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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.


So who, why, which or what is this '''[[hypothetical broker-dealer]]'''? Well, he’s a fellow just like the ''actual'' [[broker-dealer]] — in the same jurisdiction, having the same taxation status, earning the same income, executing the same hedge transactions, eating at the same restaurants, having the same GSOH and watching the same stuff on Netflix — but ''not'' the actual [[broker-dealer]]. He’s like actual [[broker-dealer]]’s “sober me”, only ''he gets drunk too''. Now this might strike you, as it strikes the [[JC]], as just too cute – too much of a playground argument to hold water. (“I didn’t break the window, sir, honest, sir, it was a boy who looked exactly like me who arrived from out of nowhere and is gone now”). But [[US tax attorney]]s seem to be taken in by it even, if they won’t buy arguments on actual economic substance.
So who, why, which or what is this '''[[hypothetical broker-dealer]]'''? Well, it’s a fellow just like the ''actual'' [[broker-dealer]] — in the same jurisdiction, having the same taxation status, earning the same income, executing the same hedge transactions, eating at the same restaurants, having the same GSOH and watching the same stuff on Netflix — but ''not'' the actual [[broker-dealer]]. He’s like actual [[broker-dealer]]’s “sober me”, only ''he gets drunk too''. Now this might strike you, as it strikes the [[JC]], as just too cute – too much of a playground argument to hold water. (“I didn’t break the window, sir, honest, sir, it was a boy who looked exactly like me who arrived from out of nowhere and is gone now”). But [[US tax attorney]]s seem to be taken in by it, even if they won’t buy arguments on actual economic substance.


About the economic substance: synthetic equity derivatives don’t resemble disguised custody arrangements at all:  
===But ''do'' synthetic equity swaps resemble disguised custody arrangements?===
:(i) a synthetic 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; and
About the economic substance: [[synthetic equity derivatives]] don’t resemble disguised custody arrangements at all:  
:(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, lending it out for [[cash]], so again the [[prime broker]] won’t be holding a physical [[hedge]] ''at all''m, let alone one it is covertly custodying for its swap clients.  
:(i) a [[synthetic 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.  


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.
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