The UK’s Financial Services Authority has published a consultation paper proposing greater disclosure of significant “economic interests” in a company’s shares held through derivatives such as Contracts for Difference.

The paper sets out evidence, which shows how potential market failures could occur from using CFDs on an undisclosed basis to influence corporate governance and build up stakes in companies. These failures, although not widespread, need to be addressed to ensure market confidence and efficiency are maintained, the FSA said.

The paper proposes two alternative approaches to securing greater disclosure. The first approach would require disclosure of any CFDs written in reference to 3% or more of total voting rights attached to a company’s shares unless it was clear that: the CFD holder could not exercise voting rights and had made a clear statement to that effect; and, there were no arrangements or understandings in relation to the potential sale of the underlying shares by the CFD holder. The majority of CFDs are expected to fall within this “safe harbour”, removing the need for disclosure.

In addition, this proposal would enable companies to request a notification if they believed a CFD holder had an economic interest of 5% or more of the company’s shares regardless of “safe harbours”. It would also make clear the responsibilities of a CFD holder to ensure that any statements made about voting rights in a company are clear and not misleading. The proposals would also make it harder for CFD holders to build up significant stakes in companies without disclosure. The cost of implementing such targeted disclosure is expected to be minimal.

The alternative approach is a general disclosure regime which would achieve the same objectives by requiring CFD holders to reveal all economic interest of stakes of 5% or more in a company’s shares. The total direct cost of implementation could be about £20 million to £50 million with potential wider costs to the CFD and equity market as a whole. While this regime would cost more it would entail simpler rules.

“This is not a clampdown on CFDs but a means, following extensive research, of addressing the concerns about their use on an undisclosed basis. While the behaviour that concerns us is not widespread, it is important enough to require a tightening of the existing regime to ensure fair and orderly markets,” said Sally Dewar, FSA Director of Markets. “Our goal is to provide an effective and proportionate disclosure regime that works for all involved, and sustains market confidence and efficiency.”

The consultation period will end on Feb. 12, 2008.

Earlier this year, the Investment Dealers Association of Canada published a regulatory study on CFDs, which it expects to become more popular in Canada, outlining its concerns with their place in the existing regulatory regime.