FSA Proposes New Disclosure Regime for Hedge Fund Positions

In an effort to prevent hedge funds and other market participants from using derivative contracts for difference to influence corporate governance and build up undisclosed stakes in companies, the UK Financial Services Authority proposed two alternative disclosure regimes. The first approach would strengthen the current disclosure regime by requiring a disclosure of any contracts for difference written in reference to 3 per cent or more of total voting rights attached to a company's shares. The alternative approach is a general disclosure regime which would achieve the same objectives by requiring holders to reveal all economic interest of stakes of 5 per cent or more in a company's shares.

Both approaches would have the benefit of providing greater transparency for
issuers and for the market at least in terms of who holds economic interest in them
and therefore who their potential shareholders are. The consultation period ends on 12 February 2008.

A contract for difference is a share in a derivative product giving the holder an economic
exposure to the change in price of a specific share over the life of the contract. Hedge funds are the typical holders of contracts of difference, which allow them to take an economic exposure to a movement in the referenced share at a small fraction of the cost of securing a similar exposure by acquiring the shares themselves. Essentially, the hedge fund or other holder of such a contract has an economic interest in the company without direct ownership of shares in the company. Currently, contracts for difference fall outside the FSA’s transparency and disclosure rules.

Disclosure under the 3 percent rule would not be required if it was clear that the holder could not exercise voting rights and had made a clear statement to that effect; and there were no arrangements in relation to the potential sale of the underlying shares by the holder. The FSA expects the majority of the contracts to fall within this safe harbor, removing the need for disclosure.

In addition, this proposal would enable companies to request a notification if they believed a holder had an economic interest of 5% or more of the company's shares regardless of safe harbors. It would also make clear the responsibilities of a hedge fund to ensure that any statements made about voting rights in a company are not misleading. The proposals would also make it harder for hedge funds to build up significant stakes in companies without disclosure.
Any rule changes would only apply to contracts relating to UK shares admitted to trading on a regulated or prescribed market, including shares admitted to the regulated markets of UK Recognized Investment Exchanges and the Alternative Investment Market.

The proposed disclosure would allow companies to verify claims by hedge funds as to their holdings. Currently, companies approached by individuals claiming to have an economic interest in their shares have no way to verify such claims. The proposal would allow companies to make appropriate enquiries into such claims and then disseminate the conclusions to the market. In turn, said the FSA, such a verification process will reduce the number of misleading statements being made in respect of significant holdings

Finally, the FSA intends to coordinate the new disclosure rules with existing takeover rules in order to avoid duplicative disclosure. There are two ways of achieving this dovetailing. The first would be for the new rules to state that they do not apply if the information regarding the same holdings has already been publicly disclosed pursuant to the takeover rules, even if to a different level of detail. The second would be to switch off the new rules when an offer period begins.