Treasury just released the highly anticipated Section 871(m) regulations. These regulations deal with dividend equivalent payments and are basically a re-souring rule that subjects various derivative instruments to withholding if the holder of the instrument is a foreigner. The newly issued regulations finalize a set of proposed regulations from December 2013, which succeeded another set of proposed regulations from 2012.  There was a lot of commentary about the proposed regulations, including on this website, and the overall sentiment was not very positive.  Various stakeholders from the single stock futures industry, the options industry, and broker dealers were up in arms arguing that the proposed regulations missed the mark on several key points and posed an unnecessary administrative burden and complexity. There were many issues that were debated, among others, the delta threshold used in the regulations, cascading withholding, delta combinations, and whether single stock futures and publicly traded options reflecting estimated dividends should be subject to the rules.
 
One of the issues that we previously touched upon on this website that is of significant interest for the investment fund industry is the treatment of publicly traded stock options and single stock futures (SSF). These instruments incorporate a price formula which includes in the calculations a dividend estimate.  Based on this, the 2013 proposed regulations were to subject options and SSFs to withholding (for options, if the delta of the options was at least .7). This proposal was critiqued by OneChicago, SIFMA, and the U.S. Securities Markets Coalition. The industry argued that estimated or implicit formula dividends should be exempted from the scope of the regulations, due to for example, the fact that there is no actual payment. Regrettably, Treasury did not heed these suggestions. To the opposite, it concluded that the economic benefit of a dividend is present in transactions that implicitly incorporate estimated dividends to virtually the same extent as transactions that pay actual dividends. On the bright side, the delta threshold for ELIs went up from .7 to .8 so fewer options will fall within the regulations' net. Finally, the regulations will generally apply to transactions issued after January 1, 2017.

The regulations can be found here. Tags: Section 871(m)