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Template:Hypothetical broker-dealer capsule: Difference between revisions
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In some jurisdictions, derivatives are taxed differently — more favourably — than [[Cash equity|cash equities]] (for example [[stamp duty reserve tax]], and in the US, for certain types of underlier, under [[871(m)]]) so it is important that your synthetic position doesn’t look like a tax play. [[Tax attorney|Tax attorneys]] — especially American ones — fret mightily that high-delta [[equity derivatives]] do. | In some jurisdictions, derivatives are taxed differently — more favourably — than [[Cash equity|cash equities]] (for example [[stamp duty reserve tax]], and in the US, for certain types of underlier, under [[871(m)]]) so it is important that your synthetic position doesn’t look like a tax play. [[Tax attorney|Tax attorneys]] — especially American ones — fret mightily that high-delta [[equity derivatives]] do. | ||
One of the key indicators, they intuit, is the degree to which the contract permits a swap counterparty influence or control its [[prime broker]]’s hedge. A swap counterparty should care not one whit about its broker’s hedge — other than its [[cost]]. If it does takes an unhealthy interest, the swap position may be — dramatic look gopher — [[recharacterised]] as a ''disguised [[custody]] arrangement'' of shares the swap counterparty has in reality bought, and on which it should pay tax, [[stamp duty]] and so on. Depending on which tax specialist you ask, an “unhealthy interest” might extend even to the execution price the[[broker-dealer]] achieves on its hedge. (This seems potty to us, by the way, but such is the interior world of the US tax attorney). [[US tax attorney]]s are greatly calmed by the suggestion that a hedge execution price is imaginary, and not real, even though it happens to be identical to the real one. Thus, you will see much chatter about prices a “[[hypothetical broker-dealer]]” might achieve selling [[fungible]] securities, and [[volume-weighted average price]]s and so on. | One of the key indicators, they intuit, is the degree to which the contract permits a swap counterparty influence or control its [[prime broker]]’s hedge. A swap counterparty should care not one whit about its broker’s hedge — other than its [[cost]]. If it does takes an unhealthy interest, the swap position may be — dramatic look gopher — [[recharacterised]] as a ''disguised [[custody]] arrangement'' of shares the swap counterparty has in reality bought, and on which it should pay tax, [[stamp duty]] and so on. Depending on which tax specialist you ask, an “unhealthy interest” might extend even to the execution price the [[broker-dealer]] achieves on its hedge. (This seems potty to us, by the way, but such is the interior world of the US tax attorney). [[US tax attorney]]s are greatly calmed by the suggestion that a hedge execution price is imaginary, and not real, even though it happens to be identical to the real one. Thus, you will see much chatter about prices a “[[hypothetical broker-dealer]]” might achieve selling [[fungible]] securities, and [[volume-weighted average price]]s and so on. | ||
===What is a hypothetical broker-dealer anyway?=== | ===What is a hypothetical broker-dealer anyway?=== | ||
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===But ''do'' synthetic equity swaps resemble disguised custody arrangements?=== | ===But ''do'' synthetic equity swaps resemble disguised custody arrangements?=== | ||
Um — ''no''. About the economic substance: [[synthetic equity | Um — ''no''. About the economic substance: [[synthetic equity swap]]s don’t resemble disguised custody arrangements at all: | ||
:(i) a [[ | :(i) a [[prime broker]] will hedge [[delta-one]] across its whole client portfolio — some of which will be [[short]], and some [[long]] — so there is no one-to-one relationship between each client’s long position and the [[prime broker]]’s net physical [[hedge]] in the first place — that is to say, there is no assurance that the prime broker is holding ''anything'' in custody at any time; and | ||
:(ii) even if there were, the [[prime broker]] will almost certainly finance the [[net]] [[long]] portion of its [[delta]] anyway, to reduce its [[funding cost]]s, by lending it out, [[title transfer]], for [[cash]], so even if the [[prime broker]] has a corresponding exposure, it won’t be hedging it with holding a physical [[hedge]] ''at all'', let alone one it is covertly holding on custody for its clients. | :(ii) even if there were, the [[prime broker]] will almost certainly finance the [[net]] [[long]] portion of its [[delta]] anyway, to reduce its [[funding cost]]s, by lending it out, [[title transfer]], for [[cash]], so even if the [[prime broker]] has a corresponding exposure, it won’t be hedging it with holding a physical [[hedge]] ''at all'', let alone one it is covertly holding on custody for its clients. | ||
But US [[tax attorney]]s wilfully ignore all this dispiriting logical talk and insist the only thing that can save you are some [[magic words]] about you [[hedge]] costs being incurred by a [[hypothetical broker dealer]] exactly ''like'' you, but who ''isn’t'' you. | But US [[tax attorney]]s wilfully ignore all this dispiriting logical talk and insist the only thing that can save you are some [[magic words]] about you [[hedge]] costs being incurred by a [[hypothetical broker dealer]] exactly ''like'' you, but who ''isn’t'' you. | ||