In our previous article on “Hedging your Bets” (see HERE), we discussed the Treasury’s proposal to the AASB requiring companies to disclose their option hedging policies. This time we look at a typical hedging product, what companies are doing in regard to hedging policies, identify regulations that lobbyists want changed, and note areas that companies should look out for.
A typical LTI option hedging product currently available in the market:
- Is available for vested securities with a minimum value of $100,000
- Sets a minimum protection level where any share price decrease does not affect the executive
- Sets a maximum cap level where any share price increase is forfeited to the issuing institution
- Allows the executive to benefit from ordinary dividends and franking credits
- Provides access to loan funds up to the minimum protection level, which can be used for anything including further option exercises
- Allows access to funds without selling shares; so executives can continue to receive dividends and postpone capital gains tax
Most products we have seen only allow hedging of LTI options after they have vested. So it seems that in these cases, the requirement that the securities be vested does not diminish the impact of the LTI plan as an incentive.
More problematic is that hedging of vested LTI allows executives to effectively sell securities outside the established trading window and without market notification of the trade. Shareholders are left unaware that a senior executive has cashed in at the current share price, presumably based on lessened expectations for growth.
Our cousins in the US have also been concerned about this topic, recently introducing new disclosure requirements that specifically mention incentive hedging. The Compensation Analysis and Disclosure standards outlined in the SEC’s Final Rule Release No. 33-8732A cite as an example the need to disclose the company’s equity or other security ownership requirements or guidelines and any company policies regarding hedging the economic risk of such ownership.
The Australian Council of Super Investors (ACSI) has been active in raising concerns about potential hedging to the Australian Securities Investments Commission. ACSI conducted a review of hedging policies by sending an enquiry to each of the ASX/S&P 200 companies about whether they have a hedging policy. 120 responses had been received as of August, showing that:
- 72% have some form of a share trading policy
- 53% cover the issue of hedging within their share trading policy
- 18% allow hedging after incentives vest, generally subject to share trading policy and trading windows
- No company commented that it allowed hedging prior to vesting
According to ACSI, current Australian disclosure laws do not directly deal with incentive hedging. For unvested incentives, the body calls for a complete prohibition. For vested incentives, ACSI wants information on, among other things, when and how the market will be informed that a hedging transaction has taken place. Further, ACSI calls for amendments to Section 305G of the Corporations Act and ASX Listing Rule 3.19A.
Companies that have addressed LTI hedging directly are taking a number of approaches. Many companies already have a provision in their LTI plan documents that prohibits the transfer or hedging of any unvested securities. Further, we expect that most offer letters will include a prohibition on hedging as a requirement for participation in the plan. Separately, companies are including a provision in their share trading policies banning the use of hedges on unvested LTI. Alinta has even created a stand-alone hedging policy, which they disclose under the governance section of their website (see HERE).
A policy that bans unvested security transactions only will not address the market notification issue for executive directors. Companies that have this concern may require executives to notify the company secretary immediately if they hedge vested LTIs.
Treasury has told us disclosure requirements will change in regard to hedging. We will let you know once the proposed new disclosure requirements are announced.© Guerdon Associates 2022 Back to all articles