Dividend-arbitrage trades will soon be a thing of the past for the securities finance business, industry insiders claim, bringing an end to the much maligned practice.

The trades, which take advantage of inefficiencies between tax rates to generate a return, have been one facet of the lending business since it began.

Often transactions involve large foreign investors lending out their holdings of stocks, engineered by banks, so they are not on their books at dividend time.

The practice isn’t illegal but is increasingly under the media and regulatory microscope, particularly given the public focus on tax avoidance in a time of austerity.  

“It’s still part of the business but it has shrunk dramatically,” one individual, who wished to remain anonymous, told Global Investor/ISF.

“The industry has to move on. If you’re a broker concentrated on dividend arbitrage trades then you’re going to suffer.”

The comments were made at the International Securities Lending Association’s (ISLA) annual conference in Vienna this week.

Another conference delegate who works for a major European prime broker said his desk had been “extremely conservative” in the div-arb space recently.

He also urged companies to adapt and find other types of legitimate trades.

Earlier this year Newspapers Handelsblatt and the Washington Post, along with investigative journalism group ProPublica obtained a "cache of confidential documents" showing "complex stock-lending deals".

The group claims the trades were "structured and marketed as tax-avoidance vehicles that drain an estimated $1bn a year from the German treasury".

While critics point out the losses to the taxpayer, others argue that investment firms and pensions engage in div-arb deals because it helps their retail and retirement savers.

The German government is expected to regulate away the practice, but most firms have already phased out the transactions including Commerzbank, which was named in the media investigation as a div-arb participant. 

Rule changes in Germany are expected this summer. There are also calls to harmonize tax rates to make div-arb an inefficient trade.

ISLA, the securities lending body, has been educating market participants about Germany’s tax rules and continues to work with the German Ministry of Finance.