Back in 2012, we discussed issues around disclosure of equity derivatives in our paper, “Laying Your Cards on the Table – Equity Derivative Positions in Australia Exposed by Crown and Echo Entertainment”.
Our paper, which also provides some background to the disclosure issues, can be found here.
Our paper was prompted by the media attention given to Crown’s disclosure in June 2011 that it had an economic interest of 4.9% in Echo Entertainment by way of cash-settled equity derivatives, its subsequent disclosure in February 2012 that it held 10% interest in Echo by way of a derivative that was to be settled by the physical delivery of Echo shares, and the position that Crown took that notwithstanding this, it had no obligation to lodge a substantial holder notice in respect of Echo.
The topic of disclosure of equity derivative positions is back on the table following the release by the Takeovers Panel of proposed revisions to its Guidance Note 20 (Equity Derivatives).
Generally, holdings of equity derivatives which give rise only to an economic interest but do not give the holder of the derivative (that is, the “taker”) a right to acquire the underlying shares (i.e. a cash-settled equity derivative) is not required to be disclosed under the substantial holding provisions of the Corporations Act 2001 (Cth) (Corporations Act), unless there are other circumstances giving rise to a relevant interest in the shares. The discussion surrounding the Crown-Echo affair related to the impact on an informed market if holdings of equity derivatives are not disclosed, particularly in the context where they are used to acquire pre-bid or blocking stakes.
Crown’s use of equity derivatives is by no means unique. Some examples of positions held via equity derivatives that have been recently reported in the media include:
- New York-based hedge fund, Coltrane Asset Management’s, position in Spotless Group Holdings Limited, which was the subject of a takeover bid;
- The Children’s Investment Fund’s stake in Aurizon Holdings Ltd; and
- Mr Bruce Gordon’s use of equity swaps to increase his economic position in Nine Entertainment Co. Holdings Limited without falling foul of broadcast assets ownership limits.
Disclosure of 5% position may be required irrespective of whether there is a control transaction
As stated in our 2012 paper, notwithstanding there is no obligation to disclose an equity derivative holding under the Corporations Act, the Takeovers Panel’s Guidance Note 20 states that the Panel considers that equity derivatives may be a substantial interest even though they give rise only to an economic interest, and that where there is a control transaction, the Panel expects all long positions of 5% or more (either alone or when combined with the holder’s physical position) to be disclosed.
At that time, we noted that this applied only if a control transaction had commenced, and whether or not a “control transaction” exists in a particular set of circumstances could be subject to much contention. It was also our view that where substantial derivative positions are taken where a control transaction had not yet commenced (or does not ever commence), the market integrity and efficiency arguments in favour of disclosing substantial economic interests derived from long equity derivative positions appeared to be no less relevant.
Fast forward to 2019 and the Takeovers Panel is now considering addressing this gap. In its recently released consultation draft of a revised Guidance Note 20 (Draft GN20), the Panel is considering changing its guidance to provide that irrespective of whether there is a control transaction, its expectation is that all long positions over 5% (whether cash-settled or exchanged for physical) should be disclosed.
Long position of over 20% may be unacceptable
Draft GN20 also reiterates the Panel’s view that the provider of the equity derivative (that is, the “writer”) usually has an economic incentive to hedge its position, regardless of whether the derivative is cash-settled or exchanged for physical. By creating the economic incentive to hedge and then by controlling the unwinding, the taker of a long equity derivative position may affect the supply of the underlying shares, which may in turn affect control or potential control of the entity, or the efficient, competitive and informed market for control of the entity’s shares.
An important change proposed by Draft GN20 is that the Panel may consider that the acquisition of a long equity derivative position of more than 20% may give rise to unacceptable circumstances, even if the acquirer does not have a physical position or interest in the underlying shares and the acquisition does not result in acquirer breaching the 20% rule in the Corporations Act. In general terms, the “20% rule” provides that a person must not acquire a relevant interest in issued voting shares in a listed company if that would result in that person (or someone else’s) voting power in the company increasing from 20% or below to more than 20%.1 The Panel is specifically seeking comments on this proposed change.
Identity of writer may need to be disclosed
Another area which the Panel is seeking specific comments on is whether there should be more guidance provided in relation to the information that is required to be disclosed. Draft GN20 contains a list setting out information that the Panel considers should be disclosed, including:
- the identity of the taker;
- relevant security;
- price (including reference price, strike price, option price etc);
- entry date;
- number of securities to which the derivative relates;
- type of derivative;
- any material changes to information previously disclosed to the market;
- long equity derivative positions held by the taker and its associates, its relevant interests and its associates’ relevant interests (and the identity of all associates referred to);
- short equity derivative positions that offset physical positions; and
- short positions of more than 1% that have been acquired after a long position is disclosed.
This list is substantially the same as currently contained in Guidance Note 20. However, the Panel is specifically seeking submissions on whether the identity of the writer should also be required to be disclosed.
Consistent with the current Guidance Note 20, Draft GN20 states that in considering whether timely and adequate disclosure of an equity derivative position has been made, the Panel will have regard to the timing requirements for substantial holder notices – that is, within 2 business days of becoming aware (or, in a bid period, by 9.30am on the next trading day).
Panel may make orders to reverse benefit or effect
Guidance Note 20 currently states that if the Panel finds unacceptable circumstances, it may make orders such as the disclosure of the derivatives, disposal of any securities, and cancellation of agreements. Draft GN20 expands on the examples of the orders that the Panel may make to specifically include the following:
- if a person has benefitted from or gained an advantage from non-disclosure or inadequate disclosure, the Panel may seek to make orders to reverse that benefit or advantage;
- if the non-disclosure or inadequate disclosure has an effect on control, potential control or the acquisition or proposed acquisition of a substantial interest, the Panel may seek to make orders to reserve that effect.
Draft GN20 can be found here. Submissions on it are due at the end of this month (Friday, 31 May 2019). We are supportive of the proposed changes and the resulting simplified, clearer guidance.
If you hold, or are thinking about entering into, a long equity derivative position, keep in mind that you may soon need to disclose this holding to the market.
1. Section 606 of the Corporations Act.
Liability limited by a scheme approved under Professional Standards Legislation.
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