European Banking Authority Publishes Results of Inquiry into Dividend Arbitrage Trading Schemes, Announces Ten-Point Action Plan

On May 12, the European Banking Authority (EBA) published the results of its inquiry into dividend arbitrage trading schemes, sometimes called “Cum-Ex” or “Cum-Cum” schemes.  Cum-Ex/Cum-Cum trading has been defined as “a form of dividend arbitrage where trading and lending of securities and derivatives are constructed around dividend dates in order to generate multiple withholding tax (WHT) reclaims for the same stock.”  It typically involves rapid exchanges, in as many as a dozen transactions, of exchanging stock “with” and then “without” dividends between three parties, where at least two of the parties then claim tax rebates on taxes only paid once.

Background

Since the mid-2000s, Cum-Ex trading became a means of conducting tax evasion on a massive scale.  From 2006 to 2011, according to the New York Times, hundreds of bankers, lawyers, and investors “made off with a staggering $60 billion, all of it siphoned from the state coffers of European countries.”  Because of a gap in its tax code, Germany was most heavily affected, losing an estimated $30 billion.  Ultimately, German prosecutors charged and successfully prosecuted two key figures in Cum-Ex trading, Martin Shields and Paul Mora, for tax fraud that involved double tax reclaims totaling $486 million.

In response to the extensive reporting about Cum-Ex’s role in tax evasion, the European Parliament asked the European Securities and Markets Authority (ESMA) and the EBA to

conduct an inquiry into dividend arbitrage trading schemes such as cum-ex or cum-cum in order to assess potential threats to the integrity of financial markets and to national budgets; to establish the nature and magnitude of actors in these schemes; to assess whether there were breaches of either national or Union 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 Report

The EBA Report included a number of important findings, based in part on EBA surveys, with regard to Cum-Ex schemes:

• National-Level Laws Prohibiting Cum-Ex Schemes: In eight European Union (EU) Member States,  dividend arbitrage trading schemes such as Cum-Ex schemes are tax crimes and therefore constitute a “criminal activity” within the meaning of the EU’s Fourth Money Laundering Directive.  One EU Member State indicated that such schemes were not a tax crime under its national law.  In some other Member States, such schemes were not tax crimes under national law, but “were treated as tax crimes on the basis of case law.”
• Money Laundering/Terrorist Financing (ML/TF) Risk: For five Member States, dividend arbitrage schemes were being assessed as part of those States’ national ML/TF risk assessment under Article 7 of the Fourth Money Laundering Directive.  In addition, for nine States AML/CFT supervisors indicated “that these schemes gave rise to the risk that a financial institutions’ governance and internal control framework would be insufficient to adequately manage the risk of the financial institution, or someone acting on the financial institution’s behalf, committing or facilitating tax crimes.”
• Supervisory Action Regarding Cum-Ex Schemes: Survey responses indicated that “most competent authorities have not considered the relevance that dividend arbitrage trading schemes may have for financial institutions’ sound and prudent management and for ML/TF risks due to weaknesses within the internal control framework and, consequently, few have taken supervisory actions.”
• Cooperation: Notably, most competent authorities (whether prudential and/or AML/CFT supervisors) in Member States indicated that they “had not cooperated with other public authorities in their jurisdiction (such as tax authorities) or other competent authorities in their jurisdiction or in other Member States because they believed that there were no dividend arbitrage trading schemes in their Member State.”

The Report concluded that because facilitating tax crimes, or handling proceeds from tax crimes, “undermines the integrity of the EU’s financial system,” the EBA “expects institutions and competent AML/CFT and prudential authorities to take a holistic view of the risks highlighted by dividend arbitrage trading cases, . . . which may give rise to questions about the adequacy of financial institutions’ anti-money laundering systems, internal controls and internal governance arrangements.”  The Report recommended a number of measures to address the problem with regard to the current regulatory framework.  Those included AML/CFT supervisors’ outreach to local tax authorities, cooperation arrangements for information exchange between relevant competent authorities (including tax authorities) with regard to financial institutions’ involvement in Cum-Ex schemes, and competent authorities’ taking mitigating measures that are commensurate with the risks that such schemes pose.

The EBA Action Plan

Consistent with the Report’s findings and recommendations, the EBA’s Action Plan addresses ten specific actions that the EBA will take – with deadlines specified for each action — “to enhance the future regulatory requirements applicable to dividend arbitrage trading schemes”:

1. Amend its prudential Guidelines on Internal Governance, “in order to ensure that the management body develop, adopt, adhere to and promote high ethical and professional standards”;
2. Amend its prudential Guidelines on the Assessment of the Suitability of Members of the Management Body and Key Function Holders, “in order to ensure that tax offences, including where committed through dividend arbitrage schemes, are considered in the assessment”;
3. Amend its prudential Guidelines on Supervisory Review and Evaluation Process (SREP) with regard to the section on governance, in order to include an appropriate reference to tax crimes, such as dividend arbitrage schemes”;
4. Monitor “how prudential colleges have followed up, in a risk-based approach, on guidance” with regard to Cum-Ex schemes;
5. With regard to the EBA’s ongoing consultation on its Guidelines on ML/TF risk factors, assess the responses that the EBA will receive “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 its Guidelines on Risk-Based AML/CFT Supervision “to include additional requirements on how AML/CFT competent authorities should, in a risk-based approach, identify, assess and address ML/TF risks associated with tax crimes such as illicit dividend arbitrage schemes”;
7. Amend its biennial Opinion on ML/TF Risks, by assessing ML/TF risks associated with tax crimes in greater detail than did the previous version of the Opinion;
8. Continue to allocate, in the EBA’s ongoing multi-annual program of staff-led AML/CFT implementation reviews of AML/CFT competent authorities, “explicit time to authorities’ handling of ML/TF risks associated with tax crimes, where this risk is significant”;
9. Monitor discussions in AML/CFT supervisory colleges, “and intervene actively as necessary, to ensure that AML/CFT colleges for financial institutions that are exposed to significant ML/TF risks associated with tax crimes, address such risks”; and
10. Carry out an 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 as amended.”

Note:  These actions by the EBA represent a concerted effort to rationalize and coordinate efforts within the EU to treat Cum-Ex schemes as tax crimes warranting inclusion in AML/CTF regulation.   Financial institutions subject to EBA regulation should closely read the EBA Report and Action Plan, and promptly review their own AML/CTF compliance programs to identify any components that require revision to provide appropriate risk assessment and timely identification of customer participation in Cum-Ex schemes.  As the Action Plan indicates, both the EBA and national AML/CTF supervisors can be expected to devote substantial effort to addressing such schemes in 2020, 2021, and beyond.