How to evade $6 billion in taxes

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adrian2
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How to evade $6 billion in taxes

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Hat tip to prefblog:
Senate Literary Critics Don't Like Fictional Derivatives
Matt Levine wrote:It is so simple, yet so lovely. Here:

1. Renaissance puts some money, say $1 billion, into a pot.
2. Renaissance's prime broker, Barclays or Deutsche Bank, also puts some money, say $9 billion, into the pot.
3. Renaissance manages the money in the pot, buying $10 billion worth of stuff and trading in and out of it rapidly: "The overall composition of the securities basket changed on a second-to-second basis."
4. In a little over a year, the prime broker takes back its $9 billion, plus some extra money for its troubles, and Renaissance takes back whatever was left, the $1 billion it had put in, minus the money that the prime broker takes, plus any profits (or minus any losses).

That's a neutral description; that's just a thing that happened. Renaissance put some money into a pot, its prime broker put a lot more money into the pot, Renaissance managed the pot, and later the prime broker got its money back and Renaissance had the upside and the risk.

But the magic is that, in life -- in finance, anyway -- dreary reality imposes few limits on the power of the human imagination. There's a thing that happens, and there are words you use to describe it, and that thing and those words need to have some connection, but only a dullard would think that each thing has one single never-changing set of words appropriate to it. The joy is in trying out different sets of words on the same thing and seeing if they fit.

If you are a normal person with some financial understanding, you will read that list above and instinctively supply some magic words:

1. Renaissance is putting equity into its account at the prime broker.
2. The prime broker is providing financing, or margin, or leverage, or a loan, against Renaissance's account.
3. Renaissance trades its account, subject to portfolio margining.
4. At the end of the year, the prime broker's loan is repaid with interest and fees, and Renaissance keeps the levered upside or downside in the account.

Those are the normal magic words of prime brokerage, and their operation is straightforward and well understood. Everyone knows the effects that those magic words have. That's mostly good: Basic mechanical things such as how much this should cost, how it should be documented, what happens if the pot loses money instead of making money, etc., are all straightforward and predictable.

[...]

Here's the incantation they came up with:

1. Renaissance pays $1 billion of option premium to the pot.
2. The prime broker owns the pot, which is a subsidiary of the prime broker, and puts in $9 billion of its own money. But it writes a 3-year American call option on the subsidiary's performance to Renaissance.
3. The subsidiary hires Renaissance as an investment manager, for a small fee. Renaissance advises the pot on how to trade.
4. In a little over a year, Renaissance exercises its option. Its payout on the option is the upside above $9.X billion, where $9.X billion is basically equivalent to the prime broker's initial leverage plus interest and fees.

Why does this incantation work? Well, there's no margin rule that limits the leverage you can get on an option, so you can get 10 to 1 -- actually it got as high as 16.8 to 1 -- rather than 6 to 1 leverage. And if you have a three-year option and wait a year to exercise it, you have long-term capital gains on the option, rather than short-term capital gains on the underlying trading, so you save a lot -- $6 billion? maybe? -- in taxes. And if the payout on an option adjusts for dividends, there's no tax withholding on that adjustment (or those dividends), so you keep 100 percent rather than 70 percent of your dividends.
Any ominous signs on the horizon (pun intended) for ETF's like HXT, HXS etc?
Imagefiniki, the Canadian financial wiki
“It doesn't matter how beautiful your theory is, it doesn't matter how smart you are. If it doesn't agree with experiment, it's wrong.” [Richard P. Feynman, Nobel prize winner]
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