EU-wide short selling disclosure rules?

Useful liquidity providers, and an informed source of true market value, or scavenger taking advantage of ill fortune in bad times? The hedge fund industry is fighting back against the latter image, notably in the FT whilst regulators look at how to ensure that the problems of last year are not seen again. CESR’s proposals would require a significant amount of reporting.

We have seen so far 3 types of reaction from regulators; outright bans on short selling of financial stocks, now mostly being unwound, the reintroduction of US uptick rules preventing any trade being executed at a lower price than the one prior, and increased disclosure of short positions.

CESR has proposed a two-tier system under which a short position of 0.1 per cent would have to be disclosed to the regulator of the most liquid market in which the stock trades. A short position of 0.5 per cent or greater would have to be publicly disclosed to the market as a whole. CESR also has proposed incremental steps of 0.1% of issued capital for disclosure.

This is as compared to the proposed regimes in Europe, where a standard of 0.25% disclosure to the market as a whole is emerging as the proposed norm.

A couple of questions: first does the EU actually need a common standard? Given the wildly different approaches take thus far by national regulators who understand their markets, possibly not.

And what would IR teams do with the information if they receive it? Simply knowing would be helpful, perhaps, but engagement in the same way as with a traditional long investor is unlikely.

Finally, an interesting part of the CESR consultation refers to any short selling, whether done through a regulated exchange, or MLTF. Another sign that the activities of dark pools are coming under increasing transparency.

Technology, trading and investor relations

It is a moment many an IR person dreads. A significant number of shares have changed hands overnight, and the FD wants to know why. Unfortunately, there are an increasing number of occasions when the technology has hidden the reason – or even the transaction – from view.
The good news is this may be about to change, following 2 announcements this week.

First, dark pools. Or more properly, multi lateral trading facilities. Dark pools of liquidity are crossing networks that provide liquidity that is not displayed on order books. They offer institutional investors many of the efficiencies associated with trading on the exchanges’ public limit order books but without showing their hands to others. Neither the price nor the identity of the trading company is displayed.

In new developments in dark pools. regulators have said this week that they will look into what Mary Schapiro, SEC Chairman, describes are “the potential investor protection and market integrity concerns raised by dark pools”. The European Commission is also looking into whether more disclosure around these trades should be required. However new platforms continue to arrive. BATS – a major player in the US - has unveiled plans to launch a pan-European dark pool, competing with the growing number of services launched by traditional stock exchanges.

Also in the US, NYSE and Liquidnet announced a cooperation that will allow NYSE-listed companies to see the ratio of intended buy orders against intended sell orders. This should help companies to react more effectively to developments that may be moving their share price - such as market rumours - by analysing buy and sell trends on the stock in the dark pool.

And almost inevitably, Twitter has found its way into trading systems. US-based technology firm StreamBase has announced the capability to monitor "tweets" for price sensitive information, and turn them into buy/sell orders to be executed through algorithmic trading systems.

All of which causes this old timer, who remembers blue buttons and jobbers, to shake his head in wonderment.

Governance up the agenda for IR teams

“Governance” and “interesting” used to be contradictory terms for most IR people. However earlier this week, I went to a private lunch hosted by Tomorrows Company and Radley Yeldar (see my bio) which managed to combine both.

The point of the event was to allow a high quality group to debate the ‘stewardship’ of companies, and a potential disconnect of interests between ownership and the long term success of the company.

Tomorrows Company had produced an interesting perspective which graded degrees of stewardship, from the original founders of businesses with the highest degree of stewardship instincts, to speculators – members of the ‘casino’ economy, rather than the real one. The use of derivatives by these speculators to leverage investment without transparency has been an important contributor to this disconnect.

One of the key discussions centred around engagement with companies by (institutional) investors. We have recently seen cases of noted activists such as Knight Vinke joining up with traditional long investors to raise concerns with the companies in which they invest. However this is far from the norm.

Since few investors proactively seek to engage regularly with the companies they own, the discussion developed of how to communicate the governance values that companies subscribe to. Regulation is certainly not the answer, according to those at the lunch. And yet there is coming a need to defend comply or explain. The so-called Lecce framework – potential governance rules for companies across the EU – are due to be debated at the next G8 summit. And many other regulators are looking at their own codes, including the Walker Review, the FRC review of the Combined Code, the new Belgian Code, the PIRC calls for radical overhaul, the new Institutional Shareholder Committee governance recommendations....the list goes on.

However, in the meantime, how companies communicate their governance ambitions and culture is important. And difficult. One attendee told me that she was responsible for the governance section of her annual report, and that she had wanted to enhance it well beyond a simple set of compliance statements. However the company wanted to balance the information provided with the risk of “over complicating” their governance discussions with investors - and their proxy advisors.

By observation, many (most?) annual reports’ governance sections are formulaic and uninformative. A new best practice should evolve, which explains not only the compliance with the codes, but also the culture of governance within the company.

Corporate reporting is about ‘cutting out the clutter’.

The preparers of annual and other reports have always had to balance between compliance and communication. Traditional wisdom has it that so much of what the ‘rules’ say should be reported is of no interest to anyone, and is simply there for compliance sake.
Well now there is support for the view that reporting should be more about principles of good communication.

2 years ago, the Financial Reporting Council launched its project to review the complexity and relevance of current corporate reporting requirements. This week, it published Louder than Words: principles and actions for making corporate reports less complex and more relevant.
The discussion paper looks like a first step along a long road of change to what companies tell the market. Probably the most important conclusion to be drawn from it is that the FRC thinks that reporting should be more principles based. Indeed it lays down a series of communication principles. They are hard to argue with – motherhood and apple pie and all that – but the fact the FRC says them is helpful.

The report also makes 5 ‘calls for action’. In these days of focus on survival, the first call for action – to provide better information on cash flow and net debt – is vital. Pulling out and explaining key metrics used by investors such as debt ratios (gearing, interest and dividend cover), debt maturity profile, and contractual obligations will assist analysts relying only on the notes to the accounts.

So far so good. There are 2 areas where I am tempted to disagree.

First the title. We know that well over 50% of a company’s valuation does not lie on the balance sheet but in assets like management skill, technology, brands, patents etc. It would be unfortunate if some read the title as meaning that the narrative in annual reports – words after all – somehow mattered less.

The second is the statement about the intended audience for reporting. It says “One widely acknowledged problem is that reports currently aim to please too many types of user. There is a need to refocus them on their primary purpose: providing investors with information that is useful for making their resource allocation decisions and assessing management’s stewardship. We suggest that regulators and companies should reconsider how they address the needs of other stakeholders – for example, those with specialist interests in environmental and employee diversity issues.”

Environmental and employee issues absolutely deserve equal consideration with financial issues, and should be of interest to investors as well as wider stakeholders. They are part of the equity story, and should not be shunted into another report.

The trouble with IMS’s...

One of the proposals when the Transparency Obligations Directive was in discussion in Brussels was whether to oblige companies to produce a full quarterly financial report, a l’Americain. After all went the argument, a significant number of European member states already require it; why not make it a pan EU requirement?

There are of course a great number of drawbacks to that as an idea, including a risk of increased short termism, so after a good amount of lobbying notably by the Quoted Companies Alliance, a solid (you might almost say British) compromise was reached.

The Interim Management Statement was born, and has been troubling companies and their advisors ever since. So we have been looking forward to a much trailed FSA review of IMS, and any “guidance” they can offer. And indeed it does offer a few clues that are worth considering, although it specifically rules out – probably to the relief of all – a template approach.

Aside from highlighting that some companies haven’t produced an IMS at all, the FSA review notes that the market regards IMS as useful communications opportunities, and that by and large there has been good compliance. However the review focuses especially on 2 issues: materiality and financial performance.

On whether a previous announcement is ‘material’ the FSA has declined to offer any further definition, although it does say that issuers may “find it helpful to consider the impact of an event/transaction on its financial position”. This still leaves a fairly wide margin of options.

On financial performance: ‘a general description of the financial position and performance of the issuer and its controlled undertakings during the relevant period’ as the DTR’s say, the FSA notes this is biggest problem area. This may be because of their statement in List! 14, that “We believe that IMS may not require financial data in certain circumstances.”

Some issuers have included data such as debt ratios, cash flow, gross and net assets, NAV’s and divi yields. In profiling this, the FSA may be giving a clue as to what they would like to see, although they do highlight that either narrative of financial data would be OK.

Finally they observe that different financial performance reporting indicators have grown up within different sectors, and that this is not a bad thing. So maybe when all is said and done, watching what the other guys do will continue to be the practical step. And after all, producing an IMS is a heck of a lot better than the originally planned quarterly report.

Walker Review – the missing link

The Walker Review closes for its initial public feedback at the end of next week. This independent review looks at corporate governance in the UK banking industry. Unsurprisingly, there are many who create a connection between the massive failures in the banking sector and an absence of corporate governance.

What is however surprising – at least to me – is the lack of focus on disclosure and reporting in the review. The Treasury website highlights 5 areas on which the review will dwell, but they do not include how the communication of governance should be enhanced. Why does this matter? Well, for one thing, much has been made of the role of institutional shareholders in engaging effectively with companies and monitoring of boards. But how can they monitor that which they cannot see?

The current reporting model is too dependent on the financial, technically complex, aspects of reporting, Narrative reporting on the non financial value drivers of the business has been subject to less intervention. Consequently too much short term focussed data is available, but not enough information.

Many companies take a largely compliance approach to governance reporting, However there are some great examples of good practice, which could be adopted more widely. For example, the reporting of some sub-committee activity to explain what issues the sub-committee has been dealing with over the year. There is a strong argument that the board should explain in broad terms the scope and nature of the issues that it has dealt with over the year.

Another example would be explanation of the how the board has got independent feedback on the overall board performance, discussion of the outcomes of the evaluation and what the board plans to do as a result. And of course, with executive compensation top of mind in this annual meeting season, transparency around how the Rem Comm works.

Whether good governance is working or not depends on many things, but an important indicator is the company's overall commitment to transparency and its ability to provide a coherent picture of key success factors for the company.

It would be good to see the Walker review include this in its thinking.

It's that word again - transparency

It has been impossible to turn on the TV this week without hearing that ‘transparency’ is needed. The theme that public companies have been used to for many years – the demand for greater insight in to their affairs – has come home to our lawmakers.

I had a very interesting discussion early this week with a senior IR person who had been through a tough baptism into IR. She had taken the IR reins a few years ago at a company going through significant turmoil. Products were out of date and new ones not yet arrived; the share price was tumbling, each set of results produced further downgrades, and the (generally very supportive) long investors were getting concerned. And the financial profile of the company started looking attractive to new value investors.

I wanted to know more about this for a strategic IR course I am running in June for some East European IR directors. There were a number of lessons that emerged from this case study, but one that stands out was the decision to expand their disclosures. Putting more information into the public domain was a conscious decision, and aimed at supporting existing holders, providing insight to the sell side and to potential new investors.

The result was good news, and the company went on to great things.

I was reminded of this theme in reading the very helpful survey published by Citigate Dewe Rogerson. A key focus of the survey was on disclosure and guidance, where the survey reported that over 40% of companies have increased their disclosures over the past year and 28% plan to increase disclosure this year. And more companies are, according to the survey, offering ‘guidance’. This is very much European style guidance – focussing on non financial value drivers – rather than US style EPS point and figure guidance.

Telling the company story has never been more important. And no doubt our lawmakers will get there soon.