Banking crises are back. The collapse of Silicon Valley Bank and Signature Bank, as well as UBS’s takeover of Credit Suisse and JP Morgan’s acquisition of First Republic Bank, serve as stark reminders of how quickly banks and other financial institutions can fail, and of the risks of contagion when they do.
Sophie Lalor-Harbord, James Le Gallais, Alex Lerner and Ikeoluwa Otuyemi consider whether, against this backdrop, investigations into ‘cum-ex’ and ‘cum-cum’ trading have the potential to be a spark in a tinderbox for European banks?
Dividend arbitrage, cum-ex trading and cum-cum trading
Dividend arbitrage strategies involve the placement of shares in favourable tax jurisdictions with the aim of minimising tax on dividend payments. These trading strategies have existed for many years and are not automatically problematic.
However, more recently, particular strategies – being ‘cum-ex’ and ‘cum-cum’ – have attracted significant attention from national authorities in Europe:
- Cum-ex trading strategies generally involve the establishment of an equity position ‘cum’ (with)-dividend in a jurisdiction providing favourable tax treatment. After payment of the dividend, the shares are returned ‘ex’ (without)-dividend to the jurisdiction in which they were originally held.
- Cum-cum trading generally involves an investor in a jurisdiction with no (or limited) entitlement to tax relief in respect of tax incurred in relation to a dividend trading with a party in a jurisdiction where there is an entitlement (or a greater entitlement) to such tax relief with a view to sharing the available tax relief (or an equivalent amount).
- Both cum-ex and cum-cum trading usually involve trading conducted on or around the dividend payment date. Structures vary, but cum-ex trading is generally carried out before the dividend is paid out, with settlement taking place after the distribution date. Cum-cum trading transactions are generally carried out and settled prior to the dividend being paid out.
According to investigative reporting platform Correctiv, cum-cum and cum-ex trading has cost taxpayers globally €150bn, including €36bn in Germany and €33.4bn in France.
Ongoing investigations, litigation and regulatory actions
Our post on TP ICAP Limited v Nex Group Limited  EWHC 2700 (Comm) noted that the German authorities’ investigations into cum-ex trading concerned 1,500 people, and implicated several banks: JP Morgan, Barclays, Bank of America, Morgan Stanley, Deutsche, Macquarie, Unicredit HypoVereinsbank, Commerzbank West LB, HSH-Nordbank, Canadian Maple Bank, Sarasin, Warburg and Fortis.
Authorities in Denmark and the UK are also taking significant action – including against TJM Partnership Limited, Sunrise Brokers LLP and Sapien Capital Ltd in the case of the latter – while the French authorities have recently raided the local offices of five banks including Societe Generale, BNP Paribas and HSBC on suspicion of tax fraud and money laundering in connection with cum-cum trading.
Reports suggest that, if proven, the French investigations could lead to fines of more than €1bn. Other criminal, tax, regulatory or civil consequences may also follow. However, the French banking lobby Federation Bancaire Francaise has reportedly filed suit in the nation’s highest administrative court requesting that French authorities clarify which arbitrage strategies do not function as intended and result in tax being due.
It is also worth noting that national authorities are coordinating their investigations. For example, it is understood that German investigators assisted French investigators involved in the recent cum-cum raids, while HMRC is carrying out investigations in the UK at the request of the German authorities.
The broader picture – what are the implications?
In recent months, the focus has been on the strength (or otherwise) of banks’ balance sheets as the spectre of a financial crisis is haunting global markets once again. Against that backdrop, the potential scale of unexpected fines and penalties arising from cum-ex and cum-cum trading cannot be ignored.
Nevertheless, even though the raids in France are something of a new development and global financial conditions have changed materially, the embers of cum-ex and cum-cum trading have been smouldering for a while now. Given the sheer number of parties involved in cum-ex and cum-cum trading (and, therefore, their collective capacity to absorb losses), the slow pace of investigations, and political feeling around the health of the banking sector, it is unlikely that cum-ex and cum-cum trading investigations will provide the spark that sets off a European banking crisis.
That is not to underplay the threat posed to the balance sheets of individual European banks and other financial institutions by the risk of criminal, regulatory, tax and civil litigation-related consequences arising from ongoing European investigations. The potential liabilities – and therefore the stakes – are extremely high.
Any party contemplating a claim arising out of cum-ex and cum-cum trading must balance the twin concerns of limitation and the solvency of a potential counterparty, and so may wish to take steps now to protect its position going forwards.
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