Explanation of Contract For Difference (CFD) Market ~ market folly

Wednesday, September 2, 2009

Explanation of Contract For Difference (CFD) Market

The contract for difference (CFD) market in the UK has grown significantly during the last ten years. In late 2007 the Financial Services Authority estimated that 30% of equity trades in some way involved CFD transactions*. Today, it is highly likely that the figure is even higher.
Many may ask, why use CFDs instead of purchasing the plain vanilla equities directly? One big advantage that CFD holders have in the UK is that they avoid the Stamp Duty of 0.5% that is levied on all equity purchases (but not sales) in companies listed on the London Stock Exchange. Other potential advantages include greater leverage, the ability to go short and, until very recently, anonymity. Anonymity is of course something prized by many hedge funds and large investors as they try to tip-toe around the markets without leaving a massive footprint. Secrecy is the name of the game in hedge fund land. The last thing hedge fund managers want is copy-cat investors jumping in and influencing the share price of a company before they have finished buying or selling. Similarly, hedge funds involved in activism or takeovers can at times be more effective and influential if they can build large shareholdings in the target company without being seen.
However, the Financial Services Authority (FSA), the British equivalent of the SEC in the United States introduced new rules which came into effect on June 1st. These rules now force hedge funds to disclose CFD stakes they had previously built up secretly. The new rules require an investor holding more than 3% of a company’s equity through derivatives to disclose their stakes. Investors that build large shareholdings via a combination of normal shares and CFDs must also disclose their combined position once it crosses the 3% of issued shares threshold.
The new rules produce a more level playing field between stocks and CFDs with regard to disclosure. However, there seems to be at least one loophole in the legislation in that it applies only to interests in UK-headquartered companies but not investors in overseas companies that are listed in London.
Those of you who like to track the best hedge fund managers now have a new way to follow them due to the rule changes. A good example of the extra information we can look forward to in the future is provided by a recent filing from Ken Griffin’s Citadel Advisors LLC. Citadel revealed that they have a large 16% stake in property developer, Songbird Estates via CFDs (see table below).

Songbird Estates Plc (Interest in Ordinary class B shares via contract for difference CFD)

Date company was notified of purchase No. of shares % of company’s issued stock
01/06/2009 30940584 16.0
20/08/2009 30797470 15.96

Taken from Google Finance, Songbird Estates plc is "engaged in the management of its investment in its main subsidiary, Canary Wharf Group plc, the holding company for a group that specializes in integrated property development, investment and management focusing particularly on the Canary Wharf Estate, including Heron Quays West, Riverside South and North Quay (the Estate). Canary Wharf Group is also involved through joint ventures in the development of Wood Wharf and the redevelopment of Drapers Gardens. As of December 31, 2008, Canary Wharf Group’s investment portfolio comprised 16 completed properties (out of the 31 constructed on the Estate) totaling 7.9 million square feet net internal area (NIA), of which 99.7% was let. On November 17, 2008, Canary Wharf Group announced that it had concluded an agreement for the staged development of Riverside South with JP Morgan. In December 2008, Canary Wharf Group reached an agreement to commence work on the Crossrail station at Canary Wharf."
This is an expansion of our hedge fund portfolio tracking series to cover holdings in other markets. Thanks to a reader, we are now able to track prominent hedge fund positions in the UK markets. We've previously covered Lone Pine Capital's UK positions and their recent UK movement. Additionally, we've covered Sprott Asset Management's UK positions where we saw them playing defense. We'll continue our coverage in this regard so stay tuned for future updates.

*Financial Services Authority “Disclosure of Contract for Difference: Consultation and draft Handbook text”, Vol 20 No. 20 November 2007.

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