The Takeovers Panel (Panel) recently decided that a holding of cash settled equity swaps which exceeds five per cent (by itself or together with physical holdings) needs to be disclosed.
The decision related to Glencore’s holding of 4.9 per cent of Austral Coal followed by Glencore’s entry into cash settled equity swaps in relation to a further 7.4 per cent of Austral Coal. Disclosure of the swaps was not made until two weeks after the swaps had been entered into. The combined interest had been sufficient to thwart Centennial Coal’s endeavours to reach 90 per cent, which would allow it to compulsorily acquire minority shareholdings.
Centennial Coal applied to the Panel alleging unacceptable circumstances in relation to the failure by Glencore to make timely disclosure once the aggregate of physical shares held and shares under swaps exceeded five per cent. The Panel made a declaration of unacceptable circumstances and various orders.
Glencore sought a review of the initial Panel’s decision. In a decision handed down on Monday, the Review Panel confirmed that unacceptable circumstances existed but at the same time tinkered with the orders of the initial Panel. Nevertheless, it now seems clear, at least in the context of a takeover bid, that the Panel will not allow cash settled equity swaps to be used as a means to acquire economic control over a strategic stake without disclosure.
However, this may not be the end of it all. Glencore has lodged an appeal in relation to the Review Panel decision with the High Court.
- Glencore held 4.9 per cent of Austral Coal’s voting shares.
- On 21 March 2005, Glencore and CSFB negotiated a cash settled equity swap. Immediately thereafter, CSFB commenced acquiring Austral shares to hedge its position. Such acquisitions, when added to Glencore’s 4.9 per cent holding took the combined holding over the five per cent substantial holder disclosure threshold.
- Between 21 and 30 March 2005, CSFB hedged its exposure by acquiring approximately 4.6 per cent of Austral’s issued voting shares on-market.
- On 29 March 2005, Glencore negotiated a cash settled equity swap with ABN AMRO. Between 31 March and 4 April 2005, ABN AMRO acquired 2.5 per cent of Austral to hedge its position. ABN AMRO’s acquisitions of Austral shares took the combined holding to 12.3 per cent.
- Glencore made no disclosures to the market until 4 April 2005, by which time Glencore’s physical holding in Austral was 4.6 per cent and the hedge shares constituted 6.5 per cent of Austral (the percentage of the holdings had reduced as Austral had issued some new shares).
In essence, the Panel decided that Glencore should have made disclosure of the combined holding (and the matters listed below) to the market before 9.30am on the next ASX trading day after the combined holding increased beyond five per cent of Austral’s issued voting shares and following each one per cent increment in the combined holding. Glencore’s failure to do this constituted unacceptable circumstances. The initial Panel decided that the following matters needed to be disclosed:
- the parties to the swaps
- the number of Austral shares to which the swaps related
- the date the swaps were entered into
- whether the Glencore position was long or short
- the reference/initial price, and
- the duration of the swaps and the circumstances in which the swaps must or may be closed out.
In arriving at its decision, the initial Panel made some interesting and important observations, including:
Eggleston principles—the Panel considered that the existence of the swaps, once the combined holding passed five per cent, was material information which the market for control of Austral required to be efficient, competitive and informed. This information was material to decisions by Austral shareholders as to whether to accept the Centennial bid, or to buy, sell or hold shares in Austral. The Review Panel also placed a large emphasis on the materiality of the information to shareholders and investors.
Policy behind substantial holding provisions—the Panel considered that Glencore’s strategy to accumulate a strategic stake above five per cent of Austral without disclosing the existence of the stake went directly against the policy and objectives of the substantial holdings provisions of the Corporations Act.
This appears to be the main driver behind the Panel decision. The Panel reiterated that a breach of the Corporations Act was not a prerequisite for a finding or a declaration of unacceptable circumstances. In this respect, it did not need to decide if Glencore’s actions breached the Corporations Act.
Relevant interest and association—although the Panel did not consider it necessary to determine whether or not the control which Glencore exercised over the hedge shares amounted to a relevant interest or if there was an association between Glencore and the banks, the Panel considered that:
- the economic incentive for the banks to hold the hedge shares to hedge their exposure under the swaps gave Glencore a real degree of effective negative control over the disposal of the hedge shares by the banks, and
- the banks may well have become associates of Glencore prior to disclosure on 5 April 2005. In this regard the Panel noted that the banks knew the swaps and connected transactions were designed to give effect to a strategy to acquire a strategic stake without disclosure.
The initial Panel ordered that:
- Glencore make immediate disclosure to the market of the essential terms of the swaps
- Glencore offer to sell (for a period of one month) to any person who sold Austral shares from 22 March 2005 (ie the next trading day after the combined holding exceeded five per cent) to the opening of trading on 5 April 2005, the same number of ASX shares as were sold by such person at the same price at which such shares were sold in the non-disclosure period, and
- if Glencore did not have enough Austral shares to satisfy requests under its offer, Glencore may require CSFB or ABN AMRO to sell sufficient hedge shares to it at the initial price of the relevant swap in order to fulfil its obligations under the above offer. The extension of this order to cover CSFB and ABN AMRO is another example of the wide range of orders the Panel can make.
The Review Panel effectively did away with the disclosure order. It appears that it considered that suffPicient disclosure had now been made to the market. Also, the Review Panel did not, at this stage, insist on Glencore having resort to the hedge shares should Glencore itself not have enough Austral shares to satisfy acceptances under its offer. Rather it left open the possibility that Glencore could apply to the Panel for further orders should this possibility eventuate.
While the initial Panel and the Review Panel made orders against Glencore, Centennial’s request for orders requiring the swaps to be unwound and the hedge shares disposed of on market or accepted into the Centennial bid was dismissed. Both Panels were of the view that Centennial accepted that it might not achieve the compulsory acquisition threshold when it waived the 90 per cent minimum acceptance condition on 23 March 2005 and that Centennial’s own interests were not sufficiently harmed as a result of the unacceptable circumstances.
It is interesting to note that during the non-disclosure period, the Austral shares traded as low as $1.23. At the close of trading on Monday just passed, the day of the Review Panel decision, Austral Shares closed at $1.35. On this basis, investors who sold Austral shares at $1.23 would be better off accepting the mandatory sale offer which the Panel required Glencore to make and then selling into Centennial’s scrip bid or selling on market. If enough investors do so, this may be enough for Centennial to get over the 90 per cent threshold, which would, in effect, give the same result as if the Panel had made the orders requested by Centennial.
In any case, as mentioned above, this may not be the end of the matter with Glencore appealing to the High Court. No one has taken such a course of action before. Apart from the interest in the swaps issue, such a case will be watched closely.
What does it all mean?
As discussed in earlier editions of this newsletter and as noted by the Panel in its decision, considerable media commentary has focused on the use of cash settled equity swaps in takeovers including in the Cleveland Cliffs bid for Portman and the BHP Billiton bid for WMC Resources and whether disclosure should be made of cash settled equity swaps.
The Panel decisions provide some clarification.
While the Review Panel clearly stated that the decision did not state any general rule, from a practical perspective, in the context of takeovers, persons holding cash settled equity derivatives which along or together with physical holdings exceed five per cent of the target will, in almost all cases, need to disclose that position to the market. This is the case irrespective of whether disclosure is required under the black letter of the substantial holding provisions.
The initial Panel stated that ‘it does not consider that its decision or the orders made by it will inhibit the legitimate use of equity derivatives in the Australian market’.
However, with the prudent course of action in takeover situations being to disclose holdings above five per cent, a potential attraction of cash settled equity swaps derivatives is no more. Indeed, given the initial Panel’s comments on the potential for an ‘association’ to arise between a bidder and a swap counterparty who is ‘in’ on the rationale behind the bidder’s swaps, a bidder with swap and physical holdings of less than five per cent needs to take care to avoid a requirement to disclose its holdings on entry into the swap. To do so, a bidder needs to ensure no association arises with its counterparty or if an association does arise that the relevant interests of the counterparty group when aggregated with the bidder’s interests do not go over the five per cent disclosure threshold. Swap counterparties also need to consider these disclosure implications.
Nevertheless, the use of cash settled equity swaps in takeovers may continue as some of the benefits of using such derivatives remain, including:
- locking in the acquisition price over a parcel of the target company’s shares equivalent to the swap shares, thereby hedging against target share price rises
- providing a means of efficiently financing a pre-bid acquisition, and
- possibly as a means of gaining economic exposure above the 15 per cent threshold in the Foreign Acquisitions and Takeovers Act prior to obtaining FIRB approval (and perhaps the same could be said in respect of thresholds in other legislation).
There are some questions which remain unanswered. For example, to what extent will the Panel’s decisions hold sway when the relevant company is not subject to a takeover? Would the Panel’s decisions have been the same if they did not form the view that Glencore was motivated by a desire to avoid disclosure? Or if the banks were unaware of that motivation, and could not be said to be acting in accordance with the interests of the swap taker? Is disclosure still required if the swap writer does not hedge by buying shares in the relevant company? In such a case there would be no argument that the swap taker had negative (or any other sort of) control over the disposal of target company shares. What if the swap taker does not know if the swap writer has hedged or not? Do they need to enquire or does it just not matter? Also, do the principles extend to tracing notices?
Depending on the answers to these questions there may be some scope to argue that a properly structured cash settled swap, which is entered into for purely economic (rather than control) reasons, need not be disclosed (even in a takeover context).
We understand that the Panel is currently preparing a guidance note on the use of derivatives generally. Hopefully the guidance note will address the above questions which will ensure that market participants understand the bounds of the ambit of the disclosure principles established by the Panel.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.