CFM62925 - Foreign exchange: matching: derivative contracts used to hedge share transactions: example acquisition scenarios

Example 1

PQ Ltd has agreed to acquire 60% of RS Ltd for €100 million, although the deal is dependent on receiving regulatory agreement. PQ Ltd is a GBP functional currency company and therefore decides to take out a deal contingent forward contract over €100 million to hedge its exposure to the acquisition cost.

PQ Ltd has a relevant hedging relationship between the deal contingent forward and the anticipated acquisition of the shares in RS Ltd.

Example 2

A plc has a wholly owned subsidiary B Ltd, with B Ltd having a wholly owned subsidiary C Ltd (B Ltd and C Ltd could also be non-UK resident companies). A plc has an anticipated transaction to acquire the whole of Z Inc, based in the United States, for $1 billion. C Ltd is the international holding company for the group’s foreign operations, so will acquire the shares in Z Inc. A plc enters into an ordinary forward contract to hedge the foreign exchange risk between US dollars and sterling.

As A plc with the derivative contract is not acquiring the shares, the company intends to enter into a creditor loan relationship of $500 million with B Ltd and subscribe for shares in B Ltd of $550 million, which includes $50 million to cover incidental costs. B Ltd will then directly pass these funds to its subsidiary C Ltd to acquire the shares in Z Inc. These transactions are carried out on the date the share transaction completes (although this is not required for REG 5ZA to be in point, the share subscription and entering into a creditor relationship may have happened in the days leading up to the acquisition).

A plc has two forecast transactions as the hedged item, the cash advance under the creditor loan relationship and the cash subscription of shares, which relate to the anticipated transaction (being the acquisition of Z Inc by C Ltd). A plc therefore has a relevant hedging relationship between the derivative contract and these hedged items.

Example 3

ABC Ltd intends to acquire the shares of XY Inc for $500 million. Instead of ABC Ltd holding the shares, it intends to incorporate a new wholly owned United States subsidiary, Bidco Corp, which will acquire all the shares in XY Inc. The amount of funding to be provided to Bidco Corp is expected to be $500 million (it may not be determined upfront whether the $500 million would be shares or debt or a combination). ABC Ltd enters into an ordinary forward contract to hedge the currency risk between its functional currency of GBP and USD. Bidco Corp is incorporated a month before the transaction completes and, as expected ABC Ltd makes a share subscription of $500 million. This will be a substantial shareholding in Bidco Corp. Bidco Corp, in turn, will apply these funds to acquire the shares in XY Inc on completion of the anticipated acquisition. The share subscription is also the hedged item in relation to the anticipated share acquisition. ABC Ltd therefore has a relevant hedging relationship of this hedged item resulting from the intended acquisition of the shares in XY Inc, made by the connected company Bidco Corp.

Example 4

XYZ Ltd enters into an agreement to join with three other companies, each with an equal share in the acquisition of the entire share capital of the Australian based OZ Ltd, for AUD$800 million. JV Ltd, a joint venture company between the four investing companies, is incorporated in Australia to acquire OZ Ltd. Each investing company will subscribe for shares worth AUD$200 million to fund the future share acquisition of OZ Ltd.

XYZ Ltd takes out a deal contingent forward contract to hedge its exposure to making the investment of AUD$200m. The subscription of shares in JV Ltd is a forecast transaction relating to the anticipated acquisition of OZ Ltd. XYZ Ltd therefore has a relevant hedging relationship.

Example 5

AHC Ltd, a qualifying asset holding company (QAHC), enters into an agreement to acquire, indirectly, 8% of the share capital of German based GER GmbH for €50 million. AHC Ltd indirectly owns the entire share capital of Bidco GmbH, which will be the acquisition vehicle. To fund the acquisition, AHC Ltd intends to subscribe for shares worth €50 million in Bidco GmbH and enters into a derivative contract to hedge the foreign exchange risk between the AHC functional currency of GBP and the euro cash subscription of shares. There is therefore a relevant hedging relationship.

There is a requirement to consider the substantial shareholding test as regards this acquisition vehicle. As AHC Ltd indirectly owns the entire share capital in Bidco GmbH, this requirement is met.

However, as AHC Ltd is a QAHC it does not matter that the shares being acquired do not represent a substantial shareholding. However, in this case, the shares should be “qualifying shares” as defined in FA22/SCH2/PARA53, IFM40930

It should be noted that, to qualify as a QAHC, AHC Ltd’s main activity must be carrying on an investment business which does not include the acquisition of listed or traded equity securities - FA22/SCH2/PARA13(2)(a), see IFM40265.