Recently, the German Ministry of Finance presented a draft bill of a “Law to Strengthen Investor Protection and to Improve the Functioning of the Capital Market”.
It provides for tighter regulation of the capital markets, particularly in the following areas:
- Extension of certain rules to the “grey capital market” which was previously unregulated
- Stricter regulation of open-ended real estate funds regarding valuation and the duty to buy back
- Compliance rules for financial services companies
- Prohibition of “naked” short sales — this part has been brought forward and will be enacted as a separate law
- Extension of the rules governing disclosure of substantial shareholdings to include certain financial instruments
This article covers the extension of the disclosure rules.
In summer 2008, the Schaeffler Group announced a takeover offer for Continental AG, the German automotive company. Schaeffler had at the time of the announcement entered into cash settled swaps covering nearly 30 per cent of the Continental’s shares. As far as is known, these swaps were total return equity swaps which conferred upon Schaeffler the financial position of an owner of the shares without holding any shares or voting rights. Thus, Schaeffler had the economic benefit of securing the shares before the price went up when the offer was announced.
Schaeffler had concluded that it did not need to disclose these swaps under the rules governing disclosure of substantial shareholdings even though it was probable that the underlying shares would be sold to Schaeffler when the swaps were terminated. After an investigation, the German securities regulator (BaFin) concluded that Schaeffler had not violated the disclosure rules. This caused an intense debate among capital market lawyers and many proposed that the law should be changed. In particular, German corporates urged the German government to introduce new rules governing the disclosure of financial instruments which are equivalent to shareholdings. In parallel, other European countries such as Switzerland1 and the United Kingdom2 introduced new rules to deal with such instruments.
The German Ministry of Finance presented a draft bill (Diskussionsentwurf) earlier this year which the government passed in September 2010 and plans to have it presented to the German Parliament soon with an expected effective date in early 2011.
The Proposed Rules
Presently, under German Law every shareholder of a listed company has to notify the company and the regulator BaFin if its holdings of voting shares cross one of the thresholds of 3, 5, 10, 15, 20, 25, 30, 50 and 75 per cent. The same applies — with exception of the 3 per cent threshold — for holders of financial instruments giving a right to acquire such voting shares. This covers in particular forward contracts and call-options. The draft law extends these disclosure duties to any instruments which “enable” the acquisition of voting shares. The draft law names examples of “enabling” instruments as those where:
- The counter-party can hedge its risk under the instrument by holding voting shares.
- There is a right or an obligation to acquire voting shares. Under this alternative, it is assumed that options are exercised.
Thus, the new law will require the disclosure of for example:
- Contracts for difference
- Cash settled equity swaps
- Call options, even if cash settled
- Put-options for the party writing the option
There was preciously some doubt whether stock lending and repo transactions were covered by the existing disclosure regime; BaFin assumes that they are not subject to disclosure presently. The new law subject them to disclosure.
It is BaFin’s opinion that, under the current law, stock purchase agreements do not need to be disclosed if they are subject to conditions outside of the control of the contractual parties, in particular subject to merger control. The wording of the draft law suggests that such contracts will be covered by the new rules and will need to be disclosed even before such conditions have been satisfied. This may result in many disclosures which are confusing rather than enlightening.
Financial institutions in the EU are exempted from the new disclosure regime with regard to instruments they issued on a regular basis. Even though the law does not state this explicitly, the exemption should cover not only options etc. issued to investors, but also the transactions by which the risk is hedged.
What Will the Law Achieve?
Certainly, the law will make it much more difficult to secure substantial stakes in German companies without disclosure. On the other hand, new ways will most probably be developed allowing to stake building without triggering a disclosure obligation.
Disclosures of shareholdings in Germany are complicated and often confusing, and therefore do not make shareholder structures transparent. The new law will add complexity, and may thus increase the confusion.