The uproar surrounding Porsche’s massive undisclosed stake in Volkswagen has illustrated the potential market failures which can arise as a result of secret stakebuilding using cash-settled derivatives.
In a press release last weekend, Porsche announced that it held 42.6 per cent of the shares in Volkswagen as well as cash-settled options over a further 31.5 per cent. Because the Federal State of Lower-Saxony holds about 20.2 per cent of voting rights, free float has now decreased to about six per cent.
Porsche was able to build up this stake unobserved by the market for two reasons. Firstly following its mandatory bid last year when its interest reached 30 per cent of VW’s share capital, it had no further disclosure obligation under German law until its stake reached 50 per cent. Secondly, as the cash-settled derivatives by which Porsche built up its stake neither gave access to voting rights in the company, nor a right to the underlying shares, they were not subject to any disclosure obligation even over 50 per cent.
Under English law Porsche would not have been able to build such a stake without alerting the market as the UK Takeover Code imposes a mandatory bid requirement where a holder of a 30 to 50 per cent interest in shares increases such interest. “Interests in shares” for the purpose of the UK Takeover Code include derivatives creating an economic long position in the underlying shares.
However, under current law in the UK, significant stakebuilding activity can still take place below the 30 per cent threshold as the disclosure regime outside of the Takeover Code is currently similar to the German regime, i.e. pure economic interests can be structured so as not to fall within the disclosure regime under the FSA’s Disclosure and Transparency Rules.
This position is set to change from September 2009, when the FSA intends to make such interests disclosable in the same way as other significant interests in shares, under its Disclosure and Transparency Rules.
The issue of disclosure of contracts for difference and similar derivatives has been kept under review by the FSA since its consultation on the implementation of the Transparency Directive showed a lack of general consensus as to the necessity for a disclosure regime. In November 2007 it published a consultation paper specifically in relation to this issue. This consultation paper made two alternative proposals: the first being a strengthening of the existing regime by requiring disclosure subject to safe harbours for pure economic interests, and the second being a general disclosure regime.
The FSA has decided to proceed with a general disclosure regime and on 23 October released a policy statement outlining its proposals for a general dislosure requirement. The policy statement includes draft amendments to the Disclosure and Transparency Rules which are subject to further technical consultation.
The draft amended rules require disclosure of any financial instruments whose terms are referenced to shares and which result in a long position on the economic performance of those shares, whether settled physically or in cash. Holdings of such financial instruments must be aggregated with holdings in the shares to which they relate and the aggregate holding must be disclosed at the existing thresholds. Long positions may not be netted against short positions.
The new disclosure regime will be subject to an exemption for intermediaries acting in a client-serving capacity, similar to the existing exemption under the Takeover Code. The current trading book exemption will also apply.
If the benefit of introducing a disclosure regime for contracts for difference and similar cash-settled derivatives has previously been unclear, the Volkswagen experience has provided a colourful illustration of the possibilities for covert stakebuilding where disclosure is not required.