News and views

Investor Relations Society backs extended disclosure of CFDs

The Investor Relations Society (the Society) has submitted its response to the Financial Services Authority’s (FSA) Consultation Paper on the Disclosure of Contracts for Difference, ahead of the FSA’s deadline of 12 February.

The Society believes that the FSA should extend the current disclosure requirements for shareholdings of 3% and over to cover CFDs.

Peregrine Riviere, Chairman of the Society said:

“The absence of transparency in CfDs and similar instruments is of great concern to UK listed companies. The Society and its members support completely the principles of full transparency. Whilst the Society believes that CfDs have an important role to play in creating liquidity for UK equities, we believe that their built in ‘stealth’ feature inhibits an open and fair market for securities.”

A copy of the Society’s full response to the FSA is included below.

Contacts:

Peregrine Riviere, Chairman 020 8753 8041

Mark Hynes, Policy Committee Chairman 020 7454 5384

Michael Mitchell, General Manager 020 7379 1763

Notes for Editors:

The Investor Relations Society represents members working for public companies to develop effective two way communication with the markets and create a level playing field for all investors. It has 600 members drawn both from the UK and overseas, including the majority of the FTSE 100 and much of the FTSE 250, mostly at the IR and Group Communications Director level.

The Society’s board includes members from the following companies:

The Carphone Warehouse, Galiform, SAB Miller, Stora Enso

ICI, LogicaCMG

The Society has lobbied strongly on behalf of it members for increased disclosure of CFDs and other similar derivative instruments.

The FSA issued a Consultation paper on the Disclosure of Contracts for Difference in November 2007. Responses are required by 12 February 2008. The full text of the Society’s response is included below.

 

Copy of response to the FSA:

Dear Mr Cottee

The Investor Relations Society welcomes the opportunity to comment on the proposals laid out in CP 07-20, on the Disclosure of Contracts for Difference.

The Investor Relations Society represents members working for public companies to develop effective two way communication with the markets and create a level playing field for all investors. It has 600 members drawn both from the UK and overseas, including the majority of the FTSE 100 and much of the FTSE 250.

Introduction.

The absence of transparency in CfDs and similar instruments is of great concern to UK listed companies and their investor relations teams, whose key task is to engage with those interested in the company. Directors of companies look to their in house IR team to provide analysis of who owns – or can influence – the company’s shares.

With the huge expansion of the CfD market representing potentially up to 30-40% of a company’s issued capital, and 50% of the daily transactions on the exchange, this task has become almost impossible.

The IR Society and its members support completely the principles of transparency, the DTR and related regulation. UK quoted companies have been subject to a hugely changed regime in the last few years, with vast tracts of new regulation affecting listed companies being applied. The IR Society members believe, therefore, that the same concepts should apply equally to investors.

The IR Society also believes that CfDs and other similar investment vehicles have an important role to play in creating liquidity for UK equities. Features such as tax advantages, margin purchase and fast settlement make them attractive investments. However, we believe that their built in ‘stealth’ feature inhibits an open and fair market for securities.

Members also note the success of the regime introduced by the Takeover Panel in 2006. Including CfDs as material for the purposes of disclosure has had a very beneficial effect on transparency in a takeover situation. The IR Society believes that these obligations should serve as a benchmark for a general disclosure regime in the DTR.

Market failures

The FSA has identified a number of potential market failures. In practical terms, we would add and restate these as follows:

· Asymmetry of information. A major holding – above 3% - identified under a nominee holding, would normally trigger the use by a UK Plc of a Section 793 notice, which would inform the issuer – and the market – of the identity of the shareholder, allowing all to make informed investment decisions. However, when the shareholding is a hedge against a CfD position, the Section 793 enquiry is ineffective, as it elicits the response that the position is owned by the investment bank’s nominee. This creates confusion in the market. What are their intentions? How will the market react to an unknown presence? Has one of the longer term shareholders decided to exit? Does someone know something about the company that others don’t?

· Influence. Acknowledged or not in the Consultation Paper, the IR Society is clear that cases exist where the writer of the CfD has been “asked” to exercise a vote in a particular way by the owner of the CfD. On occasion, the issuer is able to discover through ‘detective work’ the identity of the CfD holder, and to request a meeting. Members of the IR Society have had personal experience of these requests being refused.

Similarly, requests by alleged CfD holders for management access cause problems when the CfD position cannot be verified.

· Covert stake building and toeholds. The DTR rightly oblige investors in equities to tell the market as they build an incremental position over 3%; however there is no corresponding obligation on CfD holders. Therefore it is possible for a position to be built using CfDs, and for the underlying shares hedged against the CfD to be sold subsequently to the CFD holder.

In practical terms, there is no need for a formal arrangement to be in place in order for an investor to purchase the underlying shares hedged against the CfD. Winding up the CfD means that (by definition) the CfD holder has prior knowledge of the sale, and the availability of a substantial position. The CfD owner can then execute a buy order at the same time as the sell order from the CfD writer, thus achieving the same end.

FSA identified options.

The FSA identifies 3 potential options:

1. Do nothing; ie to make no change to existing disclosure regime. This is rejected by the FSA itself, recognising that market failures do exist.

2. Require disclosure of substantial economic interests unless the holder has taken steps to preclude itself from exercising influence over the underlying shares through a safe harbour regime. The IR Society believes this is impracticable and unworkable for several reasons:

2. 1. The safe harbour would immediately become the standard form for the writing of a CfD, thus requiring management by exception. In real life, the IR Society believes it would add little or nothing to the public information on CfD holdings.
   2. Enforceability. An enforcement action against a CfD writer/holder would have to prove intent to mislead - extremely difficult, if not impossible to prove.
   3. Complexity. The FSA identifies the issue of costs of compliance. In practice, compliance systems are automated, and writing a system to identify the conditions under Option 2 which would trigger a disclosure, would be a challenging – and expensive - task.
   4. There would be nothing to prevent the owner of a CfD seeking management access as under the existing situation, with the same problems.
   5. Covert stake building would still be possible, as the acquisition of the underlying shares would be achievable as explained above.

3. A general disclosure regime along the lines of that under the Takeover Code. The IR Society welcomes the concept of a generalised disclosure regime, however has the following concern:

3. 1. The levels of threshold proposed. i.e. for disclosure where holdings of economic interest cross thresholds set at 5%, 10%, 15% etc.
   2. The proposed aggregation of direct holdings and CfD holdings for disclosure purposes. CfDs would be aggregated in one category, separate from shares. In practical terms, this would allow an undisclosed stake of up to 8% to be built up, through a combination of a directly owned stake of 3% and a CfD stake of 5%. This is a massive stake in the context of the FTSE 350 companies where much of the CfD activity is concentrated.

IR Society preferred alternative.

Given the concerns noted above, the IR Society does not believe that either Option 2 or 3 is practicable, and that neither would solve the issues identified.

The IR Society therefore would like to see a regime similar to the successful Takeover Panel rules, applied generally, ie economic interests in shares such as CfDs and similar instruments should be disclosed as if they were shares; and these interests should be aggregated with shares including voting rights, for the purposes of disclosure. Thus an aggregated position of 3% and above would be disclosable in line with the existing DTR regime.

FSA concerns on cost.

A consistent thread in the FSA Consultation Paper is that of cost potentially imposed on the writer/ holder of the CfD. The IR Society believes these concerns are misplaced because:

a) The vast majority of the CfD transactions on the exchange are not in relation to hedged positions, but rather in connection with basket trading, or even spread betting – where the holding thresholds very seldom, amount to more than 3%.

b) The Takeover Panel notes that the increase in disclosures since the introduction of its regime has been around 19%. Since CfDs are used substantially more in takeover situations than outside, the burden of disclosure would be smaller, especially given the burden of further disclosures falling at the 1% level.

c) Systems put in place to manage the disclosures under the Takeover Panel regime have coped admirably. Extending them to manage generalised DTR disclosures would not create costs anywhere near those estimated by FSA, especially if the threshold and aggregation conditions were the same.

Conclusion.

The IR Society welcomes the work undertaken by the FSA in addressing the real and substantial difficulties faced by UK public companies, and indeed the market as a whole. We agree with the FSA that “doing nothing” is not a realistic option.

For the reasons stated, we think that whilst the identified options 2 and 3 would address some of these difficulties, they fall well short of a workable regime.

Thus the IR Society would like to see a regime where the generalised disclosure regime under DTR5 would be extended to capture Contracts for Difference at the 3% threshold, with aggregation with equity ownership.

Thank you for the opportunity to express our views.

Yours faithfully,

Peregrine Riviere

Chairman, The Investor Relations Society and Group Director of Corporate Affairs, The Carphone Warehouse Group plc