Lago Kapital
Jarkko Järvitalo
07 January 2014
Lago Kapital’s Jarkko Järvitalo shines a light on Finland, where securities lending and borrowing is on the rise, but obstacles to business remain
Image: Shutterstock
What is Lago Kapital and what does it do?
Lago Kapital provides securities lending and financing services. Located in Finland, it is regulated by the local financial authorities, is owned by its key personnel and is fully bank-independent. We essentially act as a securities borrowing and lending broker for our clients
When did securities lending begin as a practice in Finland?
Securities lending started in the late 1990s with the LEX stock lending product run by the Helsinki Stock Exchange. It was regarded as a derivative instrument, where the stock exchange was the central counterparty to each loan. LEX lending was designed mainly to help with delivery failures.
OTC lending started when Finland’s corporate tax law was amended to facilitate securities lending. It was amended so that securities could be lent without the transfer being regarded as a sale. This was, however, limited to a maximum period of 10 days and it was mainly used for delivery failures. For short sales, the loan had to be re-booked every 10 days, resulting in high settlement costs.
But the OTC lending market truly kicked off in 2008 when the 10-day rule was eliminated and the new maximum period was set to one calendar year. The Nordic banks quickly took over the securities lending market and the LEX product was soon closed down.
What does Finland’s securities lending market look like today?
The current OTC market is cash collateralised due to tax legislation (there is no tax exempt transfer of ownership in non-cash collateral). Business is quite small on a global scale, but the top five names in the OMX Helsinki 25 index are very liquid. Indeed, there have been lots of specials lately, including Nokia, Outokumpu, Outotec, Talvivaara and Neste Oil. The rest of the market is now catching up as new lenders are coming on-board.
Beneficial owners, including fund and investment companies, are increasing their interest in lending, while hedge funds and private investment companies are increasing their demand for both Finnish and foreign securities. We are working with independent fund companies, and there are also insurance companies, foundations and investment companies.
There are two main problems with securities lending in Finland. The first is that in Finland, as I mentioned above, securities cannot be used as collateral. Unfortunately, Finnish law has not been updated to reflect EU directives, so the transfer of funds as collateral is viewed as a sale and a purchase. In the past, the tax authorities have discussed the possibility of derivatives transactions not being viewed as sales, but they have said nothing about securities lending.
As a result, collateral has to be cash, although there is a legal way around it. If a party lends securities to another and is owed collateral, the party can borrow securities, so there will be netting.
The other problem is that only companies under the Finnish corporate tax law can lend securities with no tax issues. A private individual can only borrow securities. It has been said that private individuals cannot lend out securities because they do not do the same book keeping as institutions. It is a very bad situation for us because there are a lot of specials in Finland at the moment. We have a lot of private clients who are actually borrowing a lot of securities from us. They can borrow it in but not lend it out, so you can see the frustration.
How can Finland help with the elusive Russian market?
Finland can be used as a safe gateway to Russia and vice versa: Finnish funds have significant Russian holdings, and Russian counterparties have trust in the Finnish market regulation and transparency.
The Finnish government is in fact pushing Finnish companies to do business in Russia because they see that opportunities are growing and risks are reducing. We were chosen for a government-sponsored project where we get a lot of help from professionals in Russia. What we are exploring right now, with the help of local attorneys and specialists within the Russian markets, is a pre-study on whether we can do securities lending on a much bigger scale in the Russian markets. Right now, we are borrowing and lending Russian securities, but they are mainly from Finland-based Russian companies, and now we would like to work with Russian clients as well.
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