Following the LVMH stake increase in Hermès, the Lactalis stake increase in Parmalat in Italy and the AMF's decision to inflict a penalty to Wendel for its stake increase in Saint-Gobain, all three transactions using equity swaps, Senator Philippe Marini has filed a bill (proposition de loi) before the Senate aiming to treat cash settled derivatives (i.e. derivatives settling in cash only rather than by delivery of the underlying shares), notably equity swaps and contracts for difference, as owned shares, for the purposes of determining threshold crossings and the applicable threshold of mandatory takeover bids.
The current Article L.233-9 of the French Commercial Code, stemming from yet a recent reform (Order no. 2009-105 of January 30, 2009, adopted pursuant to the 2008 report prepared by the AMF's working group led by Mr. Bernard Field), treats shares that one "is entitled to acquire on its own initiative" as owned shares, which includes equity swaps settling by physical delivery, i.e. settling by delivery of the underlying shares. On the other hand, equity swaps that may only be settled in cash are not assimilated to owned shares but are subject to a separate additional information if and when a "real" threshold crossing is crossed (Article L.233-7 I (c) of the French Commercial Code refers to all financial instruments "purely cash settled and which have for such person an economic effect similar to owning such shares").
1. The content of the bill
The bill of Senator Marini seeks to modify several aspects of the current system.
- Assimilation of cash settled financial instruments. Article L.233-9 of the French Commercial Code (listing instances of assimilation to owned shares or voting rights) would be modified to include "shares already issued to which relates any agreement or financial instrument mentioned in Article L.211-1 of the French Monetary and Financial Code, settled in cash and having (…) an economic effect similar to owning such shares (…)". Cash settled derivatives would therefore now be treated as shares owned for threshold crossings disclosure purposes. Consequently, such instruments would no longer be subject to a separate disclosure, such a separate disclosure being however maintained for securities giving access to capital not yet issued and for shares already issued that one cannot acquire on its own initiative.
- Assimilation when calculating the 30 % threshold crossing relating to mandatory takeover bids. The method for calculating the 30 % threshold crossing applicable to mandatory takeover bids would remain identical to the method for calculating threshold crossings. Cash settled derivatives would therefore be taken into account when calculating the 30 % threshold.
- Lowering to 3 % of the first threshold disclosure. The first statutory threshold crossing disclosure would be set at 3 % of the shares or voting rights (against 5 % today). Existing exemptions would be maintained, notably for shares being held in the trading book of financial institutions up to a maximum of 5 % of the shares or voting rights. This new threshold would come in addition to the current 5 % threshold which would be maintained.
- More precise and updated disclosures. The disclosure of intention which is required when crossing the thresholds of 10, 15, 20 and 25 % of shares or voting rights would now state the intentions of the person required to provide the information with respect to the settlement of the agreements or financial instruments to which he is a party. Any person who has disclosed a threshold crossing would in addition be bound to update such disclosure if the method of ownership of the shares or voting rights was to change.
- Reinforcement of the AMF's sanctioning power. A specific penalty would be created enabling the AMF to punish the violation of any disclosure requirement up to a maximum amount of 100 billion Euros or ten times the amount of any profits potentially earned.
Despite a particularly busy agenda for Parliament, Senator Marini contemplates turning the bill into a law before the end of 2011, for an entering into force on January 1, 2012.
2. Some adjustments are needed
The need to strengthen transparency on the market is undeniable and some flaws in the current rules should be addressed. The bill of Senator Marini is therefore right on point. However, some elements of his proposal should be adjusted to make sure transparency on the market is ensured without pernicious effects.
- Maintain a separate disclosure, but which wouldn't be tied to a "real" threshold crossing. The idea of a separate disclosure for cash settled financial instruments should be favored rather than contemplating an assimilation to owned shares, which would lead to major practical difficulties, particularly if the same method of calculation is used for calculating the 30 % mandatory takeover bid threshold crossing. Such difficulties had been highlighted in a reform proposal of the regime of cash settled instruments disclosures published jointly on January 28, 2011 by three professional associations (AMAFI, ANSA and FBF). An alternate solution to the assimilation proposed by Senator Marini would be to maintain the idea of a separate disclosure for cash settled derivative instruments, but which wouldn't be tied to the disclosure of a "real" threshold crossing: the disclosure should be required when one owns an economic exposure of over 5 % of the shares or voting rights, even if he/she owns less than 5 % of the "real" shares. The AMAFI-ANSA-FBF proposal, indeed favors such a disconnection, adding a few additional specificities. Such disconnection of disclosures would ensure that transparency on the market is preserved and the abuses which have been recently criticized probably wouldn't have occurred under such a system.
- Maintain the first threshold crossing at 5 %. Lowering the first statutory disclosure threshold to 3%, as suggested by the bill and also contemplated in the AMAFI-ANSA-FBF proposal, would give rise to an increasing number of disclosures, which could drown the relevant disclosures amongst a great majority of irrelevant information. Such a reduction of the threshold would also be a burden for stakeholders with a significant interest in listed companies and who already have to deal on a day to day basis with potential threshold crossings, whether upward or downward, in shares or voting rights. If the market is aware of shares held and, by a separate and independent disclosure, of potential cash settled financial instruments, maintaining the first statutory threshold at 5 % seems satisfactory to ensure adequate transparency on the market.
- On the opportunity to create a dedicated penalty. Watchdog of the transparent information of the market, the AMF already has several tools and an important judicial arsenal enabling it to impose sanctions on potential violations of the regulation, notably if a cash settled equity swap is improperly used to facilitate a transfer of corresponding shares. The AMF has notably already penalized violations of the threshold crossings regulation. It might therefore not be necessary to create an additional penalty in this respect.
The bill (in French) "aiming to improve information of financial markets with respect to threshold crossings in securities law" can be obtained, in its entirety, by clicking on the link below: http://www.senat.fr/leg/ppl10-695.html
Head of Capital Markets