Mediobanca’s Generali deal revives an old sec lending concern

Back in April, Italy played host to a compelling boardroom battle over control of insurer Generali. Major shareholder Mediobanca wanted to put in a slate of directors led by the current chief executive officer, while Italian billionaire Francesco Gaetano Caltagirone favoured an alternative team including a new CEO.

Six months earlier, Mediobanca boldly stated that it had borrowed an extra 4.42% of outstanding shares in Generali “from a leading market counterparty” to take its holding over 17% and bolster its voting rights at the upcoming annual general meeting.

Borrowing shares solely to use the voting rights at an AGM – known as empty voting – is a bit of a grey area. In theory, a firm could borrow a large number of shares to influence a company in a direction that is not in the best interests of the stock lender.

The International Securities Lending Association (Isla) does not consider this behaviour best practice. The activity also runs against guidance set out in the UK Money Markets Code, which is embedded in the Financial Conduct Authority’s senior managers regime.

But this particular showdown took place in Italy, where securities regulator the Commissione Nazionale per le Società e la Borsa has not stated any objection. Even so, after some rumblings in the press about the merits of the transaction, Mediobanca put out a statement on April 11, which it said was at the insistence of Consob, to say that it is “fully legitimate” to use voting rights from borrowed shares to influence the direction of an AGM.

At the meeting on April 29, Mediobanca won comfortably with 56% of the vote, meaning the borrowed stock was not the deciding factor. Reuters reported that Mediobanca’s stake dropped back to below 13% a month after the vote. While that was essentially case closed in Italy, the episode has tweaked the nose of the Bank of England.

Given the size of the stock borrow – 4% of one of the largest insurers in Europe – the suspicion is that the liquidity was sourced in the much deeper London market. While this behaviour is rare, the BoE is nevertheless on a mission to ward off a repeat.

In a May meeting of the BoE-led securities lending committee, the central bank declared it was “disappointed that this transaction had taken place in clear breach of Chapter 4, section 6.3 of the UK Money Markets Code”.

That section of the code says “it is accepted good practice in the market that securities should not be borrowed solely for the purpose of exercising the voting rights at, for example, an AGM or EGM”.

The BoE money markets committee said at its May meeting that empty voting fears could erode the confidence of institutional investors to lend shares

Mediobanca is not a signatory to the code but is a member of Isla. In a May blog post, Isla chief executive Andrew Dyson said that borrowing shares to influence an AGM vote “must been seen as market manipulation” and that it causes reputational damage to the securities lending industry.

The BoE money markets committee said at its May meeting that empty voting fears could erode the confidence of institutional investors to lend shares, ultimately threatening proper market function.

A lack of transparency around the intentions of borrowers was one of the reasons Japan’s Government Pension Investment Fund pulled out of stock lending in 2019.

The committee considered whether to ask market participants to re-adhere to the code to remind them of this aspect, but the minutes say it might cause many to withdraw “until a fresh assessment had been undertaken”.

Instead, sources say a letter highlighting these issues is expected to be written from the BoE to market participants. This should include any proposed changes to the code.

The Bank of England declined to comment.

The question now is whether the BoE’s recent efforts will make a difference.

For term loans over a period including an AGM, some suggest lenders could do more due diligence around borrower motivations before entering the transaction.

But much of the lending is done on so-called open transactions with no end date, and on platforms such as EquiLend where there’s no information on a borrower’s intentions.

That means it’s up to the lender to decide whether to recall the shares ahead of an AGM – ultimately a trade-off between the relevance of the vote and the revenues generated from keeping shares out on loan.

There may be other factors driving change. With environmental, social and governance principles requiring that shareholders be more active in votes to keep companies’ corporate governance standards high, recalls could be more common in the future.

Other rules may play a role, for example the UK and EU’s Securities Financing Transactions Regulation requires market participants to report their securities lending and borrowing positions, meaning UK regulators can monitor instances of empty voting more closely.

After firing a warning shot on the issue, UK regulators may choose to police this activity more aggressively in the future. But with a seeming lack of interest in tackling the issue outside of the UK, it is equally possible that this recent burst of attention will fade away as quickly as it surfaced.