Dividend Arbitrage

Mitigating exposure to Europe’s largest tax scandal

Matt Banham, Partner and Richard Hodge, Senior Associate, Dechert LLP
Originally published in the August | September 2020 issue

Over seven months ago, Mark Steward, Executive Director of Enforcement and Market Oversight at the UK Financial Conduct Authority (FCA) announced that the FCA had been working closely with European authorities “for some time” on investigations into “substantial and suspected abusive share trading” in London’s financial markets. This trading activity allegedly supported dividend stripping tax avoidance schemes that caused losses of €55 billion in tax revenues across Europe. 

As we await the outcome of the FCA’s investigations, which were said in February 2020 to be “very close to their conclusion,” there has been an acceleration in related enforcement and civil action across Europe including; arrests and convictions which we expect to continue for some time.

This article focuses on the risks and recommended actions for asset management firms which have either participated in, or otherwise been exposed to, dividend arbitrage schemes. While dividend arbitrage can represent a legitimate tax avoidance strategy, in the current regulatory and enforcement climate firms engaging in such practices would be well advised to check their historic transactions and exposure and confirm their policies and procedures are effective in detecting, and preventing, future abuses. 

In determining their potential civil or enforcement exposure, the core question asset management firms should bear in mind is the underlying purpose of the relevant transaction.

In determining their potential civil or enforcement exposure, the core question asset management firms should bear in mind is the underlying purpose of the relevant transaction. Was the transaction a legitimate tax avoidance strategy, or was it contrived to artificially generate tax claims or exploit differentials in tax policies? Tax avoidance schemes falling in the latter category, which may comply with the letter but not the spirit of the law, could draw the scrutiny of the FCA or other relevant authorities.  

In this context, this article addresses the following:

  1. The nature and purpose of dividend arbitrage schemes.
  2. Recent scrutiny over the use of dividend arbitrage schemes.
  3. The implications for asset management firms, including potential civil, regulatory or criminal liability, and the action asset management firms should take to mitigate their exposure.

Dividend arbitrage overview

There are two types of dividend arbitrage scheme that are under focus by regulatory and enforcement authorities, known as “cum-ex” (“with-without”) or “cum-cum” (“with-with”). This terminology refers to the nature of dividend rights held by the relevant parties to the transactions – with or without dividend rights.

Cum-ex transactions
Media attention has primarily focused on cum-ex transactions, which have accounted for the substantial losses to European Governments already assessed. Cum-ex is a trading strategy under which traders obtain two tax refunds of dividend withholding tax (“WHT”):

  • In some countries, dividends are subject to WHT, deducted at source. The shareholder receives a certificate confirming the WHT deduction. The shareholder can then make a corresponding claim to the relevant tax authority, to claim its WHT refund. 
  • Cum-ex strategies exploited this by arranging situations through which multiple certificates could be simultaneously owned by different parties and therefore multiple reclaims made. Specifically:

– Where countries have double taxation treaties, overseas investors may be entitled to a refund of dividend WHT on shares held in domestic companies.

– Investors could transfer or borrow shares in the domestic companies immediately prior to the distribution of a dividend. This allowed multiple ownership of the shares around the dividend date, and confusion over who had accounted for the WHT.

– The parties involved in the scheme were each able to request WHT certificates, and therefore each make a corresponding claim for the same WHT.

In other words, in respect of one WHT payment, multiple refunds could be generated. The profit realised through this activity could then be shared between the relevant parties.

Cum-cum transactions
Cum-cum or “dividend washing” schemes are aimed at exploiting differences in tax rates between jurisdictions, and buying and selling shares around dividend payment dates:

  • In certain countries, domestic investors receive a higher WHT refund than foreign investors.
  • To mitigate their exposure or generate a profit, these domestic investors may take shares on loan from foreign investors over dividend periods, and take a portion of the improvement in the tax refund.

Cum-cum is in some respects indistinguishable from dividend stripping activities, under which shares are purchased before a dividend is declared with the intention of selling them immediately after payment of the dividend. The expectation is that the shares will have risen in value because of the anticipated dividend payment, but fallen by the time the shares are sold. Like cum-cum, the strategy is based on the expectation that the price will not fall by as much as the dividend received.

Scrutiny and recent enforcement action

In Europe, legal and regulatory action against suspected abuses in cum-ex practices commenced in 2012, when the German Government banned the means of claiming double ownership. Other European Governments followed suit, and have also sought to close loopholes. Cum-cum transactions have received less attention across Europe, but the German Government introduced a new law in 2016 requiring domestic investors to hold shares for at least 45 days surrounding the dividend date before the investor can qualify for a tax refund. 

Germany and Denmark
The German and Danish Governments have been particularly active in investigating participants and launching proceedings. Recent high-profile actions include the following:


  • In March 2020, a German court held two London-based investment bankers guilty of tax evasion offences, following an interim ruling that cum-ex was illegal. In return for their cooperation with prosecutors, the two bankers received suspended sentences of 34 months and were required to repay several million Euros. The court also imposed a financial penalty of €176 million on the German private bank MM Warburg, accounting for its profit from the transactions. 
  • German prosecutors have announced that they intend to pursue a further 400 suspects connected to almost 60 investigations.  
  • In late June 2020, arrest warrants were issued at the request of German prosecutors for Henry Gabay, CEO of Duet Group, alongside another employee. 


  • The Danish tax authority is currently pursuing High Court proceedings in London against Sanjay Shah, a former banker who operated a London-based investment fund involved in cum-ex schemes in respect of Danish WHT reclaims. 

European Banking Authority and European Securities and Markets Authority
Further investigations, inquiries and proceedings across Europe are anticipated, in particular in view of a recent report issued by the European Banking Authority (“EBA”). In 2018, the EBA was mandated to carry out a review into dividend arbitrage schemes. In May 2020, the EBA published its findings and recommendations:

  • The EBA identified that European authorities did not share the same understanding of dividend arbitrage schemes, which in part had led to discrepancies in regulation and enforcement. The EBA determined that the practice had undermined the integrity of the EU’s financial system. 
  • The EBA drew up a 10-point action plan to enhance the European regulatory framework, setting out its expectations for credit institutions and national authorities. Its recommendations include encouraging authorities to set out regulatory guidelines to financial institutions and to carry out targeted inspections in cases of concern. 

UK – the FCA
The FCA launched an initial review back in 2017, prior to the EBA and ESMA’s mandates. The FCA’s 2017 report highlighted deficiencies in the monitoring, detection and remediation of potentially abusive practices by financial institutions, noting that “some firms may not have identified the risk posed by contrived or fraudulent trading for the purposes of making illegitimate WHT reclaims.” The FCA emphasised the need for firms to monitor their existing business and assess new business opportunities, and to report their concerns to the FCA in accordance with their reporting requirements.

As much of the trading activity primarily took place in London, and many of the participants were UK nationals, UK-based conduct will be a focus of much of the European enforcement action. The FCA’s recent announcement that its own investigation findings are imminent relates to investigations into 14 financial institutions and 6 individuals. 

By putting the regulatory issues of the dividend trading schemes in the spotlight, the EBA’s report provides a basis for future enforcement action. Accordingly, it will likely lead to further scrutiny around relevant trading activities and increase Europe-wide expectations on enhanced monitoring and controls to mitigate the risks of abusive actions.

On 24 September 2020, the European Securities and Markets Authority (“ESMA”) published a final report on its own two-year review into dividend arbitrage schemes. ESMA’s report supplements the EBA’s review, by focusing on the importance of increasing the cooperation between national authorities in sharing information, to assist in identifying and deterring relevant schemes.

As demonstrated by some of the recent proceedings, participants located outside the country of the relevant tax liability may still face scrutiny.

What are the implications for asset management firms?

Asset management firms may utilise dividend arbitrage strategies to reduce their tax liabilities, or may otherwise be party to such schemes on behalf of their clients or connected parties. Firms may have participated in the schemes directly, or been involved, knowingly or unknowingly, in relevant activities such as share lending, to facilitate other participants in the schemes.

The strategies deployed by or connected to firms may represent entirely legitimate tax avoidance strategies. However, the increased scrutiny, regulation and enforcement activities across Europe heighten exposure. As demonstrated by some of the recent proceedings, participants located outside the country of the relevant tax liability may still face scrutiny. 

Firms face two key risk areas: 

  • Historic transactions. Firms should ensure their historic practices or exposure did not contravene relevant laws or regulations. Firms should check and re-confirm any prior legal determinations on legitimacy, for instance in connection with the German (re-)assessment of cum-ex and cum-cum practices. 
  • Future transactions. To ensure ongoing compliance, firms should assess whether their procedures and policies are sufficiently robust in respect of the review, approval and monitoring of future transactions. Firms should include in this assessment appropriate checks on their exposure to potential abuses by connected third parties.

In all the circumstances, the core question to ask and consider is whether there is a legitimate purpose to the transaction. In its 2017 review, the FCA highlighted the following activities as relevant conduct for the assessment of the legitimacy of dividend arbitrage schemes: 

  • Offshore funds instructing share transactions through UK broking firms.
  • The use of off-exchange over-the-counter (“OTC”) execution for stock trades.
  • The use of back-to-back securities lending agreements.
  • The use of OTC derivative instruments to hedge stock trades.
  • Share transactions, where the volume traded represents a large part of the free float.
  • Potential connection and/or associations between the owners of offshore funds and the firms involved in the custody, settlement and clearing of the stock.
  • Lack of transparency as to the source and availability of funds used to finance the trading.
  • Lack of transparency as to the source of stock needed to fulfil a trade.
  • Lack of a realistic assessment or assurance of whether some of the institutions involved in the trading have sufficient financial standing.

What are the UK legal risks?

Any transaction deemed improper could, under UK law, give rise to civil liability, or constitute a regulatory breach or criminal offence. These include:

  • Market abuse. The FCA has already confirmed that in its view dividend arbitrage schemes may amount to market abuse on account of the potential for false or misleading impressions concerning the supply or demand of a relevant security. 
  • Tax evasion. While the UK tax authority, HMRC, does not appear to have been the target of dividend arbitrage schemes, under Part 3 of the Criminal Finances Act 2017 (“CFA”) participants in such schemes may be liable in the UK for “failing to prevent” the facilitation of foreign tax evasion by any of their associated persons, which may include connected parties. Any transactions entered into since September 2017, when Part 3 of the CFA came into force, could generate potential exposure under this offence. 

To mitigate their exposure to regulatory or enforcement sanction, firms should consider the following:

  • Ensure they have effective processes for carrying out due diligence on new business proposals and clients, and for monitoring ongoing business. Firms that are FCA-registered should ensure they meet the FCA’s standards in this respect.
  • Firms may also wish to consider past practices, as relevant enforcement activity could extend to historic transactions. If these concern European countries which are leading current enforcement activity, such as the UK, Denmark and Germany, firms should seek relevant local advice to determine their exposure.
  • Where issued are identified, firms should comply with their reporting obligations under regulatory rules, such as Principle 11 of the FCA Handbook (requiring FCA-regulated firms to act openly and cooperatively with the FCA, including making relevant disclosures). 


Dividend arbitrage is a highly complex area, and there have been conflicting decisions on the legitimacy of relevant practices. However, the widespread publicity, recent regulatory and enforcement efforts, and the gathering context of financial recession, means this is likely to remain a key area of focus for some time to come. Asset management firms, alongside other financial market participants, are likely to face particular scrutiny, and they would be well advised to proactively review, identify and assess their historic and ongoing risks and exposure.