Canada's plans to significantly tighten rules that force disclosure by investors accumulating large stakes in companies are not popular with all shareholders, including the activist investor community that is now suggesting Canada may no longer be a target for shareholders trying to shake up management.
Depending on where you sit, that may or may not be a good thing. Hedge funds have their share of critics. However, if you are a long-time shareholder of Canadian Pacific Railway, for example, you might want a hedge fund doing activism. CP is worth more than double what it was when activist Bill Ackman of Pershing Square Capital Management got involved.
The goals of the proposal at first are hard to question. The market will know sooner who is buying into a company. What could be wrong with that? Plenty, it turns out, according to a broad swath of shareholders. It's not just activist hedge funds who are unhappy. There are significant questions raised by everyone from investors in Canadian small-capitalization companies to some of the biggest pension funds in Canada, including the Caisse de dépôt et placement du Québec and the Ontario Teachers' Pension Plan.
The rules that Canada is proposing are on the surface, quite similar to those in other regions.
The centrepiece is lowering the disclosure threshold from 10 per cent of a company's stock to 5 per cent. However, there are other changes that make Canada tougher.
First, in the U.S., once reaching 5 per cent, there is a 10-day window in which to file a report. That enables a fund to buy far more before actually disclosing. Many funds are able to hit double digits by the time the actual disclosure kicks in. Under Canada's proposed rule, the filing would have to be made immediately.
Secondly, not only would a fund have to file right away, under the proposed Canadian rule it would have to observe a one-day "moratorium" that would require a halt to buying for a full day.
The effect will be to make it very tough to acquire a stake of greater than 5 per cent at undisturbed prices. Once word is out that an activist is involved, the underlying stock usually takes off higher, making it more expensive for the activist.
And that, some in the activist industry argue, will make it difficult to do as much activism in Canada. An activist has less leverage with a 5-per-cent stake than a 10-per-cent stake, but speaking to some in the industry that is not the issue. Even a small stake is enough to push management.
The real issue is economic. Without a large stake, the returns are not big enough in many cases to justify the time and effort of a proxy battle.
"The lower threshold will make share acquisitions by engaged investors more expensive and, in many circumstances, too costly to justify the resources, time and effort for such activity. This, in turn, will chill the market for engaged investing, and erode the benefits of the value creation that results from having shareholder engagement," the hedge fund industry said in a letter to Canadian securities regulators.
It's not just hedge funds that are not happy. Everyone from small-cap managers to some of the biggest institutions in Canada has issues with the changes.
Ontario Teachers' Pension Plan laid out a similar concern to the hedge fund industry, saying that lowering the threshold to 5 per cent forces investors to consider whether it is worth the time and effort to try to dig up undervalued companies in Canada.
"We believe the combination of lowering the investment threshold to 5 per cent and the revised disclosure requirements will have the unintended consequence of incentivizing investors to invest less in Canada and to allocate capital elsewhere."
The Caisse de dépôt et placement du Québec, one of the country's largest pension funds, raised the concern that it is so big that it has 5 per cent of many companies. It would have to issue roughly 50 news releases a year, by its estimate, up from 10 currently. Having to disclose earlier, and more often (because any 2-per-cent change after that triggers another disclosure) will "hinder agility" for big funds, the Caisse argued, in asking for an exemption for passive managers.
At the other end of the spectrum, Hugh Cleland, a portfolio manager at BluMont Capital Corp., suggested the change could have a "devastating impact on the share prices, cost of capital and access to capital" for smaller companies. That's because many portfolio managers don't want to report holdings, and so limit themselves to holdings below the disclosure threshold.