Corporate actions - GMSLA Provision
2010 Global Master Securities Lending Agreement
Clause 6.7 in full
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There is a tension between 6.6 and 6.7: while under 6.6 a Borrower is not obliged to vote in a certain way, for a corporate action — even one involving a lender option — the Lender may requests the Equivalent securities be returned with the rights taken up.
Best illustrated by way of example:
- Under Italian Law a shareholder on the Record Date who does not vote in favour of a proposed merger acquires a “withdrawal right” if the merger is approved. The withdrawal right allows a shareholder who abstained or voted against the merger to be cashed out of the equity at a pre-defined price equal to the average closing price published by Borsa Italiana for the six months prior to the notification date for the merger. It is therefore possible that the withdrawal right as a call option over the stock. It is only exercisable if the shareholder does not vote.
In this case the Lender who has lent out over the record date could not (without prior agreement) oblige the Borrower to vote against the merger, but if the Borrower has done so, the Lender can, by request under 6.7, require the Borrower to deliver the proceeds of the withdrawal in lieu of Equivalent Securities.
What is a “reasonable time”?
There’s no amplification on what counts as a “reasonable time”. You will find scant authority in the law reports about it. Even the FT’s Mastering Securities Lending Documentation is mute on the subject.
The tension here is that the exercise date – the latest possible time for exercise – will be after the record date — the date on which you had to actually own the Securities. And your ability to exercise at all is dependent on having held the Securities on the record date.
The case against
If the Lender gives notice after the record date but before the exercise date, is that a reasonable time? I think you could construct a fairly good argument that it is not, at least if the Borrower happens to be short the stock:
- The 2010 GMSLA is a title transfer document designed for short selling.
- The parties’ expectations must be that the Borrower will not hold the stock in inventory during the loan.
- A “reasonable time” would therefore need to be enough time to get the stock back in to vote it to meet the Lender’s instructions
- A 2010 GMSLA Borrower is not meant to be writing a call option.
- Once the record date has passed the Borrower cannot exercise the option itself, so would be making a payment it will not itself receive.
- The manufactured dividend process is designed to pass on actual economics of the security, not the best of economics. Therefore the Borrower must be able to effectively exercise the rights. That includes having time to get the securities in inventory if they’re not already there.
- The 2010 GMSLA’s voting rights clause is clear a Lender can’t vote on securities.
- If it wants to, it must recall the Loan in time for the record date.
- Even if the Borrower fails to return, under the Buy In terms (Para 9.3), it wouldn’t be liable for consequential loss (which we surmise would include the lost opportunity to exercise the option).
- By extension, if a Lender wants (effectively) to exercise a vote, it must signal its intention in enough time for the Lender to recall securities, and that is what the “reasonable time” is designed to capture.
- If the Borrower was obliged manufacture the payment whether or not it held it in long inventory, then there’s no real reason to have a deadline on the underlier at all.
- Why exercise the notice before the exercise time?
- It wouldn’t make any difference from the Borrower’s perspective.
The case for
Pal, it’s my stock, you borrowed it, you take the risk of all economic performance in the mean time. Your safest way of doing that it by holding it. If you can hold it, you can put in your notice and exercise, no problem.
What do you mean you shorted the security? Who knew? More to the point, who cares? By doing so you took a view on it: this risk is express something you bet against happening.