3G and TCI are the hedge fund that intended to take over certain company like CSX. These kind of hedge fund employ certain strategies that are different from other Hedge fund in the VW cases, they write options speculating the price of Volkswagen goes down, while earn the profit by option premium. they are simply the profit driven hedge fund
1. The risk of volatility of the CSX return because what 3G and TCI received from investment bank are totally determined by the return of the CSX’s common share. So they are exposed to the CSX’s equity risk 3. Regulatory risk Because 3G and TCI have large undisclosed position represented by total return swap (12.6%), literally they defend themselves by just owning the economic benefit of the share. however investment bank actually act as the voting proxy for TCI and 3G and help TCI and 3G gain the seats in the board 4.
In the VW cases, hedge funds are exposed to1. the unlimited lose on the downside of the option2. potential short screeze situation3. The total return swap the TCI and 3G enter into with the investment bank is the contract that mandates TCI and 3G pay a fix rate. In return, investment bank pay TCI and 3G a floating rate based on the performance of common stock of CSX. in order to hedge against the risk exposed to the fluctuation of the price of common share of CSX. investment bank also take the long position of the CSX’s common share. So the risk of the fluctuation of the CSX’s common share does not fall on the shoulder of the investment bank. Since the TCI and 3G enter into total return swap with Investment bank, These two hedge fund bear the risk of the CSX’s common share. by saying that, investment bank basically has no risk related to the risk of the common share. they simply earn the spread. fund who buys the total return swap may expose to the equity risk of the underlying asset. also the funds who buy the total return swap may subject to a higher risk of regulation.
I totally agree with the separation of the economic benefit and voting rights. it is what the modern cooperate based on, since the one who is holding the economic benefits may not be the expert to run the company. while the one who is holding little share might actually know how to run the company. separation of the voting right and economic benefit can enable the firm to work the best way it can. However one share one vote has been a tradition for a long time. even NYSE requires listed company to employ one share one vote policy. this is to ensure that more you are to be influenced by the company’s future cash flow, the more vote you should hold to defend your own right to claim that future economic benefit. it is also true that it is not common to see a company with different classes of common stock with different voting power represents by one share.
However disclosure of significant position in the equity of certain company also keep the market healthy. the disclosure itself serves two purposes 1. disclose the potential buy-out event, stabilize the market 2. protect small investor
3. stabilize the environment of cooperate governance
If total return swap can be contracted with voting proxy agreement, and fail to deliver essential disclosure of the significant position fund took in the stock. I’d say the total return swap is more like a equity itself, and should be disclosed in favor of the whole market stabilization or the protection of the small investor. a hedge fund is an investment fund that can undertake wide range of investment strategy and trading activities based on what kind of roles they are in the financial system, either a hedger, speculator or arbitrager.