## _cr06343

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---

### Overall stability assessment — main findings
- The financial system is generally resilient and well supervised, underpinned by an effective legal and financial infrastructure.
- Recent strong performance is driven by rapidly expanding credit and an exuberant housing market and "will be difficult to sustain."
- Supervisors should intensify efforts to monitor risks and use stress testing more effectively in assessing banking system vulnerability.
- Authorities should make greater use of their authority to require additional capital as appropriate in individual cases.
- The mission found generally a high degree of compliance with the international financial standards and codes.
- The autonomy and accountability of the DFSA should be entrenched by providing the agency a statutory basis and granting it greater budgetary autonomy.
- The regulatory framework could benefit from upgrading the guideline on internal controls to an Executive Order and broadening the coverage of fit-and-proper requirements.

### Key quantitative indicators and vulnerabilities
- Economic growth reached 3.2 percent in 2005.
- Inflation is "close to 2 percent."
- General government balance realized a surplus of some 4 percent of GDP in 2005.
- External current account surplus reached 3.0 percent of GDP.
- In 2005, bank lending grew 21 percent and loans by mortgage credit institutions increased 12 percent.
- House prices in Denmark increased by 22 percent on average during 2005.
- Household indebtedness increased to some 230 percent of disposable income.
- Loans with variable rates accounted for about half of total mortgage loans at the end of January 2006.
- At end-2005, total assets of commercial banks were around 194 percent of GDP.
- The two largest banking groups—Danske Bank and Nordea Danmark—account for about 65 percent of commercial bank lending.
- The five largest banking groups account for approximately 79 percent of total loans and 83 percent of total assets.

### Stress testing and capital adequacy — design, scenarios, results, interpretation
- Methodology
  - Top-down and bottom-up stress tests using severe, but plausible, single factor shocks and macroeconomic scenarios developed with DN and DFSA.
  - Bottom-up: banks ran scenarios through their internal models as requested by DFSA.
  - Top-down: portfolio credit risk based methodology implemented by staff.
- Scenarios (selected macro shocks and channels)
  - Scenario 1 — boom-bust in real estate prices and credit:
    - Credit growth: down by 14.2 percent.
    - Collateral prices: down by 27 percent.
    - Unemployment: up by 3.8 percent.
    - GDP: down by 6.8 percent.
  - Scenario 2 — foreign shock from abrupt correction in global imbalances:
    - Exchange rate: Danish kroner (in line with the euro) appreciates against the U.S. dollar and other currencies (up to 29 percent).
    - GDP: down by 4.1 percent.
    - Unemployment: up by 3.2 percent.
  - Scenario 3 — boom-bust in real estate and credit plus strong increase in European interest rates:
    - Policy interest rates rise: 250 bp.
    - Credit growth: down to 19.5 percent.
    - Collateral prices: down by 41.9 percent.
    - Unemployment: up by 5.1 percent.
    - GDP: down by 9.2 percent.
- Stress test results — resulting capital adequacy ratios (percent)
  - Top-down results:
    - Scenario 1: 2006 = 8.5; 2007 = 8.3; 2008 = 6.7.
    - Scenario 2: 2006 = 8.5; 2007 = 8.3; 2008 = 8.1.
    - Scenario 3: 2006 = 8.6; 2007 = 8.0; 2008 = 5.7.
  - Bottom-up results:
    - Scenario 1: 2006 = 10.5; 2007 = 9.0; 2008 = 6.6.
    - Scenario 2: 2006 = 10.1; 2007 = 9.2; 2008 = 7.7.
    - Scenario 3: 2006 = 9.3; 2007 = 7.4; 2008 = 4.5.
- Interpretation and limitations
  - Results should be interpreted with caution: the most severe scenario simulates hypothetical extreme events with low likelihood.
  - The model does not account for second round portfolio adjustments and is based on the average banking system; individual banks will be affected differently.
  - Capital cushions are expected to decline with the implementation of Basel II.
  - As large investors in mortgage bonds, banks have benefited from revaluation gains from declining interest rates; prospective interest rate increases would likely have the opposite effect.

### Banking sector structure, competitiveness, and soundness
- Competitiveness and efficiency
  - The banking sector is relatively competitive and efficient by international comparison even though it is highly concentrated.
  - Intermediation efficiency indicators have been improving: the spread between lending and deposit rates and operating costs as a share of total assets have been declining.
  - Both net interest income and net fee and commission income as a percent of total assets are higher than the EU-25 average.
- Structure and scale (selected indicators)
  - Number of banks (All banks): Dec-95 = 211; Dec-00 = 197; Dec-05 = 170.
  - Assets (percent of GDP), All banks: Dec-95 = 208.7; Dec-00 = 250.8; Dec-05 = 331.9.
  - Commercial banks assets (percent of GDP): Dec-95 = 103.1; Dec-00 = 140.3; Dec-05 = 193.6.
  - Mortgage banks assets (percent of GDP): Dec-95 = 100.9; Dec-00 = 106.5; Dec-05 = 134.3.
  - Number of employees, All banks: Dec-00 = 46,263; Dec-05 = 43,879.
- Financial soundness and buffers (selected indicators and trends)
  - Overall capital adequacy ratio at end-2005: 13¼ percent.
  - Accumulated provisions at end-2005: 1.0 percent of total loans outstanding.
  - Banks reported record profits in 2005 — 21¼ percent return before tax on equity compared with 17¾ percent in 2004.
  - System-wide income to cost ratio improved from 1.7 to 2.0.
  - Selected Dec-05 indicators:
    - Regulatory capital to risk-weighted assets (Tier 1+Tier 2): 13.2.
    - Tier 1 capital to risk-weighted assets: 10.2.
    - Capital (net worth) to assets: 5.7.
    - Nonperforming loans to gross loans and guarantees: 0.3.
    - Stock of total provisions to total gross loans: 1.0.
    - Credit growth: 24.7.
    - Return on equity before tax (Dec-05): 21.2.
    - Net interest income to gross income (Dec-05): 61.9.
    - Noninterest income to gross income (Dec-05): 38.1.
    - Liquid assets to total assets (exclusive of interbank lending) (Dec-05): 7.4.
    - Gross loans to deposits (Dec-05): 115.3.
    - Liquidity coverage as a percentage of the requirement (Dec-05): 140.1.
- Foreign presence and systemic notes
  - At end-2005, there were 9 foreign subsidiaries, 26 foreign branches, and 271 foreign credit institutions providing some cross-border banking services into the country.
  - Banks with Nordic parents accounted for approximately 84 percent of foreign banks’ total assets.
  - Nordea’s contemplated transformation into a European Company would leave Danish branches systemically important and pose supervisory challenges.

### Mortgage finance, covered bonds, and mortgage credit institutions
- Mortgage credit banks — system characteristics
  - Total assets close to 135 percent of GDP; mortgage credit institutions are slightly smaller than commercial banks.
  - Mortgage bonds and mortgage credit institutions are highly rated by international rating agencies.
  - Mortgage bonds are accepted by the Nationalbank as collateral.
- Product and market developments
  - New products include variable interest rates, deferred amortization, and capped adjustable rate loans.
  - Variable rate mortgage loans now account for about half of all such loans.
  - Wider range of mortgage products could reduce homogeneity, producing smaller and less liquid bonds and potentially lowering investor appetite.
- Impending EU covered bonds regulation — effects and transition
  - Covered bonds will require continuous observation of loan to value (LTV) rather than only at origination.
  - Banks would be allowed to issue covered bonds in addition to mortgage credit institutions.
  - Effects include more funding flexibility for issuers and potential limitation of direct access to capital markets for borrowers under the current system.
  - Long-run benefits depend on effective disclosure, transparency, and a level playing field among market participants.
- Selected mortgage credit institution indicators (Dec-00 to Dec-05 excerpts)
  - Regulatory capital to risk-weighted assets (Tier 1+Tier 2): Dec-00 12.6; Dec-05 12.7.
  - Tier 1 capital to risk-weighted assets: Dec-00 11.5; Dec-05 11.3.
  - Capital (net worth) to assets: Dec-00 5.3; Dec-05 5.3.
  - Adjustable rate lending to total lending: Dec-00 8.7; Dec-05 45.8.
  - Liquid assets to total assets: Dec-00 15.8; Dec-05 28.9.
  - Credit growth: Dec-00 3.8; Dec-05 11.1.

### Insurance and pension sector observations
- Sector size and concentration
  - At end-2005, assets of life insurance and general pension funds amounted to almost 120 percent of GDP.
  - The five largest companies account for about 55 percent of gross premiums and the ten largest for 73½ percent.
  - Assets of non-life insurance companies amounted to 9 percent of GDP at end-2005.
  - In 2005, gross premiums amounted to 2.9 percent of GDP.
- Performance indicators (selected)
  - Life insurance gross premiums to GDP: 2005 4.3.
  - Solvency indicator for life insurance: 2005 196.8.
  - Pension funds solvency indicator: 2005 476.7.
  - Non-life return on assets: Dec-05 6.4.
  - Non-life solvency ratio: Dec-05 4.7.
- Vulnerabilities and monitoring
  - A substantial share of older contracts with a guaranteed annual return of 4.5 percent is still outstanding.
  - Many companies have bought derivatives to cover these risks.
  - Stress testing shows much of the impact of shocks would be absorbed by the collective bonus pool component (retained earnings).
  - DFSA’s “traffic light” system:
    - Red light scenario: decline of 12 percent in the price of stocks and 8 percent in the price of real estate, and an increase in the interest rate level of 0.7 percentage points.
    - Yellow light scenario: decline of 30 percent in the price of stocks and 12 percent in the price of real estate, and an increase in the interest rate level of 1.0 percentage point.
    - As of end-2005: One company (nonlife company) flagged under red light; Six companies signaled under yellow light.
  - Capital requirements:
    - Effective January 1, 2007, the minimum capital requirement will increase to the equivalent of the requirements in EU Solvency I Directive.

### Payment, clearing and settlement systems — KRONOS, Sumclearing, VP
- Infrastructure and activity (2005)
  - VP: 10.2 million transactions settled with a market value of DKr 30,924 billion.
  - Sumclearing: around 1.1 billion payments with a value of DKr 5,027 billion processed (Sumclearing processed transactions amounting to 3¼ times nominal GDP).
  - KRONOS: turned over nominal GDP about 57¼ times in 2005.
  - Denmark had around 670 million card payments in 2005; the highest number of card transactions per capita in Europe.
- System assessments and recommended corrective actions
  - KRONOS:
    - Classified as generally sound, efficient, and reliable; recommended enhancements include contingency coordination, reducing maximum restart time to align with best practice (two hours), security and stress testing improvements, and price/cost analysis.
  - Sumclearing:
    - As a deferred net settlement system for retail payments, has more difficulties fully observing the CPSIPS; risk management measures in case of a default are inadequate and unwinding is the principle solution.
    - Recommendations include drafting and publishing a comprehensive memorandum describing the system and its risks; implement loss-sharing or liquidity arrangements; lower netting positions by batching; cease booking retail payments to customer accounts before settlement is final.
  - VP (CSD) — main findings
    - Securities are dematerialized and settled on a DVP basis in central bank money; VP does not act as a CCP.
    - Recommended actions include analyzing effects of failure of the largest participant and multiple failures, coordinating contingency plans with KRONOS and Sumclearing, and enhancing overseers’ rights in case of outsourcing.
- Liquidity and contagion notes
  - At end-2005 banks’ holdings of bonds (mostly collaterable assets) represented 19.5 percent of total assets and 49.5 percent of all deposits.
  - DN analysis of uncollateralized bilateral exposures indicates the risk of interbank contagion is insignificant and manageable.
  - Stress testing model used in banks’ baseline projections assumes profitability remains at the 2005 level, which may understate negative impacts under stressed scenarios.

### Supervisory capacity, DFSA institutional issues, and compliance with standards
- Supervisory approach and structure
  - DFSA conducts effective risk-oriented supervision as an autonomous institution under the Ministry of Economic and Business Affairs.
  - Risk-oriented approach comprises an early warning system, supervisor ratings, simple stress tests, and assessment of systemic importance.
  - Inspection cycles: large institutions examined under a four-year cycle; medium-sized at least every fourth year; smaller low-risk institutions every seventh year.
- Governance, autonomy, and resources
  - Consider providing statutory basis to the DFSA to entrench autonomy and accountability.
  - Consider granting DFSA greater budgetary autonomy and separating legislative/regulatory activities and supervisory budgets.
  - DFSA’s resources should be reassessed to expand capacity to validate banks’ internal models, undertake stress testing, and ensure an effective AML/CFT framework.
  - DFSA faces challenges in building capacity to validate internal models, identifying emerging risks, and strengthening coordination with other regional supervisors.
- Compliance with international standards (selected)
  - Basel Core Principles for Effective Banking Supervision (BCP): either fully or largely observed.
  - Insurance Core Principles (IAIS): either observed or broadly observed.
  - Core Principles for Systemically Important Payment Systems and the Recommendations for Securities Clearing and Settlement Systems (RSS): overall compliance is high.
- Main recommendations to improve compliance (selected)
  - Establish a law or provision formally establishing the DFSA to enhance transparency and autonomy (CP 1.1).
  - Provide the DFSA with its own budget (CP 1.2).
  - Apply ‘fit-and-proper’ tests to holders of other key management positions and upgrade internal control guidelines into an executive order.
  - Introduce routine monitoring of net funding requirements, stress testing, and contingency planning for liquidity crises.

### AML/CFT assessment — FIU, legal framework, supervision, and recommendations
- FIU operations and capacity
  - FIU is an operationally independent unit within the office of the Public Prosecutor for Serious Economic Crime (SØK).
  - Staffing: "three prosecutors and seven police officers"; "also has access to supplementary staff."
  - FIU has direct access to a wide range of data, but a court order is usually needed to obtain additional information from reporting entities.
  - Analysis of STRs is "limited to gathering information, largely through basic checks against databases"; "virtually all STRs are disseminated for investigation, with little additional analysis or value-added."
  - Recommendation: Enhance STR analysis capability and staffing, and provide specialized training in tracing proceeds, financial analysis, and FT.
- Legal framework and coverage
  - ML criminalization through a "money receiving offense" covering proceeds from "any crime committed intentionally"; penalties: "a fine, and/or for the basic offense imprisonment of up to 18 months and for the aggravated offence up to six years."
  - FT criminalization is consistent with international standards; Faroe Islands and Greenland lack full FT provisions and need harmonization.
  - Confiscation framework is comprehensive and flexible; freezing of terrorist assets implemented through EU Regulations and national mechanisms.
- Preventive measures and supervision
  - The MLA adopted in March 2006 implements the third EU AML Directive; key provisions come into force in January 2007.
  - Gaps in CDD: no requirement to identify and verify that an individual purporting to act on behalf of a legal person or arrangement is so authorized; identification for occasional wire transfers applies only to those involving €15,000 or more; some exemptions not justified by risk assessment.
  - Supervisory authorities: FSA and DCCA oversight; FSA AML/CFT supervision has focused on reviewing internal guidelines with insufficient on-site inspection depth historically.
  - Recommendation: Expand on-site inspections, increase supervisory resources and training, and improve supervision of DNFBPs (lawyers, accountants, real estate agents, casinos).
- National and international cooperation
  - Domestic coordination is informal; recommendation to establish a platform for inter-agency policy level review of AML/CFT initiatives.
  - Denmark is a party to all relevant international AML/CFT instruments but they have not yet been extended to the Faroe Islands or Greenland.
- Key recommended actions (selected)
  - Use ML provision more effectively and increase prosecution of aggravated ML (Section 290(2)).
  - Extend and align Faroe Islands and Greenland legislation on ML and FT.
  - Ensure FIU can obtain additional information without a court order and increase FIU staffing and specialized training.
  - Align wire transfer rules with international standards (incoming payments, no personal contact, intermediary account cases).
  - Strengthen supervision and reporting from DNFBPs and collect better statistics on ML/FT enforcement and MLA/extradition.

### Box 1 — Denmark FSAP: Main recommendations (summarized)
- Near-term financial stability
  - Any easing of capital requirements under Basel II should be done gradually; supervisors should make use of regulatory authority to require additional capital as appropriate in individual cases.
  - The mission supports the regulation limiting the decreases in capital requirements in 2007-08 for institutions that would use advanced methods for determining their capital adequacy.
  - Intensify monitoring, compilation of information, and modeling of shocks through strengthened stress testing capacity at the DFSA; consider more frequent inspections as warranted.
  - Close monitoring of the housing market, strict adherence to supervisory rules, and effective consumer information about risks of over-borrowing.
- Structural issues
  - Entrench DFSA autonomy and accountability by providing the agency a statutory basis and granting it greater budgetary autonomy; consider separation of legislative/regulatory and supervisory budgets.
  - Reassess DFSA resources to expand capacity for model verification, stress testing, and AML/CFT.
  - Upgrade the guideline on internal controls to a more binding Executive Order and broaden fit-and-proper coverage.

*Source: _cr06343 - 2006. The assessment was conducted by Richard Lalonde (Team Leader), Paul Ashin, Margaret Cotter,*

### 2006. The assessment was conducted by Richard Lalonde (Team Leader), Paul Ashin, Margaret Cotter,

### _cr06343 - 2006. The assessment was conducted by Richard Lalonde (Team Leader), Paul Ashin, Margaret Cotter,

### Overall stability assessment — main findings
- The financial system is generally resilient and well supervised, underpinned by an effective legal and financial infrastructure.
- Recent strong performance is driven by rapidly expanding credit and an exuberant housing market and "will be difficult to sustain."
- Supervisors should intensify efforts to monitor risks and use stress testing more effectively in assessing banking system vulnerability.
- Authorities should make greater use of their authority to require additional capital as appropriate in individual cases.
- The mission found generally a high degree of compliance with the international financial standards and codes.
- The autonomy and accountability of the DFSA should be entrenched by providing the agency a statutory basis and granting it greater budgetary autonomy.
- The regulatory framework could benefit from upgrading the guideline on internal controls to an Executive Order and broadening the coverage of fit-and-proper requirements.

### Key quantitative indicators and vulnerabilities
- Economic growth reached 3.2 percent in 2005.
- Inflation is "close to 2 percent."
- General government balance realized a surplus of some 4 percent of GDP in 2005.
- External current account surplus reached 3.0 percent of GDP.
- In 2005, bank lending grew 21 percent and loans by mortgage credit institutions increased 12 percent.
- House prices in Denmark increased by 22 percent on average during 2005.
- Household indebtedness increased to some 230 percent of disposable income.
- Loans with variable rates accounted for about half of total mortgage loans at the end of January 2006.
- At end-2005, total assets of commercial banks were around 194 percent of GDP.
- The two largest banking groups—Danske Bank and Nordea Danmark—account for about 65 percent of commercial bank lending.
- The five largest banking groups account for approximately 79 percent of total loans and 83 percent of total assets.

### Stress testing and capital adequacy
- Stress test results show that while the system can absorb sizable shocks, a very severe scenario could entail significant shortfalls in required capital.
- Capital cushions are expected to decline with the implementation of Basel II.
- As large investors in mortgage bonds, banks have benefited from revaluation gains from declining interest rates; prospective interest rate increases would likely have the opposite effect in the near term.

### Mortgage finance and covered bonds
- Mortgage finance institutions are financially sound and risks in their balance sheets are well contained by design.
- Mortgage bonds must have cash flows that fully match those of the loans they finance, enabling low cost financing in the capital market.
- The impending EU regulation on covered bonds is likely to pose significant transitional issues for the mortgage bond system.
- Amendments in accordance with the EU regulations would trade off some attractive features against potential long term benefits of opening up mortgage bond issuance to banks.
- To realize benefits, continued effective disclosure and transparency and a level playing field among market participants are important.

### Insurance and pension sector observations
- The life-insurance and pension funds industry has largely addressed problems from past issuance of contracts with high guaranteed returns, aided by higher interest rates, reductions in guaranteed rates, and some hedging.
- Life-insurance companies and pension funds continue to sell products with guaranteed returns that "may cause problems later," requiring continued DFSA monitoring of companies’ ability to meet long-term obligations under varying interest rate environments.

### Financial market infrastructure and safety nets
- Payment and securities clearing and settlement systems are generally functioning effectively and efficiently.
- Amendments to the Securities Trading Act (STA), making explicit the oversight responsibilities of the Danmarks Nationalbank (DN), further enhance the system.

### Supervisory capacity and institutional issues
- The DFSA conducts effective risk-oriented supervision as an autonomous institution under the Ministry of Economic and Business Affairs.
- Challenges going forward include: building capacity to validate banks’ internal models, identifying emerging risks, and strengthening mechanisms for effective coordination with other supervisory authorities in the region.
- The DFSA’s resources should be reassessed to expand capacity to verify internal models, undertake stress testing, and ensure an effective AML/CFT framework.
- Consideration should be given to separating legislative/regulatory activities and supervisory budgets to enhance DFSA budgetary autonomy.

### Box 1 — Denmark FSAP: Main recommendations (summarized)
Near-term financial stability
- Any easing of capital requirements under Basel II should be done gradually; supervisors should make use of regulatory authority to require additional capital as appropriate in individual cases.
- The mission supports the regulation limiting the decreases in capital requirements in 2007-08 for institutions that would use advanced methods for determining their capital adequacy.
- Intensify monitoring, compilation of information, and modeling of shocks through strengthened stress testing capacity at the DFSA; consider more frequent inspections as warranted.
- Close monitoring of the housing market, strict adherence to supervisory rules, and effective consumer information about risks of over-borrowing.

Structural issues
- Entrench DFSA autonomy and accountability by providing the agency a statutory basis and granting it greater budgetary autonomy; consider separation of legislative/regulatory and supervisory budgets.
- Reassess DFSA resources to expand capacity for model verification, stress testing, and AML/CFT.
- Upgrade the guideline on internal controls to a more binding Executive Order and broaden fit-and-proper coverage.

*Source: _cr06343 - 2006. The assessment was conducted by Richard Lalonde (Team Leader), Paul Ashin, Margaret Cotter,*

### 13.       The banking sector is relatively competitive and efficient by international

### _cr06343 - 13.       The banking sector is relatively competitive and efficient by international

### Competitiveness and efficiency
- The banking sector is relatively competitive and efficient by international comparison even though it is highly concentrated.
- Intermediation efficiency indicators have been improving:
  - The spread between lending and deposit rates and operating costs as a share of total assets have been declining.
  - Banks are quick to adopt new technologies.
- Both net interest income and net fee and commission income as a percent of total assets are higher than the EU-25 average.
- Concentration indicators:
  - Standard concentration ratios—the share of top five banks and the Herfindahl Index—are high but comparable to Belgium, Finland, and the Netherlands.
  - Competition is intense among large institutions and at the domestic regional level.
  - The market is quite contestable; an increasing number of institutions provide cross-border banking services.
- Policy note:
  - Efforts to promote transparency can further increase competition and allay reported consumer concerns about banks’ fees and charges.

### Financial system structure and scale (selected indicators)
- Selected system-level figures and trends (from Table 1 and descriptive text):
  - Number of banks (All banks): Dec-95 = 211; Dec-00 = 197; Dec-05 = 170.
  - Assets (in percent of GDP), All banks: Dec-95 = 208.7; Dec-00 = 250.8; Dec-05 = 331.9.
  - Commercial banks assets (percent of GDP): Dec-95 = 103.1; Dec-00 = 140.3; Dec-05 = 193.6.
  - Mortgage banks assets (percent of GDP): Dec-95 = 100.9; Dec-00 = 106.5; Dec-05 = 134.3.
  - Number of employees, All banks: Dec-00 = 46,263; Dec-05 = 43,879.
  - Source: The Danish Financial Supervisory Authority.

### Foreign presence
- The presence of foreign banks—mainly from other Nordic countries—is substantial:
  - At end-2005, there were 9 foreign subsidiaries, 26 foreign branches, and 271 foreign credit institutions providing some cross-border banking services into the country.
  - Banks with Nordic parents accounted for approximately 84 percent of foreign banks’ total assets.
- Operational and supervisory point:
  - The largest bank, Nordea, is contemplating transforming into a European Company based in Sweden, with a branch structure; the Danish branches would be systemically important and pose supervisory challenges.

### Financial soundness and buffers (selected indicators and trends)
- Capital and asset quality:
  - Overall capital adequacy ratio at end-2005: 13¼ percent.
  - Accumulated provisions at end-2005: 1.0 percent of total loans outstanding.
- Profitability and income composition:
  - Banks reported record profits in 2005 — 21¼ percent return before tax on equity compared with 17¾ percent in 2004.
  - Profitability was boosted by growth in fees and commissions, primarily from securities trading and refinancing activity.
  - System-wide income to cost ratio improved from 1.7 to 2.0.
- Selected indicators from Table 2 (Dec-05 unless otherwise indicated):
  - Regulatory capital to risk-weighted assets (Tier 1+Tier 2): 13.2.
  - Tier 1 capital to risk-weighted assets: 10.2.
  - Capital (net worth) to assets: 5.7.
  - Nonperforming loans to gross loans and guarantees: 0.3.
  - Stock of total provisions to total gross loans: 1.0.
  - Credit growth: 24.7.
  - Return on equity before tax (Dec-05): 21.2.
  - Net interest income to gross income (Dec-05): 61.9.
  - Noninterest income to gross income (Dec-05): 38.1.
  - Liquid assets to total assets (exclusive of interbank lending) (Dec-05): 7.4.
  - Gross loans to deposits (Dec-05): 115.3.
  - Liquidity coverage as a percentage of the requirement (Dec-05): 140.1.

### Implementation of IFRS and Basel II implications
- Implementation of IFRS has allowed banks to revoke previous provisions.
- Ten Danish banks have indicated intent to use advanced internal ratings under Basel II to be implemented in 2007-08.
- Regulatory stance:
  - A regulation limiting the reduction of capital requirements during 2007-09 for banks using advanced methods is welcomed.
  - The DFSA would need to carefully assess capital adequacy in individual institutions and require additional capital commensurate with the risk profile of each institution, consistent with Pillar II of Basel II.
- Policy recommendation:
  - Reduction of the capital buffer needs to be approached with caution and implemented gradually given rapidly expanding bank balance sheets and prospective changes in the interest rate environment.

### Stress tests — design and credit risk scenarios
- Methodology:
  - The FSAP mission conducted top-down and bottom-up stress tests using severe, but plausible, single factor shocks and macroeconomic scenarios developed with DN and DFSA.
  - Bottom-up: banks ran scenarios through their internal models as requested by DFSA.
  - Top-down: portfolio credit risk based methodology implemented by staff.
- Scenario 1 — boom-bust in real estate prices and credit:
  - Credit growth: down by 14.2 percent.
  - Collateral prices: down by 27 percent.
  - Unemployment: up by 3.8 percent.
  - GDP: down by 6.8 percent.
  - Channel: decreases in asset returns, reverse wealth effects, lower consumption and aggregate demand, increased non-performing loans.
- Scenario 2 — foreign shock from abrupt correction in global imbalances:
  - Exchange rate: Danish kroner (in line with the euro) appreciates against the U.S. dollar and other currencies (up to 29 percent).
  - GDP: down by 4.1 percent.
  - Unemployment: up by 3.2 percent.
  - Channel: loss of competitiveness, lower demand for Danish goods, deteriorating trade balance, higher non-performing loans.
- Scenario 3 — boom-bust in real estate and credit plus strong increase in European interest rates:
  - Policy interest rates rise: 250 bp.
  - Credit growth: down to 19.5 percent.
  - Collateral prices: down by 41.9 percent.
  - Unemployment: up by 5.1 percent.
  - GDP: down by 9.2 percent.
  - Channel: higher interest rates increase debt servicing burdens and reinforce asset price reassessment, increasing non-performing loans.

### Stress test results — resulting capital adequacy ratios (percent)
- Top-down results:
  - Scenario 1: 2006 = 8.5; 2007 = 8.3; 2008 = 6.7.
  - Scenario 2: 2006 = 8.5; 2007 = 8.3; 2008 = 8.1.
  - Scenario 3: 2006 = 8.6; 2007 = 8.0; 2008 = 5.7.
- Bottom-up results:
  - Scenario 1: 2006 = 10.5; 2007 = 9.0; 2008 = 6.6.
  - Scenario 2: 2006 = 10.1; 2007 = 9.2; 2008 = 7.7.
  - Scenario 3: 2006 = 9.3; 2007 = 7.4; 2008 = 4.5.
- Source of table: Banks’ staff estimates.

### Interpretation, limitations, and risk implications
- Interpretation caveats:
  - Stress test results should be interpreted with caution: the most severe scenario simulates hypothetical extreme events with low likelihood.
  - The model does not account for second round portfolio adjustments aimed at limiting profitability impact, which typically act as a first line of defense.
  - Results are based on the average banking system and will affect individual banks differently.
- Risk assessment:
  - The cumulative macroeconomic shocks increase probabilities of default and expected and unexpected losses over the three-year period.
  - Credit risk remains a major risk factor and could materialize if a later collapse in real estate prices follows accelerated house price increases and higher household leverage.
  - Recent developments increasing household vulnerability to interest rate fluctuations, combined with an external shock (scenario 3), could reinforce stress on the banking system.

### Market risk
- On average, exposure to market risk appears modest but varies among institutions.
- Single-factor shocks to interest rates, equity prices, real estate prices, and the exchange rate have modest impacts on capital on average.
- Transmission:
  - Most loans have flexible interest rates, so single-factor shocks transmit primarily through credit risk.
  - Shocks can result in losses on holdings of financial instruments, mainly mortgage bonds, but banks dynamically hedge most of this portion to maintain matched duration.
  - Banks’ net open position in foreign exchange (including the euro) is modest, so even a substantial exchange rate shock results in limited impact on capital adequacy.

*Source: _cr06343 - 13.       The banking sector is relatively competitive and efficient by international*

### 21.      Liquidity and Contagion Risks: Analysis of banks’ holdings of large amounts of

### 21. Liquidity and Contagion Risks: Analysis of banks’ holdings of large amounts of government and mortgage bonds

### Liquidity and interbank contagion assessment
- At end-2005 banks’ holdings of bonds, of which most are collaterable assets, represented 19.5 percent of total assets and 49.5 percent of all deposits.
- Danmarks Nationalbank (DN) analysis of uncollateralized bilateral exposures in the interbank market indicates the risk of interbank contagion is insignificant and manageable.
- The stress testing model used in the banks’ baseline projections:
  - Assumes profitability remains at the 2005 level, which may be difficult to sustain under the stressed scenarios, implying the negative impact on capital may be understated.
- Expected losses (EL) defined as EL = PoD x Exposure x LGD, where PoD is the probability of default and LGD is the loss-given-default.
  - Note: estimating “unexpected losses” (ULs) is fundamental; economic capital should be available to cover ULs.

### References to DN analyses and publications
- Approach and results presented in Danmarks Nationalbank’s Financial Stability Report, 2005 and in Contagion Risk in the Danish Interbank Market by Elin Amundsen and Henrik Arnt, Danmarks Nationalbank Working Papers 2005–29, Danmarks Nationalbank, Copenhagen.
- Liquidity in the payment systems discussed in “Protection of Settlement in Danish Payment Systems” in Danmarks Nationalbank’s Financial Stability Report, 2006.

### C. Mortgage Credit Banks — key findings and risks
- System characteristics:
  - Total assets close to 135 percent of GDP; mortgage credit institutions are slightly smaller than commercial banks.
  - Mortgage bonds and mortgage credit institutions are highly rated by international rating agencies.
  - Mortgage bonds are accepted by the Nationalbank as collateral.
- Market and product developments:
  - New products include variable interest rates, deferred amortization, and capped adjustable rate loans.
  - Variable rate mortgage loans now account for about half of all such loans.
  - New loan types require corresponding new types of bonds to observe the balance principle.
  - Wider range of mortgage products could reduce homogeneity, producing smaller and less liquid bonds and potentially lowering investor appetite.
- Impending EU covered bonds regulation:
  - Covered bonds will require continuous observation of loan to value (LTV) rather than only at origination.
  - Banks would be allowed to issue covered bonds in addition to mortgage credit institutions.
  - Effects:
    - More funding flexibility for issuers.
    - Potential limitation of direct access to capital markets for borrowers under the current system.
    - Two largest banks and regional banks as a group would be in a more advantageous position due to branch networks and customer proximity.
    - Banks would be better positioned to adapt to LTV fluctuations because of broader collateral and possibilities to provide additional capital.
  - Long-run benefits depend on effective disclosure, transparency, and a level playing field among market participants.

### Table 3 — Selected financial soundness indicators for mortgage credit institutions (2000–05) — selected statistics
- Capital adequacy:
  - Regulatory capital to risk-weighted assets (Tier 1+Tier 2): Dec-00 12.6, Dec-01 11.5, Dec-02 11.7, Dec-03 11.6, Dec-04 12.4, Dec-05 12.7
  - Tier 1 capital to risk-weighted assets: Dec-00 11.5, Dec-01 11.1, Dec-02 11.2, Dec-03 11.0, Dec-04 11.6, Dec-05 11.3
  - Capital (net worth) to assets 1/: Dec-00 5.3, Dec-01 4.8, Dec-02 4.8, Dec-03 4.9, Dec-04 4.7, Dec-05 5.3
- Asset composition and quality:
  - Residential real estate loans to total loans 2/: Dec-00 76.1, Dec-01 76.6, Dec-02 76.7, Dec-03 77.0, Dec-04 77.0, Dec-05 77.8
  - Commercial real estate loans to total loans 2/: Dec-00 22.3, Dec-01 21.6, Dec-02 21.7, Dec-03 21.4, Dec-04 21.4, Dec-05 20.8
  - Adjustable rate lending to total lending: Dec-00 8.7, Dec-01 19.2, Dec-02 26.7, Dec-03 33.2, Dec-04 41.3, Dec-05 45.8
  - FX loans to total loans: Dec-00 1.4, Dec-01 4.6, Dec-02 6.4, Dec-03 6.1, Dec-04 5.7, Dec-05 4.8
  - Credit growth: Dec-00 3.8, Dec-01 9.2, Dec-02 7.7, Dec-03 8.4, Dec-04 6.5, Dec-05 11.1
- Earnings and profitability:
  - ROA before tax: Dec-03 0.4, Dec-04 0.4, Dec-05 0.5
  - ROE before tax: Dec-03 9.1, Dec-04 10.5, Dec-05 9.3/10.9 (table shows ROE before tax progression and Dec-05 entries)
  - Operating income to operating expenses ratio 4/: Dec-01 2.6, Dec-02 2.5, Dec-03 2.9, Dec-04 3.1, Dec-05 3.6
- Liquidity:
  - Liquid assets to total assets 5/: Dec-00 15.8, Dec-01 22.6, Dec-02 23.0, Dec-03 23.2, Dec-04 26.6, Dec-05 28.9
- Sensitivity to market risk:
  - FX exposure to Tier I capital 7/: Dec-00 2.9, Dec-01 5.0, Dec-02 1.5, Dec-03 3.1, Dec-04 1.1, Dec-05 1.2

Notes from table:
- 1/ Shareholders' equity to total assets.
- 2/ Residential lending includes lending for owner-occupied dwellings, private rental housing, subsidized housing. Commercial real estate lending includes lending for trade, industry, offices and agriculture.
- 3/ Defined as "gearing" by the FSA.
- 4/ Income on core activities including value adjustments for changes in current prices as a percentage of expenses on core activities including provisions.
- 5/ Included in liquid assets are items due from credit institutions and bonds.
- 6/ Bond liabilities in foreign currency to total liabilities.
- 7/ Calculated as the largest amount of the short-term currency exposures and the long-term currency exposures.

### D. Insurance Companies — sector structure and resilience
- Sector size and concentration:
  - At end-2005, assets of life insurance and general pension funds amounted to almost 120 percent of GDP.
  - The five largest companies account for about 55 percent of gross premiums and the ten largest for 73½ percent.
  - Assets of non-life insurance companies amounted to 9 percent of GDP at end-2005.
  - In 2005, gross premiums amounted to 2.9 percent of GDP.
- Life insurance and pension indicators (selected from Table 4):
  - Life insurance gross premiums to GDP: 2001 3.7, 2002 4.0, 2003 4.2, 2004 4.2, 2005 4.3
  - Solvency indicator for life insurance: 2001 166.8, 2002 182.1, 2003 201.5, 2004 195.0, 2005 196.8
  - Pension funds solvency indicator: 2001 433.3, 2002 309.5, 2003 398.5, 2004 460.5, 2005 476.7
- Non-life insurance indicators (Table 5, selected):
  - Gross premiums to GDP: Dec-01 2.3, Dec-02 2.9, Dec-03 3.1, Dec-04 3.1, Dec-05 2.9
  - Return on assets: Dec-01 0.6, Dec-02 0.1, Dec-03 5.8, Dec-04 5.9, Dec-05 6.4
  - Solvency ratio: Dec-01 3.4, Dec-02 3.7, Dec-03 4.2, Dec-04 3.9, Dec-05 4.7

### Insurance sector vulnerabilities and monitoring
- Guaranteed returns legacy:
  - A substantial share of older contracts with a guaranteed annual return of 4.5 percent is still outstanding.
  - Many companies have bought derivatives to cover these risks.
  - Better returns in 2004 and 2005 limited the problem, but a substantial decline in investment returns would re-emerge the issue.
- Stress testing outcomes:
  - Much of the impact of shocks would be absorbed by the collective bonus pool component (retained earnings) of companies’ reserves.
  - The exercise covered the largest companies; shocks used were consistent with those applied for the banks for market risk.
  - Sizable collective bonus pools, long-term nature of investment portfolios, and some hedging cushion impacts.
- DFSA monitoring—“traffic light” system:
  - Red light scenario: decline of 12 percent in the price of stocks and 8 percent in the price of real estate, and an increase in the interest rate level of 0.7 percentage points.
  - Yellow light scenario: decline of 30 percent in the price of stocks and 12 percent in the price of real estate, and an increase in the interest rate level of 1.0 percentage point.
  - If a company cannot meet the red scenario, DFSA may require monthly reporting and the company will not be allowed to increase its overall risk.
  - As of end-2005:
    - One company (nonlife company) flagged under red light.
    - Six companies signaled under yellow light.
- Non-life sector performance:
  - Five largest non-life companies accounted for almost 67 percent of gross premiums and the ten largest for almost 83 percent in 2005.
  - Two non-life insurers experienced serious difficulties in the prior five years; one company failed.
  - No direct customer losses observed, but guarantee fund costs estimated at €16 million in one case.
- Capital requirements:
  - Effective January 1, 2007, the minimum capital requirement will increase to the equivalent of the requirements in EU Solvency I Directive.
  - Market participants anticipate further increases when EU progresses on Solvency II.

### E. Cross-Border Financial Conglomerates — systemic considerations
- Challenges:
  - Substantial exposures to non-residents and presence of large conglomerates active in the Nordic region.
  - Centralization of key functions (e.g., risk management) abroad increases the need for coordination and information sharing among regional supervisors.
  - Systemically important institutions require coordinated arrangements for liquidity provision and crisis management.
- Existing arrangements:
  - Regional supervisory agencies have a general memorandum of understanding (MoU); a similar MoU exists at the EU level.
  - Special agreement regarding the Nordea Group (lead supervisor: Swedish FSA; inspected by joint teams).
  - MOUs are legally non-binding and do not involve Ministries of Finance, which may be required for crisis resolution.
- Market shares (Table 6, 2005 highlights):
  - Large Nordic financial groups in Denmark accounted for: Banking 65.7, Mortgage banking 85.7, Life insurance 30.9, Non-life insurance 36.6 (in percent).
  - Danske Bank Group (Denmark): Banking 38.0, Mortgage banking 33.4, Life insurance 17.1.
  - Nordea Group (Sweden): Banking 20.0, Mortgage banking 10.7, Life insurance 8.1.
  - Nykredit Group (Denmark): Banking 3.0, Mortgage banking 41.2, Non-life insurance 2.8.
  - Total market share in Denmark (2005): Banking 75.4, Mortgage banking 99.9, Life insurance 53.6, Non-life insurance 65.0.

*Source: IMF staff summary of the content unit titled "21. Liquidity and Contagion Risks: Analysis of banks’ holdings of large amounts of government and mortgage bonds acceptable as collateral to the Nationalbank" from the provided PDF.*

### 33.      Monetary policy is firmly anchored on maintaining the Danish kroner within its

### Monetary policy is firmly anchored on maintaining the Danish kroner within its ERM2 band of ±2.25 percent vis-à-vis the euro

### Monetary policy and framework
- Policy anchored on maintaining the Danish kroner within ERM2 band of ±2.25 percent vis-à-vis the euro.
- Strong commitment to observe the convergence criteria for membership of the European Monetary Union has helped anchor inflation expectations.
- Policy interest rates generally follow ECB rates.
- The Nationalbank’s authority governed by the Nationalbank of Denmark Act and the By-laws of the Nationalbank of Denmark since 1936 with four minor amendments.
- Some Articles of the Statutes of the European System of Central Banks apply to the Nationalbank, strengthening its autonomy.
- The Board of Governors solely determines key interest rates to support the peg.
- The Minister of Economic and Business Affairs has final authority to determine the exchange rate regime, coordinated with the Nationalbank according to the Act on Foreign Exchange.
- Danmarks Nationalbank clarifies its mandates in its different publications.

### Safety nets

- Lender of last resort
  - Danmarks Nationalbank (DN) functions as lender-of-last-resort to solvent banks facing liquidity pressures on a case-by-case basis.
  - Banks are encouraged to meet liquidity needs first from the money market, which is quite liquid.
  - Banks typically hold large portfolios of certificates of deposits issued by the DN, government securities, and mortgage bonds usable as collateral for repo transactions.
  - For solvent banks unable to obtain market liquidity, collateralized loans may be granted.
  - No established rules for such loans, but they would involve DFSA views on solvency and stringent conditions.
  - Any bank rescue operation involving taxpayers’ money requires prior approval of the Finance Committee of the legislature.
  - Effective crisis response requires prompt decision-making among DN, the Ministry of Economic and Business Affairs, the DFSA, and the Finance Committee.

- Deposit Insurance
  - Guarantee Fund for Depositors (GF) is the mandatory deposit insurance scheme.
  - Deposits covered up to DKK 300,000 (about €40,250) per depositor after deduction of loans; certain special deposits are fully covered.
  - Coverage is higher than the EU minimum requirement of €20,000.
  - Foreign branches must “top-up” to the Danish level through the GF if their coverage is less than required in Denmark.
  - GF covers losses from failure to return securities up to €20,000.
  - Since 1987, GF has covered 10,520 clients in nine different institutions and paid out DKr 528.4 million.
  - Clients are typically repaid within six months after closure.
  - GF reserve is DKr 3.2 billion derived from a fee set as a percentage of covered deposits.
  - At end-2004, GF reserve represented 0.9 percent of insured deposits, which seems insufficient to cover depositors in the event of failure of a large institution without resort to a government guarantee.
  - The discretion to issue a government guarantee may limit moral hazard.

### Payment and securities clearing and settlement systems
- Payment system infrastructure is highly developed and technologically advanced; risks are well contained.
- High degree of compliance with international standards.
- Systemically important infrastructures:
  - KRONOS — interbank real-time gross settlement (RTGS) system; channel for monetary policy transactions and large-value interbank transactions; linked to TARGET (ESCB RTGS).
  - Sumclearing — retail payments clearing.
  - VP Securities Services — clearing and settlement of listed securities.
- 2005 statistics and operational notes:
  - In 2005, 10.2 million transactions were settled in VP with a market value of DKr 30,924 billion (around US$5,012 billion).
  - Suggested technical enhancements include risk control measures in Sumclearing and in VP to ensure timely settlement in the event of a bankruptcy of a participant.
  - In 2005, around 1.1 billion payments with a value of DKr 5,027 billion were processed in the Sumclearing infrastructure (Sumclearing processed transactions amounting to 3¼ times nominal GDP).
  - In 2005, KRONOS turned over nominal GDP about 57¼ times.

### Financial markets

- Money and foreign exchange markets
  - Well functioning and liquid.
  - In 2005, average daily uncollateralized interbank exposure increased by 35 percent to DKr 10.4 billion.
  - These exposures are monitored by DN and occasionally stress tested.
  - Banks maintain sizable stocks of collateralizable assets.
  - Money market closely linked with foreign exchange market, anchored by the euro peg.

- Bond and equity markets
  - Danish capital market is dominated by mortgage bonds; with public debt declining, mortgage bonds now account for about two thirds of total bond market capitalization.
  - Government securities market is quite liquid, benefiting from electronic trading platforms and sound issuance policy.
  - Danish equity market is medium-size with structural issues: historically outperformed major international markets but has low turnover; significant delistings and difficulties attracting new listings.
  - Market structure: SMEs constitute vast majority of listed companies, but activity concentrated among a handful of large corporations (including Maersk), concentrating liquidity and reducing attractiveness for investors.
  - Exchange initiatives:
    - Launch of FirstNorth (alternative market place for small companies with reduced listing requirements); too recent to assess effectiveness.
    - Risk that more opaque markets could weaken investor protection and reduce benefits of transparency and corporate governance frameworks.
  - Regional integration:
    - Creation of a common regional market place with common trading (Norex and consolidation of OMX) increases homogeneity and investor access, but integration of clearing and settlement infrastructures lags trading-side developments due to cost considerations.

- Investment funds
  - Investment fund industry experienced steady growth and transformation.
  - Assets in relation to GDP still lower than in Sweden and EU-12 average.
  - Hedge fund–type vehicles progressively allowed; effective July 2005, new regulatory regime introduced regulated onshore hedge funds (hedge associations).
  - New regulations focus on extensive information obligations and frequent redemption windows; rely primarily on investors to control fund managers.
  - Supervisory authority should establish clear jurisprudence in areas such as asset valuation practices, which remain the responsibility of the funds.

- Corporate governance and accounting
  - Governance framework basically sound.
  - IFRS adopted for all listed companies, including financial enterprises, effective January 2005.
  - Nørby Committee recommendations on corporate governance: listed companies must comply or explain deviations.

### Financial supervision and standards assessments

- Supervisory and regulatory framework
  - Financial sector stability is a shared responsibility of the Danish Financial Supervisory Authority (DFSA) and Danmarks Nationalbank (DN).
  - DFSA covers regulation, supervision, and information on financial institutions and securities markets.
  - Good coordination among domestic institutions; a Coordination Committee on Financial Stability chaired by the Permanent Secretary of the Ministry of Economic and Business Affairs exists.
  - DFSA has been an integrated supervisor since 1988; legal framework provided by the Financial Business Act and other laws; EU directives adopted and implemented.
  - Organizational structure and limited size facilitate internal coordination and effective integrated supervision.

- Supervisory approach and responsibilities
  - Emphasis on responsibility of boards of directors and management for appropriate procedures and personnel.
  - Fit-and-proper requirements compulsory for Board of Directors and Management Board; responsibility of Boards to institute rules for other senior managers.
  - Recommendation to consider broadening coverage of fit-and-proper rules to key personnel beyond the Management Board and to upgrade guidelines on internal controls to a legally binding Executive Order.
  - Supervisory approach is risk-oriented based on:
    - (i) an early warning system;
    - (ii) a rating by the supervisor in charge;
    - (iii) simple stress tests (sensitivity analysis);
    - (iv) institution’s systemic importance.
  - Firms with larger risks subject to intensified supervision (more frequent reporting and annual inspections); DFSA meets annually with management of large financial institutions.
  - Transparency facilitated by comprehensive annual reports on DFSA activities.

- Governance, autonomy, and resources
  - Consider providing statutory basis to the autonomy and accountability of the DFSA to entrench current practices.
  - DFSA is an agency under the Ministry of Economic and Business Affairs but overseen by independent Councils (Financial Business Council, Securities Council, Pension Market Council) including industry representatives and experts to ensure independence from the Ministry.
  - DFSA must request additional mandate from the Ministry to exceed standard supervisory authority in some cases; Minister may ask DFSA to examine specific matters but has no authority to issue instructions.
  - Adequacy of DFSA resources should be reviewed; resources have increased due to new assignments.
  - Consider granting DFSA greater budgetary autonomy with appropriate checks and balances; consider separate budgets for regulatory and supervisory activities.
  - Operational recommendations:
    - May need earlier action and more frequent inspections to maintain low probability of sector failures, particularly amid IFRS implementation, aggressive expansion, efforts to reduce reporting burden, and more complex supervision (Basel II).
    - Review personnel policies to ensure retention of specialists in high-demand areas (validation of internal models, stress tests, determining additional capital requirements for special areas).

*Source: IMF staff report content unit _cr06343 - 33. Monetary policy is firmly anchored on maintaining the Danish kroner within its*

### 51.      There is generally a high degree of compliance with the international

### _cr06343 - 51.      There is generally a high degree of compliance with the international

### Overview / Compliance with International Standards
- The assessment finds generally a high degree of compliance with the international supervisory standards assessed.
- Basel Core Principles for Effective Banking Supervision (BCP): either fully or largely observed.
- Insurance Core Principles (IAIS): either observed or broadly observed.
- Core Principles for Systemically Important Payment Systems and the Recommendations for Securities Clearing and Settlement Systems (RSS): overall compliance is high.
- Securities markets operate within a strong legal framework; IOSCO principles were not formally assessed.
- The DFSA, as a unified regulator, has efficiently strengthened consolidated supervision and prevented regulatory gaps.

### AML/CFT and Legal Framework
- A new AML/CFT law enacted in February 2006 will strengthen preventive measures when it fully enters into force and is effectively implemented.
- Laws criminalizing ML/FT are well developed; flexible mechanisms exist for restraint and confiscation of proceeds of crime.
- Requirements to build a fully-effective, FATF-compliant system include:
  - (i) enhancing prosecution of the ML/FT offenses,
  - (ii) supervising financial and particularly the non-financial sectors more proactively,
  - (iii) stimulating additional STR reporting, especially from the non-bank and the designated non-financial sectors,
  - (iv) re-evaluating the roles and responsibilities of the Financial Intelligence Unit (FIU), and
  - (v) improvements in the regimes of the home-rule jurisdictions of the Faroe Islands and Greenland.

### Payment, Clearing, and Securities Systems
- Technical suggestions were made to further limit risks in Sumclearing and VP (VP is the sole central securities depository (CSD) in Denmark and clears and settles securities transactions in the regulated markets and in the over-the-counter (OTC) market).
- Payment and securities clearing and settlement systems are generally effective and efficient; oversight is generally effective.

### Financial Sector Structure and Key Statistics
- The Danish financial sector is deep: "total assets are close to five times GDP."
- Credit institutions at end-2005:
  - Total assets of credit institutions were around 332 percent of GDP.
  - 170 credit institutions registered in Denmark: 161 commercial banks, 8 mortgage banks, and 1 specialized bank.
  - The two largest banking groups—Danske Bank and Nordea Danmark—account for more than 50 percent of the commercial bank lending.
  - The five largest banking groups account for about 80 percent of total loans (71 percent if foreign branches are excluded).
- Commercial bank profitability and capital (2005, 2004):
  - Return on equity before tax for the sector as a whole was 21¼ (2005) and 17¾ (2004) percent.
  - Average capital adequacy ratio was 13¼ (2005) and 13½ (2004) percent.
- Bank lending growth:
  - Bank lending increased by 14 percent (2004) and 25 percent (2005).
  - Loan to deposit ratio was 115 percent at end-2005.
- Mortgage credit institutions:
  - Total assets around 134 percent of GDP.

### Supervisory Structure, Powers, and Practices
- Financial sector stability is a shared responsibility of Danmarks Nationalbank and the DFSA.
- DFSA responsibilities:
  - Overseeing various financial institutions and regulation of investment business.
  - Payment systems oversight is shared with the Nationalbank.
  - Accountable to the Minister of Economics and Business Affairs; many matters are decided by independent councils under the Financial Business Act (FBA) (Financial Business Council and Securities Council).
  - Minister has no authority to issue instructions to the DFSA but can ask it to examine specific matters.
- Supervisory approach:
  - Risk-based supervision: large institutions examined under a four-year cycle; medium-sized at least every fourth year; smaller low-risk institutions every seventh year.
  - Large banking groups: at least one risk area inspected each year; DFSA meets at least annually with their management.
  - DFSA relies on on-site inspection supplemented by analysis of periodic reporting; uses internal and external auditors’ work.
- Governance notes:
  - Recent National Audit Office (NAO) audit noted on-site inspection frequency needed shortening, IT supervision needed upgrading, and follow-up of inspections made more effective.
  - DFSA may face resource constraints; its costs are fully borne by supervised institutions but revenues and expenses are included in the fiscal budget and approved by the legislature.
  - Adoption of IFRS and implementation of Basel II may reduce capital cushions and increase monitoring demands.
- Deposit insurance:
  - Guarantee Fund for Depositors and Investors covers deposits up to DKr 300,000 per depositor; certain special categories of deposit covered in full. Membership compulsory for all credit institutions.

### Main Findings on Basel Core Principles (selected)
- Objectives, autonomy, powers, and resources (CP 1):
  - DFSA is the sole authority responsible for supervision of the financial sector.
  - Potential autonomy issues arise because the DFSA is an institution for which the Minister is responsible to Parliament and the DFSA’s budget is incorporated into the government budget subject to the annual Finance Act.
  - A formal law establishing the DFSA could enhance transparency and autonomy.
- Licensing and Structure (CPs 2–5):
  - FBA clearly defines "bank" and permissible activities; DFSA has authority over authorizations for acquisitions or increases of qualifying holdings.
- Prudential regulation and requirements (CPs 6–15):
  - Capital adequacy rules conform to the Basel Capital Accord and observe the EU Banking Directive; solvency ratio requirement applies to bank holding companies.
- Methods of on-going supervision (CPs 16–20):
  - On-site inspections supplemented by periodic reporting; inspection cycles as noted above.
- Information requirements (CP 21):
  - Banks required to comply with IFRS; DFSA can dismiss external auditors and appoint additional auditors.
- Formal powers of supervisors (CP 22):
  - Range of sanctions up to revocation of license; serious breaches transferred to police for prosecution.
- Cross-border banking (CPs 23–25):
  - DFSA can request information from foreign supervisors, undertake direct inspections, and has MoUs with several supervisory authorities; powers to access information on subsidiaries of foreign banking institutions in Denmark.

### Recommended Action Plan to Improve Compliance (selected)
- Objectives CP 1.1: A law or a provision formally establishing the DFSA is desirable to make the organization of financial supervision in Denmark more transparent.
- Independence CP 1.2: The DFSA would have more flexibility, if it had its own budget.
- Licensing Criteria CP 3 / Internal Control and Audit CP 14 / Remedial Measures CP 22:
  - The ‘fit-and-proper’ test of the DFSA should apply to holders of other key management positions.
  - Develop the guidelines for internal controls into an executive order.
- Investment Criteria CP 5: The FBA should require prior approval for investments in non financial companies.
- Connected lending CP 10: Consider power to deduct connected lending from capital or require collateralization.
- Other Risks CP 13: Introduce routine monitoring of net funding requirements, stress testing, and contingency planning for liquidity crises under various scenarios.
- Bank Management Contact CP 17: Consider routine meetings with management of banks where on-site inspections are infrequent.
- Supervision Over Foreign Banks’ Establishments CP 25: Consider how to assess the home country supervisory system when receiving an application from a bank from a country not represented in Denmark.

### Authorities’ Response (selected)
- Broad agreement with IMF assessment team with some exceptions.
- Consideration will be given to establishing the DFSA as an independent institution by providing a statutory basis in legislation and to separating its regulatory and supervisory budget.
- DFSA notes it has been allocated increased resources as a consequence of the Capital Requirement Directive and the Third Money-Laundering Directive.
- DFSA is developing the use of stress tests and will consider mission comments; building stress-testing capacity would require additional DFSA resources.
- Danish regulation includes floors to limit maximum decreases in capital requirements for institutions using advanced Basel II methods in 2007, 2008, and 2009 in accordance with the EU Capital Requirement Directive.
- DFSA will consider issuing executive orders instead of guidelines but notes administrative costs and resource implications; DFSA generally concurs it could be useful to have fit-and-proper powers over key staff but warns of resource burden and administrative cost.

*Source: IMF staff assessment (annexes from the FSAP mission to Denmark).*

### 1.      The assessment of the observance of Insurance Core Principles (ICP) developed by

### _cr06343 - 1.      The assessment of the observance of Insurance Core Principles (ICP) developed by

### Background and context
- The assessment used the Insurance Core Principles (ICP) developed by the International Association of Insurance Supervisors (IAIS) dated October 2003.
- The assessment was carried out as part of the first Financial Sector Assessment Program (FSAP) mission to Denmark during November 7–18, 2005.
- The assessment was carried out by Henning Goebel (Bafin, Germany) with the assistance of Kirsten Nordbø Steinberg (Kredittilsynet, Norway).

### Institutional and market overview
- Legal and institutional framework
  - The Danish Financial Supervisory Authority (DFSA, Finanstilsynet) is identified in legislation as the principal authority to supervise insurance companies.
  - The most senior decision-making body is the Financial Business Council or the Danish Securities Council.
  - An annual contract between DFSA and the Ministry for Economic and Business Affairs (MoEB) addresses overall objectives of effective supervision and is published as an annex to DFSA’s annual business statement.
  - The legislation and prudential regulation for insurance and pension funds does not automatically cover Greenland; changes enter into force separately in Greenland approximately one year after Denmark. The Faroe Islands have separate legislation, regulation, and supervision.
- Market structure and size
  - At end-2005, there were 36 life insurance companies and 29 general pension funds; some entities are organized as groups so that there were effectively 18 life insurance companies/pension funds (groups).
  - The life insurance companies and pension funds are covered by the same legislative framework.
  - There were 44 company pension funds.
  - The life sector is dominated by a relatively small number of groups; major products are with-profit pension schemes with minimum guaranteed rates of return.
  - Cross-border activities are limited for both foreign insurers operating in Denmark and Danish insurers operating abroad, principally because premiums paid to foreign undertakings are not tax deductible for the insured under tax law.
  - Life insurance and general pension funds mainly provide a second supplementary pension that is mandatory for employees; typical contribution rates for these mandatory schemes range from 12 to 17 percent of the wage.
  - Policyholders are allowed to transfer their contract between companies but are not entitled to undistributed profits (collective bonus reserves), which in practice impede such transfers.
  - In 2005, insurance companies and pension funds achieved a result before tax of over DKr 16 million, with the result on investments amounting to DKr 165 million.
  - Administration costs have been reduced from 6.49 percent in 2001 to 5.33 percent in 2005.
  - Non-life market: there are 124 non-life insurance companies; the number has declined over the last five years but further consolidation is possible.
  - The total non-life market represents 0.46 of the world non-life insurance market.
  - The non-life market is mainly personal lines: motor and household insurance represent approximately 70 percent of the non-life market.
  - Reinsurance cover is mainly provided from the international reinsurance market; there are five pure Danish reinsurance companies, primarily reinsuring group-originating risks.
  - Failures and guarantees:
    - During the last five years, one non-life insurer failed and one went into run-off.
    - One failure in 2001 related to claims after September 11; a restoration plan is running to wind up the company and no direct losses observed.
    - Another failure resulted from mispricing, under pricing, excessive overheads, inadequate reinsurance, decrease of equity prices, and management causes; the company is under forced liquidation and no direct losses were observed as the guarantee fund covered customer losses.
    - The cost of the guarantee fund is estimated to €16 million.

### Supervisory framework and practices
- Legal powers and transparency
  - DFSA has necessary powers to impose sanctions to protect policyholders.
  - The regulation is updated regularly and publicly available.
  - Administrative decisions of the DFSA can be subject to substantive judicial review without impeding timely interventions.
- Information sharing and cooperation
  - DFSA is able to share information with other supervisory authorities subject to confidentiality requirements; some memoranda of understanding are in place to set framework and procedures.
- Licensing and capital assessment
  - Licensing procedures and requirements are set out in the FBA.
  - According to Executive Order no. 1399, DFSA shall assess whether an insurance company has adequate capital to obtain a license; DFSA can require additional capital or decline a license if plans raise reasonable doubts about financial soundness.
  - Consideration should be given to require assessment of the suitability of auditors and actuaries in licensing.
- Risk-based supervision and on-site inspections
  - DFSA uses stress-tests incorporated into an indicative "traffic-light-system" as part of an overall risk assessment rating that also includes qualitative supervisor assessment.
  - On-site inspection frequency:
    - Larger non-life insurers: full scale inspection every four years.
    - Smaller non-life insurers and all life insurers: full scale inspection every seven years.
    - Vulnerable insurers may be subject to more frequent full scale or focused inspections based on regular risk evaluations.
  - The DFSA plans and prioritizes on-site inspections annually following overall management principles.
- Assessment of key functionaries and internal control
  - DFSA’s system to assess appropriateness of key functionaries is based on assumption that senior management ensures adequate personnel assignment.
  - Fit-and-proper requirements are applied consistently but may be narrower in scope; consideration should be given to apply fit-and-proper requirements to a broader range of senior management.
  - Internal audit:
    - Requirement that internal audit functions should be compulsory for smaller companies is recommended.
    - Guideline 9680 does not clearly define DFSA’s internal control requirements and does not expand on section 71 in the FBA; an executive order is recommended for this function.

### Main findings and supervisory observations
- Risk assessment and management
  - DFSA expects companies to examine financial robustness in material risk areas (e.g., market risk and realistic disaster scenarios including reinsurance cover) and receives regular stress-test (traffic light) reports.
  - Recommendation: requirement to establish a risk-assessment framework should be obligatory for all companies and expressed in an executive order.
- Market analysis
  - Recommendation: DFSA should enlarge market analysis activities and obtain information, including macroeconomic developments, to forecast market trends and project potential sector impacts.
- Preventive and corrective measures
  - DFSA possesses means to ensure shortfalls or misuse of regulation will not be supported, but the range of sanctions is biased toward drastic measures; consideration should be given to a broader range of graduated sanctions.
  - Sanctions will not be published on company level nor on country level.
  - During 2002−05, there were in total six noncompliances reported to the prosecutor.
  - In 2005 (until November), 169 orders had been issued with a view to ensuring corrective actions.
- Enforcement powers
  - IMF team finds DFSA does not possess power to dismiss controlling owners and managers or to restrict their powers; issuing an executive order was suggested.
  - DFSA currently cannot directly dismiss controlling owners/managers; recommendation that DFSA should have means to address management problems directly.
- Group-wide supervision
  - DFSA supervises three financial conglomerates active in the Danish market.
  - Risk assessment of Danish business takes place in joint DFSA meetings; MoU with Nordic countries facilitates consistent cross-border approach.
  - Recommendation: simultaneous assessment of major risks in all countries of a group to impede unsupervised risk transfer.

### Recommended Action Plan (by IAIS Core Principle references)
- Conditions for Effective Insurance Supervision (CP 1)
  - More specific rule-based requirements should be applicable to all companies; current regime is principle-based but allows risk-based supervision.
  - Guideline 9680 guides organization but does not define minimum standards applicable to all companies.
- Supervisory authority (CP 3)
  - Potential interference of executive branches in budget allocation should ideally be limited; DFSA must agree on its budget with the Ministry of Economic and Business Affairs despite expenses being covered by supervised entities’ fees.
  - Possibility of resources being allocated to regulation to the disadvantage of supervisory activity noted.
- Licensing (CP 6)
  - Consider requiring suitability assessment of auditors and actuaries; risk-based approach requires tighter, rule-based supervision in first years of newly established businesses.
- Suitability of persons (CP 7)
  - Consider applying fit-and-proper requirements to a broader range of senior management despite current consistent application.
- Internal control (CP 10)
  - Require internal audit functions for smaller companies; Guideline 9680 should more clearly define internal control requirements; executive order recommended.
- Market Analysis (CP 11)
  - DFSA should enlarge market analysis activities and gather macroeconomic information to enable market-trend forecasting.
- On-site inspection (CP 13)
  - Risk assessment should account for company size to balance risk sensitivity and potential market financial impact; inspection cycles as noted in supervisory practices.
- Preventive and Corrective Measures (CP 14)
  - Consider broader range of graduated sanctions; withdrawal of license may not be adequate for all noncompliances.
- Enforcement or sanctions (CP 15)
  - DFSA should have means to address management problems directly; consider issuing an executive order to enable dismissal or restriction of powers of controlling owners/managers.
- Group-wide supervision (CP 17)
  - Simultaneous assessment of major risks in all countries of a group recommended to impede unsupervised risk transfer.
- Risk assessment and management (CP 18)
  - Risk-assessment framework should be obligatory for all companies and expressed in an executive order.
- Insurance activity (CP 19)
  - Consider whether DFSA should issue an executive order with minimum requirements regarding insurance activity.
- Investments (CP 21)
  - Consider more detailed suitability requirements for investment functions.
- Derivatives and similar commitments (CP 22)
  - Consider requiring suitability requirements for derivatives function.
- Anti-money laundering (CP 28)
  - See separate detailed AML/CFT assessment.

### Authorities’ response (DFSA / Government)
- Agreement
  - Authorities are broadly in agreement with IMF assessment team and elaborate on several issues.
- DFSA independence and budget
  - Consideration will be given to establish DFSA as an independent institution by providing a statutory basis in legislation and to separate regulatory and supervisory budgets.
  - Authorities emphasize ensuring adequate funds at all times is essential; a distinct division of the budget could provide clearer transparency.
- Fit-and-proper regime
  - Current fit-and-proper test is compliant with EU directives.
  - Authorities will consider adjusting regulation to enable DFSA to take measures if a person in additional functions is not fit-and-proper, but extending the test widely is seen as potentially not cost efficient.
  - Preference for management responsibility in hiring fit-and-proper personnel, with DFSA having means to act if deficiencies are discovered ex post.
- Powers to restrict or penalize owners/managers
  - Authorities stress DFSA can abolish voting rights of shareholders if a qualified owner counteracts sound and safe operation and may give specific instructions to firms; therefore they do not see a need for further measures to dismiss owners/managers.
- Internal audit and executive orders
  - Authorities note internal auditors in Denmark participate in financial auditing and are not part of the company control system; they do not see a need for compulsory internal audit functions in small companies.
  - Authorities will consider making requirements more detailed and converting guidelines into an executive order but will weigh benefits against intention to keep administrative burden low and against practical difficulties for small firms to attract internal auditors.

*Report excerpt from the IMF FSAP assessment of Denmark (ICP assessment, November 7–18, 2005).*

### 1.      The assessment of the observance of the Core Principles (CPs) for Systemically

### The assessment of the observance of the Core Principles (CPs) for Systemically Important Payment Systems (CPSIPS)

### Assessment overview
- The CPSIPS developed by the Committee for Payments and Settlement Systems (CPSS) dated January 2001, was carried out as part of the first FSAP mission to Denmark, November 7–18, 2005.
- The assessment was performed using the assessment methodology described in the Guidance Note for Assessing Observance of Core Principles for Systemically Important Payment Systems of the IMF/World Bank.
- The assessment relied heavily on self-assessments by the two systems’ overseers and on in-depth interviews with staff of the Payment System Department of Danmarks Nationalbank and of the DFSA charged with oversight.
- Prior to the mission, Danmarks Nationalbank provided laws, articles, brochures, guidelines, and completed the questionnaire on payment systems; two books published by Danmarks Nationalbank on monetary policy and payment systems were made available.

### Systemically important systems identified
- Two payment systems are declared systemically important by the Danish authorities:
  - KRONOS, the RTGS system for large-value payments.
  - Sumclearing, a multilateral netting system for the clearing and settlement of retail payments.
- Sumclearing is defined as systemically important primarily because it is the only retail payment system in Denmark and it also handles relatively large payments.
- The retail payment infrastructure is described as a “pyramid shaped structure” consisting of two sub-clearings and their results (sum totals) netted in the Sumclearing. The infrastructure is described in the Aftalebog and the Håndbog for Betalingsformidling of the Danish Bankers Association (DBA), the owner of Sumclearing.
- During the mission the assessor also carried out an assessment of the CPSS/IOSCO Recommendations for Securities Settlement Systems of VP, the Danish Central Securities Depository (CSD).

### Institutional and market structure
- KRONOS:
  - Is the RTGS system used to settle monetary policy transactions and large-value interbank transactions.
  - Is a multicurrency system that settles transactions in Danish kroner and euro.
  - For the settlement of euros KRONOS is linked to TARGET, the RTGS system of the ESCB.
  - Also settles transactions in Swedish kroner and Icelandic kroner in connection with settlement in VP of securities denominated in these currencies.
  - Settles the kroner leg of foreign exchange transactions that are cleared via the Continuous Linked Settlement (CLS) system.
- Sumclearing and VP settle via clearing accounts that their participants have opened with Danmarks Nationalbank.
- Payment instruments and activity (2005 data where specified):
  - Around 1.1 billion payments with a value of DKr 5,027 billion were processed in the Sumclearing infrastructure.
  - Around 670 million payments by cards in 2005; Denmark had the highest number of card transactions per capita in Europe.
  - A large amount of recurrent bills for telephone, utilities, and other services: 168 million in 2005 paid via direct debits.
  - 9 out of 10 households use the services of Payment Business Services (PBS).
  - About 2.7 million Danish citizens have opened an e-banking account and send in their payment orders via the internet.
  - Average value per transaction cleared through the Sumclearing in 2005 was DKr 22.850 (checks are especially used for larger payment obligations).
- Retail payment infrastructure composition:
  - Three parts: two sub-clearings (the electronic clearing and truncation system and the PBS clearing) and the Sumclearing.
  - Sub-clearing results are combined and cleared in the Sumclearing and final result is settled via accounts at Danmarks Nationalbank.
  - In both subsystems payments are submitted continuously 24 hours per day.
  - The electronic clearing and truncation system processes checks, credit transfers, and cash withdrawals by clients of other banks; datacenters exchange information bilaterally and prepare debit and credit balances for participants, which in the evening are sent into the Sumclearing.
  - The PBS clearing processes direct debits and EFTPOS transactions with a debit or credit card and cross-border card transactions; it is a common infrastructure owned by the banking industry and provides services to all Danish and foreign banks active in the Danish market.
- Financial market settlement:
  - Transactions in the financial markets are cleared via VP (the Danish CSD) and until recently FUTOP (the clearinghouse for derivatives).
  - KRONOS, Sumclearing, and VP settle via clearing accounts their participants have opened with Danmarks Nationalbank.
  - Denmark’s capital market is typically a bond market with active trading in mortgage bonds and government securities; although most bonds are listed on the Copenhagen Stock Exchange (CSE), most trading is carried out OTC in the informal interbank telephone market.
  - Note on FUTOP: In 2005, FUTOP was taken over by OMX Group AB in Sweden. It does no longer operate under the umbrella of a Danish license and regulations. However, derivative contracts in Danish kroner are still settled on the accounts in Danmarks Nationalbank.

### Developments and reforms
- No payment system reform as such has taken place since the introduction of KRONOS in November 2001 or is planned for the near future.
- Developments of the payment infrastructure and in payment instruments are mainly market driven.

### Prerequisites for effective payment systems oversight
- All relevant prerequisites for effective payment and clearing and settlement systems are fulfilled.
- Key characteristics:
  - High degree of co-operation within the financial sector in relation to the technical infrastructure.
  - Main parts of the infrastructure for the clearing of retail payments and securities are owned by the banks collectively, resulting in unified systems handling all types of retail payments.
  - All banks have access to the common infrastructure and smaller banks can offer clients a full range of payment services; the common infrastructure is highly automated.
  - Governance framework is well arranged and all banks can influence decision making on development, pricing, and other issues.
  - Collusive practices and discrimination in payment systems are not allowed; the Danish Competition Authority enforces rules laid down in the Danish Competition Act.
- Legal and regulatory framework:
  - Denmark has a sound legal infrastructure for payment and securities settlement transactions; key issues as finality, netting, delivery-versus-payment (DVP) and the enforceability of collateral arrangements are well regulated.
  - Electronic signatures and the use of electronic data are recognized by the court; all contractual relationships are enforceable.
  - A zero hour rule does not exist. Finality of payments is ensured in case of bankruptcy.
  - There are separate laws for the provision of payment instruments that also regulate consumer protection with respect to electronic payments and card payments.
  - Accounting practices are up to international standards.
- Oversight arrangements:
  - Payment systems are overseen by the DFSA and Danmarks Nationalbank, which cooperate closely.
  - The oversight powers of the two institutions are regulated in the STA.
  - Cooperation and consultative arrangements between the two overseers are laid down in a MoU that is publicly available.
  - The STA was amended effective March 1, 2006, which further clarifies the oversight authority.
  - There is narrow cooperation between central banks and banking supervisory authorities with respect to crisis management in the Scandinavian countries and in the EU.
- Operational risk, fraud, and consumer protection:
  - There are efficient procedures for resolution of problems in case of fraud, errors, delays, and failures.
  - Procedures in case of a bankruptcy in VP and in the Sumclearing to reduce replacement cost risk, credit risk, liquidity, and possible systemic risk could be strengthened.
  - The Act on certain payment means, applicable on electronic payment instruments, protects consumers on excessive risks due to fraud.
  - Due to design of the infrastructure for debit card transactions, the system might be vulnerable to fraud (use of magnetic stripe cards, no centralized check on availability of sufficient balances in the account, part of the infrastructure is still signature based instead of pin-based).
  - Introduction of EMV-chip cards to replace magnetic stripe cards encounters resistance from the retail sector due to costly terminal upgrades.
  - A comprehensive cost benefit analysis for different payment instruments for all parties, and a thorough comparison of costs and fees in Denmark with costs and fees in other similar countries, is not yet available.
  - A clear analysis of incentives to use the most efficient payment in certain situations would be useful to gauge macro-economic efficiency and reduce overall costs.

### Main findings
- KRONOS:
  - The assessment demonstrates that KRONOS, the RTGS system for large-value payments operated by Danmarks Nationalbank can be classified as a generally sound, efficient, and reliable system, although some minor improvements are possible.
- Sumclearing:
  - As a deferred net settlement system for retail payments, Sumclearing has more difficulties to fully observe the CPSIPS.
  - Risk management measures in case of a default are inadequate; unwinding is the principle solution in such cases.
  - Problems might aggravate during a crisis due to the practice of making payments received via direct debit services of PBS already available to the beneficiary the day before settlement is final.
  - A reversal of these payments in a default would encounter major operational difficulties and may take almost a week, if possible at all.
  - Under normal circumstances systemic risk is small due to participants’ access to abundant intraday liquidity facilities at Danmarks Nationalbank.
  - Danish banks generally have large portfolios of bonds that are accepted as collateral; this source of liquidity is also the main protection against systemic risk in other systems like VP.

*Assessment performed by Jan Woltjer, Monetary and Capital Markets Department, International Monetary Fund (formerly with De Nederlandsche Bank).*

### 21.      Danmarks Nationalbank has built up special knowledge and skills for the oversight of

### _cr06343 - 21.      Danmarks Nationalbank has built up special knowledge and skills for the oversight of

### Oversight mandate and initial assessment
- Danmarks Nationalbank has developed "special knowledge and skills" for oversight of systemically important payment and clearing and settlement systems for securities and produced a well organized book describing the infrastructure, risks, and relevant issues.
- Effective March 1, 2006, the Bank was officially charged as the sole overseer of payment systems important for implementing monetary policy transactions by an amendment to the STA.
- Remaining gaps identified:
  - Oversight methodology and internal procedures could be worked out in more detail.
  - Reporting and cooperation with other relevant authorities in the payments area could be improved.

### Summary of main findings and recommended corrective actions (by topic / CP reference)
- Understanding of the system’s impact on risks; and procedures for the management of risks (CPs II–V) — Sumclearing
  - The Danish Bankers Association should as soon as possible:
    - Draft a memorandum providing a comprehensive description of the functioning of the system; the risks involved; the risk management and liquidity management measures and tools for participants; the consequences of an unwind; and the main rules and regulations and procedures, especially in abnormal situations. This memorandum should be published on its open website in English and in Danish.
    - Lower the risks in the system by either implementing a loss-sharing and liquidity arrangement or lowering the positions in the netting by setting lower maximum limits for individual transactions and dividing the payment flows effectively in batches during the settlement day instead of concentrating them in the first normal settlement cycle at 1:30 a.m.
    - Take measures to prevent the booking of the retail payments in the account of customers before the settlement is final, as long as the settlement is not guaranteed by adequate risk management measures. Alternatively, the results of the ordinary clearing could be settled immediately after the processing is finished, whereupon the data on the underlying retail payments could be distributed.

- Assets for settlement (CP VI) — Sumclearing
  - The overseers should:
    - Gather information on possible concentration risk, the amounts settled and the deposit risk for the smaller banks that use a specific settlement bank, and analyze the consequences for smaller banks and the trust in the system in case of a default of one of the larger settlement banks.

- Security and operational reliability; and contingency arrangements (CP VII) — KRONOS
  - Recommended actions:
    - Coordinate the contingency plans of Danmarks Nationalbank, BEC, VP, PBS, and develop an infrastructure for broad testing of emergency procedures.
    - Re-negotiate with BEC the maximum restart time and agree to comply with the international best practice of two hours.
    - Develop the securities analysis methodology developed by the ECB further and adapt it according to new insights with respect to IT security.
    - Ensure that communication via the proprietary network observes international standards with respect to integrity.
    - Stress test all parts of the system adequately and ensure sufficient peak capacity.
    - Analyze the complexity of the system design and its interaction with other systems of Danmarks Nationalbank or of BEC and study how this complexity could be reduced.
  - Sumclearing:
    - Contingency measures should be tested with participants and emergency measures should be coordinated with other system providers.

- Practical for the markets and efficient for the economy (CP VIII) — KRONOS
  - Recommended actions:
    - Re-analyze in depth the costs of the system.
    - Define the part of the cost to be borne by the central bank.
    - Develop a price strategy that takes into account the fees charged in comparable countries.

- Objective and publicly disclosed criteria for participation (CP IX) — KRONOS and Sumclearing
  - KRONOS:
    - Reconsider the discretionary powers with respect to access and exit.
    - Analyze the effects of the language barriers for remote members and whether they are in line with the very open access policy and the promotion of Denmark’s financial markets.
    - Formulate explicit exit procedures in the rules and regulations.
  - Sumclearing — The Danish Bankers Association should:
    - Facilitate public disclosure of the access criteria by stating the rules in the memorandum mentioned under CP II.
    - Make the exit rules more formal by drafting exit criteria and work out decision procedures and procedures to facilitate the exit of a participant and publish them in the aforementioned memorandum.

- Governance of the system should be effective, transparent and accountable (CP X) — Sumclearing
  - The Danish Bankers Association:
    - May want to consider enhancing transparency of the infrastructure for clearing and settlement of retail payments by making the memorandum (as indicated under CP II) available to the public on its open website.
    - Should take action to comply in full with all Core Principles.

- Central bank responsibilities (Responsibility B)
  - The central bank should:
    - Draft a mission statement and work out the oversight methodology and an implementation plan.
    - Ensure that the oversight of KRONOS is performed on a continuous basis.
    - Ensure that sufficient resources and expertise are available.
    - Establish internal and external relationships within the context of the oversight policy.
    - Analyze in more depth the pros and cons of the different roles and their usefulness to tackle specific issues in the Danish institutional context and coordinate the use of these different roles.

- Central bank responsibilities (Responsibility C)
  - The central bank should:
    - Formalize the oversight policy with respect to systems operated outside Danmarks Nationalbank.
    - Broaden the scope of the oversight with respect to the Sumclearing.
    - Establish a crisis management framework with respect to problems in the infrastructure.
    - Ensure that the oversight can be adequately performed in case of outsourcing.
    - Strengthen the cooperation with other Danish authorities and relevant foreign authorities.
    - Increase the involvement of the participants in the oversight.
    - Strengthen the reporting of oversight in the annual Financial Stability Report.

### Authorities’ responses (selected points)
- KRONOS
  - The assessments and recommendations for KRONOS "essentially reflect the findings of Danmarks Nationalbank."
  - On renegotiating the legal binding maximum restart time from four to two hours: numerous tests in recent years have shown that KRONOS can in practice be restarted in less than one and a half hours. Danmarks Nationalbank agrees with the recommendation and has started negotiations with the system operator.
  - On efficiency: Danmarks Nationalbank notes that the large number of direct participants shows an appropriate balance between security and efficiency. Cost recovery is less than full but seems adequate and in line with similar RTGS-systems in other small- to medium-sized European countries.

- Sumclearing (retail payments)
  - Assessments and recommendations are broadly in line with Danmarks Nationalbank and the DFSA.
  - Danmarks Nationalbank and the DFSA agree to the recommendation that the practice of booking retail payments in customer accounts before settlement is final should be terminated; discussions with the banking sector will start to change this practice.
  - Danmarks Nationalbank and the DFSA will further analyze proposals to lower financial risks (loss-sharing agreements, pools of collateral, lowering net positions by restructuring the settlement cycle and introducing new settlement blocks); Danmarks Nationalbank will start discussions with the system owner to identify costs and benefits.
  - Supervision of settlement agents and indirect participants and possible concentration risks lies primarily with the DFSA; the DFSA has taken note of the recommendation to gather information on possible concentration risk and will take steps to formalize and recurrently carry out such supervision.

- Central bank responsibilities
  - Recommendations to strengthen oversight are consistent with Danmarks Nationalbank’s self-assessment.
  - Important steps already taken:
    - Legal basis strengthened by an amendment to the STA effective March 1, 2006.
    - The "memorandum of understanding between Danmarks Nationalbank and the Danish Financial Supervisory Authority concerning payment systems and clearing centers" will be revised to enhance cooperation.
    - Danmarks Nationalbank will broaden oversight of the retail payment system (Sumclearingen) to cover all major components, including different payment instruments and sub-clearings.
    - High priority assigned to formalize oversight tasks through written procedures and guidelines.
    - Full observance is expected to be achieved in 2006.

### Securities settlement systems — Report on observance of CPSS/IOSCO Recommendations (selected findings)
- General and scope
  - The assessment was part of the first FSAP mission to Denmark, November 7–18, 2005.
  - Værdipapircentralen (VP) is the sole CSD in Denmark; it registers ownership of securities issued in the country, clears, and settles securities transactions in the regulated markets and OTC market.
  - In 2005:
    - 10.2 million transactions were settled in VP with a market value of DKr 30,924 billion (around US$5,012 billion), made up of DKr 27,485 billion in bonds and DKr 3,439 billion in shares.
  - Prior to the mission, Danmarks Nationalbank and the DFSA prepared a comprehensive self-assessment used as the basis for this assessment.

- Derivatives and other market structure details
  - Derivatives trades in Danish securities are conducted through OMX Derivatives Markets (SSE) where OMX acts as central counterparty (CCP) for derivatives trades in that market.
  - Derivatives market size (mid-2005):
    - Around 700,000 contracts outstanding with an average daily settlement of DKr 1.5 million.
  - Assessment covers only VP as the core SSS; law allows other entities to offer registration and clearing and settlement services.

- Institutional and market statistics
  - Denmark’s capital market is mainly a bond market:
    - Mortgage bond turnover 2004: 282.5 percent of GDP.
    - Government paper turnover: 157.5 percent of GDP.
    - Total turnover of bonds and treasury bills 2004: 486.7 percent of GDP.
    - Turnover in listed equities 2004: 40.9 percent of GDP.
    - Trading in derivatives: 1.3 percent of GDP.
  - The CSE (subsidiary of OMX) has 44 members.
  - Market activity:
    - Total market value of stock exchange transactions increased by 23.8 percent from 2004 to 2005.
    - Equity trading increased 57.8 percent during the same period.
  - CSE bond trading values:
    - 2004: DKr 7,059 billion
    - 2005: DKr 8,534 billion
  - CSE equity trading values:
    - 2004: DKr 593 billion
    - 2005: DKr 936 billion
  - Stock market index increased 37¼ percent during 2005.

- Cross-border settlement and links
  - Danish government bonds can be traded on the MTS platform (launched 2003) to promote international trading.
    - MTS Denmark: 16 MTS participants of which 2 are clearing members of Euroclear Bank.
    - Daily turnover approximately DKr 2 billion (US$325 million).
  - VP has effective links with Euroclear and Clearstream allowing DVP and back-to-back settlement without loss of value dates.

- VP operational features
  - Securities in VP are dematerialized and settled on a multilateral netting basis in several settlement cycles during the settlement day.
  - VP does not act as a central counterparty, nor as a settlement bank, and does not organize a securities borrowing and lending arrangement.
  - Trades can also be settled in VP on a real-time gross basis.
  - All settlements are conducted on a DVP basis with the settlement of the cash leg in central bank money.
  - VP has a settlement agreement with Danmarks Nationalbank that includes collateral management services by VP for intraday credit granted by the central bank, founded in the Securities Trading Act.

### Study note on collateral and participant exposures (footnote content)
- A study triggered by this assessment demonstrated that in 2005:
  - All larger banks’ eligible collateral significantly exceeded their total net payment obligations in all systems — even when the participant with the largest net payment obligation was withdrawn from the settlement on every day during 2005 and all the remaining participants' net positions were recalculated.
  - Among the minor banks, only a handful had recalculated net positions which on very few days surpassed the value of their eligible collateral.
  - The study noted methodological flaws that tend to exaggerate effects on small banks and does not include that banks can pledge securities for intraday credit already in the settlement cycle in which the securities are received.
  - The study titled “Protection of Settlement in Danish Payment Systems” is cited as being in Financial Stability 2006 published by Danmarks Nationalbank.

*IMF staff report: assessment of observance and recommended corrective action plan for Danish payment, clearing, and securities settlement systems (excerpts).*

### 12.      Securities in VP are normally registered in the name of the end investor (3.0 million

### _cr06343 - 12.      Securities in VP are normally registered in the name of the end investor (3.0 million

### Description of VP and market participation
- Securities in VP are normally registered in the name of the end investor (3.0 million accounts have been opened in VP).
- Banks and other eligible financial institutions act as account controllers for investors and offer cash settlement services.
- Large customers, such as investment funds or pension funds, are allowed to report directly to VP.
- Account controllers can opt to become clearing members and settle transactions on behalf of their clients.
- In 2004 VP had 131 clearing members, of which 31 were remote members (foreign financial institutions).
- Foreign investors hold especially stocks (28.4 percent of all stocks issued) and bonds (15.9 percent).
- Foreign custodians are allowed to open omnibus or nominee accounts and normally do not register investments directly in the name of end investors.

### Regulatory structure and institutional responsibilities
- Danish Securities Council (the Council)
  - Overall responsibility for the framework within which the securities market operates and for supervision of the market.
  - Main focus on market supervision and surveillance; issues rules relating to general conditions and rules that regulate clearing and settlement institutions and CSDs.
  - Composed of representatives of securities dealers, issuers, and investors, including Danmarks Nationalbank.
- Danish Financial Supervisory Authority (DFSA)
  - Responsible for regulating the Danish financial sector; authorization and prudential supervision of market participants and market institutions.
  - Designates payments and securities settlement systems under the Settlement Finality Directive and notifies Danish system operators and relevant authorities abroad in case of a bankruptcy.
  - Tasks and responsibilities with respect to the securities sector are outlined in the STA.
- Danmarks Nationalbank
  - Objectives: maintain a safe and secure currency and facilitate and regulate circulation of money and extending of credit; monitors stability and efficiency of payments and securities settlement systems.
  - February 2006: Parliament acknowledged oversight task with respect to payment systems via amendment of the STA.
  - As the settlement bank of VP, set requirements in a settlement agreement obliging VP to observe the CPSS/IOSCO recommendations for securities settlement systems.
- Danmarks Nationalbank and DFSA
  - Work closely on oversight of payments and securities settlement systems and have concluded an MoU on cooperation and coordination.

### Information and methodology used for the assessment
- Assessment based on:
  - Self-assessment by Danish authorities using CPSS/IOSCO assessment methodology for Recommendations for Securities Settlement Systems.
  - Self-assessment by VP.
  - Completed questionnaire of the European Central Securities Depository association (not yet published).
  - Discussions with Danmarks Nationalbank, the DFSA, VP, and market participants.
  - Review of relevant laws, rules and regulations, memorandums of understanding, and VP’s annual report.
  - Publications: Payment Systems in Denmark (Danmarks Nationalbank) and articles by central bank staff.

### Main findings — Legal risk (recommendation 1)
- There is a consistent set of laws, regulations, and contracts forming the legal foundation for custody and clearing and settlement of securities.
- All relevant laws and regulations are publicly available.
- Finality is well regulated, also in the case of a bankruptcy; a zero-hour rule does not exist.
- Customer assets are protected by law against the bankruptcy of an account controller or custodian.
- Dematerialization, netting, securities lending arrangements, and establishment of collateral interest are well regulated.
- All laws, regulations, and contractual arrangements are fully enforceable.
- VP is aware of conflicts of laws in linkages and remote participation and indicates Danish law will apply to each aspect of settlement; conflicts are identified through legal opinions when relevant.

### Main findings — Pre-settlement risk (recommendations 2–5)
- Matching and confirmation are essential and all transactions are matched prior to settlement, mostly on trading day.
- Transactions in regulated and OTC markets are settled on a rolling settlement procedure on T+3 or on a shorter settlement cycle in VP.
- Incentives ensure timely settlement and settlement failures are closely monitored.
- No central counterparty is established in Denmark for settlement of securities transactions; market participants believe such an entity would not add value, though cost-benefit studies were never published.
- Unclear whether changing risk profiles from order driven platforms, internationalization (NOREX), and cross-border trading (MTS-Denmark) were adequately considered.
- Securities lending is well established, fully supported by legal, accounting, and tax frameworks; Danmarks Nationalbank acts as last resort lender if market borrowing is unavailable.

### Main findings — Settlement risk (recommendations 6–10)
- Denmark introduced electronic registration of securities in 1983 and has actively promoted dematerialization; currently all shares and bonds traded in regulated markets and in the OTC market are dematerialized, as well as a large amount of unlisted unit trusts.
- All transactions in VP are settled on a DVP basis in central bank money between clearing members.
- Smaller participants make use of a primary cash provider and are thus exposed to deposit risk.
- Various netting cycles during the long opening day and a trade-for-trade RTGS facility result in almost all trades being settled with intraday finality and reusable funds for other settlement obligations the same business day.
- No rigorous risk control measures ensure timely settlement in the event of bankruptcy of the participant with the largest obligation in deferred netting schemes.
- Stress test studies by Danmarks Nationalbank indicate participants can raise sufficient liquidity under automatic collateralization to reduce liquidity pressure in the present situation; effects of multiple failures were not analyzed.

### Main findings — Operational risk (recommendation 11)
- VP has an appropriate IT security policy and has proactively assessed threats.
- Risk controls are reviewed annually.
- Adequate contingency plans and back-up facilities are available and tested periodically.
- Operational reliability is high and sufficient capacity exists to handle peak volumes.

### Main findings — Custody risk (recommendation 12)
- Investors are protected against claims of an account controller, custodian, or VP.
- Securities are normally directly registered in VP in the name of the end-investor.
- For omnibus or trustee accounts, segregation of custodian’s own investments and client securities is required.
- Liabilities of account controllers and custodians are clearly defined and monitored.
- Ample compensation schemes exist in case of theft, misuse, or errors.

### Main findings — Other issues (recommendations 13–19)
- VP’s governance structure is clearly specified, transparent, and ensures fulfillment of public interest requirements while promoting owners’ and users’ objectives.
- Access criteria do not limit access other than on grounds of legal risk to finality.
- VP’s operations are cost effective and provide participants sufficient information on risks and costs.
- VP has developed efficient and safe DVP links with Euroclear and Clearstream and free-of-payment (FOP) links with Iceland and Sweden; no provisional deliveries take place over these links.
- VP is supervised and regulated by DFSA under the STA; Danmarks Nationalbank is involved in oversight. Cooperation is effectively organized and laid out in an MoU.

### Recommended corrective actions (summarized from Table 2)
- Settlement risk (Rec 6–10)
  - Analyze effects of failure of the largest participant and effects of multiple failures, including costs of guaranteeing settlements or preventing losses (e.g., collateralization of market risks).
  - Analyze spillover effects to other systems in case of failure of the largest participant and losses related to outstanding uncollateralized loans in the money market and the tiered structure of VP and Sumclearing.
  - Overseers should monitor concentration risk related to use of the same primary cash provider and take appropriate action if necessary.
- Operational risk (Rec 11)
  - VP should coordinate and test contingency plans and emergency procedures (including communication with participants) with system owners and operators of KRONOS and Sumclearing.
- Other issues (Rec 13–19)
  - Overseers should be allowed to oversee activities and systems in case of outsourcing and should have the right to conduct on-site inspection if deemed necessary.

### Authorities’ response and actions
- Danmarks Nationalbank and the DFSA agreed with the IMF’s recommendations and considered the IMF assessment thorough and comprehensive.
- Danmarks Nationalbank will review benefits and costs of introducing additional measures to reduce settlement risks, including evaluating benefits and costs of a central counterparty and addressing potential effects of increased foreign participation.
- Participants generally have far more eligible collateral than needed for daily net payments in VP settlement, Sumclearing, and CLS.
- Supervision of concentration risks from indirect participation regarding VP payments is part of DFSA supervision; steps will be taken to further formalize supervision in this area.
- Central bank responsibilities:
  - Recommendations to strengthen oversight are consistent with Danmarks Nationalbank’s self-assessment.
  - Legal basis was strengthened by an amendment to the STA, effective March 1, 2006.
  - The MoU between Danmarks Nationalbank and DFSA will be revised to enhance cooperation.
  - Danmarks Nationalbank will broaden oversight of the retail payment system (Sumclearingen) to cover all major components and formalize oversight through written procedures and guidelines.
  - Full observance is expected to be achieved in 2006.
- Footnote summary (study findings):
  - A study showed that in 2005 all larger banks’ eligible collateral significantly exceeded total net payment obligations in all systems—even when the participant with the largest net payment obligation was withdrawn and net positions recalculated.
  - Among minor banks, a handful had recalculated net positions that on very few days surpassed the value of their eligible collateral; the methodology of the study likely exaggerates effects on small banks and did not include that banks can pledge securities for intraday credit in the settlement cycle in which securities are received.
  - The study “Protection of Settlement in Danish Payment Systems” is in Financial Stability 2006 published by Danmarks Nationalbank.

*Report: Assessment of Værdipapircentralen (VP) and related Danish securities settlement system oversight as presented in the supplied IMF chapter content.*

### 6.      The FIU has direct access to a wide range of data. It conducts basic checks of

### _cr06343 - 6.      The FIU has direct access to a wide range of data. It conducts basic checks of

### FIU operations and analytic capacity
- The FIU is an operationally independent unit within the office of the Public Prosecutor for Serious Economic Crime (SØK).
- Staffing: "three prosecutors and seven police officers"; it "also has access to supplementary staff."
- The FIU "has direct access to a wide range of data" but "a court order is usually needed to obtain additional information from reporting entities."
- Current analytical practices:
  - Analysis of STRs is "limited to gathering information, largely through basic checks against databases."
  - "Virtually all STRs are disseminated for investigation, with little additional analysis or value-added."
- Capacity concerns and training needs:
  - "With a likely increase in STRs, the need for more extensive STR analysis, and the possibility that staff are deployed for SØK investigations, there is some concern that the current staffing level of the FIU will not be sufficient going forward."
  - Staff "could benefit from more specialized training in the areas of tracing proceeds of crime, financial analysis, and FT."
- Operational recommendation:
  - Enhance STR analysis capability and staffing, and provide specialized training in tracing proceeds, financial analysis, and FT.

### STR reporting and overall reporting effectiveness
- "The overall level of reporting by all sectors to the FIU is low."
- STR reporting patterns:
  - "STR reporting by Danish financial institutions has been modest and largely concentrated in bureaux de change and commercial banks."
  - "Little progress has been made since the 1997 evaluation in reporting by the insurance and securities sectors, with virtually no STRs reported."
- Result: "The reporting regime is thus not fully effective."

### Legal framework: ML and FT criminalization, penalties, and limitations
- ML criminalization:
  - ML is criminalized through a "money receiving offense" covering conduct in applicable conventions.
  - Extends to proceeds from "any crime committed intentionally."
  - "Grossly negligent acquisition or receipt of proceeds through an offense is also subject to criminal sanctions."
  - "Laundering of one’s own proceeds is not actionable unless proceedings against the person for the predicate crime are not successful."
  - Penalties: "a fine, and/or for the basic offense imprisonment of up to 18 months and for the aggravated offence up to six years."
  - Observation: "The imprisonment penalty for the basic offense is less than in many countries. Penalties imposed have been relatively low."
  - "Legal persons have criminal liability."
  - "Provisions in the Faroe Islands and Greenland do not extend to all necessary predicate crimes."
- FT criminalization:
  - "The criminalization of FT in Denmark is consistent with international standards."
  - Limitation: "the Faroe Islands and Greenland, which rely on complicity in the commission of concrete terrorist acts, have not yet enacted specific provisions criminalizing the financing of terrorist acts, terrorists and terrorist organizations."
  - Enforcement: "Danish authorities have pursued FT investigations and prosecutions and a couple of cases are pending in the courts."
- Recommendation/concern:
  - Extend and align Faroe Islands and Greenland legislation to ensure full criminalization of FT and inclusion of necessary predicate crimes.

### Confiscation and freezing of assets
- Confiscation framework:
  - "A comprehensive, flexible confiscation framework includes traditional conviction-based confiscation, preventive confiscation, and can require a defendant to prove the legal origin of assets in some instances."
  - Law enforcement "has tools to identify, trace and seize criminal and terrorist assets."
  - "Statistics do not yet illustrate the efficiency of the system in place."
  - "Provisions in the Faroe Islands and Greenland are being updated."
- Freezing of terrorist assets:
  - Denmark implements UN freezing decisions through "European Union (EU) Regulations 2580/2001 and 881/2002 and through national mechanisms."
  - "The EU Regulations that Denmark applies do not limit the scope of terrorist assets that can be frozen."
  - National mechanisms limitation: "When using national mechanisms however, Denmark is not prepared to freeze funds held by, or collected or provided for, terrorists or terrorist organizations for their non-terrorism related activities."
  - Recommendation: "Guidance on the implementation of the freezing obligation should be improved, and additional legal provisions and practical arrangements are needed in the Faroe Islands and Greenland."

### Preventive measures, the MLA, and customer due diligence (CDD)
- MLA adoption and timing:
  - "The MLA was adopted in March 2006 to implement the third EU AML Directive and the revised FATF Recommendations."
  - Key provisions "come into force only in January 2007."
- Scope of reporting entities and thresholds:
  - The new AML/CFT law covers "about 4800 lawyers, 2700 accountants/auditors, 2700 real estate agents, and 6 casinos."
  - Denmark did not make its "650 dealers in precious metals and stones reporting entities" but instead "outlaws all cash transactions above DKK 100,000 (€13,410) for all forms of business."
- Assessment of MLA vs. FATF standards:
  - "The MLA’s requirements appear to be generally in line with the FATF standards. However, some CDD requirements need to be adjusted."
  - Specific gaps:
    - "There are no requirements to identify and verify that an individual purporting to act on behalf of a legal person or arrangement is so authorized."
    - "Identification requirements for occasional transactions in the case of wire transfers apply only to those involving €15,000 or more."
    - "Some exemptions to the CDD requirements, as they do not appear to be justified on the basis of a risk assessment, do not conform with the FATF standard."
  - Sanctions and enforcement: "Not all MLA obligations are covered by sanctions, nor were sanctions applied under the 1993 act. The range of administrative sanctions is limited and relatively few actions taken."

### Financial sector structure and supervision
- Size and composition:
  - "The Danish financial sector is deep (total assets close to five times GDP), sophisticated and dominated by the banking sector."
- Supervisory authorities:
  - The FSA regulates and supervises all financial institutions "except for money remitters and exchange bureaus" for which the Danish Commerce and Companies Agency (DCCA) is responsible.
  - Authorities "are appropriately structured and enjoy sufficient operational independence." However, "Regulation-making authority with respect to AML/CFT is limited."
- Supervision quality and recommendations:
  - "The FSA’s AML/CFT supervision has focused on reviewing internal guidelines of FIs and paid little attention to assessing their implementation."
  - "The depth and breadth of on-site inspections need to be increased."
  - Historically, "AML/CFT inspections of large banks were infrequent" though "since then the FSA has completed on site inspections of the largest banks."
  - "The depth and breadth of the DCCA’s inspections also need to be increased."
  - Recommendation: Review resources allocated to inspections for AML/CFT and expand staff training.

### DNFBPs, implementation, and supervision gaps
- On-paper coverage vs. effectiveness:
  - "Denmark’s CDD and STR requirements for DNFBPs, while sharing the general shortcomings detailed above, are relatively robust on paper."
  - "The recent passage of the MLA leaves no base for judging how effective this regime will be in practice, and the low level of reporting from DNFBPs who were covered under previous legislation raises a significant question."
- Specific supervisory weaknesses:
  - "The Bar and Law Association does not conduct examinations of its members’ AML/CFT practices."
  - "Casino inspectors serve primarily as reporting conduits."
  - "The DCCA is taking on an expanded set of functions likely to tax allocated resources."
  - DCCA can "build on its existing supervisory role for accountants and its role in company formation in overseeing accountants and company service providers."
  - "Supervision of the real estate profession may pose greater challenges."
- Recommendation: Strengthen supervisory regimes, increase on-site inspection depth, and evaluate the effectiveness of the cash transaction ban.

### Company ownership, registers, and bearer shares
- Legal persons and registration:
  - "Danish legislation permits the formation of several forms of legal persons. In general, legal persons have full legal capacity."
  - "However, in some cases the entity is not recognized as a legal person until it is registered."
  - "All businesses are registered in a Central Business Register (CVR), and in other registers."
- Beneficial ownership transparency:
  - "Very little beneficial ownership information is available through the CVR and the authorities rely on investigative and inspection powers to obtain information on beneficial ownership."
  - "Some companies can issue bearer shares up to their entire capital and beneficial ownership information is available only with respect to holdings that exceed designated thresholds."

### Law enforcement, prosecutions, and enforcement statistics
- Institutional integration: "Denmark has an efficient, integrated law enforcement and prosecution approach, with a well staffed national prosecutorial and law enforcement office, local police districts with both police officers and prosecutors, a national criminal investigation support center and a service responsible for national security."
- Prosecution statistics and observations:
  - "Only 16 cases have been prosecuted in the last six years for aggravated ML, a low figure even with Denmark’s relatively modest level of criminal activity."
  - "A couple of FT cases are pending but no convictions have yet occurred."
  - "Authorities recognize that even the relatively low level of organized crime can generate significant proceeds, but there are no accurate estimates of the amounts involved and authorities believe that in most cases, the proceeds of crime are transferred elsewhere."

### Cross-border cash controls
- Declaration requirement: "Cash and similar assets in amounts above €/US$15,000 that are transported across borders are required to be declared to customs authorities."
- Compliance and enforcement: "However, the small number of declarations suggests low compliance levels and no sanctions for non-compliance have been imposed."

### Non-profit organizations (NPOs)
- NPO landscape and oversight:
  - "Non-profit organizations (NPOs) are numerous, diverse, and mainly 'regulated' through their relationships with the tax authorities."
  - "The largest organizations, accounting for the bulk of the financial activity, have received tax privileges in return for significant levels of financial disclosure."
  - "About 75 percent of all NPOs of all sizes have registered their basic identification information with the authorities."
  - "The bulk of NPO income comes from Danish Government, EU, or other international organization grants which are closely monitored."
  - "Danish authorities have only conducted an informal review of their NPO system, and should use the recent elaboration of the international standard as an opportunity to examine mechanisms for oversight of NPOs more comprehensively and formally."

### Inter-agency coordination and international cooperation
- Domestic coordination:
  - "The FIU and other domestic agencies involved in AML/CFT cooperate informally but there is no one mechanism for coordinating national AML/CFT policies and practices."
  - Recommendation: "A platform for inter-agency policy level review of AML/CFT initiatives should be established, and the FIU and supervisory agencies should engage in closer and more regular coordination of efforts."
- International cooperation:
  - "The FSA, DCCA, FIU, and law enforcement authorities each have the ability to provide international cooperation by exchanging relevant information, and various cooperation agreements and channels have been established and used for such exchanges."

*Source: IMF assessment text as provided in the content unit.*

### 30.      Denmark is a party to all relevant international AML/CFT instruments but they have

### _cr06343 - 30.      Denmark is a party to all relevant international AML/CFT instruments but they have

### Summary
- Denmark is a party to all relevant international AML/CFT instruments but they have not yet been extended to the Faroe Islands or Greenland.
- Denmark has an exemplary MLA framework; extradition may occur through a series of instruments.
- The Faroe Islands and Greenland have a more circumscribed ability to provide MLA and extradition cooperation; this is being addressed.
- Denmark is an active and cooperative international criminal justice partner.

### Key recommendations to improve the AML/CFT system (organized by theme)
- Legal System and Related Institutional Measures
  - Criminalization of Money Laundering (R.1, 2 & 32)
    - Use the criminal ML provision more effectively by developing and prosecuting a larger number of cases involving serious ML, that is under Section 290(2) of the Penal Code involving aggravated conduct.
    - Seek to increase the penalties actually imposed for violations of the ML provision, and increase the maximum penalty available for the negligent ML offence.
    - Make the provisions that criminalize ML in the Faroe Islands and Greenland fully consistent with the requirements of the Vienna and Palermo Conventions.
    - Consider the extent to which Denmark may be able to criminalize self-laundering.
  - Criminalization of Terrorist Financing (SR.II & R.32)
    - Have the Faroe Islands and Greenland enact, as Denmark already has, specific provisions that criminalize the financing of terrorist acts, terrorists and terrorist organizations in a manner consistent with the Terrorist Financing Convention.
  - Confiscation, freezing and seizing of proceeds of crime (R.3 & 32)
    - Evaluate regularly the use of the comprehensive tracing, seizure and confiscation provisions in Denmark to determine whether the provisions are being used effectively to recover proceeds.
    - For the Faroe Islands and Greenland, continue the work on updating the legal and practical requisites to enable tracing, seizing and confiscating proceeds in all cases.
  - Freezing of funds used for terrorist financing (SR.III & R.32)
    - Be prepared to use national mechanisms to freeze funds held by, or collected or provided for, terrorists or terrorist organizations for their non-terrorism related activities.
    - Provide additional written guidance to the financial sector, DNFBPs, and others about the practical aspects of obligations under the freezing regime and procedures for access to funds.
    - Adopt legal provisions and implementation measures in the Faroe Islands and Greenland to facilitate compliance with the UN Resolutions.
    - Undertake additional efforts to ensure that all appropriate institutions and persons receive notice regarding lists that countries forward, and ensure institutions making inquiries about possible name matches receive prompt feedback.
  - The Financial Intelligence Unit and its functions (R.26, 30 & 32)
    - Enhance the analysis of STRs with the view to improving the quality of the information that is disseminated for investigation.
    - Ensure the FIU is able in all instances to obtain additional information without using a court order.
    - Adopt written requirements regarding the manner of reporting, as well as reporting forms or procedures that should be followed when reporting.
    - Considering the likely increase in numbers of STRs and the desirability of more extensive analysis of STRs, increase the staff of the FIU and provide more specialized training.
  - Law enforcement, prosecution and other competent authorities (R.27, 28, 30 & 32)
    - Use the Money Laundering Steering Committee or another like mechanism to regularly evaluate the effectiveness of the AML/CFT program.
    - Improve statistics gathering and analysis of such statistics.
    - Provide more particularized training that covers ML and FT typologies, and ML and FT issues as they arise in the Danish context, and more intensive training on techniques in tracing, seizing and confiscating property.
  - Cross-border declaration & disclosure
    - Increase compliance with the system including through use of sanctions and fines for non-compliance.
    - Provide practical guidelines for customs officers to guide them in implementing the system.
    - Maintain declaration records so that information is organized and readily usable, especially to track patterns of cross-border cash movement.

- Preventive Measures – Financial Institutions
  - Customer due diligence, including enhanced or reduced measures (R.5–8)
    - Extend the applicability of the new MLA to the Faroe Islands and Greenland.
    - Align identification requirements to take also into account the circumstances set forth by SRVII in the case of wire transfers.
    - Undertake an assessment of whether individual countries of the EU, or those with which the Community has entered into an agreement for the financial area, are in compliance with and have effectively implemented the FATF Recommendations, for purposes of exempting from proof of identity customers that are FIs located in these countries.
    - Adopt a general clear requirement for a FI to determine whether the customer is acting on behalf of another person and an obligation to take reasonable steps to obtain sufficient identification data to verify the identity of that other person.
    - Limit to pooled accounts only the exemption from the CDD requirement where a beneficial owner has funds in an account maintained by a lawyer for a client.
    - Have the MLA empower supervisory authorities to issue regulations in the area of PEPs.
    - Adopt provisions to require FIs to document the respective responsibilities of the correspondent and respondent institutions and determine if the respondent bank has been the subject of a ML or FT investigation.
    - Issue guidance/regulation relating to the types of documents which are to be verified during the identification process.
  - Third parties and introduced business (R.9)
    - Place the obligation to immediately obtain the necessary information on the FI that is relying on the third party.
    - Restrict a FI’s privilege of relying on CDD carried out by third parties either by limiting such reliance to those located in jurisdictions where the authorities have themselves ascertained that the supervisory framework and CDD measures are FATF-compliant, or by requiring FIs to satisfy themselves on that score (whether or not the jurisdictions are within the EU or in a country with whom the Community has concluded a financial area agreement).
  - Record keeping and wire transfer rules (R.10 & SR.VII)
    - Align the requirements for wire transfers with the international standard by extending them to incoming payments, to situations where there is no personal contact and to situations where the sender has an account with an intermediary.
  - Monitoring of transactions and relationships (R.11 & 21)
    - Consider having supervisory authorities provide guidance as to how to implement the provision to monitor customers’ activities.
    - Introduce a broader requirement to pay special attention to business relationships and transactions with persons from countries which do not or insufficiently apply the FATF recommendations.
  - Suspicious transaction reports and other reporting (R.13, 14, 19, 25 & SR.IV)
    - Assess effectiveness of the reporting regime to check for potential under-reporting.
    - Address the misalignment between the criminalization standard and the reporting requirement., either through legislative changes or enhanced supervision to guard against potential under-reporting.
    - Adopt measures that bring the reporting regime in the Faroe Islands and Greenland up to international standards, especially in the area of terrorist financing.
    - Enhance outreach to insurers and investment agents.
  - Internal controls, compliance, audit and foreign branches (R.15 & 22)
    - Provide guidance to FIs to ensure that the compliance officer or other appropriate staff has access to customer records and relevant information.
    - Step up the scope and intensity of initial and ongoing employee training programs.
    - Introduce requirements to ensure that reporting entities have adequate screening procedures for hiring employees.
  - The supervisory and oversight system – competent authorities and SROs
    - Role, functions, duties and powers (including sanctions) (R.23, 30, 29, 17, 25 & 32)
      - Enhance scope and frequency of FSA inspections for AML/CFT and scope of DCCA inspections.
      - Introduce fit-and-proper criteria for the registration of newly covered businesses.
      - Introduce detailed regulations and formal guidelines to elaborate and clarify best practice for complying with the MLA.
      - Review the adequacy of current staff resources of the FSA allocated to AML/CFT.
      - Increase resources of the DCCA allocated to AML/CFT (notably for inspections of money remitters and currency exchangers).
      - Expand considerably training of FSA and DCCA staff on AML/CFT matters.
      - Review the effectiveness of the powers of supervisory authorities to sanction for non-compliance.
    - Money value transfer services (SR.VI)
      - Reconsider applying the fit-and-proper test requirements also to undertakings that were carrying out the MVT activities before the entry into force of the new MLA.
      - Review the DCCA’s inspection policies and procedures, and practice and improve their scope.

- Preventive Measures – Nonfinancial Businesses and Professions (DNFBPs)
  - Customer due diligence and record-keeping (R.12)
    - Strengthen procedures for ascertaining beneficial owner information, especially where lawyers are holding client’s funds in their own accounts.
    - Establish clearer guidelines on appropriate identity verification procedures and documents (especially for legal persons).
    - Extend the AML/CFT regime to DNFBPs in the Faroe Islands and Greenland.
    - Enhance casino provisions and procedures to identify customers making transactions above the FATF-established threshold and comply with FATF record-keeping requirements.
  - Suspicious transaction reporting (R.16)
    - Enhance the effectiveness of the reporting requirement for DNFBPs, including improving outreach to the sectors and ensuring that internal procedures, training, and compliance arrangements are sufficient to ensure adequate and accurate reporting.
    - Introduce CFT reporting in casinos and consider streamlining the reporting process.
  - Regulation, supervision, monitoring, and sanctions (R.24 & 25)
    - Ensure that casino inspectors monitor compliance with AML/CFT preventative measures.
    - Enhance the Bar and Law Society’s active supervision of its members’ compliance with AML/CFT preventive measures.
    - Move more decisively to implement DCCA supervision of other DNFBPs including increasing resources where necessary.
    - Enhance outreach, training, and guidelines on AML/CFT issues and obligations for DNFBP practitioners.

- Legal Persons and Arrangements & Nonprofit Organizations
  - Legal Persons – Access to beneficial ownership and control information (R.33)
    - Improve the accuracy and timeliness of the information on beneficial ownership of legal persons, especially foreign legal ones.
    - Evaluate the ML/TF risks associated with the use of bearer shares and take appropriate action.
  - Legal Arrangements – Access to beneficial ownership and control information (R.34)
    - Undertake measures to ensure transparency of foreign trusts and to secure access to adequate, accurate and timely information on beneficial ownership.
  - Nonprofit organizations (SR.VIII)
    - Undertake a formal review, involving all relevant agencies, of the adequacy of their legal, regulatory, registration, and taxation systems to meet the new international standard as elaborated in recent FATF Interpretive Note on SR VIII.
    - Increase outreach to the NPO sector to raise awareness of the dangers and indicators of terrorist financing through the NPO sector and to develop and refine best practices to address FT vulnerabilities.

- National and International Cooperation
  - National cooperation and coordination (R.31 & 32)
    - Establish a platform for regular inter-agency policy level review of the effectiveness of current AML/CFT criminal justice and preventive measure initiatives and for recommending changes and new approaches.
    - Have more regular exchange between the FIU and FSA/DCCA of pertinent information to support each other’s efforts.
  - The Conventions and UN Special Resolutions (R.35 & SR.I)
    - Adopt mechanisms to freeze all assets of terrorists and terrorist organizations not only those that may be used for terrorist purposes.
    - Extend international conventions to the Faroe Islands and Greenland and put in place legal framework and implementation for all applicable convention obligations.
  - Mutual Legal Assistance (R.36, 37, 38, SR.V & 32)
    - Broaden the scope of the ML and FT criminal provisions in the Faroe Islands and Greenland to ensure effective provision of legal assistance and update tracing, seizure and confiscation provisions so a full measure of assistance can be provided.
    - Collect and evaluate statistics relating to mutual legal assistance.
  - Extradition (R. 39, 37, SR.V & R.32)
    - In the case of the Faroe Islands and Greenland, ensure there are treaties, conventions and domestic laws and procedures in place that permit extradition for ML and FT offenses in the case of countries outside of Europe.
    - Collect and evaluate appropriate statistics relating to extradition requests.
  - Other Forms of Cooperation (R. 40, SR.V & R.32)
    - Maintain more comprehensive statistics on law enforcement, FIU and supervisory international cooperation.

- Authorities’ response
  - The authorities are in broad agreement with the assessment.

### Stress Tests — Market Risk (methodology and results)
- Stress test design
  - Market risk stress tests were based on single factor shocks and focused on: (i) interest rate risk; (ii) equity and real estate price risk; and (iii) foreign exchange risk.
  - Banks included derivatives exposures in assessing market risk and used assumptions about shocks to implied volatilities.
  - The size of the shocks was determined based on draw from historical information, taking into account episodes of financial distress.
  - Single factor shocks specified:
    - Shock 1: Parallel shifts in the yield curve: +250 and -100 basis points.
    - Shock 2: Equity prices: -30 percent.
    - Shock 3: Foreign exchange DKr/Non-Euro currencies: appreciation/depreciation 40 percent.
    - Shock 4: Real estate prices: -30 percent.

- Capital Adequacy Ratio Resulting from Selected Market Shocks — Reported by the DFSA (percent) for Largest Banks (Group I)
  - 2005* (reported CAR baseline): 10.2
  - Yield curve UP 250 basis points: 9.5
  - Yield curve down 100 basis points: 9.9
  - Property prices down 30 per cent: 9.9
  - Equity prices down 30 per cent: 9.7
  - Appreciation 40 per cent: 10.2
  - Depreciation 40 percent: 10.2

- Banks’ profitability and staff validation
  - Banks forecasted their profits based on the baseline macroeconomic scenario; banks maintain positive profitability even as macroeconomic conditions deteriorate drastically.
  - Staff used a simplified approach to check consistency of bank results; staff results are consistent with banks’ presentations.
  - Staff note: market risk varies somewhat among institutions; on average, market risk seems relatively modest due to flexible interest rates in loans and dynamic hedging of holdings of financial instruments.

- Capital Adequacy Ratio Adjusted for Selected Market Risk Shocks for the Largest Banks (Group I) estimated by the mission — Mean values
  - Yield Curve up 250 bp: 9.9
  - Equity prices down 30 percent: 9.3
  - Fx Movement 40 percent: 10.1

*Source: IMF country report content provided in the supplied PDF content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06343.pdf_