September 2012

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Recent regulatory and taxation trends in Europe have an outsized impact on the global securities lending market. From legal decisions on corporate withholding taxes to European Commission directions on disclosure of short sales, new rules will change the profitability of different types of investments and transactions for securities lenders. Banks in turn will respond by taking the most advantage of the new landscape for their clients and themselves.

The willingness of European regulators to change market rules has ramifications far beyond Europe’s boundaries. Revenues earned from the dividend arbitrage trade have supported the decision to engage in securities lending for beneficial owners around the world. Hedge fund investors operate globally; a desire to short European securities may be thwarted not only by short selling bans but also by disclosure regulations. Limitations on short selling push trading interest in other products while negatively affecting liquidity in the affected securities.

This report evaluates the impacts for securities lending from several major regulatory actions that occurred in the last six months and are now finalized. While the securities finance market may shrink for some products, it will grow in others as market participants find ways to express their expectations for corporate growth or shrinkage and to take advantage of market inefficiencies. European regulatory and taxation changes are no death knell for the securities finance industry although structural shifts should be expected.

This report should be read by asset holders and agent lenders engaging in dividend arbitrage trades, and by borrowers of European securities including prime brokers, hedge funds and market makers.

This report is 29 pages with 9 exhibits.

■ Executive Summary

■ Rise of the Interventionists

■ Dividend Arbitrage
– How Much Money Is In Dividend Arbitrage?
– Furthering Tax Harmonization in the European Union

■ Short Selling

■ FATCA and the Financial Transactions Tax
– Impact of the FTT

■ Assessing the Probable Outcomes
– Implications for Beneficial Owners
– Implications for Mutual Funds

■ About the Author

■ About Finadium


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