The Role of Sovereign Wealth Funds in the Glencore Xstrata Saga

May 14, 2013 by Loch Adamson

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ON MAY 2 commodities trading giant Glencore International completed its controversial $66 billion merger with Xstrata, the world’s largest thermal-coal miner. The deal, which was announced by the two Swiss companies in February 2012, had been billed as an "all-share merger of equals," but critics contended that it shortchanged Xstrata shareholders while lining the pockets of executives at both companies with multi-million-pound retention payments regardless of the success or failure of the combined entity. As a result of pressure from investors, Glencore eventually revised the original terms of the deal and upped its price offering.

The Glencore-Xstrata merger would likely have fallen through without the actions of sovereign wealth funds, led by Qatar Holding (QH), a subsidiary of the Qatar Investment Authority (QIA). QH played an important role in getting Glencore to agree to better terms. Its activism galvanized other sovereign funds to action — in particular, Norway’s Government Pension Fund Global (GPFG) and Government of Singapore Investment Corp. (GIC) — and signaled the start of a new era in which sovereigns can no longer be counted on to stand by as passive investors.

Much of the original criticism of the merger had to do with the cozy relationship between Glencore and Xstrata, both of which had primary listings on the London Stock Exchange. (Xstrata had a secondary listing on the SIX Swiss Exchange) Glencore had spun out Xstrata in 2002, and the trading company retained a 34 percent shareholding, which gave it substantial influence on the Xstrata board. In fact, it was Glencore board members, including CEO Ivan Glasenberg, who drove the appointment of Mick Davis as chief executive of Xstrata. Investors often characterized Davis as a puppet of the Swiss trading firm.

Some skeptical Xstrata investors were disappointed with the original terms of the merger, which gave them 2.8 shares of the merged entity for every share of Xstrata they owned. They felt they should be paid more, arguing that the mining company had better assets, a more robust balance sheet and stronger growth prospects than Glencore. Edinburgh-based Standard Life Investments and the U.K.’s Schroders, which between them owned 3.6 percent of Xstrata, said the deal undervalued the company and that they would vote against the merger. These grumblings were largely overlooked until May, when the British media revealed that Xstrata executives would be receiving a windfall without any link to performance. Under the terms of the deal, Davis would be paid nearly £29 million ($44.7 million) in three annual "retention payments" following the merger, and 64 of Xstrata’s senior employees were offered similar payments, amounting to a total of £46.4 million. This ran counter to the zeitgeist in London, where the "shareholder spring" and public opinion had forced public companies to reduce executive pay awards. Consequently, the Association of British Insurers issued a "red-top alert" about the retention awards offered to Xstrata executives.

Into this cauldron leapt QH, which owned a little more than 3 percent of Xstrata at the time the merger was announced. The sovereign fund began buying additional shares in daily open public transactions. Initially, the market appeared to consider QH’s purchases a vote of confidence in the transaction, likely spurred by coverage in London’s Sunday Times in mid-April. QH increased its Xstrata holding almost every trading day from February 22 to June 13, bringing its stake to 10.98 percent and becoming the second-largest shareholder after Glencore at a cost of £2.59 billion. Two weeks later QH issued a statement to the LSE saying it had informed Glencore that while it saw merit in a merger, it was seeking improved terms of 3.25 new-entity shares for every Xstrata share to provide a "more appropriate distribution of benefits of the merger."

Moves to overcome the differences between Glencore and QH failed, and the company called an extraordinary general meeting for September 7. QH continued its buying spree and hardened its stance against the merger. On August 30 it issued another statement, committing to its previous position; by then it owned 12.3 percent of Xstrata. What happened next was unexpected. On September 6, Glencore released a statement to the market saying it would postpone the EGM. But a last-ditch overnight meeting between Glencore CEO Glasenberg and the chairman of QIA, Qatari Prime Minister Hamad bin-Jassim bin-Jabr al-Thani, mediated by former British prime minister Tony Blair, came up with a solution and much-revised terms: a takeover of Xstrata rather than a merger, with a single management structure led by Glasenberg as CEO; Davis would be made redundant. Investors would get 3.05 Glencore shares for each Xstrata share. The terms and structure were welcomed by several smaller shareholders, including Standard Life, and proposed for a vote at another Xstrata meeting.

Although QH has been unafraid of the limelight, other, less-visible sovereign funds also had an interest in the deal — and added to the clout wielded by the Qataris. Norway’s GPFG, managed by Norges Bank Investment Management (NBIM), was a shareholder in both Glencore and Xstrata. While it has maintained its Glencore holding at less than 0.5 percent, after privately indicating to both Xstrata and Glencore that it opposed the merger terms, it raised its Xstrata stake to more than 3 percent, from 1.76 percent in February 2012. This situation meant that QIA and NBIM owned enough shares between them to block the merger, and they were backed by several smaller shareholders, adding to QH’s ability to play hardball with Glencore.

The dark horse was GIC. When the two companies announced the merger, the Singaporean sovereign fund held stakes of just under 1 percent in Xstrata and about 0.6 percent of Glencore. From February 2012 onward, GIC slightly increased its Xstrata shareholding, but there was more to the story than that. In 2009, Glencore had raised $2.2 billion in convertible bonds from a group of investors including GIC; New York–based investment behemoth BlackRock; Greenwich, Connecticut–based private equity firm First Reserve Corp.; and China’s third-largest copper producer, Zijin Mining Group Co. Under the contract the bonds were due December 2014 and convertible into Glencore shares upon an initial public offering or "other pre-determined qualifying event," such as a merger. Glencore listed 20 percent of its equity on the LSE in May 2011, but GIC did not convert; rather, it bought its small holding of ordinary shares. Filings required by the merger reveal that GIC’s bonds would convert into about 26 percent of Glencore — turning GIC into a powerful player in the deal.

During the review of the proposal put forward to Xstrata on September 7, 2012, it became clear that negotiations were faltering over the merged company’s postdeal governance structure. With governance at both the board and senior management levels an issue for Xstrata from the outset, QH began privately backing the mining company’s management retention proposal. Negotiations pressed on past the formal September 27 deadline, and the U.K.’s Takeover Panel granted an extension to the companies for October 1. At this point, Glencore and Xstrata had reached a revised agreement on the all-share merger that gave Xstrata’s shareholders the option of approving the takeover regardless of a separate vote on the company’s related executive retention package. The new agreement was seen by some Xstrata shareholders, led by London-based Threadneedle Investments and activist Swiss investor Knight Vinke, as "deeply disappointing" and a consequence of Xstrata’s nonexecutive directors’ failing "to demonstrate sufficient independence and robustness throughout this process."

Following the agreement QH went public for the first time concerning its stance on the deal. On October 15 the Qatari prime minister indicated Qatar’s support but omitted any details of the fund’s view of the significant change in Xstrata’s management retention package — an agreement that QH had earlier said was essential to the deal. Then, on November 15, QH formally clarified its position. In contrast to the strong position it took on the deal’s share price over the summer, QH backed down on the issue of executive retention. Noting in a release that Qatar still "strongly" believed that retention of Xstrata’s operational management would be crucial to the takeover’s success, the sovereign fund stated it would abstain from voting on the issue of management because it was "conscious of the sensitivities concerning governance in the U.K."

Five days after QH’s statement, Xstrata’s shareholders met in Zug, Switzerland, to decide whether to accept or reject the takeover. Despite QH’s support of the retention of Xstrata’s management and board, the company’s shareholders voted in favor of the takeover but rejected the revised management incentive arrangements.

Confirmation of the deal rescued Glencore from the downward spiral that the company, encumbered with debt and financing problems, had experienced throughout 2012. In November, Glencore’s largest shareholder, Aabar Investments — a unit of Abu Dhabi’s state-owned International Petroleum Investment Co. (IPIC) — wrote off losses totaling $392 million of its initial investment of $1 billion at the company’s 2011 IPO. In November, Glencore’s shares were trading at approximately 40 percent below their IPO price of £5.30, underperforming the global mining sector by 10 percentage points because of a combination of internal problems and cooling global demand for commodities.

In anticipation of a revived demand for Glencore shares as a result of the approved Xstrata takeover, on April 29, 2013, GIC sold 250 million of its 600 million convertible bonds through Morgan Stanley for $121 million. With part of the proceeds of the sale, GIC bought £55 million of Glencore shares. This transaction leaves GIC with bonds that would have converted into 15.2 percent of Glencore (10.2 percent of the merged entity).

Earlier this month, 450 days after the original merger announcement, the new Glencore Xstrata started trading on the LSE. Glencore’s senior management took 15 of 17 executive positions within the company, leaving two of Xstrata’s executives to manage iron ore and coal mines. The takeover created the fourth-largest natural-resources group in the world, with a market capitalization of $71 billion, trading and producing more than 90 commodities and spanning 50 countries.

This saga highlights a couple of serious points. First, sovereign wealth funds are no longer simply passive investors. While Qatar is unusual among sovereigns for not fearing publicity, its activism has inspired other funds to action. As sovereign funds continue to diversify their holdings in pursuit of a better risk-return profile and increasingly rely on internal management and direct investment to do so, they are likely to take a more active interest in the management of their portfolio companies.

Second, although QH’s activism provided the sovereign wealth community with lessons regarding the negotiating power that funds can wield over their holdings, the deal also illustrated the delicate ground on which they walk when investing internationally. Following the Glencore-Xstrata merger, it has become apparent that sovereign funds are subject to constraints associated with high-profile transnational deals, despite their significant negotiating power. Most notably, QH’s abstention in voting for Xstrata’s executive retention package demonstrates the political dimension of foreign direct investment: Had QH voted against the majority of Xstrata’s U.K. shareholders, it is likely that this would have generated an international furor, as Qatar could have been seen as meddling with European corporate conventions.

Last, the deal sheds a light on the growing role of government investors in markets. Had the merger gone ahead on the terms proposed in August 2012, sovereign wealth funds from Norway, Qatar, Singapore and the United Arab Emirates would have held a combined 12.8 percent shareholding in the new company. If the takeover had been a "qualifying event" for GIC to convert its bonds, this would have risen to 28.7 percent — enough for at least two of the larger sovereign investors (GIC and QIA) to have seats on the board and work in concert to protect their interests in the commodity supply chain. Though this may have functioned as a check on the apparent cronyism of the original proposed executive structure for Glencore Xstrata, it does lay bare the extent to which governments are increasingly likely to play a crucial role in the commodities markets — and the need for them to act as good corporate citizens.

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