CFM62920 - Foreign exchange: matching: derivative contracts used to hedge share transactions: acquisitions

REG 5ZA(2)(a)(i) and (iii) S.I. 2004/3256

A company may use a derivative contract to hedge the currency risk in relation to an anticipated future acquisition of a relevant shareholding (see CFM62915).

Hedging direct acquisitions of a relevant shareholding

The most straightforward scenario is where the company making the acquisition enters directly into a derivative contract with an unrelated party to hedge the foreign exchange risk arising from the anticipated acquisition.

In other cases, one company in a group may enter into a derivative contract with a third party and pass on the effect of this hedge to the company making the acquisition, by using a derivative contract on equivalent terms. For further detail on this rule see CFM62932.

Indirect acquisitions

However, there may be circumstances where it is not feasible for internal derivative contracts to be entered into in this way, for instance but not limited to, cases where security arrangements required by external lenders prevent the use of such ‘internal’ derivative contracts. REG 5ZA is extended to cover certain circumstances where the company that is party to the hedging derivative contract acquires the shares indirectly.

In particular, a derivative contract may hedge the foreign exchange risk in relation to the subscription of shares in, or the entering into of a creditor loan relationship to provide debt funding for, another company for the purposes of financing (directly or indirectly) the anticipated acquisition of a relevant shareholding. This is a hedge of an anticipated transaction: the hedged item is in effect the foreign currency amount that needs to be subscribed on issue of the shares or creditor relationship, rather than any risk arising from the holding once the subscription has been made.

Conditions relating to the acquisition vehicle

REG 5ZA(3) requires the company with the hedging relationship to have a substantial shareholding in the company that is acquiring the relevant shareholding (the acquisition vehicle). This can be at the time the derivative contract is entered into or before the anticipated acquisition of shares completes.

In this context, the substantial shareholding test (TCGA92/SCH7AC/PARA8) is widened to incorporate indirect shareholdings as there could be a chain of companies between the company with the hedging relationship and the acquisition vehicle (the company with the anticipated share acquisition).

This acquisition vehicle need not necessarily be a subsidiary of the company hedging the acquisition. It could also be a joint venture vehicle in which the company entering into the hedging derivative contract holds at least 10% of its ordinary share capital (and so there is no requirement that the company hedging the proposed acquisition owns 75% or more of the ordinary share capital in the acquisition vehicle).

Funding the acquisition vehicle

In an indirect acquisition of a relevant shareholding, the funding of the acquisition may take the form of the issue of shares or entry into a creditor relationship or a combination of the two. The relevant hedging relationship will be between the derivative contract and the forecast cashflow in relation to the subscription for shares or creditor relationship. There can be a series of share subscriptions or debt issues. ‘Creditor relationship’ takes its meaning from CTA09/S302(5).

It does not matter for the purposes of REG 5ZA where, for example, if the anticipated transaction was originally intended to be funded by a subscription of shares but was subsequently changed to be funded through a loan relationship (or vice versa). As long as the relevant hedging intention exists, the relevant amounts will be disregarded.

Incidental costs

In the case of a direct acquisition, a derivative contract can hedge the currency risk associated with the acquisition cost of the shares and any incidental costs associated with the acquisition. Incidental costs are those allowable under TCGA92/S38(2). In the case of an indirect acquisition, a hedged subscription for shares or for the issue of a creditor loan relationship may be of a sufficient amount to also cover the incidental acquisition costs of the acquisition of the relevant shareholding.

Bringing amounts into account

The application of the EGLBAGL Regulations, SI2002/1970, which may bring amounts into account on a disposal of a relevant shareholding is dealt with at CFM62950. This guidance also deals with bringing amounts back into account where a derivative contract has hedged the foreign exchange risk in relation to the entry into a creditor relationship, used to fund the acquisition of a relevant shareholding.

Further guidance

There are example acquisition scenarios at CFM62925.