Give up

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Brokerage Anatomy
The original EGUS standard electronic give up was developed by the futures commission merchant Stock, Aitken & Waterman

Resources: Bank of England Financial Stability Papers | FIA/ISDA documentation |
Trading capacities: Principal | Undisclosed principal Riskless principal | Agent | Undisclosed agent
Broker types: Broker | Dealer | Broker/dealer | Executing broker | Clearing broker | Prime broker | FCM | CCP
Clearing: Clearing overview | How clearing works | What gets cleared? | Who clears? | Clearing documentation

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Never surrender.

A give up is, in practical theory, an arrangement whereby a hedge fund “gives up” pending transaction — be it a derivative or a cash trade — it has executed (or, cough, unsubtly hinted it is “highly interested” in executing) to its prime broker, who accepts the hedge fund’s contract with the executing broker on condition that it puts on an economically identical off-setting transaction with the hedge fund.

It sounds, you might think, like some kind of novation. But oh, no. That would be far too sensible.

There are three normal ways of giving up, and ironically none of them involve a contract which is “given up” as such. To make matters worse, the three methods are profoundly different in every respect.

ISDA give-ups

ISDA give-ups only work if what you are purporting to give up is itself an ISDA Transaction — an not a hedge to an ISDA Transaction (unless it is, itself, an ISDA Transaction). ISDA give-ups are therefore most frequently spotted in credit derivatives, interest rates and cross currency swaps. Equity derivatives, on the other hand, tend to be hedged by physical assets (i.e., shares), so you wouldn’t use an ISDA give-up to settle a synthetic equity trade, for example.

Under the 2005 ISDA Master Give-Up Agreement, a fund may “give up” derivatives it has traded with a broker to its Prime broker. It will usually do this because it does not have an ISDA Master Agreement with the broker. Under this arrangement the hedge fund acts at all times as the prime broker’s agent (it may not be a client of the executing broker at all) and never creates its own principal contract with the executing broker, but simply arranges the contract between the executing broker and the prime broker. The PB then puts on a back-to-back trade with the HF under the ISDA Master Agreement between them. Net result: the PB intermediates between EB and HF. Calling this arrangement a “give-up” is something of a misnomer.

Equity give-ups

Note: equity give-ups are the standard way of executing delta-one equity swaps in the European market, a common method in APAC, but unheard of in the U.S. This is mainly due to their varying attitudes towards tax.

Under a cash equity give-up, the hedge fund seeks a firm price indication for a cash equity from an executing broker, but does not act on it: rather, the hedge fund says, “all right, sir: hold that thought”, and runs off to its favourite prime broker, whom it instructs to enter into a swap at the exact price quoted by the executing broker, directing the PB’s attention to the winsome executing broker who is sitting by the phone, dutifully holding its thought, all dressed up and with nowhere yet to go.

In practice, the executing broker is not quite that demure. It will pre-emptively “allege” the cash trade to the hedge fund’s prime broker,[1] which is rather like buzzing in on University Challenge before Bamber Gascoigne has finished asking the question: “a little birdie tells me you are going to instruct me to trade on an equity to hedge an equity swap you’re about to put on with your client hedge fund X. Well — here it is!”

Once the PB has accepted the EB’s “allegation”, the PB “prints” the trade with the hedge fund, usually in the form of a synthetic equity swap[2] transacted under an ISDA Master Agreement.

Calling this a “give-up” is a misnomer, since nothing is actually “given up”. In theory — even if not awfully often[3] in practice — the prime broker can feign ignorance and refuse to transact with the executing broker, thereby hanging the executing broker out to dry with any recourse against anyone for the equity trade it has executed.

The executing broker may have stern words to the hedge fund about this, but not ones that would sound in actual damages (but — you know — good luck with your ongoing relationship with that broker, right?): the entire theory of their arrangement is that the hedge fund never committed to any trade with the executing broker. All care, no responsibility.

Why all this delicate tiptoeing around the subject? Tax, in a word. There are no[4] stamp duties payable on equity derivatives. There are all kinds payable on cash equity transactions.[5] So the name of the game is that the fund is arranging a transaction between two brokers, not executing one.

Regulated broker-dealers may have intermediary exemptions from these; clients like hedge funds generally will not. So if the taxman decides that the fund has bought the security from the executing broker and then sold it to its prime broker, then the hedge fund gets hit for stamp duty twice. If the broker buys directly from another broker, there will be at the most one dutiable transaction (and, if intermediary relief applies, there may be none).

ETD Give Up

Documented under the FIA standard giveup documentation, available free to the world, here. There is a Customer Version and a Trade Version of the Electronic Give-Up System (EGUS).

The ETD give-up is the only one that functions as a real trade between client and executing broker and then a novation of that trade from client to clearing broker, at which point a back-to-back transaction springs into life between the clearing broker and the client.

See Also

References

  1. Whose identity the hedge fund may have “inadvertently” let on during the post-coital conversation. WAIT: THERE WAS NO COITUS, REMEMBER?
  2. A.k.a a “contract for differences” or “CFD”.
  3. That is to say, ever.
  4. Okay — mostly no stamp duties. In the US, Section 871(m) has gone some way to equalising the tax payable under synthetic and cash transactions, which means the resting state of squeaky-bummitude of your US tax attorneys is now some way more comfortably positioned than it was in the old days.
  5. SDRT in the UK, FTT in various European jurisdictions, and in the US a typically baroque arrangement covered in Section 871(m) of the Internal Revenue Code.