QDD basics for banks — scope, eligibility, 871(m) & reviewer expectations

QDD basics for banks — scope, eligibility, 871(m) & reviewer expectations

Considering QDD? This guide outlines core concepts: scope & eligibility, the 871(m) dividend-equivalent regime, minimal control framework, and how QDD intersects with your QI review. It’s designed for banks with limited derivatives exposure or light prime/custody flows.

Scope: What QDD is (and isn’t), eligibility & onboarding considerations, 871(m) essentials, core processes (documentation, withholding, reporting), and reviewer expectations for a bank-grade control set.

1) What is QDD (quick definition)

  • QDD = Qualified Derivatives Dealer: a status under the QI framework for certain dealers issuing/holding derivatives that reference U.S. equities.
  • Goal: address dividend equivalents under §871(m) so tax is applied appropriately and cascading withholding is avoided in dealer chains.
  • Not every QI needs QDD. Consider QDD only if you have material 871(m) exposure (e.g., equity swaps/forwards, options) or dealer activity.

2) Eligibility & onboarding (bank context)

  1. Activity profile: do you issue or intermediate equity-linked derivatives referencing U.S. equities?
  2. Systems & data: can you identify 871(m) transactions, compute dividend equivalents, and aggregate exposure?
  3. Controls & governance: policies, model ownership, independent validation, exception logging, and audit trail.
  4. Resourcing: tax + product control + front-office coordination; periodic testing.
Bank reality: If derivatives are de minimis or only client-cleared via a third-party broker, you may not need QDD. Scope carefully before applying.

3) 871(m) essentials (dividend equivalents)

  • In scope: certain swaps, forwards, options, and complex instruments referencing U.S. equities.
  • Delta & combination rules: exposure determined via delta and combination/anti-abuse rules.
  • Withholding & reporting: identify payees, compute dividend equivalents, and apply appropriate withholding/reporting (often on Forms 1042/1042-S).
  • Documentation: ensure W-8/W-9 and intermediaries’ statuses reflect 871(m) operational needs.

4) Minimal control framework (right-sized)

  1. Policy & procedures: concise QDD/871(m) policy, ownership, and escalation.
  2. Identification logic: a ruleset to flag 871(m) positions at trade inception and lifecycle events.
  3. Calculation & review: maker-checker on dividend equivalent amounts; model validation where relevant.
  4. Withholding/Reporting: map to 1042-S income codes and boxes; corrections workflow with receipts.
  5. Reconciliations: totals → 1042 → GL; specific sub-ledgers for 871(m) where used.
  6. Governance: KRIs (e.g., flagged trades vs reviewed, exceptions aging), training, and periodic testing.

5) QI periodic review vs QDD

A standard QI review focuses on documentation, withholding, reporting and reconciliations. If you operate as (or interact with) a QDD, reviewers typically expand testing to 871(m) identification, calculations, and evidence of controls specific to QDD activity.

  • Confirm scope (do you truly have QDD-level exposure?).
  • Walk through flagging logic and a sample of trades.
  • Evidence calculations, withholding & reporting for dividend equivalents.
  • Show governance: KRIs, exceptions, closures, and training specific to 871(m).

6) Quick scoping questions (use internally)

  • Which desks/products can generate 871(m) exposure? Volume/order of magnitude?
  • Do we calculate dividend equivalents in-house or receive them from a broker/CCP?
  • Where do we store evidence (trade attributes, delta, adjustments)?
  • Do we have any passthrough/chain exposure that could create double withholding risk?
Not sure if you need QDD?
We run a quick QDD scoping and give you a yes/no with a minimal control plan if needed.

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