Mediobanca’s Generali deal revives an old dry lending problem

Last April, Italy played host to an exciting board battle for control of insurer Generali. Majority shareholder Mediobanca wanted to put in place a slate of directors led by the current CEO, while Italian billionaire Francesco Gaetano Caltagirone favored an alternative team including a new CEO.

Six months earlier, Mediobanca boldly said it had borrowed an additional 4.42% of Generali’s outstanding shares “from a market-leading counterparty” to take its more than 17% stake and boost its voting rights. at the next annual general meeting.

Borrow shares only to use the voting rights of a AGM – known as empty voting – is a bit of a gray area. In theory, a company could borrow a large number of shares to influence a company in a direction that is not in the best interest of the stock lender.

The International Securities Lending Association (Isla) does not consider this behavior to be best practice. The activity also goes against the guidelines set out in the UK Money Markets Code, which is part of the Financial Conduct Authority’s senior management scheme.

But that particular confrontation took place in Italy, where the securities regulator, the Commissione Nazionale per le Società e la Borsa, raised no objections. Despite everything, after some rumors in the press on the validity of the operation, Mediobanca published a press release on April 11, according to it at the insistence of Consob, to say that it is “fully legitimate” to use borrowers’ voting rights. actions to influence the direction of a AGM.

At the April 29 meeting, Mediobanca comfortably won with 56% of the vote, meaning borrowed shares were not the deciding factor. Reuters reported that Mediobanca’s stake had fallen below 13% a month after the vote. While it was essentially a closed case in Italy, the episode got the nose in the nose of the Bank of England.

Given the size of the equity loan – 4% from one of Europe’s biggest insurers – the suspicion is that the liquidity was coming from the much deeper market in London. While this behavior is rare, the BoE is nonetheless on a mission to prevent a repeat.

At a May meeting of the BoE-led Securities Lending Committee, the central bank said it was “disappointed that this transaction took place in flagrant violation of Chapter 4, Section 6.3 of the UK Money Markets Code”.

This section of the code states that “it is good accepted market practice that securities should not be borrowed solely for the purpose of exercising voting rights, for example, in a AGM Where AGE”.

The BoE’s Money Markets Committee said at its May meeting that empty-vote fears could erode institutional investors’ confidence in lending stocks.

Mediobanca is not a signatory to the code but is a member of Isla. In a blog post in May, Isla chief executive Andrew Dyson said that borrowing shares to influence a AGM voting “should be considered market manipulation” and that it damages the reputation of the securities lending industry.

The BoE’s Money Markets Committee said at its May meeting that empty-vote fears could erode institutional investors’ confidence to lend stocks, ultimately threatening the smooth functioning of the market.

Lack of transparency regarding borrowers’ intentions was one reason Japan’s Government Pension Investment Fund pulled out of equity lending in 2019.

The committee considered whether to ask market participants to re-adhere to the code to remind them of this aspect, but the minutes indicate that this could lead to many opting out “until a new assessment has been company”.

Instead, sources say a letter outlining these issues should be written by the BoE to market participants. This should include any proposed changes to the code.

The Bank of England declined to comment.

The question now is whether the BoE’s recent efforts will make a difference.

For term loans over a period including a AGMsome suggest that lenders could do more due diligence on the motives of the borrower before closing the deal.

But much of the lending is done on so-called open transactions with no end date, and on platforms such as EquiLend where there is no information about a borrower’s intentions.

This means that it is up to the lender to decide whether or not to recall the shares before a AGM – finally, a trade-off between the relevance of the vote and the income generated by keeping the shares on loan.

Other factors may cause the change. With environmental, social and governance principles requiring shareholders to be more active in voting to maintain companies’ high corporate governance standards, recalls could be more frequent in the future.

Other rules may play a role, for example the UK and EUThe Securities Financing Transactions Regulation requires market participants to report their securities lending and borrowing positions, which means UK regulators can monitor cases of empty votes more closely.

After firing a warning shot on the matter, UK regulators may choose to regulate this activity more aggressively in the future. But with an apparent lack of interest in addressing the issue outside of the UKit’s also possible that this recent burst of attention is fading as quickly as it surfaced.

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