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The European Banking Authority’s long-awaited inquiry into dividend arbitrage trading schemes (“Cum-Ex/Cum-Cum”) and 10-point action plan to enhance the future regulatory framework – what are the implications for UK financial institutions and the Financial Conduct Authority?

  • The EBA’s inquiry showed that national authorities do not share the same understanding of dividend arbitrage trading schemes, due to differences in Member States’ domestic tax law;

  • The inquiry concluded that facilitating, or handling proceeds from tax crimes undermines the integrity of the EU’s financial system and, therefore, sets out a number of expectations of credit institutions and national authorities under the current regulatory framework;

  • The EBA decided on a 10-point action plan for 2020/21 to enhance the future framework of prudential and anti-money laundering requirements covering such schemes.

EBA press release dated 12th May 2020.

Summary

The European Banking Authority (EBA) has recently published the results of its inquiry into dividend arbitrage schemes, which looked into the actions of prudential and anti-money laundering (AML) and countering the financing of terrorism (CFT) supervisors in dealing with such schemes.

The resulting Report sets out the EBA’s expectations of credit institutions and national authorities under the current regulatory framework. The EBA also decided on a 10-point action plan for 2020/21 to enhance the future framework of prudential and anti-money laundering requirements covering such schemes.

Legal Basis

The EBA has a legal duty to contribute to preventing the use of the financial system for the purposes of money laundering and terrorist financing (ML/TF) and to lead, coordinate and monitor the AML/CFT efforts of all EU AML/CFT financial institutions across all sectors. The law implementing these powers came into effect on 1st January 2020.

On 28th November 2018, 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”.

EBA’s Report on competent authorities’ approaches to tackling market integrity risks associated with dividend arbitrage trading schemes

It is fair to say that there were varied responses from the competent national authorities, which responded to the EBA enquiries on the two key identified perspectives: i) an anti-money laundering and countering the financing of terrorism (AML/CFT) perspective, if there was clarity that a predicate offence had taken place, and ii) the more general governance perspective of prudential supervision.

This was partly due to the fact that some took the view that this was a matter for the tax authorities, some due to the fact that no such schemes were believed to exist, some due to domestic tax regimes or applicable laws and/or the fact that no relevant offence may have been committed and finally some due to the fact of ongoing investigations.

Nevertheless, the Report was able to conclude from the responses that:

1) Few competent prudential supervisors have considered the link between weaknesses in financial institutions’ internal control and wider governance frameworks and tax crimes; and

2) Few competent authorities have considered the impact of tax crimes committed at home or abroad on their institutions’ exposure to ML/TF risks. Handling the proceeds from tax crimes is likely to amount to money laundering, irrespective of where the tax crime took place.

To date, cooperation and information exchange between competent authorities, and between competent authorities and other public authorities, for example tax authorities appear to have been attempted in a minority of cases and only where risks had crystallised.

Facilitating tax crimes, or handling proceeds from tax crimes, undermines the integrity of the EU’s financial system. For this reason, 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, for example the Cum-Ex scandals, which may give rise to questions about the adequacy of financial institutions’ anti-money laundering systems, internal controls and internal governance arrangements.

To that end, competent prudential authorities should take information received from AML/CFT supervisors into account when performing their reviews of institutions’ internal controls and internal governance arrangements including suitability assessments.

In such cases, the Report concludes that cooperation arrangements allowing information exchange between relevant competent authorities, including tax authorities, in respect of financial institutions’ involvement in such schemes are needed. This will support their determination and assessment of:

a. the adequacy of financial institutions’ internal control systems and governance arrangements and the risk that financial institutions in their sector may be facilitating illicit dividend arbitrage schemes; and

b. the risk that financial institutions in their sector may be handling the proceeds from illicit dividend arbitrage trading schemes.

Where appropriate, the Report concludes that competent authorities should take mitigating measures that are commensurate with those risks, including:

a. setting out regulatory expectations in guidance to financial institutions, stating that competent authorities may wish to refer to ESMA’s report on preliminary findings on multiple withholding tax reclaim schemes in this context;

b. carrying out targeted inspections in cases of concern, or conducting a fact-finding thematic review of several institutions to inform the competent authority’s understanding of the nature and scale of the risks, looking in particular at:

  • the adequacy of institutions’ assessment of risks associated with dividend arbitrage trading schemes and their capacity to identify customers who may be using those schemes for illicit purposes;
  • the existence of adequate and effective internal governance and internal control frameworks, including in relation to AML/CFT;
  • accountability and the extent to which relevant staff at all levels are capable of performing their roles in line with the institution’s risk appetite and risk capacity; and
  • “the tone from the top” and the extent to which the management body promotes, monitors and assesses the institution’s risk culture;

c. reassessing the suitability of members of the management body.

EBA’s 10-point Action Plan

Having assessed the responses to two surveys, the EBA’s inquiry concluded that national authorities do not share the same understanding of dividend arbitrage trading schemes and the extent to which financial institutions’ handling of the proceeds from these schemes constitutes money laundering.  This was due to differences in Member States’ domestic tax regimes: dividend arbitrage trading schemes are not possible in some jurisdictions and, where they are possible, they are not always treated as tax crimes.

Despite these divergences, the EBA’s inquiry concluded that facilitating tax crimes, or handling proceeds from tax crimes, undermines the integrity of the EU’s financial system. As a result, the EBA has set out expectations of credit institutions and national authorities under the current regulatory framework. This included:

  • taking a comprehensive view of the risks highlighted by dividend arbitrage trading cases, which may give rise to questions about the adequacy of financial institutions’ internal controls and internal governance arrangements, and their anti-money laundering systems and controls.
  • prudential and AML/CFT authorities exchanging information when performing reviews of institutions’ internal controls and governance;
  • AML/CFT authorities reaching out to local tax authorities to understand whether or not dividend arbitrage trading schemes constitute tax crimes, and sharing this information with their prudential counterparts as appropriate;
  • prudential and AML/CFT authorities pursuing targeted inspections; and
  • supervisory colleges discussing such schemes in the context of the 2020 supervisory cycle of the EBA’s supervisory convergence plan, with a view to establish whether potential (joint) supervisory activities in case of concerns should take place (for example with targeted reviews and inspections).

In addition to the conclusions of its inquiry in relation to the current regulatory framework, the EBA has now set out an action plan to enhance the future regulatory requirements applicable to dividend arbitrage trading schemes.

The EBA’s action plan acts on the opportunities afforded by recent legislative changes in EU law. Directive 2019/878/EU (CRD5) makes explicit the link between AML/CFT and the prudential framework and aims at providing competent authorities with common tools to assess the potential impact on institution’s governance arrangements, to ensure sound risk management, and to take appropriate supervisory measures where weaknesses are identified.

In essence, the EBA’s 10-point action plan intends to incorporate assessments of tax crimes, including “illicit” dividend arbitrage trading schemes, within its guidelines and opinions. 

The table below sets out the key actions with the applicable timetables for implementation.

 

Table of Actions

 

Action

EBA  structure

Deadline

i

Amend Guidelines on Internal Governance

SCREPOL

Q1 2021

ii

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

SCREPOL

Q1 2021

iii

Amend Guidelines on Supervisory Review and Evaluation Process (SREP)

SCOP

Q4 2020

iv

Monitor prudential colleges, with report on convergence

SCOP

Q2 2021

v

Assess Guidelines on AML risk factors

AMLSC

Q2 2020

vi

Amend Guidelines on Risk-Based Supervision

AMLSC

Q2 2021

vii

Amend Opinion on Money Laundering/Terrorist Financing (ML/TF) Risks

AMLSC

Q1 2021

viii

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

EBA Staff

Q2 2021

ix

Monitor discussions in AML/CFT colleges and report

EBA Staff

Q4 2020

x

Carry out inquiry under Article 22 of the EBA Regulation

Art 22 Panel

TBD

 

Potential Impact on UK financial institutions and the FCA?

It has been nearly three years since the FCA conducted a review of the activities of firms involved in dividend arbitrage trading schemes, concluding that:

“some firms may not have identified the risk posed by contrived or fraudulent trading for the purpose of making illegitimate WHT reclaims”.

The FCA highlighted the need for firms to monitor existing business and assess new business and stressed the importance of reporting any concerns to the FCA.

More recently, in a February 2020 speech, FCA Executive Director of Enforcement and Market Oversight Mark Steward confirmed that:

“the FCA has worked closely with European authorities for some time on a story that appeared this week about the seizure of a property in London as part of proceedings against a trader allegedly involved in dividend stripping tax avoidance schemes that have operated in Denmark, Germany, France and Italy”. He went on to confirm that “the FCA had been investigating substantial and suspected abusive share trading in London’s markets that has allegedly supported these schemes. These investigations are now very close to their conclusion and decisions about action are imminent.”

Plainly the timing of the EBA’s Report will add increased pressure on the FCA to be seen to be responding to the losses allegedly caused by Cum-Ex trading to certain EU treasuries, especially since much of the trading is known to have been carried out in London.  This must surely apply despite, or indeed because of, the U.K.’s recent departure from the EU.  It is known that prosecutors in Europe conducting ongoing criminal investigations arising out of Cum-Ex have asked U.K. authorities under requests for Mutual Legal Assistance to assist in evidence gathering.

The provisions of Part 3 of the Criminal Finances Act 2017 have placed increased responsibility on financial institutions to implement measures to ensure that they do not fail to prevent the facilitation of tax evasion, both domestically and abroad.

Accordingly, U.K. financial institutions would be well advised to consider the effects of the Report and 10-point Action Plan when conducting their own internal investigations into any alleged exposure to Cum-Ex trading schemes as well as when assessing the adequacy of their own compliance and governance programs and seeking improvements to the same.

13 May 2020.

David Stern is an experienced barrister practising in financial crime. He is Joint Head of Business Crime at 5SAH in London.

David was at the forefront of the LIBOR benchmark manipulation scandal successfully representing senior bankers and inter-dealer brokers in SFO criminal proceedings.

He is also considered a leading legal expert on the implications of Cum-Ex dividend arbitrage trading practices.

David is ranked in Chambers & Partners as a leader in the field of Financial Crime (London) as well as the Legal 500 for Business and Regulatory Crime (including Global investigations) (London).

Email: davidstern@5sah.co.uk

Telephone: +44 (0) 207 332 5400.

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