The US Internal Revenue Service (IRS) regulation under Section 871(m), which imposes US withholding tax in derivative transactions (issued on or after January 1, 2017) over US equities when paid to non-US persons, has led Dutch providers of listed products to stop providing offer prices on existing in-scope leverage products, making those products bid-only instead.
Whether a product becomes bid-only or not depends on the delta, according to Christophe Cox (pictured), assistant vice president, derivatives public distribution Belgium and the Netherlands, Commerzbank. "When the delta of a product is too high the investor becomes eligible to pay the dividend tax. So when the delta of for example a warrant is too high the product becomes bid-only," said Cox.
Specifically in the Dutch market there are no listed warrants, but at Euronext you see that for other markets there are still warrants issued on US equities and in that case the delta of the product dictates whether the product becomes bid-only or not, according to Cox. "But turbos are delta one products and therefore bid-only anyway," said Cox. "Why does this only apply to turbo long? Because with turbo short's Commerzbank is selling the underlying value and therefore you will receive no dividends from the company."
Not all products are considered in-scope according to the IRS 871(m) regulations. "Only products on US equities with a delta of 97% or higher are considered by Citi," said Robin Said, head of turbos for the Netherlands at the US bank. "In the Netherlands this is the case for limited turbos long, best turbos long and turbos long on US equities," he said.
Whereas most issuers have halted the issuance of any new leverage long products linked to American stocks, 'until a solution is found', one provider, Binck, launched new turbos long on US equities on January 4, for which it provides bid and offer prices, and, because the products are being bought after January 1, they are subject to the new legislation which means a 30% dividend tax is payable to the IRS.
"The US market is important for clients of Binck," said a spokesperson for the online broker. "That's partly why during the introduction of the Binck turbo we made sure we expanded the trading hours in line with the US market. Precisely because of the importance to our customers we have, together with our partner UBS, ensured that the Binck turbo complies with the new [871(m)] legislation," said the Binck official.
However, according to the spokesperson, many other providers of leverage products in the Netherlands have had to decide to stop offering turbo long as a result of the new ruling. "At Binck, despite the fact that our customers have to start paying tax on dividends they can continue to invest with leverage in US equities," said the spokesperson.
There are seven issuers actively issuing listed investment products on the Dutch market. Of these, Societe Generale, which launched its first turbo certificates in October last year, has, at least for the moment, no leverage products on US underlyings. Goldman Sachs currently has 230 turbos and traders linked to American companies, including Amazon, Apple, Boeing, Coca Cola and IBM, while around 180 turbos and boosters from BNP Paribas, of which 29 are linked to the Apple share, use US underlyings. For the Binck turbos linked to a share the 80:20 rule applies fairly well, according to the spokesperson. "That means that about 20% is linked to US stocks."
Commerzbank also has a significant number of products linked to US underlyings, according to Cox. "Of course, in the Dutch market investors mainly trade in indices, especially the AEX and Dax, but if you look at the Euronext figures for 2016 for most traded underlyings, you will see that Facebook is in 24th place and Apple is 28th. US underlyings are certainly well traded," said Cox.
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