Clock is ticking to save Germany鈥檚 lending market
07 December 2017 London
Image: Shutterstock
The German securities lending market may be on the verge of a mass exodus next month if greater transparency and standardisation isn鈥檛 brought to the German Investment Tax Act (GITA 2018), according to the International 网爆吃瓜 Lending Association (ISLA).
GITA 2018 will introduce a 15 percent tax on incomes from manufactured dividends and lending fees on German equities, as of 1 January, through the Manufactured Dividend Rule.
In a statement on the rule, an ISLA spokesperson explained that the working group was focused on making the rule, as it is written, workable, with specific attention to the time sensitive parts, which have the greatest potential to disrupt the German equities market.
鈥淒ue to a lack of clear understanding across the industry, lenders may determine that the risk of lending securities is no longer low and therefore will withdraw from the market, rather than accept a higher level of risk or uncertainty,鈥� ISLA warned.
鈥淎 number of members have indicated that they may have to cease securities lending activity in German equities mid-December in order for positions to be fully returned by borrowers before January 1, 2018. It should be noted that a wholesale withdrawal of liquidity over the typically lightly traded Christmas period, could have an unpredictable and outsized impact on equity markets.鈥�
The association's working group sent a letter outlining its concerns and included a long list of questions they required answers for to the German Federal Ministry of Finance on 5 December.
In order to ensure that the market can continue to operate from January, ISLA has called on the ministry for early guidance if it disagrees with the industry鈥檚 understanding of key aspects of the act, including details of in-scope transactions, tax base, collection of tax and application of a double tax treaty.
鈥淕etting a concession on lending fees and that borrowers cannot be forced to withhold, along with acknowledgement of the character of other income for tax treaty purposes, is the maximum ISLA hope for within the time frame,鈥� ISLA added.
鈥淚f their objective is achieved and the tax is limited to the manufactured dividend, then they have bought some additional time to work out the details ahead of the main dividend season in May.鈥�
鈥淗owever if agreement on these points is not met, ISLA believe the outlook is poor.鈥�
The rule is aims to complement the general taxation of German dividends paid to investment fund and should prevent any potential for circumventing the taxation on genuine dividends, where investment funds engage in securities lending and repo transactions.
ISLA countered that, its its opinion, 鈥渢he existing anti-cum cum legislation is robust鈥�.
The association highlighted that the 45-day holding period, meaning the need for outright economic exposure on a substantial part of the long position and the disallowance of tax benefits where there is a contractual obligation to make an onward payment of income received as dividends, all work together to prevent cum-cum trading.
Accordingly, even without the new legislation, the residual tax arbitrage risk, if any, should be very low.
GITA 2018 will introduce a 15 percent tax on incomes from manufactured dividends and lending fees on German equities, as of 1 January, through the Manufactured Dividend Rule.
In a statement on the rule, an ISLA spokesperson explained that the working group was focused on making the rule, as it is written, workable, with specific attention to the time sensitive parts, which have the greatest potential to disrupt the German equities market.
鈥淒ue to a lack of clear understanding across the industry, lenders may determine that the risk of lending securities is no longer low and therefore will withdraw from the market, rather than accept a higher level of risk or uncertainty,鈥� ISLA warned.
鈥淎 number of members have indicated that they may have to cease securities lending activity in German equities mid-December in order for positions to be fully returned by borrowers before January 1, 2018. It should be noted that a wholesale withdrawal of liquidity over the typically lightly traded Christmas period, could have an unpredictable and outsized impact on equity markets.鈥�
The association's working group sent a letter outlining its concerns and included a long list of questions they required answers for to the German Federal Ministry of Finance on 5 December.
In order to ensure that the market can continue to operate from January, ISLA has called on the ministry for early guidance if it disagrees with the industry鈥檚 understanding of key aspects of the act, including details of in-scope transactions, tax base, collection of tax and application of a double tax treaty.
鈥淕etting a concession on lending fees and that borrowers cannot be forced to withhold, along with acknowledgement of the character of other income for tax treaty purposes, is the maximum ISLA hope for within the time frame,鈥� ISLA added.
鈥淚f their objective is achieved and the tax is limited to the manufactured dividend, then they have bought some additional time to work out the details ahead of the main dividend season in May.鈥�
鈥淗owever if agreement on these points is not met, ISLA believe the outlook is poor.鈥�
The rule is aims to complement the general taxation of German dividends paid to investment fund and should prevent any potential for circumventing the taxation on genuine dividends, where investment funds engage in securities lending and repo transactions.
ISLA countered that, its its opinion, 鈥渢he existing anti-cum cum legislation is robust鈥�.
The association highlighted that the 45-day holding period, meaning the need for outright economic exposure on a substantial part of the long position and the disallowance of tax benefits where there is a contractual obligation to make an onward payment of income received as dividends, all work together to prevent cum-cum trading.
Accordingly, even without the new legislation, the residual tax arbitrage risk, if any, should be very low.
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