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Finland - a high-tech country?

www.apk.fi

Finland is traditionally known as a country of beautiful women, thousands of lakes and saunas. These clichés are still true, although in the 90's Finland has created herself another image. Finland has rapidly developed in the areas of high technology and information technology. The country has skilfully adapted to and implemented these technologies, and in some cases acted as a pioneer. Everyone knows Nokia, but there are only few who are aware of the high level of Finnish clearing and settlement technologies. The Finnish Central Securities Depository Ltd (APK) uses a real-time gross settlement system for debt instruments (called the RM-system) and has electronic connections to Bank of Finland's system of payment transactions. The APK benefits from the company's high technological level and is thus better able to meet growing domestic and international demands. Since this year APK's customers have been able to use an efficient two-way link infrastructure for trade settlement on German and French markets.

Structure of the RM-system in a nutshell
The RM-system contains the following functions as logical and separate entities: trade settlement, deliveries and custodian services. The system is centralised, i.e. there is only one book-entry register provided by the APK, in which account operators / clearing parties function.

Issues
The APK has currently the following instruments in its selection: bonds, commercial papers, treasury bills, municipal papers and certificates of deposit. Issuing of book-entries is easy and fast. Issues are carried out according to the DVP principle and trading of issues takes place in real time.

T+0; trade settlement, delivery and payment
RTGS-features were included in the RM-system already in 1993. Since then, several updated and improved versions of the system have been introduced.

Entry and confirmation:
Trades are handled as separate transactions in the APK's trade-by-trade settlement and implementation system. In DVP-process payment follows immediately after securities are transferred from one book-entry account to another, which means that trading parties are not subject to any credit risks. The process takes place in real time and is therefore free of risks. Additionally, no collateral is required for the APK. Clearing parties enter both their own and their clients' deals. It is possible to enter a deal to take place immediately (T+0) or on any other delivery date in the future. After a trade entry has been made, the APK's system checks that the buyer's and seller's data are identical. If that is the case, the system confirms the trade. A confirmed trade cannot be cancelled by the decision of solely one party.

Continuous settlement and implementation
The APK's clearing system examines, which of the concluded trades in each book-entry account can be processed separately or together with other trades. The following aspects are taken into consideration in the evaluation: cash deposits transferred by clearing parties to the APK's Bank of Finland payment transfer account for the payment of concluded trades, together with proceeds to be received from the sales of securities from the account. If the account holder's money transferred to the APK's Bank of Finland payment transfer account together with the money to be received from viable trades are enough to pay for all purchases, the system will process both purchases and sales simultaneously. Similarly, all viable trades entered in other accounts as well as viable trades having chained with waiting-to-be-settled trades are processed simultaneously. Each trading party bears the responsibility for fulfilling trading requirements, even when a particular trade is part of follow-up sales or purchases. It is justified to claim that the settlement of chained trades functions well, since 100 per cent of all trades in the RM-system take place always on the agreed settlement date.

Handling of payments

Payments between various financial institutions are handled via the APK's
Bank of Finland payment transfer account. Payments between various banks are made using so-called central bank money, which means that the APK as a clearing entity is not subject to any banking risks. The APK maintains cash deposits paid for or received from concluded trades on behalf of the buyer or the seller. A clearing party or an investor can choose either a gross principle, in which each trade is paid separately or a net principle, in which trade payments entered in the system for each delivery date are netted. Thus, each trading party gets only one payment obligation or receivable on each day.

Cross-border linking of the RM-system
Finland is the only Nordic country having a membership both in the EU and the EMU. Transferring to use the euro as a clearing currency at the beginning of 1999 went well. Due to favourable decision-making on the national level, Finnish money markets have become more international. Market participants have currently new possibilities to carry out international operations successfully, as the settlement infrastructure enables them to have a simple and automated access to the European core markets. Also other Nordic market participants are able to use, if they wish, the APK as a gateway in their operations targeted at the central markets of the EMU area. The requirement for this is naturally that the market participant has made a contract with an existing RM-clearing party /account operator or that the market participant acts as a clearing party / account operator.

How does linked settlement function in practise?
The domestic settlement of the RM-system is linked seamlessly to international, euro-denominated settlement transactions processed in the system. The APK keeps book-entries that have been transferred abroad in a so-called omnibus account of a foreign central securities depository. Trade messages are sent via the SWIFT-network between various central securities depositories. The settlement of cross-border trades in the RM-system is processed almost in real time. The only restriction is the time needed for sending messages via the SWIFT-network, which normally takes a few minutes. Trades and transfers to Germany and France are handled according to the Free of Payment -principle.

An example of handling a cross-border settlement transaction
A cross-border Free of Payment transaction is handled phase by phase. Links operate in both directions. In the example below, a Finnish clearing party transfers Finnish book-entries to a foreign party. The settlement process has the following phases:

(Phase 1)
A Finnish party enters a settlement transaction (= a trade transaction with no clearing price) in a normal way to the APK's RM-system. The party identifies the name and the account number of the recipient party of the foreign central securities depository (hereinafter FoCSD). The transaction is processed in the RM-system in the same way as Finnish transactions. Book-entries are transferred into the FoCSD's omnibus account on a settlement date as soon as the sender has a sufficient amount of book-entries in his book-entry account.

(Phase 2)
As the settlement transaction has been completed in the APK's RM-system, the APK's system sends a SWIFT-message to the FoCSD informing that book-entries have been transferred to the FoCSD's omnibus account. The name of the foreign clearing party to whom the book-entries belong is also mentioned.

(Phase 3)
The FoCSD issues a corresponding book-entry in its own system in order to register the ownership and holding of book-entries in the omnibus account. At the same time, the foreign party's (the receiver's) book-entry account is credited by the FoCSD through transferring issued book-entries to the party's account.

(Phase 4)
When the FoCSD has completed the transaction in its own system, the FoCSD will send (with some exceptions) a SWIFT-message to the APK confirming that the transaction has been completed in the FoCSD. After receiving this message from the FoCSD the APK has the certainty that the transaction has been completed in both central securities depositories.

If a Finnish party would transfer a German or a French book-entry to a German or a French party, the handling process would contain the same phases. The only exception would be that the FoCSD would not need to launch an issue in phase 3, since the German or French book-entries would already exist in the APK's omnibus account in the FoCSD's system.

Door open to Europe
Through the APK its clearing parties are able to have access to two major European clearing centres. On the domestic market the APK's clearing parties are able to settle trades with foreign securities in accordance with the DVP principle, i.e. the same principle used in the settlement of domestic trades. Investors can keep both domestic and foreign book-entries in the same book-entry account in the RM-system.

APK's clearing parties can use the ECB approved German securities transferred through this link as collateral for central bank loans in Finland. This service works in both directions as defined in the agreement between the APK and DBC. Thus, Finnish securities accepted to the link can similarly be used as collateral in Germany.

Issuers benefit from using the link, since there are potential investors not only in Finland but also in Germany and France. Issues must be denominated in the euro. Consequently, the liquidity of book-entries increases as domestic and foreign investors are able to maintain an effortless flow of communication. Payments of proceeds and refunds of principal are handled quickly through the TARGET system.

How to become a user of the APK's services?

1) Opening of an account
The easiest way is to open a book-entry account in some Finnish entity that acts as a clearing party and account operator in the APK's RM-system. A requirement for this is to have an agreement with the entity maintaining the book-entry account.

2) Becoming a clearing party
The entity seeking to become a clearing party shall submit an application to the APK. The APK's Board of Directors shall then make a decision on the acceptance of the application. In the same context the clearing party shall apply for the right to become an account operator. After the acceptance the clearing party / account operator shall make an agreement with the APK on following the rules and using the system. Details concerning practical matters shall be agreed upon with the APK. The APK shall create the clearing party into the system and shall inform all other clearing parties of the matter. The whole process takes a few weeks. According to the authorisation given to it, the clearing party / account operator can open and maintain book-entry accounts and make entries on its own and its customers' behalf.

Kimmo Kolehmainen
Finnish Central Securities Depository Ltd