Dividend arbitrage under the spotlight in EBA inquiry
19 May 2020 Paris
Image: Kostsov/shutterstock.com
The European Banking Authority (EBA) has grasped the nettle that is dividend arbitrage by publishing the results of its two-year enquiry into the infamous Cum-Ex/Cum-Cum trades.
The securities lending community has long grappled with the legal and moral grey area presented by Cum-Ex/Cum-Cum trades and has spent recent years shaking off accusations that facilitating the borrowing of equities over dividend periods could open the door to bad actors.
The spotlight was first put on Cum-Ex trades in the EU – specifically Germany – following the revelation in 2012 that a loophole in dividend payments could be exploited to allow more than one party to claim a tax refund on the same asset.
Criminal law firm Rahman Ravelli Solicitors estimates that the scandal cost German treasury €10 billion in lost revenue and suggests that there may be more than 10 other European countries affected, representing a further €55 billion of lost tax revenue.
In 2019, the German authorities, which since the scandal broke has been leading the charge in clamping down on those seeking to cheat the taxman, conducted police raids the offices of ABN AMRO and Clearstream, as well as the homes of traders, as part of its campaign against market abuse.
ABN AMRO's offices were raided for a second time in February for similar reasons, according to a report by Bloomberg.
Both firms stated at the time of the raids that they were fully cooperating with authorities on the matter.
In March, two former London-based traders were convicted in Germany of tax evasion related to Cum-Ex trades.
In part, the association with these events and securities lending is due to the fact that dividend arbitrage is a notoriously misunderstood trade type outside those few traders that conduct them.
As a result, the negative perceptions and suspicion from the headline-grabbing examples of arbitrage being used for tax evasion by a minority of bad actors have led to legitimate securities lending activities being tarred with the same brush.
This issue is highlighted prominently in the EBA’s report on dividend arbitrage schemes which looked into the actions of prudential and anti-money laundering (AML) and countering the financing of terrorism (CFT) supervisors in dealing with such schemes.
The EU regulatory agency says its study shows that national authorities do not share the same understanding of dividend arbitrage trading schemes, due to differences in member states’ domestic tax law.
The EBA concludes that facilitating, or handling proceeds from tax crimes undermines the integrity of the EU’s financial system and, therefore, sets out a number expectations of credit institutions and national authorities under the current regulatory framework.
These expectations come in the form of a 10-point action plan for 2020/21 to enhance the future framework of prudential and AML requirements covering such schemes.
The EBA says the action plan seizes on the opportunities afforded by recent legislative changes in the EU Capital Requirements Directive and the EBA’s AML/CFT mandate in the EBA regulation, which will be implemented in this year and next year.
The points are largely aimed at stamping out the lingering ambiguity around such schemes and includes a requirement for the policies implemented by institutions to set out
principles on, and provide examples of, acceptable and unacceptable behaviours linked
in particular to misconduct and financial crime.
Commenting on the report’s findings, Roy Zimmerhansl, practice lead and founder of Pierpoint Financial Consulting, tells SLT that it highlights “an area of nagging concerns for both lenders and non-lenders”.
“The eventual outcome is that national competent authorities and tax authorities will have scoured the activity in their markets, scrubbed clean any abuse they find and participants are on notice that their oversight will be under scrutiny.
“Just like the period after the short selling bans in 2008/2009 led to more countries encouraging short selling and fewer countries implementing bans this time around, I expect these inquiries to lead to general discomfort, followed by more openness and a bigger, more transparent market in future.
“These ructions are adjustments along the way, but ultimately help ensure the longevity of securities lending. The legacy opacity of the business has held it back in some corners.”
The EBA’s enquiry was the result of the European Parliament tasking the European Securities and Markets Authority (ESMA) and the EBA with investigating dividend arbitrage trading schemes in November 2018 to assess potential threats to the integrity of financial markets and to national budgets.
The study further sought to establish the nature and magnitude of actors in these schemes; to assess whether there were breaches of either national or EU law; to assess the actions taken by financial supervisors in member states; and, to make appropriate recommendations for reform and for action to the competent authorities concerned.
The EBA fulfilled the request by submitting two surveys to national authorities, by assessing
the responses to them, and by setting out its expectations of credit institutions and national
authorities under the current regulatory framework.
The action plan created after analysing the results of those surveys includes conducting a fresh inquiry in the future to monitor how national authorities are getting on in stamping out bad practices.
The securities lending community has long grappled with the legal and moral grey area presented by Cum-Ex/Cum-Cum trades and has spent recent years shaking off accusations that facilitating the borrowing of equities over dividend periods could open the door to bad actors.
The spotlight was first put on Cum-Ex trades in the EU – specifically Germany – following the revelation in 2012 that a loophole in dividend payments could be exploited to allow more than one party to claim a tax refund on the same asset.
Criminal law firm Rahman Ravelli Solicitors estimates that the scandal cost German treasury €10 billion in lost revenue and suggests that there may be more than 10 other European countries affected, representing a further €55 billion of lost tax revenue.
In 2019, the German authorities, which since the scandal broke has been leading the charge in clamping down on those seeking to cheat the taxman, conducted police raids the offices of ABN AMRO and Clearstream, as well as the homes of traders, as part of its campaign against market abuse.
ABN AMRO's offices were raided for a second time in February for similar reasons, according to a report by Bloomberg.
Both firms stated at the time of the raids that they were fully cooperating with authorities on the matter.
In March, two former London-based traders were convicted in Germany of tax evasion related to Cum-Ex trades.
In part, the association with these events and securities lending is due to the fact that dividend arbitrage is a notoriously misunderstood trade type outside those few traders that conduct them.
As a result, the negative perceptions and suspicion from the headline-grabbing examples of arbitrage being used for tax evasion by a minority of bad actors have led to legitimate securities lending activities being tarred with the same brush.
This issue is highlighted prominently in the EBA’s report on dividend arbitrage schemes which looked into the actions of prudential and anti-money laundering (AML) and countering the financing of terrorism (CFT) supervisors in dealing with such schemes.
The EU regulatory agency says its study shows that national authorities do not share the same understanding of dividend arbitrage trading schemes, due to differences in member states’ domestic tax law.
The EBA concludes that facilitating, or handling proceeds from tax crimes undermines the integrity of the EU’s financial system and, therefore, sets out a number expectations of credit institutions and national authorities under the current regulatory framework.
These expectations come in the form of a 10-point action plan for 2020/21 to enhance the future framework of prudential and AML requirements covering such schemes.
The EBA says the action plan seizes on the opportunities afforded by recent legislative changes in the EU Capital Requirements Directive and the EBA’s AML/CFT mandate in the EBA regulation, which will be implemented in this year and next year.
The points are largely aimed at stamping out the lingering ambiguity around such schemes and includes a requirement for the policies implemented by institutions to set out
principles on, and provide examples of, acceptable and unacceptable behaviours linked
in particular to misconduct and financial crime.
Commenting on the report’s findings, Roy Zimmerhansl, practice lead and founder of Pierpoint Financial Consulting, tells SLT that it highlights “an area of nagging concerns for both lenders and non-lenders”.
“The eventual outcome is that national competent authorities and tax authorities will have scoured the activity in their markets, scrubbed clean any abuse they find and participants are on notice that their oversight will be under scrutiny.
“Just like the period after the short selling bans in 2008/2009 led to more countries encouraging short selling and fewer countries implementing bans this time around, I expect these inquiries to lead to general discomfort, followed by more openness and a bigger, more transparent market in future.
“These ructions are adjustments along the way, but ultimately help ensure the longevity of securities lending. The legacy opacity of the business has held it back in some corners.”
The EBA’s enquiry was the result of the European Parliament tasking the European Securities and Markets Authority (ESMA) and the EBA with investigating dividend arbitrage trading schemes in November 2018 to assess potential threats to the integrity of financial markets and to national budgets.
The study further sought to establish the nature and magnitude of actors in these schemes; to assess whether there were breaches of either national or EU law; to assess the actions taken by financial supervisors in member states; and, to make appropriate recommendations for reform and for action to the competent authorities concerned.
The EBA fulfilled the request by submitting two surveys to national authorities, by assessing
the responses to them, and by setting out its expectations of credit institutions and national
authorities under the current regulatory framework.
The action plan created after analysing the results of those surveys includes conducting a fresh inquiry in the future to monitor how national authorities are getting on in stamping out bad practices.
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