Dividend Arbitrage (CumEx & CumCum) variant examples
Introduction
FMCR (Financial Markets Consulting & Resourcing Ltd) is a specialist consultancy which focuses on Markets-related activities. FMCR personnel are highly experienced Markets practitioners with renowned expertise.
FMCR has been undertaking in-depth technical analysis into Dividend Arbitrage - particularly CumEx and CumCum - activities on behalf of clients for 5 years+ and is likely the leading technical consultancy in this field. Additionally, FMCR has presented at senior level and undertaken Dividend Arbitrage education programmes for major global law firms and board-level management.
CumEx is a complex subject and the variety of CumEx variants that were seemingly employed by traders can be bemusing. Below we outline some schemes which have appeared in the public domain.
It should be noted that there were also additional mechanisms seemingly adopted to further disguise the nature of the activity.
A brief explanation of “Dividend Arbitage” strategies
There has been a significant amount of CumEx press coverage recently, centered mainly around the courtroom events in Germany and Denmark.
A notable feature has been the range of variants and derivations apparently employed. These can be somewhat confusing for those who are not immersed in this complex area. Below we provide an illustration of some of the more common variations used by traders, potentially to disguise the underlining activity.
Standard CumEx Trade
• A "CumEx seller” sells shares to a "CumEx buyer" cum(with)-dividend, to settle ex(without)-dividend.
• The "CumEx seller" sells the shares short over the dividend date and hence must compensate the "CumEx buyer" for the dividend (net of any withholding tax) that they would otherwise have received had the shares settled cum-dividend also.
• Such a short sale also gives rise to a rebate levied on the dividend, if the "CumEx buyer" deems themselves entitled - typically being an appropriate counterparty in the jurisdiction of the shares sold or a fund that has an entitlement to a fast-tracked dividend reclaim and/or rights under a double taxation treaty.
• Once the dividend date has passed, the " CumEx seller" buys in the shares from a 3rd party (the "share provider") to settle the prior trade that they have sold short.
• Since the 3rd party owned the shares on the record date, they may also claim a rebate for the tax levied on the dividend paid to them.
• Hence, the 'standard' strategy is one where, for a single share traded, and a single dividend paid and tax levied, there are two potential claims for the rebate of the dividend tax.
• If the initial sale was not conducted as a short sale, and instead the "CumEx Seller" held the shares on the trade date, then their receipt of the actual dividend and their payment of the dividend compensation payment to the "CumEx buyer" would be netted - and there would consequently be no entitlement to a withholding tax reclaim. Hence, without the initial sale being short, there would be only a single rebate claim based on a single share/dividend.
CumEx variants using other Asset Classes
The standard strategy has also been reported to have been effected in a manner similar to the above, but utilising different instruments. These include:
• Physically Settled Futures which have an expiry date that is cum-dividend but settle ex-dividend.
• Deep-in-the-money Stock Options whose behaviour is highly similar to those of futures contracts.
• Indices containing dividend paying shares.
• American Depository Receipts (ADRs). ADRs are instruments issued by shares in a foreign jurisdiction, which allows investors to take exposure to the shares, but denominated in US Dollars.
In these cases also, for a single instrument traded, and a single dividend paid and tax levied, there are two potential claims for the rebate of the dividend tax.
“Cum-Fake”
• More recently it has been reported that strategies may be possible where a dividend tax reclaim is made, although no traded shares are evident.
• Reporting mainly focuses on Pre-Release ADRs. Pre-release ADRs are ADRs issued by the Depository banks to financial institutionsacting as Pre-Release Brokers before shares are actually held by the Depository -the historic rationale was to address settlement time disparities that could delay delivery of the shares.
• Once issued, Pre-Release ADRs appear no different to other ADRs and can be freely traded. These transactions see the purchase ofPre-Release ADRs by the "investor", the issuance of a claim for the rebate of dividend tax, but the closing out of the instrument before the ADR is ever backed by the related shares.
• There are other situations involving circular transactions that have Cum-Fake-like properties, where the 3rd Party Share Providers role is simply omitted and the CumEx short seller services their Short Sale by engaging in a Stock Loan with the CumEx buyer that settles on the same date as the initial share sale.
• Thus, there is no net settlement of shares and no dividend paid but claims for a rebate may still be made. This generates a situation where no net short balances or dividend payments are present, but a single rebate claim might be in existence.
CumCum
CumCum is commonly regarded as a cousin of CumEx, it is sometimes confused with CumEx under the banner of Dividend Arbitrage and has historically resulted in a reduction in the dividend tax income for treasuries in various jurisdictions.
• An institution holds shares where, based on their tax treatment/jurisdiction, they would not be entitled to receive a rebate for the withholding tax levied on any dividend paid.
• Prior to the dividend record date, the institution sells (and settles -hence the name CumCum) the shares to another institution who, based on their tax treatment, may make a claim for the return of the withholding tax levied on the dividend they receive.
• Once the shares go ex-dividend, the shares are returned to the original owner.
• This strategy is different to the CumEx strategy above in that for a single share, a single dividend and tax levied, there is just a single potential claim of the rebate of the dividend tax. However, absent the execution of the CumCum trade there would not have been a possible claim of the tax rebate.
FMCR Capabilities
As acknowledged leading "Dividend Arbitrage" experts, FMCR (www.fmcr.com) provides discreet and cost-effective forensic analysis regarding potential CumEx and other Dividend Arbitrage trading activities. This includes;
• Illustration of potential "cost/profit" mitigants or offsets.
• Identify and review various potential alternative "hybrid" CumEx approaches.
• Consideration of possible similar activities in other countries.
• Review of current processes, practices and controls to ensure a current robust trading environment.
• Production of reports and presentations to Senior/C-Suite personnel as required.
• Tailored training and education, including for law firms and in-house counsel.
• Our Dividend Arbitrage team is led by Andrew Jenkins and Antony Lee, both of whom are highly experienced in this field. Please let us know if you'd like to have a discreet discussion.