(Bloomberg) -- Just a few weeks ago, in an unlikely corner of European finance, one of the continent’s most notorious trades may have reappeared. 

Traders kicked off a spree of buying and selling in obscure derivatives tied to stocks until more than €29 billion ($32.1 billion) of them had changed hands for March, more than January and February combined, according to data from the Eurex exchange. During that month, they targeted one European country more than any other: Finland.

This sudden surge in interest in the Nordic nation may have been — at least in part — because of a trade that many across Europe would like to see eliminated, according to Finnish authorities and academics. Known as “cum-cum” deals, investors can use the derivatives — called single-stock futures — to shuffle stocks from one jurisdiction to another and back again, ducking the withholding taxes that governments impose on dividends. 

“It doesn’t make sense that Finnish single-stock futures would be the most heavily traded from a pure investment point of view,” said Katja Pussila, a risk manager at the Finnish Tax Administration who has helped lead the country’s investigation into the practice. “It’s evidence of dividend-tax arbitrage, at least to some extent.”

Finland lost an estimated €320 million of public revenue between 2018 and 2021 as a result of these kinds of trades, Pussila said. Tax authorities are probing “several dozen” companies and cooperating with the country’s National Bureau of Investigation as part of a sweeping review, she said. While the country has taken measures to eliminate the transactions, it is “an ongoing problem” and new cases are likely to arise, she said. 

Cum-cum transactions, named after the Latin word for “with” that traders often use when discussing dividends, made headlines in March when French prosecutors raided the Paris offices of banks including BNP Paribas SA and Societe Generale SA. The lenders are facing fines of more than €1 billion as part of a probe into money laundering and tax fraud allegedly linked to the trades.

France and Finland are the latest fronts in European regulators’ attempts to stamp out trades that illicitly profit from tax, a strategy known as dividend arbitrage. Once widespread across global financial capitals, academics have estimated that the practice may have cost European taxpayers tens of billions of dollars over the decades. A more aggressive variety than cum-cum, known as “cum-ex,” or “with-without,” has spawned multiple investigations across Europe and several bankers have already gone to jail.

But proving wrongdoing with cum-cum transactions may be a far more difficult task. 

“It would be highly unlikely that the elevated volumes of transactions around dividend payments would be for other reasons than tax minimization,” said Timo Viherkentta, former chief executive officer of Finland’s state pension fund who has also lectured in Finnish tax law. “But it is extremely difficult to estimate how a large share of the arrangements will not withstand legal scrutiny.” 

The increased scrutiny around cum-cum trades has shone a light on single-stock futures, contracts to buy or sell individual shares at a set price and date. While some €78 billion of them have been bought and sold so far this year, they are a relative obscurity in Europe’s financial markets and are barely traded at times. Traders exchanged €7.7 trillion of similar products tied to baskets of stocks by comparison, according to data from Eurex, the Deutsche Boerse AG-owned venue. 

Yet during the spring months when many European corporations begin doling out dividends, single-stock futures suddenly pique the interest of traders. The total volume of transactions — including those tied to Finnish stocks — surged 275% in March compared with February, echoing a trend going back to at least 2016, according to Eurex data. While futures tied to baskets of stocks also jumped during the month, they do that at the end of every quarter, the data shows.

For some, single-stock futures can be seen as a proxy for dividend arbitrage. The derivatives, which “lock stock prices in time,” were key components of tax trades in Germany, according to research from Goethe University in Frankfurt. When the country changed its rules to bar cum-ex and cum-cum transactions, trading volumes linked to other nations surged. This suggested “continued cum-ex or cum-cum trading in these countries,” the research shows.

Investors targeted Belgium, Spain and France — and Finland. 

In March, traders bought and sold more single-stock futures tied to Helsinki-based bank Nordea Abp than any other. The same thing occurred a year ago while they were also among the most traded in October 2021, the Eurex data show. Investors have hardly ever traded the derivatives in such numbers otherwise. The lender’s record date — the cut-off point set by a company’s board that determines which shareholders are eligible to receive a dividend — occurred during those three periods, according to data compiled by Bloomberg. 

In April, trading in Nordea’s single-stock futures plunged 90%.

Stora Enso Oyj, a packaging company also based in the Finnish capital, was the fifth most-traded single-stock future in March, the first time its derivatives were that popular since at least 2016, according to the data. The firm’s record date also occurred that month. 

Traders didn’t buy or sell any Stora Enso single-stock futures in January or February or April, the data shows.

The volume of Nordea and Stora Enso shares out on loan also increased in March, according to Markit data. This is often an indicator that dividend-arbitrage strategies are at play.

Still, it’s difficult to know for sure what causes the springtime surge in single-stock futures. Valerie Laturnus, one of the Goethe University researchers, said there can be “several reasons” that have nothing to do with ducking taxes.

“Investors may have a year-end strategy to sell or buy certain stocks to minimize their tax burdens or to take advantage of any capital gain tax benefits,” Laturnus said. “Investors could use a specific momentum strategy. Or, it could be also due to general market trends.” 

Dividend arbitrage has diminished in recent years as governments shut down loopholes that enable the trades. Banks, brokerages and investment funds have also retreated from the strategy, spooked by mounting legal and reputational risks. Commerzbank AG, the Frankfurt-based lender, stopped offering cum-cum transactions in 2016 because they were no longer “socially acceptable.” 

In Germany, authorities are in the midst of a multi-year probe into cum-ex trades that — unlike cum-cum deals — enabled multiple parties to get refunds on taxes that were only paid once. A former trader who cooperated with prosecutors, told a Bonn court in 2019 that this strategy could be five to six times more profitable than cum-cum transactions and even up to 20 times. 

In a typical cum-cum trade, a stockholder lends shares before the dividend date to a party in another jurisdiction where the tax hit will be smaller. After the payout, the party hands back the stock and the firms split the savings. Single-stock futures and similar derivatives are also used in the transactions.

But despite the probes in France, Finland and Germany, some countries allow the financial maneuvers. The U.K.’s Financial Conduct Authority permits the activity as long as the intention is the legal “minimizing of withholding taxes,” according to a 2017 report. A spokesman for the regulator declined to comment. 

A spokeswoman for Eurex, the platform where many derivatives trades take place, said that the motivations of its clients weren’t “transparent.” When the bourse does find irregularities, it turns the data over to the relevant exchange and national regulators, she said.

“But it is a zero-sum game,” said Eric Barthe, former head of financial engineering at Leonteq Securities AG in Zurich who runs a blog focused on complex derivatives. “The one losing here is the taxman.

The questions for prosecutors is whether a cum-cum trade takes place mainly for the purpose of ducking tax. Is it “economically justified” or just a tax dodge? Even then, is it illegal or just morally dubious. 

“It is perfectly legal to sell your shares before dividend distribution and buy them back right after,” said Aziza Laguecir, professor of management accounting at EDHEC Business Schoo in Paris who recently co-authored an analysis on the differences between cum-cum and cum-ex trades in France. “The problem is the abuse of that.”

Authorities in France have targeted some of Europe’s biggest banks for cum-cum trades, culminating in the raids by Paris prosecutors of BNP Paribas, SocGen, Natixis SA and HSBC Holdings Plc. But the French banking lobby, Federation Bancaire Francaise, filed a lawsuit at the nation’s highest administrative court requesting clarification on which dividend-arbitrage strategies require the payment of taxes, Bloomberg reported March 30.

Finland Research   

Officials in Finland began researching dividend arbitrage in 2018 and there is very little case law around the phenomenon, according to Katriina Pankakoski, a former official at the Finnish Tax Administration. That makes it difficult to interpret the treaties and domestic laws underpinning the transactions, she said.

This lack of precedent can muddy the waters for authorities. There are “a considerable number of open questions and interpretation,”  said Pankakoski, who is now a lecturer at Aalto University in Helsinki.

Then there is the complex, multi-layered, multi-jurisdiction nature of any dividend-arbitrage deal. The Finnish tax authority has alleged that cum-cum trades are arranged by “malicious companies” profiting from treaties that the country has with the United Arab Emirates, the UK and Ireland. A typical trade might involve shareholders, a bank, a brokerage, stocks, derivatives and a “conduit company” in Dubai.

The result: benefits “not intended in the tax treaty” have emerged, Pankakoski said.

--With assistance from Michael Msika and Karin Matussek.

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