UK has hedge funds in its sights
The UK Financial Services Authority
(FSA) is targeting hedge funds over market abuse allegations.
And if it can't prove insider trading, it's going after
"I would not rule out a situation where the FSA takes action
on insider trading, doesn't have enough to prosecute, but is so
disappointed with the internal controls it finds that it takes
action on those as a consolation prize," said Martyn Hopper,
regulatory partner at Herbert Smith.
"I have certainly heard FSA officials talk about their
concerns about systems and controls."
The FSA signalled its intent in October by publishing Market
Watch 24. There it declared that senior management at hedge
funds hold ultimate responsibility for compliance with the
market abuse regime. "This proved that the FSA has hedge funds
in its sights," said Patrick Buckingham, regulatory partner at
Herbert Smith. "And now funds have had a couple of months to
digest Market Watch 24, it is only a matter of time before
action is taken."
Hedge fund managers will have the onerous job of considering
and checking their compliance with market abuse rules.
Principles-based regulation such as Market Watch 24 allows the
flexibility to create a bespoke system, but does not offer much
But the FSA is keen to act soon. Due to the fact that many
hedge funds have small compliance resources, they may not be
able to get up to speed in time. Indeed, there has been
speculation that the HBOS scandal would be the perfect
opportunity for the FSA to
The main points of the FSA's Market Watch
- Hedge fund senior management is solely
responsible for its market abuse regime. This
responsibility cannot be delegated.
- All hedge funds should have independent
monitoring of their market abuse controls and
procedures. In addition, the FSA highlights the
potential benefits of automated controls in IT
systems to identify or restrict market abuse.
- A list of all securities that inside information
has been received on must be kept and trading on
these securities must be restricted. The FSA notes
the benefit of Chinese Walls, but concedes that they
are not always appropriate, depending on the size of
- All staff must receive appropriate and regular
market abuse training.
- There is a general responsibility to ensure that
confidentiality is stressed where needed. This is
part of the FSA's plan to reduce the dissemination of
information and rumours.
- Hedge funds are recommended to consider the
benefits of recording telephone lines. The FSA also
asks hedge funds to consider their remuneration
- Long-term structures may reduce the attraction of
committing market abuse for short-term
European Spacs don't need formal
Special Purpose Acquisition Companies (Spacs) are so
transparent that market forces will be enough to regulate them.
"We shouldn't chip away at the general structure. It would be a
great shame to ignore the genesis of Spacs and fiddle with
them," said one panel member at the IFLR capital markets forum
"Some US Spacs have tried to change standard terms and have
been beaten back. The European market has an opportunity to
police itself and say 'that's a bridge too far' if anyone steps
out of line."
Spacs are set up to attract investors who buy shares in an
investment company and then get to vote on a potential
acquisition. They play on the entrepreneurial record of those
setting them up, rather that the financial records of
investment managers in other permanent capital products.
And it is this structure that reduces the need for formal
regulation. Typically, Spacs require 80% of shareholders to
agree with a proposed acquisition. Anyone who voted against has
the opportunity to get out what they paid.
The fact that Spacs are equity products also helps. Euronext
Amsterdam is where the majority of European Spacs are traded
and the panel described the benefits:
"A Spac unit is a tradable instrument from day one. If the
market doesn't like a proposed acquisition, the share price
will drop and this is an indication that the shareholder vote
will fail," said a panel member.
"But if the share price spikes, the market likes the
acquisition. Any Spac unit holder that disagrees with the
acquisition can sell over the exchanges. They will often profit
and the shareholder vote will go through at near enough
This point also acted as a veiled warning to London. If
Spacs are the future of permanent capital, then London will
have to make some changes to compete. At the moment, London
rules mean that as soon as a Spac announces a proposed
acquisition, shares are suspended.
"This unwinds what can be an incredibly transparent
structure," concluded the panel. NP
Debt buy-backs force change to
The trend of private equity houses
buying back their own debt has worried banks into changing
their lending documentation.
The debt issued for previous buy-outs is trading at a
discount, making it an attractive investment for private
equity. But the banks are worried because if it is bought up
the private equity houses will own debt and equity in the same
company – giving them greater control.
Danish telecommunications company TDC, which is owned by a
private equity consortium, did this recently by buying back
?200 million of its loans at a low rate of 90-95%.
"Typically, any money available should go to repaying the
debt. This is messing with the natural order of repayment,"
said a private equity partner at a magic circle firm.
"It will affect how banks draft their documentation; they
will definitely want to try and stop it. Financing partners at
our office have already started working on redrafting
Most UK loan contracts require a two-thirds majority to
implement an accelerated default procedure. If a private equity
house holds a substantial proportion of the debt in one of its
companies, it could frustrate lenders in a default or a
restructuring. It could also block votes on other aspects of
loans such as pricing, security or seniority.
"It gets problematic if people are wearing both hats. It
also raises the issue of fiduciary duties and when they apply,"
said the private equity partner.
If redrafting doesn't deal with banks' concerns, they could
push for proposals similar to those in the US. There, the Loan
Syndication and Trading Association has clarified a strong
position on the transferability of loans. Borrowers and any of
their affiliates are restricted from purchasing their own bank
debt. Private equity houses are deemed to be affiliates to
companies they have invested in.
"Exceptions are sometimes negotiated allowing a private
equity sponsor to purchase up to a certain percentage of a
portfolio company's bank debt. This is usually less than 30% in
order to prohibit the sponsor from gaining a blocking vote,"
said Jones Day partner Andrew Barker.
"Additionally, banks will sometimes allow a private equity
sponsor to own the bank debt on the condition that they cannot
exercise any voting rights, so they cannot impact enforcement
and other decisions." NP
Clear Channel infects global lending
Despite the Clear Channel dispute being settled out of court
in April, the case is infecting lending deals at least as far
away as Europe.
In May, private equity houses Thomas H Lee Partners and Bain
Capital agreed to funding of $17.9 billion ($36 per share) for
their purchase of Clear Channel Communications. Previously, the
bank syndicate had refused to fund the buyout price of $39.20,
prompting legal action for breach of contract.
This workable solution (subject to shareholder approval) is
welcome news to the parties involved in the transactions, but
the case is disrupting other deals.
"I was working on a deal this week where one of the lending
banks was a party to the Clear Channel case. The borrower
wanted special reassurance that the bank would not renege on
the deal," one partner in London told IFLR.
"But the bank was hardly going to say, 'we're not going to
lend to you either', so it just gave the normal assurances. In
the end, the deal didn't go through anyway."
The straining of relations between borrowers and banks could
have a profound effect on the market. This is not the only
acquisition finance case going on, as IFLR highlighted in its
May issue and reported when the PHH deal fell apart in
Given that Clear Channel involved six lenders (Citigroup,
Credit Suisse, Deutsche Bank, Morgan Stanley, Royal Bank of
Scotland, Wachovia) and one of them is already facing questions
from borrowers, further cases could make the leveraged lending
market even more conservative.
The fact that the case was settled means that the debate on
how a US court would enforce the breaking of a commitment
letter continues – no one knows if the judge would
enforce specific performance or impose damages.
"If the original terms were enforced, then the banks would
be back where they started," said the partner.
Spacs hits Asia
The burgeoning trend of Special Purpose Acquisition
Companies (Spacs) has finally hit Asia, with China's first
Heckmann's $625 million takeover of China Water is the first
large Spac acquisition of a Chinese target. Credit Suisse and
DLA Piper acted as Heckmann's financial advisor, and counsel in
both the US and Hong Kong.
The first Spac in China was Jaguar's takeover of China
Cablecom in April, but the deal was only $34.3 million.
While the products have become commonplace in Europe and the
US over the last year, their growth is still relatively nascent
That said, several Spacs have been formed to acquire
companies in India and some Indian companies are looking to use
the vehicles to acquire foreign companies. But the disclosure
requirements of the Securities Exchange Board of India (Sebi)
prevent companies with no track record from listing which may
restrict Spac growth there. TY
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