On Thursday morning Edward Bramson, a prominent activist investor and major shareholder in Barclays PLC (LON:BARC), found himself in hot water with other major investors after it was revealed in the Financial Times that he had used a complex financial instrument known as a ‘funded equity collar’ to borrow US$1.4bn from Bank of America (BoA) to help build up a 5.5% stake in the British bank.
The move forms part of an ongoing effort by Bramson to force himself onto Barclays’ board and scale back the bank’s operations, a strategy opposed by the incumbent chief executive Jes Staley.
The fact that the US bank was essentially backing an attack on a rival by granting the loan didn’t do BoA’s reputation any good either.
But what exactly is a “funded equity collar” and why has its use provoked so much ire for both Bramson and Bank of America?
What is it?
An equity collar is a trading technique in which someone, usually an investor with a big position in a financial security, takes out options (financial security derivatives) on a share to protect themselves from a big movement in the underlying stock; effectively, the strategy involves betting that the stock will go up while also betting that it will go down.
The investor may be unwilling to sell the stock for several reasons, possibly relating to tax liabilities or sending the wrong signal to other shareholders if they sell, and so they give up some of the upside potential to protect themselves against downside at little or no cost.
Regarding ‘funded’ equity collars, the key difference is the shareholder will usually take out a loan from a bank to purchase the collared shares, with the lender using the stake in the company as collateral.
In this situation, the lender’s risk is not on the borrower’s creditworthiness but on the volatility of the shares that have been used as collateral for the loan, and the shares are something the bank can easily hedge against.
So why is Bramson in hot water?
While some investors may opt for a collar to avoid giving the wrong impression to other stakeholders by selling, the fact that Bramson has employed the technique for Barclays has not exactly projected conviction in his desire to turn the company around given the position protects him from losses.
There is also speculation that Bramson could be using the collar to protect his coffers should his attempted disruption, if pulled off, fails in the long-term.
And why is it bad for Bank of America?
One of the more obvious criticisms of BoA revolves around the breaking of a gentleman’s agreement among banks that they will not fund activist attacks on competitors.
The institution has also come under fire as the revelation of its short position caused a higher turnover in the shares, attracting what many see as unwanted attention to the stock given its 23% drop over the last year.
In late-afternoon trading Thursday, Barclays shares were down 0.8% at 165.5p.