Corporate control on the cheap?

A couple of years ago, I got into the guts of the Melrose Industries hostile takeover of GKN. This deal squeaked through, despite it being opposed by GKN employees.

The bit of it that particularly interested me was the role of hedge funds doing the merger arbitrage trade, which ended up influencing a major part of GKN's shares (and simultaneously shorting Melrose). I say 'influencing' as the overwhelming majority of the funds' exposure to GKN was through derivatives, rather than ownership of its shares. 

My understanding of how this corner world works is that hedge funds utilise equity derivatives primarily because they are cheap. It costs a lot of money to buy 1% of a PLC, and if a hedge fund with a few billion under management went out and bought the shares it would represent both a big expenditure and a very significant position. So using CFDs or swaps enables them to gain exposure to movement in the target's shares without having to pay to own the underlying asset. They obviously pay for the derivative itself, but that's a fraction of the cost of the underlying equity.

As I blogged previously about GKN, my understanding is that, as the counter parties to the derivatives, investment banks end up holding shares. Again, no problem in principle, and everyone is clear that it is the hedge funds which have the economic interest in the shares even if they don't own them. If the hedge funds have long derivatives they make money if the shares go up and lose it if they go down. That in turn means that if the bid fails they lose money, so holders of long derivatives obviously want the bid to succeed (or look to be set to do so - if they got in early they could take profits before the outcome is decided I suppose).

In a hostile bid the bidder essentially makes an offer over the heads of the incumbent management of the target to the company's shareholders. Those shareholders in turn have to decide by a set deadline whether or not to accept that offer. If you're a shareholder you can accept that offer or not (and the management of the target will be telling you to ignore it) and if you're not a shareholder you can't. And by extension, if you hold derivatives, not shares, you're not a shareholder. So you can't respond to the bid. 

So far so simple. But what if you're an investment bank that holds the shares as a counterparty to a derivative holder? You do hold the shares, but only because of the derivatives. How do you decide how to respond? Pure survival instinct is surely going to tip you to support the bid because you know that your valuable hedge fund client is going to lose money if the bid looks like it might fail. It is possible, even, that the derivative is written in a way that stipulates this, though I simply do not know if this is the case or not.

My issue is that this may mean that de facto those holding derivatives are able to exercise influence on the outcome of bid equivalent to that of an investor holding equity. If so this is influencing what we used to call the market for corporate control on the cheap. It doesn't feel right to me that investors whose only interest is in an instrument that mirrors the share price, and its appreciation during the limited timeframe of the process a bid, should be able to influence the ownership of major employers.

I could be off-target on some of this so would welcome any corrections etc from anyone who knows this area better than I do. I will keep private just email if you don't want to comment on here. (I'd also be interested to find out how much gaining an exposure of say 1% via derivatives actually costs vs buying the shares.) But I think I do have the outlines broadly right. If so, I think this ought to attract more attention than it does currently. 

PS. Given that a change in ownership is absolutely fundamental to a company's future this is very obviously a significant stewardship issue. Yet, as I've blogged before, a number of the funds active in the merger arbitrage market do not adhere to the Stewardship Code.

How seriously do hedge funds voting disclosure?

Not seriously, I would argue. The principle that investors should disclose their voting records is pretty well established now, but we still get this cut & paste stuff justify not doing so.

Turnout tales

If recent events tell us anything, it's that voting matters... With that in mind this is a quick post on something that caught my eye this year: sharp changes in voting turnout at a number of companies. Some of the more striking examples have been at companies that have got into financial trouble, like Thomas Cook, Interserve, Kier Group and so on. Here are a few examples (excuse my poor Excel skills). I've included publicly available data on short positions at the same time as the relevant meeting, as I think that the impact of shorting might be part of the story.

For completeness, take a look at Premier Oil, where a huge short position has recently been reported (it seems this one might be hedging).

But it's not just about shorting, there are some interesting results at companies that have been in the middle of other activity. Have a look at Provident Financial, which was facing a bid from Non-Standard Finance earlier this year. I have half an idea here that it could be the result of people taking a punt on the takeover succeeding using equity derivatives, hence banks ended up on the register as counterparties but didn't vote (as I believe there is a tax issue). I'm interested if anyone can tell me if I'm talking gibberish, or not.

And if we look back at Whitbread over the past couple of years, when Elliott had a large derivative position and was pressuring the company to restructure, we also see a drop in turnout. I'm not clear why this sharpened in 2019, though it's worth noting that it bounced back at this month's EGM. Press reports suggest Elliott wound down its position in July.

 

I'd love to see what the turnout at Melrose Industries March 2018 EGM was like, as I suspect we'd see the impact of hedge funds there too. But it's the one set of meeting results not available on its website.

And with that, I'm off... Happy Xmas and see you in 2020!

Outsourcing hell - continued

If anyone were in anyone doubt that the outsourcing sector is in big trouble, Friday saw Interserve's precarious position finally resolved. The major shareholder - US hedge fund Coltrane Asset Management - voted against the proposed debt-for-equity swap, which in turn will lead to the company going into administration. Already a couple of other outsourcers are sniffing around to see of it's worth trying to pick off some of the better bits of the business.

Ultimately Coltrane and the board of Interserve played a game of chicken and in the end neither side blinked. As usual in these circumstances it is tempting to see the US hedge fund as the bogeyman. So it's important to remember that the leadership of Interserve (like Carillion before it) got the company into this mess, the hedge funds didn't create it. Nonetheless, when faced by pleas from management not to vote against the de-leveraging plan, with the knowledge that this would trigger administration and create huge uncertainty for the workforce, Coltrane's stance is not going to win many fans. 

The role of hedge funds in this one was interesting as Coltrane and Davidson Kempner were on opposite sides (the latter on the debt side) rather than, as you might expect, shorting. It's also notable that Coltrane had previously shorted Carillion and is currently shorting Mitie Group (interesting, given the latter's interest in bits of Interserve).

I guess they must think they can sort the wheat from the chaff in the outsourcing sector, but their experience with Interserve must have been pretty painful.

So first Carillion, now Interserve and Kier Group wobbles along after a rights issue flop and a new upward revision in its debt. To state the obvious, there's a sectoral problem and it looks like consolidation is likely. That in turn might start to sharpen the questions about what we've actually achieved with all this outsourcing. If we end up with an oligopoly of outsourcers it will become a bigger political problem. But we aren't there yet.

I haven't seen much coverage of what's going from the corp gov / ESG world (would be interested if anyone has seen some). There is a sectoral problem, with jobs and service provision potentially at risk. Maybe it will get more attention from here on, it surely deserves to.

Also, what does stewardship mean in this context? As far as I can see Coltrane doesn't make or need to make any kind of Stewardship Code statement. On the other side of the Interserve story, Davidson Kempner uses a version of the same generic blah as dozens of other hedge funds that neither the FCA nor FRC seem to have shown any interest in challenging. These are firms that can have a huge influence on major employers, but don't need to say anything about what they do and why. I does kind of make you wonder what the point is. The Stewardship Code sometimes seems to be more about reporting / promotion than what's under the bonnet.

Interserve & hedge funds

The ongoing battle at Interserve is grimly fascinating. The company's biggest shareholder is hedge fund Coltrane Asset Management which is trying to scupper the board's plans for a debt-for-equity swap. This would (obviously) be bad news for existing shareholders, but it looks like the company would go into administration if its plan does not proceed as planned.

There is come great coverage in the Sunday Times today, including an interview with the chief exec Debbie White. She argues: "People seem to have lost sight of 68,000 people's livelihoods [and] thousands of clients and suppliers for whom Interserve is an integral part of their lives."

I'm interested in Coltrane's role as a shareholder, as I've primarily come across them on the short side. They had a smallish short position in Carillion before it failed, and currently has a fairly sizeable short in Mitie Group. Here are its current shorts above 0.5%:

Funnily enough, there's another hedge fund I've come across several times - Davidson Kempner - on the debt side of Interserve.

By the by, Davidson Kempner currently has no shorts listed in the FCA list. In fact it hasn't had any in the list since April 2018 when it wound down its long/short merger arbitrage trade around the takeover of GKN by Melrose. Perhaps it's not shorting anymore, or perhaps it has some sitting at 0.49% or below. The more I dig into this stuff the more I wonder why the FCA sets the bar so high for disclosure.

Stock-lending and shorting, again

I've been thinking a bit more about the potential conflicts of interest around stock-lending and shorting in light of the RD:IR paper I blogged about a couple of weeks back. It suggested that passive managers are in part able to offer lower fees because they make money through stock-lending.

I was initially interested in the way that this might facilitate shorting on the cheap by the active side of the same business. If you're managing passive assets on a large scale on an AUM-based fee then I think you can probably lend to your active side safe in the knowledge that even if they call it right the decline in one stock isn't going to rock the boat (NB - I'm not saying shorting makes share prices decline!). I think that is still worth digging into, just to find out a) how extensive lending by passive managers is b) how much the passive clients make out of it and c) if cross-group lending is done, and, if so, if it's charged at a cheaper rate than to external clients.

But what interests me is what other issues might arise. I am reminded of this bit from an old Takeover Panel paper about the conflicts created for counterparties to derivatives in bid situations:

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 naïve 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;

Do similar issues arise for passive managers who stock-lend? Say you're a regular lender to funds doing the merger arbitrage trade. Say a big contentious hostile bid comes up and your lending clients have taken a big punt shorting the acquirer in the expectation that the bid succeeds. Is there any tension in how you decide to respond to the deal? Big passive managers are going to be long in both target and acquirer. I'm pretty sure there must be an optimum outcome in this situation, but if your positions are passive (so you're not being judged on performance) I suspect you've got freedom of movement to decide how to respond.

If you oppose the bid, and it fails, it's quite possible that stock-lending clients will lose a bundle. If so, will they come back to you as a borrower next time? I have heard anecdotes about borrows being sniffy about lenders who want to recall to vote, so I could imagine some conflicts / client pressure.

Another area to dig into...

More short stuff

Again, huge caveat that the data in these charts is only 0.5%+ short positions, but some interesting stuff I think. At the end of play yesterday the FCA had disclosed 581 current short positions of 0.5% and above in UK shares. So I looked at which firms had the most shorts, and - of that group - what their average, median and largest short positions were.

Blackrock has the most shorts in total, and also the second largest individual short of the sample. Odey has the largest single short and average short. AQR has the largest median short, second largest average short and third largest individual short.

A rough (and pretty obvious) reading of this is that the hedge funds that make shorting a significant part of their strategy take a small number of bigger positions. I am surprised by the sheer number of Blackrock shorts (and there must be a lot more under 0.5%) which makes me wonder if a lot of this is hedging. Also quite surprised to see both JP Morgan Asset Management and Merian Global Investors (formerly Old Mutual) in the mix.

For info I had an arbitrary way of picking firms - just those with 10 or more shorts in the list.

PS - 20 largest shorts and the funds that have them:

More hedge fund cut 'n' paste fun

I had some fun last year exposing the boilerplate blah that many hedge funds (and a few bigger firms) were using to "explain" their non-compliance with the Stewardship Code. Many thanks to Responsible Investor for recently giving this a plug.

Anyway, I thought I'd have another look. In the list we submitted to the FRC and FCA last year, I had found 34 examples using pretty much the same text. So are there any more out there? Yes. Loads.

Below are some I didn't find first time around. I haven't included all the blurb - the full text includes words to describe their approach to engagement with issuers which, miraculously, seems to be the same across dozens of firms. Incidentally, a couple of the URLs are interesting. One uses the word "template" and another includes "UK_Stewardship_Code_Applicable_BUT_firm_chooses_NOT__to_commit_and_explains_why"

These are just from the first three pages of Google results (even I get bored of this stuff). There are a lot more.

Somerset Capital Management:
While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to it.

Marine Capital (this one looks reasonable, to be fair):
MCL invests directly in shipping assets and therefore it has no exposure to UK listed companies. Therefore, whilst MCL generally supports the objectives that underlie the Code, the nature of its investment strategy makes it impractical and unnecessary to engage with investee companies through voting rights. The Firm has therefore chosen not to commit to the Code at this time.

Baker Steel
Consequently, while the Firm supports the general objectives that underlie the Code, the Firm has chosen not to commit to the Code. Given the investment strategies of the Funds, the principles of the Code are generally not relevant to the type of trading currently undertaken by the Firm. If the Firm's investment strategy changes in such a manner that the provisions of the Code become relevant, the Firm will amend this disclosure accordingly.

Sagil Capital
While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code.

Pamplona Capital Management
While the Firm generally supports the objectives that underlie the Code, the Firm has chosen to not commit to the Code.

Avenue Capital (this is the one that includes "template" in the Google results)
As such, while the Firm generally supports the objectives that underlie the Code, the Firm does not consider it appropriate to commit to any particular voluntary code of practice relating to any individual jurisdiction.

Hadron Capital
While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code.

Blue Whale
While Blue Whale supports the objectives that underlie the Code, Blue Whale is not in a position to commit to the Code in its entirety.

Nextam Partners
While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code.

AKO Capital
While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code.

Partners Group 
Whilst PGUK generally supports the objectives that underlie the Code, it has chosen not to commit to the Code at this time.

Clearance Group
While the firm generally supports the objectives that underlie the Code, the firm has chosen not to commit to the Code. 

Edgbaston Investment Partners
Whilst Edgbaston generally supports the objectives that underlie the Code, it does not consider it appropriate to commit to any code of practice relating to any individual jurisdiction.

Markham Rae
Consequently, while the Firm supports the objectives that underlie the Code, the provisions of the Code are not relevant to the type of investment currently undertaken by the Firm.

RAB Capital
While RAB generally supports the objectives that underlie the Code, it has chosen not to commit to the Code.

Atlas Square
Hence, while the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. 

KAM Portfolio Management
While the firm generally supports the objectives that underlie the Code, KAM has chosen not to commit to it.

Glen Point
While the firm generally supports the objectives that underlie the Code, Glen Point has chosen not to commit to the Code. 

Sturgeon Capital
While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code.

Stewardship Code duplication

Last year I blogged about the duplicate text that lots of hedge funds were using to "explain" their non-compliance with the Stewardship Code. It's still out there, and on a recent trawl I managed to find more examples of funds using the same blurb. But as no-one really seems to police this stuff on the regulatory side, it's just sitting there.

The other day when I was looking for ESG contacts at a couple of asset managers I don't know well I started looking through the Stewardship Code statements on the FRC's website. I noticed that I'd obviously hit one of these links (Loomis Sayles) on a previous trawl, but I also spotted that the manager is listed as both a Tier 1 and Tier 2 signatory (see below).

Actually, as you can see, both Loomis Sayles and Liontrust are listed in both Tier 2 and Tier 1. The link for the former lands in a slightly different place (which isn't actually a Stewardship Code statement) to the latter, though it's only a click away. In the case of Liontrust the links in both Tier 1 and Tier 2 go to the same document (it's the same URL I think).

And there's a third. Castlefield Investment Partners also appears in Tier 2 and Tier 1, though in the first case it's a dead link.

It's interesting that the Kingman Review (see below) was pretty sceptical about the impact of the Stewardship Code in practice and critical of the focus on policy statements. I'm not sure I completely agree overall, my own experience on the policy statement side is that there is some crap out there but no-one seems that fussed.

Shire takeover & derivatives

So the takeover of Shire PLC by Takeda Pharma has been completed. I thought I'd have a quick look for merger arbitrage plays in the filings.

A few familiar names in the list below. Most of these investors are listed as having an interest (presumably short) in Takeda too and I've found a couple of examples:

Millennium - 0.68% in shares, 2.28% in derivatives
York Capital - 1.51% in derivatives
Marshall Wace - 0.3% in shares, 0.7% in derivatives
DE Shaw - 0.54% in shares, 1.07% in derivatives (Takeda short here)
Davidson Kempner - 1.39% in shares
UBS O Connor - 1.03% in derivatives
HBK Investments - 0.17% in shares, 3.08% in derivatives
Elliott - 0.0002% [chuckle] in shares, 1.28% in derivatives (Takeda short here)

This is just from a quick Google. Final positions may have been high/lower. But doesn't take long to get to 10%+ interest through derivatives.

Cut and paste hedge fund reporting, again

Back from holidays, so had a quick Google to see if I could find any of that pro forma stewardship reporting that I had been tracking. And, yes, there is more:

Altavista Capital:

Altavista Investment Management UK LLP manages or advises a number of funds with varying strategies. The Code is therefore relevant to some aspects of the Firm’s activities. While the Firm supports the objectives that underlie the Code, it has chosen not to commit to the Code.

The Firm determines its approach to stewardship on a case by case basis, taking into account its duties to the funds that it manages and the actions that will lead to the most favourable outcome for the value of its investments and the interests of its investors.

Furthermore the Firm takes a consistent 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 code relating to any individual jurisdiction.

Greenvale Capital:

The Firm provides investment management services to various funds (“the Funds”) that pursue investment strategies that involve investing in a wide range of securities and instruments without limitation in various jurisdictions. If the Firm were to invest directly in UK single equities these would represent only a small part of the firm’s business. Hence, while the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The approach of the Firm in relation to engagement with issuers and their management is determined globally. The Firm takes a consistent 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. 

Atlas Square:

The Firm provides investment management services to clients, including a Fund, pursuing an investment strategy that involves investing in global equities. While the Firm may invest directly in UK single equities these would represent only a small part of the Firm’s business. Hence, while the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The approach of the Firm in relation to engagement with issuers and their management is determined globally. The Firm takes a consistent 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.

The next two are particularly interesting....

Gladstone Capital

The Firm provides investment management services to various funds (“the Funds”) that pursue investment strategies that involve investing primarily in equity instruments in various jurisdictions, including UK listed equities. While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The approach of the Firm in relation to engagement with issuers and their management is determined globally. The Firm takes a consistent 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. 

Aisling Capital:

The Firm invests globally, excluding UK equities. The Fund’s investment focus is in commodities, focusing on fundamental based relative value trading with directional overlays. The Code is therefore not relevant to the Firm's trading activities. 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 global jurisdictions. The approach of the Firm in relation to engagement with issuers and their management is determined globally. The Firm takes a consistent 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. 

Those two are interesting because, if you look at the URLs, both are hosted on the website of a legal firm called Duff and Phelps which advises investors on regulation and compliance, amongst other things. I wonder if this might be the source of the text?

Hedge funds and Sky

I thought I'd have another quick look at hedge fund activity around the bidding war for Sky PLC. This looks like it could be quite a profitable trade (especially after several got burnt on Qualcomm / NXP).

As before, some old favourites are in the list. One point of interest is that alongside their derivative positions, some of these funds also have very small holdings in Sky shares. I wonder why this is - maybe to give them some legal rights, or so they can legitimately call themselves "shareholders"? If anyone has any thoughts let me know.

Anyhow, here's why I can see from section 8.3 disclosures -

Elliott Capital Advisors - 4.31% derivatives, 0.0044% shares

Davidson Kempner - 3.07% derivatives, 0.00006% shares

Farallon Capital - 2.3% derivatives, no shares

Canyon Capital - 1.9% derivatives, no shares

UBS O' Connor - 1.3% derivatives, no shares

Pentwater Capital - 0.99% derivatives, 1 (one) share

So that's 13.8% in derivatives in total across these six funds - up from 12.5% accounted for by the same group of funds at the start of the month, though Pentwater has almost cut its position in half.

Just one more thing about hedge funds...

In the middle of the Melrose bid for GKN there was a point when the merger arb activity seemed to be falling back. Specifically, the total shorts in Melrose in the FCA's list started dropping (having been building up steadily up till that point). And one of the more active players Davidson Kempner wound down its positions - both long GKN and short Melrose.

If you look at the historical short positions  in Melrose disclosed by the FCA (and collated very helpfully by the Shorttracker website) you can see the drop in shorting activity kick in at around halfway through March (I've hung the cursor on 15th March in the screenshot).

Why? Well, that was the point when Airbus came out publicly warning that it would find it hard to work with Melrose in the event of a successful takeover (FT story in the links is from 14th March). This was a very significant intervention, and obviously some hedge funds blinked.

Then, about a week later, Elliott Advisors came out very strongly in support of the bid (despite not being a shareholder and therefore not party to it!) and the total shorts started creeping steadily back up.

The lesson here is that interventions like the Airbus statement really do make a difference. In this case it negatively affected the views of presumably pretty sophisticated market participants of the likelihood of the bid succeeding, albeit only temporarily. Something to remember next time we come up against a bid we don't like...

NEX Group takeover & derivatives

Another takeover, another example of hedge funds piling in using derivatives. In this case its NEX Group, which is being taken over by US-listed CME Group. It's not hostile so it went to a vote and got a strong thumbs up.

I find this one interesting as it's another example of hedge funds running the merger arbitrage trade, albeit in uncontested circumstances. This is classic 'picking up pennies in front of a steamroller' behaviour. They are taking a punt on being to skim a bit off expected price movements (upwards in the target, downwards in the bidder). As far as I can see no-one claims there is any kind of market inefficiency that this behaviour is ironing out.

Anyhow, here's who is in the mix using derivatives, based on a quick trawl of rule 8.3 disclosures.

York Capital  (also active in GKN/Melrose) with 4.63%

Magnetar Capital - 1.2%

Carlson Capital - 1.95%

Omni Partners - 1.13%

TIG Partners - 1.27%

UBS O' Connor - 1.02%

PSquared - 1.9%

Sand Grove - 1.61%

Alpine Associates - 1.5%

More hedge fund shenanigans

1. I had a quick Google to see if there are any more funds that use the generic blurb I've found in dozens of cases to avoid compliance with the Stewardship Code. And... yes there are.

Curam Capital Management:

Curam Capital Management LLP (the "Firm") provides investment management services to a Fund that pursues a global equity approach with a focus on the healthcare sector. If the Firm were to invest directly in UK single equities these would represent only a small part of the Firm's business. Hence, while the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The approach of the Firm in relation to engagement with issuers and their management is determined globally. The Firm takes a consistent 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. 

Cryder Capital

The Firm provides investment management services to a Fund (“the Fund”) that pursues an investment strategy that involve investing in a wide range of securities and instruments without limitation in various jurisdictions. If the Firm were to invest directly in UK single equities these would represent only a small part of the firm’s business. Hence, while the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The approach of the Firm in relation to engagement with issuers and their management is determined globally. The Firm takes a consistent 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.

Tencendur Capital

When the Firm does invest directly in UK single equities these would represent only a small part of the Firm’s business. Hence, while the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The approach of the Firm in relation to engagement with issuers and their management is determined globally. The Firm takes a consistent 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. 


2. In addition to Inmarsat, there is also some interesting hedge fund action around the Sky takeover. Again we can see some funds piling in using derivatives to build positions of influence.

So there's Pentwater Capital with 1.92% in derivatives.

UBS O' Connor (their hedge fund business) with 1.17%.

Our old mates Elliott with 3.73%.

Farallon Capital - 1.87%

Canyon Capital - 1.8%

And another old fave Davidson Kempner with 2.16%

That's about 12.5% just on a quick trawl. Worth keeping an eye on.

Another snippet on Inmarsat takeover and hedge funds

Just to keep this updated, there are a lot of regulatory disclosures being fired out by Inmarsat now. So I'm just keeping track of the hedge fund related ones.

Marshall Wace, which is very active on the short side in the UK, now has a 2.38% long position using derivatives.

Melqart Asset Management, one of the firms that was active around GKN/Melrose, has a 1.17% long position, again using derivatives.

UPDATE: Citadel now has a 1.95% long position, again using derivatives, plus 0.16% short.

Plus Pelham has 1.82% long derivative position I blogged on Monday. So around 7% in long derivative positions held by hedge funds in total so far, just in terms of what we can see (I'm not sure what the disclosure threshold is). I expect this will rise. Presumably these positions are offset by a counter party bank holding actual Inmarsat shares, so we might see them start cropping up on the register as major shareholders as was the case with GKN.

Also worth clocking that some more funds have outstanding short positions in Inmarsat. In addition to the names on the FCA list, regulatory disclosures show that Renaissance Technologies and Millennium Investment Management both have short positions of just under 0.5%.

Inmarsat: in come the hedge funds

At the back end of last week the UK-listed telecoms business Inmarsat revealed that it has been approached by US-listed Echostar Corporation about a potential takeover, which it knocked back.

As a result of the offer, a different regulatory disclosure regime kicks in, which means that we can see all sorts of detail on which investors are doing what. And, as you might expect, we can already see some hedge funds piling in with fairly sizeable positions.

For example, Marshall Wace:

And Pelham:

As you can see from the disclosures, the long positions these funds have taken have been built up using derivatives rather than by buying shares. This shouldn't be any surprise to anyone who followed the detail of the GKN/Melrose bid. And obviously this will be a bloc of investors that will want Inmarsat to be taken over.

It also means that we should expect to see banks emerge as major shareholders on the Inmarsat shareholder register as they build up holdings as counterparts to these derivative positions. Plus we will probably see a notable short position in Echostar emerge.

Finally, here is a quick look at who the major shareholders (1%+) at the moment, data from Capital IQ.

UPDATE: for completeness it's worth noting that a few investors are actually short Inmarsat. So worth keeping an eye on this too. Latest from FCA disclosure below.

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 naïve 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.

Unite calls for tougher takeover laws as GKN bid gets government go-ahead

Unite calls for tougher takeover laws as GKN bid gets government go-ahead

24 April 2018

The whims of short-term speculators and hedge funds will ‘drive a coach and horses’ through the UK’s industrial strategy unless the government toughens up the UK’s takeover rules Britain’s largest union Unite warned today (Tuesday 24 April).

The warning comes as the business secretary Greg Clark gave the green light to Melrose’s takeover of the British engineering giant GKN which was heavily dependent on short-term speculators influencing the bid through derivatives.

Unite estimates that over 25 per cent of the GKN shareholder base could have been influenced by hedge funds with many holding an economic interest in GKN through derivatives rather than actual shares.

Unite is set to meet Melrose in the coming fortnight to press bosses on their plans for the company and secure guarantees over jobs and assurances that were given during the takeover on future investment, pensions and research and development.

Commenting Unite assistant general secretary for manufacturing Tony Burke said: “Time will tell whether the assurances given to the business secretary Greg Clark and the ministry of defence by Melrose are worth the paper they are written on. There are still major question marks over the future of the workforce and job security.

“Unite will be meeting with Melrose’s bosses pressing for further detail over its plans and seeking the job guarantees which are absent from the undertakings given to the business secretary Greg Clark.

“GKN was at the forefront of electric vehicle technology and is a major cornerstone to the government’s industrial strategy. Our fears remain that this could jeopardised with parts of the business sold-off piecemeal and jobs shipped off overseas.”

Unite assistant general secretary Steve Turner said: “The government needs to learn the lessons of the GKN takeover, which saw short-term speculators and hedge funds influence the outcome of Melrose’s bid without actually owning any shares.

“The whim of hedge funds looking to make a short-term quick buck through takeover trading is in danger of driving a coach and horses through the UK’s industrial strategy. 

“Ministers need to ask themselves is it right that national defence interests and those of long term investors can be trumped by short-term speculators who do not even own shares in a takeover target?

“Following ministers’ refusal to properly act following the Cadbury takeover, the government must urgently strengthen takeover rules now and stop hedge funds influencing takeover bids through the use of derivatives at the expense of national and long-term interests.”   

ENDS

For further information please contact the Unite press office on 020 3371 2065 or Unite head of media and campaigns Alex Flynn on 020 3371 2066 or 07967 665869.  

Notes to editors: 

• Unite is Britain and Ireland’s largest trade union with over 1.4 million members working across all sectors of the economy. The general secretary is Len McCluskey. 

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.

Here it is at play in the bid - long GKN 1.27% using CFDs on 12th March and short Melrose 2.09% also using CFDs on 14th March.

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.

And here are a few more examples of Sand Grove's position in UK PLC that are/were potential or actual takeover targets - Fenner (long 3.63% using CFDs, 5 April), Fidessa (long 1.39% using CFDs, 18 April), Sportech (long 8.91% using CFDs, 8 January), Sevelec (long 3.17% using CFDs, Nov 2017) and Brammer (long 4.67% using CFDs, Dec 2016).

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.

Stewardship

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:

A 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.