How to hedge a promise: the new economics of EBTs

This article has been co-authored by Nigel Watson (Partner, Burges Salmon) and David Edwards (Head of Corporate Secretariat & Shareholder Services at NatWest Group).

Every share plan is a promise and every promise has a price. For listed companies, the question is simple: how, and when, do you pay it?

Issuing new shares is quick and cheap, but dilutive. Buying existing shares is expensive, but protects earnings per share and gives investors comfort on dilution discipline. The Employee Benefit Trust (EBT) is the structure that makes listed market purchases operationally possible and, used strategically, can turn future delivery risk into disciplined capital management.

Why EBT hedging matters now

With investor expectations on dilution and delivery discipline being re-articulated - including the IA’s updated approach to dilution limits - and with UK markets progressing towards accelerated settlement (T+1), boards are re-examining how they fund share plans.

The case for a proactive EBT “hedge” is straightforward. Here, “hedging” simply means pre-funding and/or price-locking the shares needed to satisfy future plan deliveries:

• Reduce dilution and protect shareholder value.
• Fix delivery costs and reduce P&L volatility caused by “buy later” price risk.
• Demonstrate governance maturity through predictable, rules-based execution.

An EBT should not be an afterthought. Properly run, it’s an instrument of capital discipline.

The traditional approach: market purchases

Most issuers still fund LTIPs and share plans through on-market EBT purchases, using company loans or gifts. The principles are simple but important:

• Disclosure thresholds and internal caps: Monitor trust holdings carefully. Crossing 3% of voting rights can trigger DTR notifications (and thereafter at 1% steps). Many issuers also apply a separate internal cap to avoid an outsized “block” sitting in the trust.
• Stamp taxes: at 0.5% applies to on on-market purchases - often modest relative to the dilution avoided.
• Trustee independence: The company may recommend, not instruct. Letters of recommendation, not directions, maintain the fiduciary line.
• Trading discipline: Use agreed dealing parameters (e.g., VWAP references, price caps, volume limits such as 10-15% of daily traded volume) and a clear execution protocol. Where appropriate, execution can be on-book or off-book (away from the LSE order book), provided MAR controls, information barriers and record-keeping are robust.

Some issuers also align EBT purchasing activity with vesting-related sell-to-cover windows. Done properly, this can help manage market impact around larger disposal flows and improve operational cadence for participants - while remaining subject to MAR controls, trustee independence and a robust audit trail. In some cases, issuers also model employer taxes (e.g., employer social security/NIC equivalents) alongside share delivery when forecasting funding needs.

It’s a slow, steady strategy, unflashy, but highly effective. Stock is “on the shelf” before vesting, and both employees and shareholders see the benefit of predictability.

The advanced alternative: total return swaps

For larger or more volatile programmes, some issuers add a synthetic layer: the total return swap (TRS).

Here, the EBT (as legal owner) enters into a TRS with a bank under an ISDA (and related credit support arrangements where required). The bank hedges in the market; the EBT receives the total return on the shares (price movement plus dividends) and pays a financing rate. The swap can settle in cash (to offset cost) or physically (to deliver shares at vesting).

Advantages:

• Price certainty: without being a visible market buyer.
• Cash efficiency: typically margin-based, rather than fully funded up front.
• Execution flexibility: can support execution planning where liquidity or timing is constrained, subject to MAR/inside information controls.
• Working capital efficiency: you can hedge the economic exposure without tying up the full purchase price in cash up front (because the structure is typically margin-based), preserving liquidity for core business uses or other capital priorities.
• Stamp taxes: no SDRT arises simply from entering the TRS (no share transfer). In practice, transaction taxes and hedge costs are typically reflected in swap pricing; SDRT can arise if and when there is physical delivery.

Drawbacks:

• Accounting volatility: fair-value movements can hit the P&L; hedge accounting is rarely available.
• Collateral and liquidity risk: margining can drain cash in falling markets.
• Governance overhead: derivatives require clear board approval, counterparty limits and reporting.
• Documentation: ISDA/CSA, trustee powers in the trust deed and ongoing compliance monitoring.
• Advisory fees: can be significant.

TRS overlays are specialist tools. Issuers should assess trust powers, accounting outcomes, liquidity/margining and MAR controls before proceeding.

In practice, some issuers now blend the two approaches: steady EBT market purchases for base delivery, with TRS overlays to lock in pricing or manage timing mismatches.

Choosing the right tool

• EBT market purchases suits predictable, run-rate delivery where you want stock “on the shelf”.

• TRS overlays can suit lumpy vesting profiles, higher volatility, or situations where signalling matters - particularly where you want economic cover without warehousing stock - provided governance, accounting and liquidity impacts are understood up front.

Comparison at a glance

A hedging programme should be treated with the same governance rigour as a buyback:

• Governance oversight: board-approved policy and risk appetite, with day-to-day execution typically delegated to Treasury (with Legal/Cosec oversight) and periodic reporting on activity, funding usage and forecast accuracy.
• Trustee engagement: independence preserved but operational alignment maintained through agreed parameters.
• Disclosure and MAR controls: DTR/TR-1 notifications where thresholds are crossed; public announcements where required by applicable rules or company policy; and MAR compliance for closed periods/inside information, supported by pre-agreed execution parameters and appropriate information barriers.

This is not finance theatre for the sake of it. It is capital management, executed through a fiduciary lens.

Practical steps for issuers

1. Forecast share plan delivery obligations over 24–36 months (and, for longer-cycle plans, consider a 3-5 year view), with base and stress cases.

2. Model funding scenarios - gift, loan, TRS margin, and (where relevant) buyback/treasury sourcing - including liquidity stress-testing.

3. Approve a formal hedging policy: timing, volume, price parameters, escalation triggers and reporting.

4. Align internal stakeholders (HR, Finance, Treasury, Legal, Cosec) so the forecasting and governance loop actually works.

5. Brief the EBT trustee and document independence safeguards, execution safeguards and audit trail expectations.

The takeaway

At Burges Salmon, we help listed issuers treat share plan funding as a capital management workstream, aligning Remco intent with Treasury execution, trustee independence, MAR controls and disclosure discipline.