Posted by Michael McKee and Chris Whittaker on 21 May 2020
Tagged to Dividends, EBA, Financial Crime, MLD5, Regulation

On 12 May 2020, the European Banking Authority (EBA) published its Report into dividend arbitrage trading schemes and announced a 10 point Action Plan to enhance the future regulatory framework.

Background to the Report  

The EBA had been charged by the European Parliament with conducting an inquiry into dividend arbitrage trading schemes to assess their potential threat to the integrity of financial markets and to make recommendations for reform and action by national competent authorities concerned.

What is dividend arbitrage?

Dividend arbitrage trading schemes (otherwise known as dividend stripping) involve the strategic placement of shares in different tax jurisdictions with a view to minimising withholding taxes, i.e. a levy deducted at source from income, for example dividends, which is paid by the company that generates the income or dividends.  

Where a withholding tax is imposed on dividends generated in one tax jurisdiction, shareholders in another tax jurisdiction can claim back a part of this tax if both jurisdictions have concluded a double taxation agreement.

The cum-ex strategy of dividend arbitrage has gained particular notoriety where traders hedge the difference in value between shares cum (with) and ex- (without) dividends, by using put options. The use of such schemes is being investigated in Germany and across other European states such as Denmark, Belgium, Austria, Switzerland and Norway. According to the European Parliament, these schemes may have cost European taxpayers approximately EUR55 billion between 2001 and 2012.

EBA Survey

In preparing the report, the EBA provided surveys to anti-money laundering (AML) authorities and prudential authorities across the European Union.

The EBA questioned AML authorities on whether cum-ex and cum-cum schemes were treated as tax crimes in each country and, consequently, whether the handling of proceeds from such schemes would amount to money-laundering under the Fifth Anti-Money Laundering Directive (EU) 2018/843 (MLD5).

The EBA questioned prudential supervisors to gain an understanding of how financial institutions’ involvement in such schemes complied with the prudential framework and in terms of the  institutions’ governance requirements.

Findings of the Report  

The EBA Report noted that national AML supervisors do not share the same understanding of dividend arbitrage trading schemes due to differences in Member States’ domestic tax law. Eight AML supervisors responded to the survey noting that, in their Member States, dividend arbitrage trading schemes were tax crimes. In all other cases, national AML supervisors indicated that dividend arbitrage schemes were not tax crimes under national law.

The EBA Report noted that most supervisors had not considered the relevance of dividend arbitrage to financial institutions’ sound and prudent management and for money laundering/terrorist financing (ML/TF) risks. Few supervisors have taken any supervisory actions. Where competent authorities took action, this was largely in response to ML/TF or governance matter that had already crystallised.

The EBA Report also noted that most competent authorities (prudential and/or AML supervisors) had not cooperated with other public authorities in their jurisdiction (such as tax authorities) or with other Member States because they believed that there were no dividend arbitrage trading schemes in their Member State. In spite of the link between dividend arbitrage schemes and tax crimes, only one competent authority had cooperated with tax authorities in their Member State.

The EBA report concluded with the EBA’s expectations of AML and prudential authorities and next steps. This included an expectation that AML supervisors reach out to local tax authorities to establish whether certain dividend arbitrage trading schemes constitute tax crimes and, if so, inform prudential authorities.

10 Point Action Plan  

The EBA 10 Point Action Plan proposes that the EBA undertake the following:

1.      Amend Guidelines on Internal Governance in order to ensure that the management body develop, adopt and adhere to high ethical and professional standards;

2.      Amend Guidelines on the Assessment of the Suitability of Members of the Management Body and Key Function Holders;

3.      Amend Guidelines on Supervisory Review and Evaluation Process (SREP) to include appropriate reference to tax crimes, such as dividend arbitrage schemes;

4.      Monitor prudential colleges, with report on 2020 convergence;  

5.      Assess Guidelines on AML risk factors to identify whether the existing references to tax crimes contained in the draft guidelines are sufficient to address the risks arising from dividend arbitrage trading schemes;

6.      Amend Guidelines on Risk-Based Supervision to include a requirement for AML competent authorities to, in a risk-based approach, assess and address ML/TF risks associated with tax crimes like illicit dividend arbitrage schemes;

7.      Amend Opinion on ML/TF Risks. The next Opinion is planned to be published in Q1 2021;

8.      Continue to assess AML competent authorities’ handling of ML/TF risks associated with tax crimes, with report on findings;

9.      Monitor discussions in AML/CFT colleges and report;

10.  Carry out inquiry under Article 22 of the EBA Regulation into the actions taken by financial institutions and national authorities within their competencies to supervise compliance with requirements applicable to dividend arbitrage trading schemes.

DLA Piper comment

This Report and Action Plan suggests that the EU is likely to take further action in this area. 

The EU has an increasingly aggressive approach towards AML and the report tends to suggest that the EU would like to categorise activity of this sort as anti-money laundering but is hampered by the fact that most member states do not treat it as even a tax crime. Firms will need to consider their risk appetite for facilitating activity of this sort – with the practical difficulty being that their customers, if engaging in such activity, are unlikely to tell them that that is what they are doing.

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