Dividend Arbitrage: Mitigating Exposure To Europe’s Largest Tax Scandal

The FCA is set to announce the outcome of its investigations into dividend arbitrage practices, related to the “CumEx scandal” that has been widely reported this year. The FCA’s review comes in the context of accelerated enforcement action across Europe, which the FCA has helped coordinate, targeting firms and individuals suspected of participating in abusive tax strategies. Such schemes are estimated to have caused losses of €55 billion to European governments. While the UK’s tax system was not a target of the schemes, London represented a key hub for the underlying dividend share trading.

The FCA’s investigation and anticipated assessment as to whether such practices amounted to market abuse, means that firms and individuals in London will likely face particular scrutiny may be subject to regulatory or enforcement inquiry. The FCA has highlighted particular activities which may draw particular scrutiny, and should therefore be included within a firm’s risk assessment of its current and historic transactions. These include the use of over-the-counter (OTC) execution for stock trades, share transactions where the volume traded represents a large part of the free float, and lack of transparency as to the source and availability of funds used to finance trading. Hedge funds and financial institutions would be well advised to proactively review, identify and investigate any historic transactions to assess their liability, and ensure they have appropriate policies and procedures to guard against future abuses. Firms should ensure they extend this risk assessment to cover their potential exposure to connected third parties. By doing this, they will mitigate the risk of unanticipated and potentially serious enforcement action.

Dechert lawyers Matthew Banham and Richard Hodge discuss these issues further and examine the specific implications for asset management firms in an article for The Hedge Fund Journal.