On February 7th 2016, the German financial authority BaFin ordered German operations of Maple Financial frozen. According to publicly available reports, between 2006 and 2010, Maple is alleged to have committed a variety of tax-related violations related to dividend stripping trades that resulted in capital gains tax underpayments. We provide further information on what happened and three implications for securities finance going forward.
If the allegations hold up, and the resulting tax payments and penalties become payable, Maple will face liabilities in excess of assets; Bafin therefore judges the bank to be technically in default. As of this writing, Maple is only acknowledging the existence of the allegations and has expressed its cooperation with the authorities.
Over and above the merits of the specific case, there are three points of wider interest in this case to the securities finance marketplace:
The first is that this case is the first significant global exercise and test of the revised credit and counterparty standards under the various Basel agreements. While Maple Financial is not necessarily a “too big to fail” institution, it is operating globally in a wide variety of markets, and has exposure to firms in nearly every aspect of securities finance. It is also large enough that in some cases it may be the larger of the two counterparties – which should mean that a true default would pose a threat to its smaller counterparties. In this case, evidence of a ripple effect is scarce… which either means that Maple is too small to really test the Basel rules or that the rules worked as designed. Additionally, and closely related, is whether or not firms were able to quickly and relatively painlessly work out collateralized positions with this counterparty under new collateral equivalency standards. There appears to be no talk of losses from counterparties, which suggests that collateralization levels were high enough to buy-in any positions when necessary.
The second is the preemptive nature of the action. As noted above, BaFin is looking at activities from between 6 and 10 years ago. This, in itself, it not particularly unusual – tax investigations are known to be long and lingering, often taking many years to sort out. Arguments may arise that, during the period in question, Maple was in compliance with then-existing rules (the alleged trades were conducted under a well-known loophole in the German tax code, which has subsequently been closed). What is very unusual is the aggressiveness of the regulator in preemptively shuttering the firm. This may be viewed as either very conservative – a risk mitigation action – or a loud demonstration of power, and a warning to the industry. BaFin cannot be seen to have overstepped their authority – the rules are clear that a sufficient reserve must be taken for the worst case outcome. But there is no evidence that Bafin or the tax authority preferred to find a way to negotiate a reserve requirement that would allow the firm to continue to operate at least long enough to work out positions with their counterparties. Other jurisdictions have been more flexible, and more amenable to finding a way to allow a firm in otherwise good standing to avoid immediate default, in order to avoid creating risks and ripples throughout the system.
Lastly – derivative of the second point – is whether or not this is the tip of the proverbial iceberg. How many firms may have similar, unannounced or undetected trades stretching back over the last decade or more? And, if they do, will we see more enforcement actions catching firms that are fully compliant with today’s capital standards on the wrong foot, and struggling to find reserves that just don’t exist?
The atmosphere towards securities finance is highly politicized, especially in Europe. It is likely that already suspicious regulators will use the Maple case as evidence for further hard-line positions whenever a previous situation warrants intervention.
