CP 107 Securities lending and substantial shareholding disclosure

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1 19 August 2009 Ms Roslyn Nippita Lawyer Investment Banks Australian Securities and Investments Commission GPO Box 9827 Sydney NSW 2001 Dear Ms Nippita CP 107 Securities lending and substantial shareholding disclosure The Australian Financial Markets Association (AFMA) welcomes the opportunity to provide comments to the Commission on its Consultation Paper 107 on Securities lending and substantial shareholding disclosure. The Commission is seeking feedback on whether it should modify the substantial shareholding disclosure requirements for securities lending and prime broking to ensure that the market has useful information. The consultation paper comments on the importance of informing the market about the acquisition of control and details of any agreements or special conditions that may affect voting rights or the disposal of securities as the determining factors behind concerns about the level of transparency associated with securities lending and prime broking activities. Our comments are provided in this context. This response is divided into two parts. The rest of this letter makes some general observations on the regulatory policy approach taken by the Commission in the consultation paper. The second part of our response is set out in the attachment which makes comment in relation to the specific feedback questions posed in the consultation paper. Legal Interpretation AFMA notes the recognition given in the consultation paper that there are different legal interpretations of how the relevant interest provisions in section 608 and 609 apply to securities lending and prime broking and that participants need to obtain legal advice about how these provisions apply in relation to the reporting of substantial holdings. AFMA considers that the Commission should take into account in administering the law in relation to substantial shareholding notices that it is directed to assisting the market identify corporate control. Australian Financial Markets Association ABN Level 3, Plaza Building, 95 Pitt Street GPO Box 3655 Sydney NSW 2001 Tel: Fax: info@afma.com.au Web:

2 CP 107 Securities lending and substantial shareholding disclosure Commercial activity clearly indicates that where a relevant interest arises because of the holding of stock by prime broker or securities intermediary it relates to the efficient operation of their business as an intermediary and not for the purpose of corporate control. This puts their activity outside the regulatory objectives of Chapter 6 of the Corporations Act Accordingly, we do not consider there is a risk of the market being misled as to the ownership and control of listed entities, particularly where a significant proportion of the entity s securities are subject to securities lending. The substantial shareholder provisions in the law were written at a time when financial services were carried out in a more straightforward fashion. AFMA has previously articulated to the Commission its view that the law needs to be interpreted and administered in a pragmatic way as a matter of good public policy. Information Quality AFMA members are seriously concerned about disclosure requirements leading to duplicated reporting and delivery of excessive documentation that would obscure relevant information. Duplicated reporting could work against market integrity because the level of suggested reporting of substantial shareholdings would create a lot of noisy data. This could result in misunderstandings of equity holding positions, particularly multiplication of holdings, resulting in misconstrued analysis by market participants and the financial press that could adversely affect market efficiency and ultimately investor confidence. It is not uncommon for the financial press to make assumptions about prime broker positions which have been notified to the market that do not reflect the diverse and unrelated underlying owners who actually own and control the shares, thereby creating a potential source of misleading rumours. The broad consensus view coming from our members is that traders are interested in knowing know how the relevant interest arises under a prime broking agreement or stock borrowing/ lending arrangement, so they can factor this information into their analysis of the market. It is not important to know who the underlying clients for in relation to a position reported in a substantial shareholding notice by a prime broker. Consequently, they do not believe a prime broker should have to identify each underlying client. Investment bankers consider information on how a relevant interest arises and when a movement occurs in the relevant securities to be of interest. This means knowledge of prime broker positions is of value when the stock subject to the prime broking agreement is utilised and not when the theoretical and remote relevant interest arises. In other words, they have an interest in knowing when stock is on the move. Disclosure of the underlying agreements is not considered to be relevant, in particular when there is a standard document governing the movement of stock. Page 2 of 11

3 CP 107 Securities lending and substantial shareholding disclosure Regulatory Burden AFMA members are very concerned about the regulatory burden that arises from the Commission s interpretation of the law. Because the position of a securities intermediary is more complicated and very different to that of the investing public, the cost and effort involved in compliance with substantial shareholding notice requirements is increased. In considering the disclosure requirements affecting stock borrowing/lending arrangements and prime broking agreements it is important to have regard to the mechanics of this business. Securities intermediaries generally view the stock as a commodity needed for use in their business. Thus, stock that is available under a prime broking agreement is really a commodity that the broker wants access to in order to facilitate the day-to-day running of its financial intermediation business. Commercial confidentiality There are also concerns with commercial confidentiality. Disclosure of fee information is not relevant to the issue of corporate control and is highly sensitive commercial information. Disclosure of that information could be able to be used by competitors in the stock borrowing/lending business for unfair commercial advantage. Thank you for considering our comments. Please do not hesitate to contact me at dlove@afma.com.au or (02) if further clarification or elaboration is desired. Yours sincerely David Love Director, Policy Page 3 of 11

4 Comments in response to specific feedback questions C4 C4Q1 We do not propose to give relief from s671b(4) for any other documents that may be connected with a securities lending transaction. Therefore, any other contract or agreement connected with the securities lending transaction would need to be annexed to the substantial holding notice. Is our proposal to give relief from the requirement to lodge the AMSLA or GMSLA with substantial holding notices likely to make compliance with s671b easier? AFMA Yes A requirement to locate and annex a copy of each prime broker or stock borrowing/lending agreement would be a very significant administrative burden. Major investment banks and stock lenders may have around 3 or 4 substantial notices to be reviewed each day. In practice this could mean that substantial holding notice might have in the order of 10 prime broker client positions and 15 stock borrowing/lending counterparties. Prime broker agreements and AMSLAs are around 50 pages long, so the agreements alone could total 1,250 pages. In addition, increasing the number of pages contained in the notice confuses readers and confounds disclosure rather than enhancing it. A practical difficulty is that the maximum allowable size for a PDF file uploaded via ASXOnline is 20MB. This requires a substantial shareholding disclosure to be split into several smaller files and uploaded individually to ensure ASXOnline will accept the document. C4Q2 Should the notice be required to: (a) summarise the key terms of the agreement, or (b) be accompanied by a copy of the completed schedules? AFMA As the market relies on the use of standard master agreements which are accessible to the public it is unclear what additional information would be provided to investors and listed entities by summarising the key terms of the agreement that is not already available to them. Variations or amendments to the agreements are done in Schedule 3 of the AMSLA. It would not be appropriate to require the release of commercially sensitive information between the contracting parties. Our view on the nature of commercially sensitive information is dealt with in response to C5Q1. The reporting burden would be eased if a simple standard format was established for key information that allows confirmation of the agreement type and whether it enables recall / return of the securities. C4Q3 Is our proposal likely to result in the market being deprived of important information? Page 4 of 11

5 AFMA No As noted in response to C4Q2 no additional information would be provided to investors and listed entities that is not already available to them. C4Q4 Should relief from the requirement to attach copies of standard master agreements be conditional on the substantial holder providing the listed entity and the market with a copy if requested by an investor or the entity? AFMA No The ASLA and GMSLA standard master agreements are available to the public on line. Accordingly, such a requirement would not provide any additional information to investors or listed entities. As we have noted above it is would not appropriate to require the release of commercially sensitive information between the contracting parties contained in the schedules. C4Q5 Should we give relief for any other types of contracts or arrangements that contribute to a person acquiring a substantial holding through securities lending transactions? For example, should we give relief so that prime broking arrangements, borrowing requests or notifications of unconditional 'holds' (binding legal commitments to lend securities) do not have to be attached? AFMA Yes Prime brokers should not be treated as having a relevant interest under a prime broking agreement unless they utilise the right to borrow stock from their client under the agreement. An untapped right to borrow does not reflect a movement of stock and is of no relevance to the market. Accordingly the documenting of such arrangements is not relevant market information. C5 We propose issuing guidance indicating that notices for substantial holdings acquired through securities lending set out any benefits given by the holder in relation to the securities. This would include: (a) any borrowing fees payable by the borrower to the lender; (b) any reduction in fees that would otherwise be payable by the lender to the borrower; (c) any reduction in interest payable by the lender to the borrower on cash collateral. If any of these amounts cannot be accurately estimated, then the notice should clearly explain how they will be calculated. Consideration that is remote from the particular securities lending transaction does not have to be disclosed (e.g. any reduction in custody fees by a prime broker negotiated for all securities for a period, such as 12 months). Page 5 of 11

6 C5Q1 Will our proposed guidance be impractical or otherwise cause undue difficulties for the securities lending industry? AFMA There is interest in transactions and movement of shares that may effect change of control of a company. This proposal would require the inappropriate release of commercially sensitive information which is not relevant to market transparency around substantial shareholdings. Consideration for a stock borrowing is properly characterised as the margin charged for the borrowing. That information is not relevant to the issue of corporate control. This is commercial in confidence information. Disclosure of such information could be used by competitors in the stock borrowing/lending business to obtain unfair commercial advantages. Under a stock lending arrangement, the stock borrower provides the lender with collateral for the term of the loan and pays the lender a fee for the use of the borrowed securities. The borrower compensates the lender for rights and distributions accruing on the borrowed securities during the term of the loan. Depending on the type of collateral lodged, a lender can earn fees on stock loans in two ways. Where a lender receives cash collateral, the lender is expected to invest this cash and to earn at least the overnight cash interest rate. From the interest received, the lender deducts their fee and rebates the balance to the borrower at the end of each month. Alternatively, where non-cash collateral is lodged, a fee rate is used to calculate fees payable. The lender s fee is negotiated with the borrower and depends on loan size, duration and availability, amongst other things. Any requirement to disclose fees would, in our opinion, add no value to an investor and could be detrimental to the borrower or lender. Each market participant will have available different pools of securities that they can tap into and this in part will form the basis of the fees charged. C5Q2 Is information about fees useful market information (e.g. as an indicator to supply and demand for borrowing and lending the securities), having regard to the purpose of the substantial holding disclosure regime? AFMA As described in answer to question C5Q1 fees are determined by a range of factors and are not positively correlated to the supply and demand of securities and do not reflect liquidity for stocks. Accordingly, no useful or relevant information would be provided to the market. Information on liquidity will be available through the disclosure on securities lending that the Reserve Bank is introducing. Page 6 of 11

7 C5Q3 What information about consideration for securities lending transactions is useful for the market, having regard to the purpose of the substantial holding disclosure regime? AFMA As noted in answer to question C5Q2 information about consideration does not provide information on market liquidity and is not relevant to the decision making of an investor or relevant to control of a company. The most important information for an investor is the price at which a borrower of securities sells those securities, this information is reported as part of the sale transaction. C6 C6Q1 AFMA We propose issuing guidance that notices for substantial holdings acquired through securities lending or prime broking give full disclosure of the registered holder of the shares in which a relevant interest is disclosed. This would, in the case of a prime broker, require disclosure of the registered holder of its client s shares (which may be just the custodian or client or both). Will our proposed guidance be impractical or otherwise cause undue difficulties for the securities lending and prime broking sectors? Yes The guidance is impractical because it could result in the disclosure by prime brokers of individual client positions that do not amount to substantial shareholdings. Disclosure which goes beyond identifying a substantial shareholding does not come within the scope of the legislative authority conferred on ASIC under section 609 of the Corporations Act. A requirement to identify the individual client positions that, in aggregate, constitute a prime broker s position, may not be substantial shareholders. Such clients under no legal obligation to have their independent positions reported. Aggregating client positions and disclosing their interest under a prime broker arrangement in effect places unfairly an additional disclosure obligation which is ultra vires and different to other investors. Such clients would be placed at an unfair commercial disadvantage which undermines investor protection objectives of the law. C6Q2 AFMA Is information about the registered holder of the shares (in respect of which the relevant interest is disclosed) useful market information? No Page 7 of 11

8 Lenders of securities are usually custodian lenders. The market is already aware generally of this fact and the identity of the custodians who provide securities lending services. As a result, this requirement will only inform the market of generic information that it already has. In addition, in a securities lending arrangement, we do not think that disclosing the name of the lender is useful market information, especially considering it is the Commission s view that that lender will retain a relevant interest itself. C6Q3 What information on the registered holder of the relevant shares for prime broking or securities lending transactions is useful for the market? The market is interested in where a relevant interest arises that give the holder substantial control over the company and the nature of the relevant interest. There is very limited utility in knowing the identity of underlying clients who do not have a substantial holding. C7 C7Q1 We would like your feedback on how the requirements could be made more workable while retaining market transparency. What information on substantial holdings acquired through securities lending transactions is important for the market? AFMA The market is interested about where a relevant interest arises that gives the holder substantial control over the company and the nature of the relevant interest. The fact that control if the securities is moving, the nature of that movement and the size of that movement is of importance to an investor, the fee paid to borrow such securities is not. In our view the most important information relevant to an investor is the price at which a borrower of securities sells them. This information is available to the market when the sale takes place. Movement information comes through in the case of a substantial holder, notice of movements of greater than 1% or when a substantial shareholding comes to an end. C7Q2 What information on substantial holdings acquired through prime broking arrangements is important for the market? AFMA The policy rationale around disclosure should be around where an entity can exercise some control over the listed company. Important information to the market is about how the relevant interest arises. Page 8 of 11

9 C7Q3 Are there any aspects of our guidance on relevant interests in Section B that are inconsistent with how securities lending transactions occur? If so, should we give any relief? AFMA Securities intermediaries generally view the stock as a commodity needed for use in their business. Thus, stock that is available under a prime broker agreement is really a commodity that the broker wants access to in order to facilitate the day-to-day running of its financial intermediation business. In some instances, it is merely just a cheaper alternative to borrowing cash. During the course of an intermediary's business day, it is not always clear where stock is going, whether its been bought and sold, who it has gone to, whether it has gone to the market, which stock has been borrowed and which stock is house stock. The matters are dealt with through back office risk control processes. This can mean that prime brokers will not always differentiate borrowed stock from any other stock; it is just a commodity that trades, as far as they are concerned. The accumulation of a substantial position can be quite transitory during a day s trading Because the position of a securities intermediary is more complicated and very different to that of the investing public, the cost and effort involved in compliance with substantial shareholding notice requirements is increased. They incur significant compliance costs in monitoring and reporting pursuant to the substantial shareholding notice obligations because they have to monitor and report on all stocks, irrespective of whether they have a substantial interest or not. Hence, the outward manifestation of the disclosure regime as it applies to an intermediary amounts to only a very small proportion of the costs and effort involved in bringing about compliance as an intermediary. The stock holding or relevant interest of a prime broker or securities intermediary is not connected to corporate control objectives but rather relate to the efficient operation of their business as an intermediary. As a result, we believe relief is justified in the circumstances, especially since it should not detract from the underlying objectives of Chapter 6. C7Q4 Are there any aspects of the substantial holding disclosure requirements that are inappropriate for securities lending transactions and if so, how should they be changed? AFMA If a stock borrower on-lends borrowed stock, it should only be required to report the number of shares not on-lent after a specified period that could be related to the settlement cycle. The view that a relevant interest continues to exist once it has been on-lent can give rise to misleading duplication of positions. For example if party 1 lends a position to party 2 who on lends to party 3 and so on all three (or more) would be required to report a substantial holding. Page 9 of 11

10 Multiple reporting of the same underlying stock position needs to be avoided. Relevant movements in stock would be identified but the noise that would come from lodging of irrelevant information in substantial shareholding notice reports should be avoided. C7Q5 Are there any aspects of the substantial holding disclosure requirements that are inappropriate for prime broking arrangements and if so, how should they be changed? For instance, what consequences would you see if ASIC provided relief so that the prime broker s relevant interest arising from its right to borrow or rehypothecate its client's securities could be disregarded (for substantial holding disclosure) until the time when the prime broker exercises that right? AFMA Knowledge of the identity of the underlying prime broker clients for a position reported in a substantial shareholding notice is not of use to the market, unless the prime broker client is a substantial holder in its own right, in which case the prime broker client will have an independent obligation to report their position. The proposal would create particular problems for large prime brokers and give small ones an unfair competitive advantage. A small prime broker provider with, for example a single client with a 1% holding would not be required to disclose the identity of the client to the market. But if that client had a 1% holding with a large prime broker whose aggregate group holdings were over 5% the large prime broker would be required to disclose the identities of all its clients to the public. This would unfairly disadvantage larger houses as hedge funds begin to realise their holdings are less likely to be disclosed with a smaller prime broker. It is not relevant for the purposes of substantial shareholdings whether a client is dealing through a large or small prime broker. C7Q6 Do you have suggestions for specific relief that ASIC should consider that would improve compliance with the provisions while still: (a) achieving market transparency of substantial holdings; and (b) mitigating the risk of avoidance or the risk of warehousing? AFMA In the context of the Commission s interpretation of the relevant interest provisions in the consultation paper, it is desirable to clarify the operation of section 609(7) as carving out the inclusion of prime brokers and securities lending positions from the calculation for the purposes of the takeovers prohibitions in section 606. A prime broker should not be obliged to make a takeover, merely because of its underlying and/or aggregated prime broker clients give it a relevant interest in excess of 20% of the outstanding voting shares of a company. The situation can arise for a prime broker where a single client holds the position in excess of 20%, but that client is not obliged to make a takeover, for example as a founding shareholder or as a result of the creep provisions of the Page 10 of 11

11 Corporations Act. A prime broker in such circumstances should not be obliged to make a takeover bid on the basis that it does not have the capacity to launch a takeover and that it is merely acting as a custodian in respect of its prime broking clients. In the case where there are multiple clients of the prime broking business and/or the prime broker itself holds a position, which when aggregated with the prime broking client positions is greater than 20%, the prime broker would not have the intention or ability to coordinate the disparate interests of its clients to achieve a takeover offer. The market could be informed by a prime broker when lodging substantial holder notices in respect of the aggregated positions of prime broking clients and principal positions in the event that a holding exceeds 20% that it is exempt from making a takeover. C7Q7 If ASIC were to simplify the requirements for securities lending (e.g. to allow the non-inclusion in substantial holding calculations of borrowed securities that are on-lent or otherwise disposed of by the borrower by T+1), how would this not: a) compromise market transparency; and b) increase the risk of avoidance or the risk of warehousing? AFMA As we have noted above, multiple reporting of the same underlying stock position needs to be avoided. Relevant movements in stock should be identified but the noise that would come from lodging of irrelevant information in substantial shareholding notices should be avoided. Including in substantial holding calculations securities that are on lent will give rise to duplication of positions which could mislead the market as to where the controlling/voting interest actually lies. C7Q8 Is the information gathered under the disclosure regimes for securities lending and short selling adequate for achieving disclosure of substantial holdings in a particular security through securities lending or prime broking? Why? AFMA Yes The Commission, the Government and the Reserve Bank have proposals that will result in a large amount of information being collected with regard to securities lending and short selling. We have put forward the view that the public release of additional information may produce so much noisy data that it actually makes more difficult for less sophisticated investors and observers to understand corporate control dynamics. Page 11 of 11