified claim of support, though perhaps I'm splitting hairs.

Why does any of this matter? Put it together - Melrose wouldn't have won without the arbs, and many of the arbs didn't hold shares. So bid was forced through by investors who didn't even hold shares. That is pretty shocking, but the point hasn't really been made effectively in much of the bid coverage.

Outstanding questions about CFDs

The fact that most people kept describing the arbs as "shareholders" showed that little attention was being paid to the detail of the bid. A question that still hasn't been answered as far as I am aware is how the arbs actually related to the bid.

The offer that Melrose made was to GKN shareholders, but, as described above, Elliott et al are not shareholders. So does that mean that Goldmans etc tender their shares by reference to what the arbs wanted to do? I'm guessing that they do but we really need to bottom this out.

Another question that has come up is whether the CFDs enable the hedge funds to vote. Voting rights aren't an integral part of CFDs, but I have been told by a couple of people that hedge funds can and do gain these when they want to. Basically the contract with the counterparty can be written how you want it.

But in any case in this bid it didn't matter because there wasn't a vote - shareholders had to respond to the offer or not. Hence the Melrose statement talks about "acceptances" not votes. This is something I hadn't really grasped. And actually the hedge funds and their bank allies didn't want a vote as it crystallises a tax liability. Here's Lex:
These hedgies, or “merger arbs”, have converged on Goldman, BofA and Deutsche because they are not advising GKN or quoted private equity group Melrose. The theory is that these neutral “prime brokers” can tender collateral shares held on clients’ behalf with fewer conflicts of interest. The broader advantage of prime brokers is that they are exempt from stamp duty. This means clients can generally buy and sell shares tax-free at arm’s length. If they vote the shares, they could crystallise a liability. Experts say the danger of that is less in a hostile bid, where investors show support by tendering shares to the bidder.
When there is a look at takeover rules as a result of this bid this is an area that needs real scrutiny. Should we really allow investors without shares, who hold derivatives because it's tax efficient, to affect the outcome of bids? I need a lot convincing that the answer to this is "yes".

The short part of the bid

Lots of people, me included, have learnt a lot more about hedge funds and the merger arbitrage business as a result of this bid. This is an inherently good thing. Union staff and MPs who a few weeks ago wouldn't even of heard of merger arbitrage now know the basics of how it works, and who the main players are. The shorting aspect of it has attracted quite a bit of interest. 

It's worth stating that the arb trade around this bid was massive. If these funds had an influence over 20% to 30% of GKN shares, they would be shorting Melrose to the same extent. We could see in the FCA list (which shows shorts of 0.5% and up) that reported shorts hit 13.5% at one point. IHS Markit, which gets a lot more data, said the total level was over 20% according to City AM.

A union friend introduced me to the 'days to cover' calculation. I worked out based on average daily volume that at the low end of the possible total shorts (the total on the FCA list) the result would have been almost 12 days. At the top end - the IHS Market number - the result would have been closer to 24 days. That would have been a lot of money trying to close out short positions quickly if the bid had failed.

There's nothing illegal about shorting but to does drive home what the arbs are really about. It's an inherently short-termist business, and their interest is only in the dynamics of the bid, and how it affects the prices of the acquirer and the target's shares, not the companies themselves. Betting against the company whose bid you are actively working to assist is the sort of thing that bamboozles the public and makes them think that much of the City doesn't give a toss about anything other than money. And they're right.


To state the obvious, these funds don't care about "stewardship". Several of the funds that had big long/short positions were in the list that I compiled at the ITF of duplicate statements of non-compliance with the Stewardship Code. Again, I find incredible that funds that can determine the future of a major engineering business can get away with just putting a few sentences of copied text on their website. In our response to the FRC in addition to providing the list of duplicate statements we also recommended that the Code be expanded to capture activity around bids:

After the experience of GKN, I think we are going to need to do a lot more. I'll be following up the duplicate Code statements with regulators, but I don't see why we shouldn't ask any funds involved in merger arbitrage to make a public statement about how they do it (i.e. shares or derivatives, is it a long/short combination etc), the typical duration of their interest and so on. But really any asset manager should make clear how they approach M&A.

And what about other shareholders (actual shareholders!) in this bid? It was striking that many big investors did not get off the fence, in public. For example, the FT suggests that LGIM supported Melrose, but I haven't seen any public statement to confirm this:

We know how a few of the other shareholders went - Aviva for the bid, Columbia Threadneedle, Jupiter, Royal London etc against - but there are loads that never went public, including some of the really big ones.

Shouldn't we expect that major shareholders make their intentions known, so that clients can override them if necessary? I don't know if asset managers typically tell clients in advance how they intend to respond to takeover bids, but they ought to. I bet some clients would not want to have their shares put up in support.  

This taps into the bigger question about the extent to which investors should be public about their stewardship/engagement activity. Very big issues were raised in this bid, lots of people are concerned about it. Why should it be acceptable that the group that plays such a major role - asset managers in control of other people's money - is allowed to treat it as a private decision?


It is inevitable that there will be pressure to overhaul the takeover rules as a result of the GKN result. This is why I think Melrose winning on such a narrow margin is actually the worst outcome possible for the arbs. 

You can see some obvious technical tweaks that could be used to tighten up the system:
  • Don't let any investors that does not have shares respond to / vote on any bid.
  • Have a qualifying period to vote - you have to be on the register before the bid is announced.
  • Increase the acceptance threshold. Why not make it a supermajority of 75% like a special resolution? After all this is the most fundamental decision shareholders typically have to make.
But more generally, I think it is very likely that interest will be revived in a public interest test for takeovers. This point has already been made by Jim Moore on the Indy. The FT also anticipates it:

So let's start working on what it would look like. LFIG and Policy Network already had a go so someone has already done some thinking. This needs to be turned into practical proposals that MPs can push.

Let's clip those hedges

A final point - it's time to go on the offensive. The hedge funds won this time, but it doesn't have to be this way. Let's start to challenge them - both how they operate in the market, and the influence they have more widely. Look at the money they poured into the Brexit campaign, or that they pour into the Tories' coffers

At the very least we should seeking to stop our pension funds from giving them any money. We should also push back on their political influence. There is a model for this. In the US labour and other groups formed the excellent Hedge Clippers campaign group. There is nothing to stop us forming something similar in the UK.

I hope that the Melrose bid for GKN can be overturned, and yesterday's result was much tighter than anyone expected at the start of the bid. But still, seeing the bad guys win is a real kick in the nuts. We should be angry about it and we should use that anger to change the system. Let's turn the the GKN arbitrage trade into the most costly bit of business that hedge funds ever did.

Saturday, 24 March 2018

Elliott's support for Melrose shows why GKN must not be taken over

Yesterday afternoon, Elliott Advisers announced that it plans to support the Melrose bid for GKN. This was duly reported, without much scrutiny, as support for Melrose from GKN's second largest shareholder.

Actually it's more complicated than that. In fact, Elliott's support for the Melrose bid demonstrates how short-termist this deal is, and the sorts of "investors" that stand to benefit at the expense of GKN workers if it goes ahead.

First up, Elliott Advisers is not actually a GKN "shareholder". If you read the intro to Elliott's statement carefully this is implicitly acknowledged:
Elliott Advisors (UK) Limited, which advises funds (together “Elliott”) that collectively have an economic interest in the shares of GKN plc (“GKN”) representing over 3.4% of its capital
If Elliott Advisers held shares. why not just say they hold over 3.4% of its shares? Because actually they hold derivatives, CFDs by the looks of it. Here's a market disclosure issued on Friday that makes this clear:

So, based on this disclosure, Elliott is not a GKN shareholder, it holds derivatives linked to GKN shares. Indeed it may never have been a shareholder during its two and a half month old economic interest. Elliott could, of course, have chosen to buy shares in the company it says it has a close interest in. Many other investors have done this. Instead apparently Elliott chose derivatives.

Two things flow from this. If Elliott isn't a shareholder, will it get to vote on the bid? I think it probably will, having read a bit around M&A arbitrage. But if so, that presumably means there is a counterparty on the GKN share register that will accept Elliott's voting instructions. This is how the future of the company may be decided.

Secondly, if they are not a shareholder, are they actually party to the bid? The offer is to GKN shareholders, not to holders of derivatives linked to GKN shares. In financial terms Elliott still cashes in of course, because presumably the counterparty passes on the economic return. But I don't think there is a direct transaction between Melrose and Elliott. So Elliot is telling other shareholders to accept an offer for the company that it may not actually be part of (though it will benefit from it).

Another important point did not get raised in press coverage of Elliott's statement yesterday. It has a very large large short position in Melrose - the second largest in the FCA list:

So actually the big investor unveiled as supporting Melrose yesterday is also betting heavily against Melrose shares in the expectation that a successful bid will hit them. Its short position is 1.8%, in the top 10% of shorts by size in the FCA list. So Elliott, despite apparently not being a shareholder in GKN, has a LOT of money on both sides of the deal riding on this bid going ahead.

Finally, Elliott is one of the firms that the ITF identified as using cut and paste copy to explain why they don't comply with the Stewardship Code. The Code was developed to try and increase shareholder responsibility after investors failed to tackle short-termist risky behaviour by banks in the run up to the crisis. Risky short-term behaviour may resonate a bit here.

Despite being willing to take a very public position on the future of a major UK company, which surely falls into 'stewardship' territory, Elliott doesn't seek to comply with the Stewardship Code. Instead it has posted a meaningless bit of copied blurb on its website to get out of it. As a result we put Elliott in the list we sent to the FRC and FCA highlighting cut and paste reporting by hedge funds. We've also suggested that the Code be amended to capture activity around M&A activity.

The fact that Elliott is the only investor with a really sizeable interest - not shareholding - in GKN to have spoken out in favour of Melrose's bid says a great deal. If your most vocal supporter also has one of the largest short positions in your shares it says a lot about who your allies are. And the fact that Elliott has only had an economic interest in GKN since January, and apparently not even a direct shareholding at that, shows you how much of a long-term interest they have.

This is a short-termist bid, backed by short-term speculators playing both sides of the deal. It deserves to fail.

PS - If I have any of the technical info wrong if anyone from Elliott, Melrose or Montfort wants to get in touch I am happy to correct it.

Wednesday, 21 March 2018

Melrose / GKN bid - is the hedge fund long/short trade unwinding?

As you'll have noticed, I've been following the Melrose bid for GKN with interest. In particular I've been looking at hedge fund activity around the bid, and the short Melrose / long GKN arbitrage trade. As I've blogged previously, one of the key players in this is Davidson Kempner, which at the start of March on its own had a short position of 3.02%. Even last week on the 15th it was at 2.55% according to the FCA's list of disclosed shorts (which shows anything above 0.5%).

The total short positions on the FCA list hit about 13.5% last week, making it (I think) the second most heavily shorted stock in that list. But according to IHS Markit data in this City AM story (which suggests investors are shorting Melrose in the hope the bid fails, which I don't think is right, but hey) the actual total short positions might be over 20%. That's an amazing amount really - about a quarter of Carillion shares were being sold short when it was in real trouble.

Well, today I checked the FCA list and the total of Melrose short positions they report is down to 11.6% (so now about the fourth most shorted stock in the list). And Davidson Kempner is no longer in the list (it's possible it has a position below the 0.5% above which the FCA reports).

When I had a quick look for market disclosures I found that the firm had reduced both its long position in GKN and its short position in Melrose this week. Assuming it had a long position in GKN roughly equivalent to its short in Melrose, this may mark the departure of quite a big investor with a big interest in the bid going ahead.

This is worth keeping an eye on. The total shorts in the FCA list have bumped around a bit, so the departure of one big player may not mean that much, or herald a wider retreat from the long/short trade. But it looks... interesting. I'll have a dig into who else is moving - Sand Grove has built up a big short position for example.

Just a thought, but if you wanted to speculate against the speculators this might be time go long Melrose. If the bid fails while between 10% and 20% of Melrose stock is sold short, and the price starts climbing, there's going to be some hedge funds buying back a lot of shares, quickly.

Thursday, 15 March 2018

ITF recommends shareholders vote against ICTSI directors

ITF recommends shareholders vote against ICTSI directors

The International Transport Workers’ Federation (ITF) today released a shareholder advisory note detailing governance issues at International Container Terminal Services Inc. (ICTSI). 
The ITF is recommending that ICTSI shareholders vote against directors Stephen A. Paradies and Jon Aboitiz at ICTSI’s 2018 Annual Stockholders’ Meeting on 19 April 2018. The ITF believes that these directors bear meaningful responsibility for major governance and operational issues at the company.
Paddy Crumlin, president of the ITF and vice-chair of the ITUC’s Committee on Workers Capital (CWC) said: “ICTSI has grown over the last decade. This growth has been accompanied by a failure to put in place decent and sustainable governance structures in line with accepted international best-practice.
“Proxy advisor Institutional Shareholder Services (ISS), the ASEAN Corporate Governance Scorecard and the Philippines’ Securities and Exchange Commission (SEC) all recommend that firms have at least three independent directors. Yet ICTSI only has two independent directors, out of a board of seven.
“The fact that the Razon family hold over 60 per cent of the voting rights at ICTSI, the lack of board independence should be a major concern for shareholders.”
The ITF notes that even ICTSI’s own documents highlights this as a risk to outside shareholders:
"…the Razon Family exercises control over or has significant ability to influence major policy decisions of the Company, including its overall strategic and investment decisions, dividend plans, issuances of securities, adjustments to its capital structure, mergers, liquidation or other reorganisation and amendments to its Articles of Incorporation and By-laws.
"If the interests of the Razon family conflict with the interests of other shareholders of the Company, there can be no assurance that the Razon Family would not cause the Company to take action in a matter which might differ from the interests of the other shareholders.”
Paddy Crumlin added: “The Board Risk Oversight Committee, chaired by Mr. Paradies, has failed to ensure that ICTSI’s internal controls are significant enough to avoid major operational issues, including major port disputes and relationships with censured regimes.
“In the last 18 months, ICTSI has seen protracted disputes at five terminals, disputes that have directly affected multiple port stakeholders, including governments, global brands and shipping lines. 40 per cent of ICTSI’s ports are operated with partnerships involving regimes that are either internationally censured or under investigation for crimes against humanity.
“These directors seem to have been unsuccessful in guiding the company towards outcomes that are better for all shareholders. We call on shareholders to vote against these directors and send a message to ICTSI management that these governance issues must be addressed.”
The ITF believes greater board independence will help ensure that minority shareholder interests are safeguarded. Additionally, the Philippines SEC recommends that directors with more than nine years of Board membership should not be considered independent. If this recommendation was rigorously enforced at ICTSI, none of its directors would qualify as independent. 
View the proxy statement here 
For more information
Contact Luke Menzies, ITF Asia Pacific | +61 433 889 844 |  
The ITF is a global union federation of over 700 transport unions, representing over 19 million transport workers from 150 countries. The ITF advises union benefit funds and their trustees on matters of corporate governance and other policy issues. The ITF is interested in the long-term success of ICTSI, its employees, and other key stakeholders. The CWC connects labour union organizations around the world to advance the responsible investment agenda on the global stage.

More on GKN / Melrose

So it's been quite a few days in terms of GKN's continued attempt to fend of Melrose Industries' hostile bid.

Last week saw Melrose get overwhelming shareholder approval for its bid. It will be interesting to dig into Q1 voting disclosures once they are online to see how these votes break down. By that stage we will know if the bid has been successful.

But in the last 24 hours we have seen a significant intervention as Airbus has basically said it would find it almost impossible to do business with GKN in the event of it being taken over by Melrose. That has to be material for shareholders planning on remaining invested in GKN.

In terms of shareholders, Aviva has gone early - before the Airbus news - saying that it supports the Melrose bid, but Jupiter has come out against it. Meanwhile the speculators are still a-speculating. Total disclosed short positions in Melrose slumped back down to about 11.5% earlier this week, but then went back over 13%. I reckon some hedge funds must be getting the jitters.

And there continues to be lots of churn in the GKN register. Check out notifications here and here for example. At one point BoA/Merrill Lynch had almost 13%. To be clear, the banks are not holding all of the shares for themselves. A lot of this will be related hedge fund money - maybe borrowing the stock, maybe getting exposure through derivatives. These are the people that will help decide the fate of GKN workers.  

For what it's worth, I think there is a good chance that the bid will fail now. If it does some of the people who have sought to speculate on the deal are going to lose a fair bit of money,

Wednesday, 14 March 2018

Duplicate Stewardship Code statements

A month or so back, I blogged that I had found several hedge funds using similar blurb in their Stewardship Code statements. This was off the back of digging into Carillion a bit. Then, when I looked a bit deeper at the GKN / Melrose bid, I found more of the same.

So I went and had a proper trawl, and in the end found 34 examples of managers using versions of the same text. So we added this list to our submission to the FRC's consultation on the UK Corporate Governance Code and Stewardship Code, which is here. I now know there are more out there.

We've picked up a bit of media interest off the back of this, which is welcome. Hopefully we can use this to develop some ideas about what needs changing under the next Labour government.

As a starter, I would question why any firm that can have a significant impact on the future of an investee firm should be allowed to get away with not saying anything meaningful. The Code itself might be tightened to capture issues such as: how managers approach stewardship where they have both long and short positions in the same company (on the long side they'll want to address causes of any underperformance, but not on the short side), managers shorting their own clients, approach to M&A issues and political donations.

But that's for another day....

Monday, 5 March 2018

Two interesting things

1. There are two different pieces about shareholder primacy, and why it might be a bad idea, in the FT today. One from the City editor of the FT and one from Rana Foroohar. Meanwhile Theresa May (remember her?) has criticised directors getting paid in way that is based on returns to shareholders.

I know I keep saying this, but I really feel that the ground is shifting, and that public policy will shift away from its 1990s focus on shareholders (and trying to make them act as a proxy for the public). There are people on Left and Right who think shareholders just aren't up to the job, for often quite different reasons. But what comes next is far from clear, hence that's where we on the Left should be busy.

2. There is a really interesting idea from Joe Dromey here: auto-enrolment into union membership (based on the experience of pensions). I can think of a couple of issues here. Part of the justification for pensions AE was that many people said that they should be saving but weren't getting around to it. So AE was helping them do what they thought they should be doing. I'm not sure we are quite in the same place with unions. Second, which union should you be enrolled into where there isn't one active?

But these are quibbles, I really like the idea. And it cuts very much with the grain from all the behavioural stuff that you should make things that you want people to do as easy as possible (which is why the Tories want to making joining a union harder, and don't want to make voting in a ballot easier).

Wednesday, 28 February 2018

Melrose / GKN battle continues

Quite a lot of news on the Melrose bid for GKN today.

Unite, which is campaigning strongly against the bid, held a rally and series of meetings at parliament. It is pleasing to see that a lot of Labour MPs are speaking out against the bid too, and it is also attracting scrutiny from the BEIS committee.

As usual, my eye is drawn to what is going on regarding the ownership of the companies involved. On that point, today we've seen two proxy adviser recommendations become public. On the one hand, ISS has come out and given Melrose the thumbs up. According to Reuters, ISS is quite chirpy about it:
“Given the sensible strategic rationale, (Melrose‘s) turnaround track record and reasonable valuation, approval of the acquisition is warranted,” ISS said in a note circulated to clients last week.
On the other, PIRC has come out against the deal:
PIRC has highlighted to investors that Melrose’s decision to go hostile means that it “has not benefited from the co-operation of the GKN board”.
The adviser also said that “significant political and other considerations, including security concerns” have been raised and that Melrose has reported annual losses two years running.
Meanwhile.... speculators gonna speculate. Following up on my last blog, I've been keeping an eye on the total disclosed short position in Melrose. And they've gone up to 11.67%. From a quick skim I think that makes Melrose the 3rd most shorted UK stock in the FCA list currently, after Provident Financial and Debenhams. What is really noticeable is the position held by Davidson Kempner, which has shot up over the past month or so and now stands at 2.46%. Elliott Capital has also built up a position quickly, now at 1.7%. 

I have little doubt that a number of those shorting Melrose are also taking corresponding long positions in GKN. I think the disclosures from the like of HSBC, Bank of America and (more recently) Goldman Sachs probably relate to underlying investors building up an economic interest in GKN, in some cases through derivatives.  

I know M&A arbitrage is a fact of life these days, but it makes me wonder what we should be doing with the takeover rules. I don't believe these sorts of investors have any long-term interest in either GKN or Melrose, they are just trying to skim value off the process of the deal and its likely impact on the values of the shares of each. Yet the deal itself will have an impact - in fact already is having an impact - on the lives of thousands of GKN workers. It seems nuts that we prioritise the interests of the speculators.

Finally, I think there is an important link here with "stewardship". After all, surely one of the genuinely important roles an investor has is influencing the change of ownership of a company. So I thought I'd have a look for Stewardship Code statements for some of investors that are in the mix. 

Here are a few bits from the statement from AQR Capital (which is short Melrose, long GKN) says:
From the introduction 
The Firm uses quantitative tools in a systematic process to build diversified and risk-controlled portfolios. The process does not typically involve subjective assessments of underlying companies or direct contact with the companies in which it invests.  
In relation to principle 3 
AQR’s investment approach, as a quantitative investment manager, is systematic and does not typically involve subjective assessments of underlying companies. AQR’s proprietary quantitative systems analyse various factors, combining them with estimates of transaction costs to arrive at daily investment decisions. All investment decisions are generated by AQR’s quantitative systems, other than in rare instances where the Risk Management Committee deems the circumstances to be exceptional. AQR does not invest in companies with a view to actively intervening in their management. 
I think the firm is pretty straight up about what it does and does not do. What is more, I found the statement very easily.

However I can't find a Stewardship Code statement for Empyrean Capital, and the Davidson Kempner statement (which took some finding) contains some of the cut and paste text to explain non-compliance that I blogged about previously:
The Firm pursues a multi-strategy investment approach, investing in strategies including distressed, event driven and equity long/short, merger arbitrage and convertible/volatility some of which will involve investments in global equities, including UK equities. The Code is therefore relevant to only some aspects of the Firm's trading. While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The Firm invests in a variety of asset classes and in a variety of jurisdictions globally and its approach in relation to the engagement with issuers and their management is therefore determined globally, on a group-wide basis, and will often vary on a case by case basis. That being the case, the Firm does not consider it appropriate to commit to any particular voluntary code of practice relating to any individual jurisdiction or asset class.
In fact the text used by Davidson Kempner is very similar indeed to that used by Elliott:

The Firm pursues a multi-strategy investment approach, including strategies that involve investing in global equities, including UK equities. The Code is therefore only relevant to some aspects of the Firm's trading. While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The Firm invests in a variety of asset classes and in a variety of jurisdictions. The approach/policies of the Firm in relation to engagement with issuers and their management are therefore determined globally, on a group wide basis. The Firm takes a consistent global approach to engagement with issuers and their management in all of the jurisdictions in which it invests and, consequently, does not consider it appropriate to commit to any particular voluntary code of practice relating to any individual jurisdiction.
I guess this is what ownership and stewardship looks like in modern capital markets: generic blurb in regulatory disclosures.