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Synthetic prime brokerage: Difference between revisions
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*'''Going [[short]]''': instead of borrowing shares from your [[PB]] and [[Short selling|selling them short]], you just put on a [[total return swap]], where you pay the return of the share price and the [[PB]] pays you a floating rate. Your PB will [[Stock loan|borrow]] the shares for its own hedge and sell them short, and will pass on the cost of the [[stock borrow]] to you (by deducting it from the floating rate). | *'''Going [[short]]''': instead of borrowing shares from your [[PB]] and [[Short selling|selling them short]], you just put on a [[total return swap]], where you pay the return of the share price and the [[PB]] pays you a floating rate. Your PB will [[Stock loan|borrow]] the shares for its own hedge and sell them short, and will pass on the cost of the [[stock borrow]] to you (by deducting it from the floating rate). | ||
*'''Terminating''': You can terminate a synthetic position on any day, at market (subject to usual [[ | *'''Terminating''': You can terminate a synthetic position on any day, at market (subject to usual [[Market Disruption Event - Equity Derivatives Provision|market disruption]] and [[Hedging Disruption|hedging disruption]] provisions (for more on this see our old friend the {{eqderivprov|triple cocktail}}). Thus you ''can'' make your [[prime broker]] liquidate its hedge, but you ''can’t'' force it to sell the hedge to you or any of your friends and relations (something it might not want to do if it has an investment banking relationship with the issuer and you are an activist {{tag|hedge fund}}), but of course it can if it wants to. Since — given the [[commercial imperative]] — it is highly incentivised to keep you happy, don’t by that surprised if the [[prime broker]] ''does'' want to sell you its hedge, but that this freaks out its [[compliance]] team, who will wish you just bought it in the market. | ||
*'''[[Tax]] Risk and the famous [[hypothetical broker-dealer]]''': In some jurisdictions, derivatives are taxed differently to equities (as regards [[stamp duty reserve tax]] for example) so it is important that your synthetic position doesn’t look like a tax | *'''[[Tax]] Risk and the famous [[hypothetical broker-dealer]]''': In some jurisdictions, derivatives are taxed differently to equities (as regards [[stamp duty reserve tax]] for example, and in the US, under [[871(m)]]) so it is important that your synthetic position doesn’t look like a play to avoid tax. Tax attorneys — especially american ones — will fret mightily if it does. One of the key indicators here will be the degree to which the contract permits you to influence or control your [[prime broker]]’s hedge. A derivative counterparty should care not one whit about its brokers hedge; if it takes an unhealthy interest, the [[fear]] will be that the swap position is [[recharacterised|really no more than]] a disguised custody arrangement of shares that you have actually bought, and should have paid tax on. Depending on which tax specialist you ask, this might extend even to your interest in the [[PB]]’s the hedge execution price. Thus, you will see much chatter about the termination price being the one a “[[hypothetical broker-dealer]]” might achieve selling [[fungible]] securities, and [[volume-weighted average price]]s and so on. | ||
Since the advent of Section [[871(m)]] the practical value of the [[hypothetical broker-dealer]] language — to | Since the advent of Section [[871(m)]] the practical value of the [[hypothetical broker-dealer]] language — to buttress the argument that this really is a [[high-delta equity derivative]], and not a disguised cash trade, has diminished, but not vanished entirely, so I am afraid you will need to persevere with it. <br> | ||
{{LOSD under synthetic pb}} | {{LOSD under synthetic pb}} | ||
{{Difference between SES and MCA}} | {{Difference between SES and MCA}} | ||