Tuesday, 1 May 2018

Derivatives, influence, tax, policy etc

One of the things that was left hanging after the Melrose/GKN bid was the nature of the relationship between hedge funds and similar investors and their counter parties, and how this plays out during bid situations.

When I watched Greg Clark defending his own inaction in relation to the bid in parliament last week, and some of the questions / comments he received in response, it was clear that a lot of the technical detail was still confused. For example, Clark talked about hedge fund acquiring shares from long-term holders, where as in reality most never held shares. And there was talk too of a "vote" of GKN shareholders to accept the deal, which did not happen.

This stuff is important, because it also affects how much tax is paid. There was a good piece in Lex at the end of March. The key bit is below:
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. However, critics of the Melrose bid are likely to resent tax breaks for hedge funds. 
So, if you're a hedge fund holding CFDs in a target that is the subject of hostile bid resulting in an offer to shareholders (but not a vote) it doesn't look like you get hit with tax if things go to plan.

The interesting question for me is whether the counterparty responds to the bid, and in a way that aligns with the interests of its client? I think that is likely - and as as reminder here is what the Takeover Panel said on this point a few years back:
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
This points to an interesting policy question. As I understand it, CFD holders incur tax when they have voting rights to tackle the problem of them acting like shareholders, but on the cheap (on this point there's a good FT piece, a bit old, on Elliott's tilt at BHP here). But surely the decision to sell a company (despite the wishes of its management) is even more important than the right to vote? Why on earth would we let this happen, and in a tax-advantaged way?

If counter parties are tendering shares by reference to the clients' wishes I would suggest that this is an easy target for Labour. It should be the case that only those who both hold shares and have the economic interest in them should be able to respond to a bid. In addition, we could increase the tax paid on CFDs and other instruments that allow access to voting rights in order that they are less attractive than holding shares.

This in turn suggests other policy interventions. A lot of this stuff couldn't happen without a load of stock lending going on. So why doesn't Labour commit to introduce a stock-lending register, hosted by the FCA? This would provide the names of lenders in a given stock above a certain ownership threshold (say 0.1%). This would enable us to see if, for example, asset managers are lending stock belonging to the sponsor of a corporate pension scheme that is being used to short the same company.

In addition there should be transparency around who gets what when stock is lent. After all, it is the property of the client (pension fund or whatever else) so let's have a look at how much the client and manager take respectively from the lending fee. This info must be captured already, so let's get it into the public domain.

Finally Labour could also ensure that the Stewardship Code is rewritten to require section on M&A and related activity. It's seems odd in retrospect that it doesn't feature when this has a major impact on the companies concerned. The guidance could include that asset managers must actively consult clients on bids (again there could be a threshold). For example, I suspect there will be one or two out there who were surprised that their manager backed Melrose in the GKN bid. So the onus should be on the manager to consult.

So there are quite a few potential policy angles on this one. And this is before we start talking about a public interest test...

PS. Judging from the feedback I've had over the past couple of months, it is striking how much companies and some key groups within them hate the behaviour of many hedge funds and activists. Even where they accept the nature the takeover regime in general, there is clearly a view that some of these funds bend the rules. I think a proper overhaul of this stuff would actually be seen as a good thing by some players that are not natural Labour supporters.


Roy Jones said...

Good piece Tom. On stocklending, it would be illustrative to ascertain which asset owners do this, and for what purpose. Anecdotally, my questioning suggests that many asset managers/custodians offer lower fees in return for managing the stock lending. It's not rocket science to see the conflicts that arise here.

Tom Powdrill said...

There is a database out there that tracks this kind of stuff, but you have to be able to share data with them to be able to access it.