financing rates offered by prime brokers and other participants in the market. “Using prime brokers would create a conflict of interest,” Hamar bluntly states. The fund itself can act as a market maker, and sometimes an intermediary in securities financing, bridging gaps between lenders and borrowers for mutual benefit.


Skillsets and relationships The strategy demands a versatile skillset and range of relationships. The requisite skills include mathematics, IT, and a precise understanding of legal documents and regulations. The operational and counterparty framework requires the ability to execute and settle on many markets, and source stock borrow through counterparty relationships and solutions in this fragmented market.


For instance, sourcing of what are usually hard to borrow shares, is based on direct custodian relationships. “The intuitu personae parameter prevails in the stock lending and borrowing world: for hard to borrow it is a people business,” explains Hamar.


“Another counterparty is also used, which acts as a matched book principal intermediary,” reveals Hamar. Cellyant have an open and transparent dialogue with financing counterparties about the target financing rates needed to make arbitrages work. “In some special situations, the extra cost of borrowing special collateral is very marginal compared with the potential profit on the trade. ADRs can sometimes plug a gap. In other cases, we simply judge that the difficulty of sourcing borrow is too great, and do not bother,” says Thomas Neveux, Cellyant’s Investment Risk Officer.


Drivers: volumes and volatility The opportunity set is linked partly to volatility and volumes of corporate actions and can be marginally affected by interest rates and regulations. “Higher interest rates can improve theoretical basis returns, but overall volumes and volatility tend to be more important,” says Hamar. Credit spreads do not have much influence on repo margins, which are somewhat divorced from other risk premiums.


Categories of arbitrage The textbook arbitrage equation states that futures prices should equal spot plus carry minus corporate actions, such as dividends, but this does not always hold. In practice, the implied financing cost can deviate from the repo or borrowing rate, and a large enough gap between the two opens up a potentially low risk arbitrage opportunity. Cellyant can arbitrage between equities and single stock futures, in either direction: cash and carry, or reverse cash and carry.


Other strategies could trade a rights issue entitlement, or another subscription right related to a capital increase, against the underlying equity. They might also trade new against old


shares, possibly based on different dividend entitlements.


Scrip entitlements to dividends can also be hedged and traded, and in some countries such as France scrips offer a way to buy shares at a 10% discount.


Cellyant can also sometimes help with sourcing financing or facilitating and arranging financing for other parties, both as a standalone strategy, and to enable their own strategies.


The strategies are usually distinct, and it is very rare for a trade to involve more than one of them. (One exception is that a capital increase could lead to an old versus new shares trade.)


The allocation to strategies is completely opportunistic and might be entirely in one of them over a quarter, so long as the liquidity and volatility make sense. The manager does not feel the need to diversify into 10 or 15 deals at any one time, though there might be 10-15 over a whole year.


“There might for instance be 30-40 share issues and scrip dividends each year in the French market, but we will only select those offering the best risk reward and satisfying multiple other criteria,” says Hamar.


WHT and FTT Withholding taxes and financial transaction taxes can sometimes be one factor indirectly explaining divergences in financing rates offered by third parties, but the Cellyant fund usually does not pay these taxes, nor is it seeking to arbitrage or reclaim them. “Withholding taxes and double tax treaties are not really relevant sources of alpha as taxation becomes more harmonized at fund levels,” points out Hamar.


Risk factors Though the setups can often sound like very logical textbook arbitrages when held to maturity, they are not entirely without risks. In contrast to some “equity capital markets” strategies, there is not any direct underwriting risk.


Presuming that interest rate and currency risks are hedged, the risks mainly relate to operational matters.


The most important factor is usually sourcing secure, stable and affordable borrow and financing, based on counterparty relationships. “There is sometimes a risk of security borrow being recalled or repriced, or both, since locking it up can be too costly and it may not be realistic to fix the cost. This could result in unbalanced hedging and/or eat up the arbitrage,” says Hamar.


There are ways to mitigate this, however. “We try to diversify and sometimes mutualise this risk by alerting lenders to profitable strategies that


make use of the borrow,” says Hamar. Cellyant works collaboratively with counterparties, in areas such as collateral upgrades, intermediation between counterparties, and optimization strategies, to take advantage of corporate actions.


There might be a dividend risk, though this can sometimes be hedged through dividend futures in very specific situations, such as for a new versus old shares trade. Dividend risks could include a surprise cut or more unusually, the “Black Swan” risk of cancellation of dividends, as a few companies did during Covid. For instance, in 2010 BP cancelled its dividend during the Deepwater Horizon disaster, and in 2020 it halved the dividend during the Covid crisis.


All legs of a trade need to be executed simultaneously to lock in the arbitrage, and this becomes especially important in more volatile markets. This can be relatively easy to address: “Asynchronous execution risks can often be dealt with through a double fixing on Euronext,” says Hamar.


There can also be a limited degree of credit and counterparty risk, though regular sweeping back and forth of margin means that this is usually limited to daily mark to market movement since the last margin call. To be comprehensive and conservative, credit risk could also include clearing houses, which have sometimes failed or come very close to failing before being bailed out.


Beyond these risk factors, the manager admits that there could be some vulnerability to events such as major credit events, tax changes or major operational problems, which might lead to drawdowns of more than the base case 2% estimate.


Returns, leverage and the opportunity set The return target is an average of 10% per year, though it could be higher in a year such as 2018 with more opportunities and might be lower in other years. Target returns for the individual strategies range from 2-3% up to 12%, and the maximum expected drawdowns for each run from 1% to 3%. Performance fees apply only above a floating interest rate (EONIA) hurdle.


The strategy has generally not used leverage but might be more inclined to as it grows. Capacity is probably at least $100 million to $300 million, and more assets would expand the opportunity set in part by allowing for more leverage, which has not historically exceeded 2x.


In June 2023, Cellyant circulated a note alerting potential investors to exceptionally attractive arbitrage opportunities in the French market. Though financial markets and interest rates are to some degree normalizing, plenty of anomalies and arbitrage opportunities remain in securities financing arbitrage.


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