What has been behind the growth in Norwegian securities lending volumes?

Dag Rudilokken: In the last two years the Oslo Stock Exchange has launched two influential new indices. The mid-cap index was launched in August 2015 and the seafood index in April 2016. Together, the two new indices represent nearly a third of the total market cap of the Oslo Stock Exchange. Both have proved popular with foreign clients, which have always been important and currently own 37% of the total Norwegian equities market.

They are increasingly important as lenders and borrowers of securities as well, with a tendency to borrow a wider range of names than domestic participants. Domestic clients tend to focus on particular companies, lately often in the seafood and oil sector.

Karin Aronsen: This growth in demand has been shadowed by an increase in supply, facilitated by rule changes for mutual funds. In particular, counterparty lending limits have increased from 10% to 50% of a fund’s total portfolio, following an earlier shift from 5% to 10%.

This has considerably reduced the workload for mutual funds. As funds realise that they can engage in lending more cost efficiently, an increasing number are entering the market. Growth in supply benefits both lenders and borrowers – as more funds lend, more borrowers are attracted to the market, which, in turn, incentivises funds to lend more.

The rule change for mutual funds, which was long-awaited and had been delayed, comes as part of the amendment of Norway’s Securities Funds Act. Funds will now be able to utilise up to 50% of their market value using efficient portfolio management techniques, including securities lending and repo.

As funds realise that they can engage in lending more cost efficiently, an increasing number are entering the market. Growth in supply benefits both lenders and borrowers – as more funds lend, more borrowers are attracted to the market, which, in turn, incentivises funds to lend more.

The rule change for mutual funds, which was long-awaited and had been delayed, comes as part of the amendment of Norway’s Securities Funds Act. Funds will now be able to utilise up to 50% of their market value using efficient portfolio management techniques, including securities lending and repo.

To what extent is market volatility attracting participants?

Rudilokken: It is attracting them significantly. The sustained market volatility across Nordic markets has cemented the appeal of the new indices. We have seen a lot of specials, even among traditional GC names, for some time. In large part this has been due to the turbulence in energy markets, following the drop in the oil price. Of the 25 stocks comprising the main OBX index on the Oslo Stock Exchange, typically ten are connected to oil.

As long as volatility continues to provide opportunities there will be extra revenue available to both borrowers and lenders. Lenders, in particular, are benefitting from the higher prices available on the two new indices. The prospect of higher fees has helped attract mutual funds into the market in larger numbers, adding supply.

What impact is regulatory change having in Norway?

Rudilokken: A key focus in the coming years will be the impact of EU regulations on the economics of securities lending, notably the treatment of margin, haircuts and the costs of holding collateral. Currently, the increased costs associated with these regulations, such as increasing capital requirements, have not yet been matched by changes in the size of margins or haircuts.

The industry needs to confront the question of which entities will absorb these increased costs. Will it be the borrowers, through higher margins? Will it be the lenders, through lower revenues? Or, a combination? Unless fees for low-margin GC names move it could soon become uneconomical for providers. It will be interesting to see who will be the first to put their head above the parapet and shift their pricing.

Aronsen: The quality of providers’ back offices will come under increasing scrutiny from clients in the coming years. Assuming Norway follows the EU’s regulatory lead – as it has done so far – fees for settlement failure are likely to be introduced. This would increase the benefit of working with a good counterparty.

The ability to provide a strong post-trade service will become, increasingly, a competitive advantage. For local clients the benefits of a simple integrated solution – encompassing elements such as reporting – are especially useful. They, particularly, will seek quality in this area.