Know Your Shareholders: The Use of Cash-Settled Equity Derivatives to Hide Corporate Ownership Interests

Abstract

Derivatives are an important class of financial instruments that has taken center stage in today’s capital markets. The reason for their increasing popularity is two-fold: they offer risk protection, and they allow innovative investment strategies. In particular, in a regulatory environment where disclosure requirements are triggered by voting rights rather than economic interest, derivatives can be used to conceal equity. This practice - generally known as “hidden ownership” - is being used by investors and strategic bidders for the purpose of discretely accumulating equity stakes in business corporations listed on European stock exchanges. The most notable examples are the cases regarding Continental, Fiat, and Volkswagen-Porsche.

This paper provides an overview of the implications on corporate governance of certain uses of equity derivatives. It outlines actions that, in the performance of their fiduciary duties, directors of corporations listed in Europe should consider in order to address or prevent situations of undisclosed stake building by means of such derivatives. It also discusses the recent regulatory initiatives undertaken to restrain abuses of these financial instruments in Belgium, France, Germany, Italy, the Netherlands, and the United Kingdom.

Keywords: governance, derivatives, financial markets