German securities lending revenues have slumped this year after authorities challenged the legality of dividend arbitrage trades and pushed to end the practice.
Data from IHS Markit shows revenues have slumped by 62% in the country, mainly down to the disappearance of div-arb trades, also known as "yield enhancement".
Often transactions involve large foreign investors lending out their holdings of stocks, engineered by banks, so they are not on their books at dividend time.
The practice isn’t illegal but is increasingly under the media and regulatory microscope, particularly given the public focus on tax avoidance in a time of austerity.
New laws in Germany force mutual/retail funds to pay a corporate tax rate of 15% on Germany-sourced income, including dividends, from securities lending and repos.
There are also no tax benefits for dividends unless investors meet certain requirements under the so-called 45-day rule, which means shares must be held for 45 days before and after the dividend ex-date.
“The unwinding of the German yield enhancement trade, which has seen the year to date revenues generated by German equities shrink by a massive 62%, has put a $230m hole in the industry’s revenue,” said IHS Markit analyst Simon Colivin.
Overall European securities lending revenues are roughly $115m behind the same point last year; at this pace revenues are set to miss last year’s tally by 7%. Germany is the main contributing factor behind the decline.
"We’ve significantly reduced lending of German stocks held by our German clients," Holger Genuneit, director agency securities lending, Deutsche Bank told audience members at at a Global Investor/ISF event earlier this year. "We don’t want clients to run into a fiscal disadvantage due to the tax changes."
"Germany has taken a big hit," added Mark Tidy, managing director, JPMorgan Agent Lending. "However, our portfolios are typically global in nature and other markets and transactions have compensated. Lending revenues in Korea, Japan and the UK, for example, are bright spots."
John Arnesen, global head of agency lending and BNP Paribas Securities Services, admitted conditions had been difficult in Germany, adding that there is now a greater focus on exactly how trades will be structured going forward.
"We’re concentrating on developing alternative and innovative ways of generating revenue for our German clients, particularly around corporate action optimisation," he said. "Collateral also matters more than ever before, which means accepting different types of collateral and understanding the associated risks is crucial to revenue generation."