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CFDs - The net closes: Final rule changes to Takeover Code

Simmons & Simmons outlines the changes to the disclosure regime in Rule 8.3 of the Takeover Code affecting third party investors and investment managers.

Rule 8 of the City Code on Takeovers and Mergers requires disclosure to be made of dealings in securities of an offeree company during an offer period and, in the case of a securities exchange offer, of an offeror.

Specifically Rule 8.3 requires a person who owns or controls 1% or more of any class of relevant securities of the company in which disclosure is required to disclose publicly all dealings in such relevant securities of that company and related derivative positions.

The Code applies to all listed and unlisted closed-end public companies resident in the United Kingdom and to certain private companies. It is therefore relevant to all companies traded on the London Stock Exchange or AIM which are UK resident.

This note focuses on the changes to the disclosure regime in Rule 8.3 affecting third party investors and investment managers and does not seek to address other changes made to the Code which more generally may affect parties engaged in the bid process.

Two steps to closure
The Panel has been consulting on proposals to amend the disclosure requirements in the Code. (See our notes dated February and June 2005). Copies of the Panel consultation papers are available from the Panel website For the initial January 2005 consultation paper PCP 2005/1 see

Phase 1: in April 2005, although the basic trigger for Rule 8 disclosures remained unchanged, the disclosure requirements were tightened to include disclosure of derivatives referenced to the security in which there has been a dealing and disclosure of related dealings where the person dealing owns or controls 1% or more of the class of securities to which the derivative is referred. (See )

Phase 2: in its May 2005 consultation paper (PCP 2005/2 ) the Panel proposed to extend the disclosure regime so that the obligation to disclose dealings or derivative transactions under Rule 8.3 should be broadened so as to be triggered where a person has a "long position" of 1% or more in any class of relevant securities, to include, for these purposes, not only physical long positions, but also long derivative interests.

Following consultation the Panel published its Response Statement (RS 2005/2 )on 5 August together with final rules. These for the most part follow the proposals of the May
consultation paper.

The principle: The Panel agreed with certain respondents that hedge funds with CFD interests frequently seek to take an active interest in corporate matters and, in effect, control the securities held by their counterparties. The Panel continues to believe that the Code should require that all material dealings in derivatives referenced to and options in respect of relevant securities of an offeree company, and where appropriate, the offeror, should be disclosed.

The rule: during an offer period, if a person is interested in 1% or more of any class of relevant securities of an offeror or offeree company, dealings in relevant securities must be publicly disclosed.

Relevant securities: the interest has to be in relevant securities, as defined in the Code. This includes the securities the subject of the offer or those having the same rights as the securities being offered, other voting securities of the offeree, securities convertible into such offeree securities, and derivatives (including spread bets) and options referenced to such securities.

An interest: covers any long economic exposure to changes in the prices of securities. An interest covers ownership or control, a right or obligation to take delivery and being party to any derivative whose value is referenced to their price and which results in the investor having a long position in the securities.

Calculating 1%: the number of securities in which a person is interested is the gross number, aggregating long positions across all interest types; ie not only physical long positions.

Netting: in calculating the gross position the Panel will permit offsetting positions to be netted but only where they relate to the same class of security; are in respect of the same investment product; the terms (e.g. as to strike price and exercise period) are the same and the counterparty is the same.

Short positions: investors with short positions, however significant, but without any long position, will not have to disclose dealings. The Panel has however stated it will keep this under review.

Borrowed securities: a person will be treated as interested in securities he has lent, but a person will not normally be treated as interested in securities borrowed, even where they have been on-lent.

Aggregation: investment managers will have to aggregate the interest of all customers managed on discretionary basis; the interests are treated as those of the manager and there is no requirement on the manager to disclose the identity of the customer for whom he is the discretionary manager.

Dealings: this will cover any dealing in physical securities and in relation to derivatives will include the acquisition of, disposal of, entering into, closing out, or exercise of rights under, or variation of, the terms of the derivative. Only variation of terms falling within the scope of disclosure will have to be disclosed.

Time for evaluation of interest: an investor should evaluate his interests, and whether they are discloseable, at midnight London time at the end of each day. No bed and breakfasting is permitted without disclosure.

Scope of disclosure: details of all open derivative positions are required to be disclosed, including the number of securities, close out date, reference price and description of the derivative instrument. Where the terms of open CFDs are the same in all material respects, individual open positions are not required to be disclosed.

Public disclosure: to the Panel and the public via a regulatory information service, using the forms provided on the Panel website.

Time for disclosure: for Rule 8.3 only (dealings by persons with interests in securities representing 1% or more) by 3:30pm London time on the day following the relevant dealing (a relaxation from the current 12 noon) although extensions can be sought.

No dealing, no disclosure: as now, the trigger for disclosure is a dealing. If a company goes into an offer period, no disclosure requirement will arise unless and until there is a dealing.

Other issues
The Panel received a number of responses to the two consultation papers including from ISDA and AIMA. Particular issues that were raised and considered by the Panel included the following:
Prop desks of investment banks: the Panel is continuing its review of principal trading activities of relevant investment banks and securities houses with a view to clarifying which desks should be exempt from disclosure.

Multiple disclosures: the Panel accepts that disclosures may represent securities adding up to more than 100% of the class of relevant securities issued by the company in question. However, it believes that differentiation by reference to types of securities and derivatives, or to seek to require disclosure dependent on whether a holder of a long derivative position was seeking to exercise control would be unnecessarily complicated and difficult to police.

Time for implementation - 7 November 2005
To allow market participants time to implement the necessary systems and controls to be able to monitor and comply with the enhanced disclosure regime, the Panel has extended the period for implementation to 7 November 2005. A review of the operation of the new regime will be undertaken in June 2007 and the results published.

The UK out of line?
Although disclosure of derivative positions is not an approach currently adopted in most European jurisdictions, nor in the US, it is a model that has been adopted in Hong Kong and, recently, in Australia where the Australian Takeovers Panel has decided cash settled equity swaps are relevant for calculating the threshold for disclosure.

Next steps?
The inclusion of derivatives for the purposes of disclosures of dealings has not been carried through to the calculation of the threshold for mandatory offers which is 30%. Nor are they relevant for the Substantial Acquisition Rules, which restrict the speed of stake building at levels of 15% and above and require disclosure of dealings at and above those thresholds. These "Control Issues" remain under review though it is likely that corresponding changes will be made.

This article was contributed by Sarah Bowles, Edward Baker and Mark Curtis from the London office of Simmons & Simmons.


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