Equity derivatives disclosure guidance finalised

• The Guidance Note largely replicates the principles in the draft, requiring swap, CFD and other long equity derivative notional interests to be aggregated with relevant interests in determining whether the five per cent disclosure threshold is met.
• Key changes are that the Guidance Note now only seeks disclosure in the context of, or leading up to, a control transaction and that equity derivative writers (including market makers) are not automatically excluded from ambit of the Guidance Note.
• Market makers are only excluded from the requirements of the Guidance Note if they: 
  • write the derivative at arm’s length 
  • are not an associate of the ‘taker’ of the derivative, and
  • are not providing corporate advisory services (except with Chinese walls) to the ‘taker’. 

Following consultation, the Panel has released Guidance Note 20: Equity Derivatives, together with a Public Consultation Response Statement.  

The Guidance Note is similar to the draft. Two key differences are: 

• the scope of the disclosure requirements in their application to market makers in equity derivatives, and  
• confining the application of the Guidance Note to control transactions and stepstowards them.

Fundamentally, the Guidance Note requires disclosure of cash-settled equity swaps, contracts for difference and other equity derivatives where there is a ‘control transaction’ and the ‘taker’s’ (the derivative acquirer’s) combined derivative and physical holdings (their ‘long position’) exceed five per cent. Failure to adhere to this may result in a declaration of unacceptable circumstances.

Does the Guidance Note require disclosure outside a control transaction context?

In its draft form, the Guidance Note’s application extended beyond takeover scenarios, however it now states that the Panel’s expectation that long positions of five per cent or more are disclosed exists where there is a 'control transaction'. Broadly, these are transactions that affect, or are likely to affect, actual or potential control or the acquisition of a substantial interest. However, the Guidance Note states that the Panel may examine long positions exceeding five per cent even in the absence of a control transaction, and a ‘control transaction’ is broadly defined (extending to, for example, transactions affecting the proposed acquisition of a parcel of securities that forms a ‘step in the direction of a takeover or change in corporate control’).

The Guidance Note applies equally to cash-settled and delivery-settled(‘exchanged for physical’) equity derivatives. Delivery-exchanged equity derivatives will, absent an exception, give rise to a ‘relevant interest’, requiring the holder to disclose them in the same way as a physical holding of the underlying security. On its face and otherwise than for disclosure purposes, section 609(6) provides such an exception. However, the Panel warns against assuming that it would not make a declaration of unacceptable circumstances because that relevant interest exception exists.

What is the key premise of the Guidance Note?

Although the Guidance Note has been redrafted to sound less prescriptive, the fundamental premise of the draft version remains: a person should disclose an equity derivative where the notional interests under the derivative and the person’s relevant interests aggregate to meet the five per cent shareholder substantial holder disclosure threshold, at least when there is a ‘control transaction’ afoot.

Failure to disclose short equity derivative positions may also risk unacceptable circumstances declarations in some circumstances.

Who has to disclose?

Under the Guidance Note, only the takers (that is, holders) of equity derivatives, not their writers, need to disclose.

Market makers receive greater coverage in the Guidance Note and unlike in the draft, are not automatically excluded from its operation. A market maker does not have to disclose an equity derivative position if it:

• writes the equity derivative at arm’s length
• is not associated with the taker, and
• is not providing corporate advisory services to the taker (unless effective Chinese walls are in place between the ‘market making’ area and the corporate advisory area).

This is the case regardless of whether the position is long or short, and extends to any ‘back-to-back’ equity derivatives that the market maker enters into to hedge its position (even if technically as a taker). These marketmaker requirements may practically limit investment banks’ scope to enter into pre-bid equity swaps with their advisory clients without the bank coming under the ambit of the Guidance Note.

How and when is disclosure to take place?

The Guidance Note largely replicates the requirements of the draft: disclosure needs to be made in a note annexed to the holder’s substantial holding notice or, if a substantial holding notice is not required, as a written notice given to the company.

Disclosure is to be made consistently with the timing requirements for substantial holder notices in the Corporations Act 2001 (Cth) and extends to all of the taker’s firm exposure (even if binding documentation in relation to the derivative has not yet been executed). Since firm exposure is often progressively increased concurrently with the writer’s hedging position, the Guidance Note anticipates that disclosure of an equity derivative position may also be progressive.

Like the draft, the Guidance Note provides that disclosure of equity derivatives in a bidder’s statement may be required. This would be the case where a derivative was on foot in the four months before a bid. However, while the Panel extrapolates into this aspect of takeover regulation, the Guidance Note does not indicate whether the Panel considers that pricing under an equity derivative contract may be relevant for the purposes of the minimum bid price rule.

What needs to be disclosed?

The Guidance Note sets out a list of information that the Panel may consider should be disclosed, including the number of securities to which the derivative relates, price (including reference price), entry date, long equity derivative positions (and relevant interests) of the taker and its associates (including the identity of the associates), and any material changes to the information previously disclosed.

The information required by the Guidance Note is largely consistent with that set out in the draft. The main difference is that the Guidance Note expressly provides that the identity of the writer does not ordinarily require disclosure.

Matters not specifically itemised in the Guidance Note will still need to be disclosed if their disclosure would be required to ‘enable the market to fully understand the nature of the taker’s long position.’ While the information likely to be required to be disclosed is extensive, there is no express requirement to release a copy of the equity derivative documentation.

Short equity derivatives only require disclosure to the extent that they offset a physical position or if a long position has been disclosed and the short position amounts to more than one per cent. The Guidance Note indicates that netting-off of long and short derivatives is rarely allowed.

Where to from here?

The Guidance Note indicates that a six month transitional period commenced on 11 April 2008, during which time the Panel will take into account the fact that systems necessary to comply with the principles in the Guidance Note may need to be changed, and that takers of undisclosed equity derivatives already in place may suffer commercial disadvantage if immediate disclosure is required.

However, in light of the Panel’s declarations in the Austral Coal applications, the Panel may find that unacceptable circumstances arise from an undisclosed equity derivative holding during a takeover even within the transitional period.

Name : Fiona Gardiner-Hill
Title : Partner
Office : Sydney
Phone : +61 2 9225 5327
Fax : +61 2 9322 4000
Email : fiona.gardiner-hill@freehills.com