In Short: Since the Cum-Ex Files were released in 2018, the European Banking Authority (“EBA”) has been conducting research, through surveys sent to competent authorities, about the risks posed by dividend trading arbitrage schemes. The subsequent report showed the risks of Cum-Ex/Cum-Cum transactions and the inconsistencies in addressing these risks among Member States.

The Result: To resolve these divergences in the regulation of such transactions, the EBA has issued expectations of credit institutions and national authorities and proposed a 10-point action plan to assess money laundering/terrorist financing and prudential risks.

Looking Ahead: The results of the EBA’s inquiry into Cum-Ex/Cum-Cum transactions will likely lead to more scrutiny around structured trading activities, as well as enhanced monitoring and controls being implemented to address the risk of such transactions.

On 12 May 2020, in response to the so-called Cum-Ex Files, the EBA published its report on competent authorities’ approaches to market integrity risks associated with Cum-Ex/Cum-Cum dividend arbitrage trading schemes and its accompanying action plan to enhance the future regulatory framework.

While the EBA’s inquiry merely revealed inconsistencies in the approach by national authorities, it put the regulatory aspects of Cum-Ex/Cum-Cum trading schemes on the radar screen of European Supervisors and lays the groundwork for future enforcement action.

The EBA’s action plan aims to enhance the future framework of prudential and anti-money laundering (“AML”) requirements relating to dividend arbitrage trading schemes, tasking the agency with issuing various interpretative guidelines through Q2 2021.

The EBA also sets out expectations of credit institutions under the current regulatory framework, including internal controls, governance arrangements and AML systems and controls. As a result, supervisors may apply more scrutiny to the organisational set-up and risk management issues surrounding structured trading activities. The EBA’s announcement puts supervised firms on notice—firms should consider the salient points in their risk management practices and anticipate closer reviews of these areas in connection with supervisory audits.

The EBA’s Action Plan

The action plan is forward looking and aims to enhance the future framework of prudential and AML requirements relating to dividend arbitrage trading schemes. It tasks the EBA with issuing various interpretative guidelines through Q2 2021 on internal governance, fit and proper requirements, Supervisory Review and Evaluation Process (“SREP”) and ML/TF risk factors. The EBA will then carry out inquiries to supervise compliance with these amended requirements.

The EBA’s amended Guidelines on Internal Governance will require supervised institutions’ policies to set out principles on acceptable and unacceptable behavior linked to misconduct and financial crime, including tax crimes through dividend arbitrage schemes. The amended Guidelines on the assessment of the suitability of members of the management body and the key function holders will provide that tax offences committed through dividend arbitrage schemes are considered in suitability assessments. Both amendments will be reflected, with regard to the section on governance, in amended Guidelines on SREP.

The EBA also recommends certain mitigating measures be taken by competent authorities to address risks from dividend arbitrage schemes. Those measures include setting out regulatory guidelines to financial institutions and carrying out targeted inspections in “cases of concern“. These inspections will look 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 internal governance frameworks, accountability among relevant staff for performing their roles in monitoring risk and the extent to which the management body promotes and assesses the institution’s risk culture.

EBA’s Expectations of Credit Institutions and National Authorities Under the Current Regulatory Framework

In addition to the action plan, the EBA sets out immediately applicable supervisory expectations of credit institutions and national authorities under the current regulatory framework. The EBA expects credit institutions to take a comprehensive view of the risks highlighted by dividend arbitrage trading cases. In turn, this may raise questions about the adequacy of financial institutions’ internal controls and internal governance arrangements and their anti-money laundering systems and controls.

We expect that as a result of EBA’s announcement, supervisors will apply heightened scrutiny to the organisational set-up and risk management issues surrounding structured trading activities. This may translate into closer reviews of these areas in connection with supervisory audits. In fact, this seems already underway with the “sweep-like” investigation by the German Bundesbank with respect to historical dividend arbitrage trading and recent reports on an investigation by the UK Financial Conduct Authority of 14 financial institutions with respect to Cum-Ex trading. In addition, we expect auditors to also focus on these issues as well as any historical trading activity when they conduct the annual audit exercise.

Financial institutions should take immediate action, updating their risk inventory and ensure they have proper internal control and monitoring systems in place to identify and determine if they are facilitating any illicit trading activities. As a matter of prudent management and, to the extent such reviews reveal issues attributable to the responsibility of members of the management body or key function holders, the review should extend to an updated review of the suitability of the respective executives.

Three Key Takeaways

  1. The EBA’s inquiry revealed divergence in the approach taken by national authorities in addressing the risks posed by Cum-Ex/Cum-Cum transactions.
  2. 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 under the current regulatory framework as well as a 10-point action plan aimed at preventing future risks associated with dividend arbitrage trading schemes.
  3. As a result of this action plan, financial institutions should ensure that they have updated their internal control and risk management systems to address these risks in compliance with the EBA’s amended guidelines and expectations. This could also lead to enhanced scrutiny surrounding structured trading activities.

Originally published June 2020.

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