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).