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March 07, 2005 at 07:00 PM
LONDON (HedgeWorld.com)–The International Swaps and Derivatives Association Inc. filed a response to a consultation paper issued in January by the United Kingdom’s Panel on Takeovers and Mergers, and ISDA contended that the takeover panel is working from a faulty presumption about the controversial equity derivatives known as contracts for difference.
The panel is concerned that the holder of a long CFD (typically either a hedge fund or the proprietary desk of a financial institution) is able to exercise a significant amount of control over the shares held by the counterparty–usually an investment bank or securities house–to hedge its position and that in exercising this control it acts in ways opaque to the statutory/regulatory structure that governs takeovers.
ISDA’s response, filed by email Feb. 28, sought to alleviate this concern. It said that there is a “well-established and reported market of activity in relation purely to price, which is particularly marked in relation to the stocks of companies involved in takeover bids.”
Such pure price plays, which don’t involve “what one would characterise as ‘real’ interest in the shares” are, according to ISDA’s response, a normal and harmless consequence of a market economy, and any reform ought to be carefully tailored so as to avoid penalizing merger arbitrage or other price plays.
Furthermore, the paper said that in ISDA’s experience the counterparties–those with title to the hedge shares–generally document with their customers the fact that those customers should not expect to claim any interest in those shares. In its 2002 ISDA Equity Derivatives Definitions, ISDA provided template language to just this effect, and those definitions are “the widely accepted basis for documenting a wide range of transactions.”
The panel’s consultation paper had expressed concern that, even in the face of such contractual waivers, the holders of CFDs might exercise de facto influence over how a counter-party votes such stock, because the counter-party would wish to cultivate the CFD holders as continuing customers.
