December 6, 2011
Practice Groups:
New German Disclosure Rules For
Swaps, CFDs and Other Derivatives
Corporate
Capital Markets
Extensive disclosure requirements for synthetic positions as of February 2012
The widely recognized precedents Schaeffler/Continental and Porsche/Volkswagen exposed a number
of loopholes in the German voting right disclosure regime that allow sophisticated investors to
secretly build up significant stakes in German public companies. In response to an urgent letter signed
by several CFOs of DAX companies, the Germany Ministry of Finance put pressure on the German
lawmaker to address several shortfalls and adopt the “Act Strengthening Investor Protection and
Improving the Functioning of the Capital Markets” (the “Act”).
Under the Act, German voting right disclosure rules will be significantly broadened extending to,
among others, derivative instruments such as CFDs, swaps, put options and any other instruments
that (directly or indirectly) enable the holder or third parties to acquire the underlying shares.
The new disclosure rules will come into force on 1 February 2012.
Key takeaways:
• Disclosure requirements will extend to all instruments facilitating the acquisition of voting shares
including cash settled CFDs, swaps, put options and claims for delivery under securities lending or
repo transactions;
• The initial disclosure threshold for such instruments is set at 5% (aggregation with voting stock
and contractual options!);
• Violation of disclosure requirements for financial instruments may be fined up to EUR 1 m;
• New rules apply from 1 February 2012;
• Status notifications required.
Extensive disclosure requirements for (financial) instruments
Under the existing law, the first disclosure threshold for voting stock is set at 3%. There is no
disclosure obligation for financial instruments that permit the holder to acquire shares until the 5%
threshold is reached. Voting stock and relevant financial instruments are generally aggregated for the
purpose of determining whether the disclosure threshold for financial instruments has been reached.
The exception to this is where the voting stock threshold has already been reached and disclosed
separately. In such a case, additional disclosure due to the aggregation of voting stock and derivatives
would only become necessary where an additional disclosure threshold has been reached.
Under the present rules, however, financial instruments only comprise derivates that give the holder
the right to acquire the underlying voting stock (that is, call options and futures). Contrary to the U.K.
or court decisions in the U.S., contracts for difference (CFDs), total return swaps (TRS) or other
derivatives providing for a cash settlement only are currently not subject to specific disclosure
requirements. Consequently, the German Financial Supervisory Authority (“BaFin”) held in the
Continental/Schaeffler case that Schaeffler’s (undisclosed) stake building in Continental did not
New German Disclosure Rules For Swaps, CFDs and
Other Derivatives
violate German disclosure rules, even though Schaeffler secretly accumulated a position of about 30%
via cash settled TRS prior to launching its takeover offer, and terminated the swap contracts during the
acceptance period of the offer – leaving the counterparties de facto no choice but to tender their
enormous hedge positions into the offer. Following public outrage and an urgent letter signed by
several CFOs of DAX companies, the German lawmaker reacted by extending the scope of the
disclosure requirements for derivates.
First of all, the disclosure obligation for financial instruments which give the holder the right to
acquire the underlying shares will also include any “other instruments” giving rights to shares, such as
claims for the return of shares transferred to third parties in the course of a securities lending or repo
transaction.
Furthermore, to the extent not already covered by the extended rules, the Act introduces additional
disclosure requirements for all “financial or other instruments that, due to their terms and conditions,
facilitate the acquisition of voting shares by its holder or third parties”, and provides for two (nonexclusive) categories clarifying cases of such facilitation:
1. The first category covers financial instruments where the counterparty may exclude or significantly
reduce its risk under the instruments by holding the relevant voting stock. This includes all
instruments which allow counterparties to hedge their risks by acquiring the underlying shares.
It will be irrelevant if and to what extent a hedging strategy will actually be implemented in the
individual case. Likewise, it will be irrelevant as to whether the (financial) instrument provides for
a cash settlement instead of the delivery of shares. The reasoning makes it very clear that the Act
encompasses CFDs, cash settled equity swaps, cash settled call or put-options, and all other
transactions which “following their economic logic” render the acquisition of the underlying
voting shares possible. The wording of the Act will even include financial instruments that relate to
baskets or indices.
2. The second category covers financial and other instruments that entitle or oblige the holder to
acquire the underlying voting stock. This applies to all cases where an acquisition of the voting
shares would be possible due to the structure of the individual instrument; in particular, hedge
positions of put options or call options that are not already covered by the existing disclosure rules
(for example, call options that are subject to a condition precedent not controlled by the holder).
Again, a specific claim for the acquisition of the shares is not necessary; it would be sufficient that
the acquisition of the shares is the economic result of the financial instrument.
In either case, even “acquisition chains” of financial instruments (that is, financial instruments that
entitle the holder to acquire other instruments that give the right to shares) and cases where, due to the
specific structure, third parties will be in a position to acquire the voting shares fall under the scope of
the Act. It should not matter as to whether the voting shares will be acquired on the initiative of the
holder of the financial instrument, its contractual partner or a third party.
Remarkably, the new law focuses on existing voting shares only. Thus, convertibles and bonds with
warrants do not require disclosure, if, as is customary, the relevant voting shares are not yet existent
but will be created through a capital increase. The number of voting rights to be disclosed generally
equals the number of voting shares that can be acquired under the relevant (financial) instrument. If
not specified, the number of voting rights corresponds to the number of voting shares that the
counterparty would need to hold, had it fully hedged its risks under the instrument. When calculating
the required number of shares a delta factor of 1 applies. The relevant point in time is the acquisition
of the instrument by the notifying party. Subsequent adjustments – due to an adjustment of the hedge
positions effectively held or a change of the delta-value, for example – are irrelevant.
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New German Disclosure Rules For Swaps, CFDs and
Other Derivatives
As regards the disclosure thresholds, similarly to the existing disclosure requirements for financial
instruments giving right to voting shares, the disclosure obligations for the aforementioned other
financial instruments do not apply before the 5% threshold is reached (the subsequent relevant
thresholds are 10, 15, 20, 25, 30, 50, and 75%). The instruments will be aggregated voting shares and
instruments giving right to shares will be aggregated in order to determine whether a disclosure
threshold has been reached. Prospective investors will therefore only be able to secure up to 4.99%
of voting rights before triggering disclosure requirements.
Example: An investor holds (i) 2.99% of the voting shares of a target company, (ii) call options giving
the contractual right to 1% of the voting shares and (iii) CFDs equaling an additional 1% of the
voting shares. In this case, the investor is not required to file a disclosure notification. Neither the first
threshold for the disclosures of voting shares (3%), nor the first threshold for the disclosure of
contractual call options or other financial instruments (5% – taking into account an aggregation of
the shares, the call options and other financial instruments) has been reached.
Legal consequences of a breach of disclosure requirements
While a violation of disclosure requirements for voting stock entails a loss of all rights stemming from
the shares held by the notifying party for the relevant default period (that is, until the correct filing is
submitted) plus, if done in a deliberate or grossly negligent manner, for a period of six months
thereafter, there are no such harsh consequences in the case of a violation of the disclosure
requirements for call options or other financial instruments. According to the Act, any violation of the
new disclosure regime for financial instruments may be fined up to EUR 1,000,000. The BaFin may,
however, increase the fine and skim off the profits of the illegal transaction (though this is rarely seen
in practice).
Commencement of new rules/status notifications
The new disclosure rules for financial instruments come into force on 1 February 2012. The Act
requires that financial and other instruments facilitating the acquisition of 5% or more of the voting
shares of a company are to be notified without undue delay, at the latest within 30 trading days
following the commencement of the new rules. Aggregation of voting stock and call options must be
taken into account. Non-compliance with the aforementioned status notifications may be fined up to
EUR 200,000.
Timely advance preparation strongly recommended
Given the complexity of the notifications and the complicated corporate structures with which many
of our institutional clients operate, the short notification period of four trading days for voting right
disclosure makes it rather difficult to comply with the notification requirements in a timely fashion if
the research necessary for preparing notifications is only commenced upon reaching a threshold.
We will, therefore, offer our clients a “shelf” notification service comprising the following elements:
• Review of corporate structure and determination of reporting requirements with the client's
compliance department for all fund entities that may acquire shares in the future;
• Preparation of a reporting routine so that all necessary information can be submitted to us on an
expedited basis;
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New German Disclosure Rules For Swaps, CFDs and
Other Derivatives
• Preparation of necessary powers of attorney for our firm’s lawyers to prepare and file the adequate
notifications upon reporting to us that client entities have reached a notification threshold;
• Designation of lawyers who will always be available in order to comply with notification duties at
short notice.
Author
Andreas Füchsel, LL.M.
andreas.fuechsel@klgates.com
+49.69.945.196.380
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