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Why the Shell-BG mega-deal was risky for the City as well as the oil giants

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By Ashley Armstrong7:17PM GMT 27 Jan 2016

It has taken nearly 10 months, five competition regulators and 40 approvals from other global authorities. But Shell’s chief executive Ben van Beurden’s white-knuckle ride is finally drawing to a close.

On Wedensday, van Beurden won overwhelming support for the £40bn takeover from his shareholders. However, his celebrations may well be drowned out by raucous hedge funds who are cheering what one called “a very profitable trade”.

At Shell’s highly-anticipated shareholder vote in The Hague, the mood was serene, with van Beurden and chairman Charles Holliday warmly greeting shareholders, safe in the knowledge that the level of proxy vote support meant the decision was never in doubt.

Throughout the process, Shell has been dogged by criticism that it is ploughing on with a blockbuster deal built on ego during the worst slump since the financial crisis. However, when it came to a two-hour Q&A session after the vote, the most prickly question Shell’s board faced was what the oil giant was planning to do on carbon emissions, according to one investor as he touched back down at Heathrow.

Despite Wednesday’s relaxed environment, the deal has been a fraught process. And it is the level of uncertainty which the City’s hedge funds have capitalised on.

When the deal was first announced, just 0.7pc of Shell shares were out on loan – a way of measuring how many people are shorting the stock. However, during the length of time it has taken to close the deal, that has jumped to 5.2pc, according to data by Markit.

There are two reasons for having shorted Shell, a top hedge fund manager told me: “Either you hate the deal and think Shell’s share price is going to suffer and you’ll be in the money that way. Or”, he said tantalisingly, “what most of us did was short Shell and buy BG shares – locking in the spread between the company’s share price falls and the deal proceeds.”

Merger arbitrageurs exploit the difference between where a company’s shares are trading and how much they will stand to receive should the deal go through. Because of the supposed risks to the deal and the sliding oil price dragging BG shares lower, there was a gaping chasm between the deal price and the cost of BG shares. This created a premium at one point for arbitrageurs of almost 15pc.

The Shell-BG deal was a sweet opportunity, but a dangerous one, too.

In 2014 big hedge funds including Paulson, Elliott, Pentwater and Magnetar were badly burnt, with as much as $11bn lost, following the implosion of AbbVie’s takeover of Shire. The deal, which had been seen as a sure-bet, was suddenly turned on its head when AbbVie split after being threatened with near constant political interference. The losses were so great that it had been dubbed “arbageddon” by some wags.

On the face of it, Shell’s takeover of BG presented an even greater barrage of problems and political meddling.

“We were worried that Brazil’s regulators would take too much time, China would want an arm and a leg and Australia would want the head. But in reality it all went through very smoothly,” another trader said.

Noticeably, there was a big spike in shorting after Shell bagged clearance from the European Commission in November and an even bigger jump when Shell’s board reaffirmed its commitment to the deal in December, despite the oil price plunge. Nevertheless, BG’s shares still languished.

Several hedge funds will have made tens of millions of pounds from the trade, including Davidson Kempner, Farrallon Capital, Pentwater and DE Shaw, who all own more than 1pc of BG shares – meaning they will have placed trades of at least £350m on the deal.

While noteable fund manager David Cumming of Standard Life slammed the deal as destructive, he was outvoted.

On Thursday, it’s BG’s shareholder vote and, unless investors want even more value to be eroded, the takeover is as good as done. As the markets closed on Wednesday, the spread was non-existent and hedgies headed out to the City’s bars to celebrate.

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