CFM55480 - Derivative contracts: issuers of convertible or share-linked securities:securities containing CFDs: meaning of 'exactly tracking contract'

CTA09/S657

History

The meaning of ‘exactly tracking’ has changed since the original ‘paragraph 45 alphabet’ (FA02/SCH26/PARA45A-45M) was introduced. For accounting periods beginning on or after 1 January 2005, the original meaning of ‘exactly tracking’ followed the definition in FA02/SCH26/PARA45F, which applied to holders of such securities.

However, the rules were changed by SI2005/2082 so that for accounting periods beginning on or after 1 January 2005 and ending on or after 17 August 2005, ‘exactly tracking’ also meant contracts that were ‘almost exactly tracking’. See the example at CFM55490. This remained the case only for a limited period.

Current position: Accounting periods ending after 30 December 2006

SI2006/3269 amended the definition of ‘exactly tracking’ for accounting periods beginning on or after 1 January 2005 and ending after 30 December 2006, in effect to repeal the ‘almost exactly tracking’ rules.

Now under CTA09/S657, the contract is ‘exactly tracking’ where the amount which is required to redeem the security is equal to the amount found by applying R% to C, where

R% is the percentage change (if any) over the ‘relevant period’ in

  • the value of the assets which are the underlying subject matter of the contract, or
  • any index of the value of those assets.

C is the amount falling to be regarded in accordance with generally accepted accounting practice as the proceeds of issue of the liability which represents the debtor relationship.

‘Relevant period’ means the period between:

  • the date when the liability representing that debtor relationship came into existence, and
  • the date when the creditor relationship corresponding to that debtor relationship comes to an end,

or any other period in which almost all of that period falls, and which differs from that period only for purposes connected with giving effect to a valuation in relation to rights or liabilities under the liability representing that debtor relationship.

This means that the definition is now the same as that applying to holders of share-linked securities (CTA09/S649 - see CFM55290). The deemed CFD will only be ‘exactly tracking’ if gains or losses on the derivative precisely mirror gains or losses on the underlying shares, or share index, without any upper or lower bound being set, and without any gearing.

Grandfathering rule for securities issued in periods of account beginning before I January 2005

Where a company was party to a contract to which S658 would otherwise apply, immediately before the start of its first accounting period beginning on or after 1 January 2005, the grandfathering treatment described at CFM55540 applies.