## Capital Markets in the Nordic Countries 2000─June 06

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### I. Review of Danish capital markets — structure and size
- Bond market structure and size
  - At end-2005, bond market capitalization amounted to 193 percent of GDP.
  - Of the 193 percent: 142 percentage points represented mortgage bonds; 40.3 percentage points represented government securities; other bonds amounted to 10.7 percentage points (including 3 percentage points for corporate bonds).
  - Danish bond market size comparison: almost three times larger than its Swedish counterpart and seven times larger than the Norwegian bond market.
  - Market capitalization of bonds has grown by 27 percentage points of GDP, while market capitalization of government securities declined by almost 10 percentage points of GDP (to 27 percent at the end of 2005).
  - Central-government debt has been on a declining trend since 1995, when it stood at about 50 percent (of GDP).
- Equity market size and composition
  - At end-2005, Danish equity market capitalization was €156 billion, representing around 17 percent of the combined capitalization of the region’s equity markets and equivalent to about 77 percent of domestic GDP.
  - Stockholm and Helsinki markets each represent more than 130 percent of domestic GDP and together account for 61 percent of market capitalization in the region.
  - SMEs constitute the vast majority of listed companies on the Copenhagen Stock Exchange (CSE), while trading activity is dominated by a handful of large corporations.
  - In Copenhagen, combined turnover in TDC, Copenhagen Airport, and AP Møller accounted for more than 52 percent of total turnover on the exchange.
- Derivatives and cross-border access
  - Danish derivatives market (futures and options) developed in the mid-1980s but never fully took off.
  - Clearing and settlement of futures and options on Danish securities moved from FUTOP (owned by CSE) to the Stockholm Stock Exchange (SSE) after merger into OMX Group AB.
  - In 2005, the Swedish market represented 94 percent of all listed contracts traded on the Swedish, Danish, and Norwegian markets; Oslo and Copenhagen accounted for 5 percent and 1 percent respectively.
  - The peg of the Danish Krona to the euro provides easy and cost-effective access to euro area listed and OTC derivative markets.

### II. Prudential framework and market supervision
- Adherence to international supervisory principles and resourcing
  - DFSA regulatory framework was reviewed with reference to the key IOSCO Objectives and Principles of Securities Regulation; a formal principle-by-principle assessment was not undertaken.
  - Area for further attention: adequacy of resources; international standard requires supervisory authorities be adequately funded to meet all supervisory objectives and to attract and retain experienced staff.
  - DFSA has improved ability to attract mid-level and senior staff by appointing them as experts with higher salaries, but more could be done to ensure resources are commensurate with responsibilities.
- Legal and institutional framework
  - Strong legal framework; as an EU member, Denmark has been one of the fastest states to integrate EU law into domestic legislation.
  - By December 2005, Denmark was among only five countries that had achieved complete transposition of the Financial Services Directives where their deadlines had passed.
  - DFSA generally has sufficient authority to promulgate regulations to complement laws.
- Danish Securities Council (DSC) and enforcement
  - DSC involves private sector in design and implementation of securities regulation while preserving DFSA autonomy; DSC responsibilities include overall securities market framework, advising DFSA on best trading practices and issuing regulations, and ensuring compliance of listed issues with accounting regulations.
  - DSC acts as an independent authority for enforcement activities; DFSA and the Danish Commerce and Companies Agency provide secretariat functions.
  - DFSA demonstrated effectiveness in enforcement, achieving the most convictions in insider trading cases among European countries in recent years.
- Supervision of exchanges and cross-border cooperation
  - CSE is under primary supervision of DFSA; recent change in ownership of CSE did not affect DFSA’s supervisory responsibility.
  - MOU on cooperation in supervision of OMX Group signed in July 2005 with Swedish Finansinspektionen and Finnish Rahoitustarkastus.
  - Delegation arrangements amended to centralize approval of listing prospectuses and review of takeover bids with the supervisory agency as of September 2006; delegation to Danish AMP regarding takeover bids to be revoked.

### III. Regional integration and market infrastructure
- Integration trends and consolidation
  - CSE pursued closer cooperation and possible integration with other Nordic and Baltic stock exchanges; strategic alliance (Norex) and consolidation (OMX) created a more homogeneous regional trading environment.
  - Further scope for integration in clearing, settlement, and depository infrastructures remains debatable.
- OMX and Norex developments and expected effects
  - OMX acquired CSE in 2005 and owns six out of eight stock markets in the Nordic-Baltic region.
  - September 2006: OMX and ICEX concluded a Letter of Intent regarding acquisition of the Iceland Stock Exchange.
  - October 2006: OMX announced purchase of a 10 percent stake in Oslo Børs Holding ASA.
  - A common “Nordic List” will replace Swedish, Finnish, and Danish equity lists in October 2006; listing requirements will be harmonized on the three exchanges.
  - Expected effects: improved international competitiveness, increased visibility, and facilitated trading.

### IV. Corporate governance and market practices
- Danish Recommendations (Nørby Committee) and approach
  - Danish framework uses a “comply-or-explain” approach; largely compliant with OECD Principles and in some areas more specific.
  - Nørby Committee provided 31 recommendations in seven areas: shareholder role; stakeholder role; openness and transparency; board tasks and responsibilities; board composition; remuneration; risk management.
  - CSE incorporated the Recommendations in disclosure requirements; 72 percent of listed companies address corporate governance in annual reports or announcements (compared to 31 percent prior).
  - Revised recommendations effective for annual reports for fiscal years beginning on or after January 1, 2006; revisions add audit and increase number of recommendations.
- Areas where Danish Recommendations go beyond OECD Principles (selected specifics)
  - Shareholders’ role: detailed guidance on takeover situations; supervisory board must assess capital and share structures and report in annual report.
  - Disclosure and transparency: require procedures for immediate publication of essential information; advise publication of quarterly reports; recommend broader annual report content including non-financial information.
  - Board responsibilities and independence: at least half of supervisory board members elected by general meeting should be independent; detailed independence criteria listed verbatim in Recommendations.
  - Remuneration: detailed requirements on remuneration policy disclosure, limits, implementation reporting, share option scheme rules, and severance information.
  - Audit and committees: recommend audit committees for complex cases and nomination and remuneration committees; proposed exemptions from audits for very small companies with specified thresholds (balance sheet total of DKr 1.5 million; net turnover of DKr 3 million; average full-time employees 12).

### Nordic stock performance, listings, and alternative markets
- Market performance and turnover
  - The Danish market gained 38 percent in 2005.
  - Since end-2000, the increase in the local market index has only been exceeded by Iceland, and Norway in the most recent months.
  - Nordic markets have outperformed major U.S. and European stock markets.
  - Despite strong price performance, turnover on the CSE has been lower than in other Nordic countries except Iceland; possible drivers include “buy and hold” investor behavior, concentration in few stocks, and limited liquidity.
- Listings and delistings (CSE 2005)
  - 6 new companies were listed on the CSE in 2005.
  - 15 companies left the market in 2005.
  - Number of delistings has exceeded new listings every year since 1999.
  - Drivers: bursting of the internet bubble, mergers and acquisitions, regional integration eliminating cross-listings, favorable economic environment reducing need to raise capital, costs and governance requirements deterring SMEs.
- Alternative market segments
  - Dansk Authoriseret Markedsplads A/S (Danish AMP) and CSE’s First North (launched December 2005) provide “organized” but unregulated segments for small companies.
  - First North (Denmark) aimed at companies with market value of DKK 400–500 million; companies not required to have three years operations, not required to report under IFRS, and not subject to specific corporate governance rules; three companies had issued shares on FirstNorth in Denmark by reporting time.
  - Benefits: can attract additional companies and serve as launching pad; Risks: potential to foster opaque markets and reduce investor protection.

### Mutual funds, hedge funds, and taxation
- Rapid growth of mutual funds
  - Institutional investors represent 47 percent of the total value of the mutual fund market.
  - Total assets under management by investment funds at end-2005: EUR 106 billion.
  - Increase from end-2004: 37 percent from EUR 77 billion.
  - At end-2005, assets managed by nonUCITS funds amounted to EUR 42.7 billion, representing 40 percent of total net assets under management of investment funds.
- Mutual fund size data (mill. DKK)
  - Retail funds (2000−2005): 177,957; 177,722; 188,028; 249,505; 297,560; 390,888.
  - Institutional funds (2000−2005): 72,117; 98,184; 91,203; 108,660; 215,500; 332,423.
  - Foreign funds (2000−2005): 7,127; 6,429; 5,256; 6,069; 6,136; 10,584.
  - Total (2000−2005): 257,201; 282,335; 284,487; 364,272; 519,196; 733,896.
- Accumulative, distributive, and pension mutual funds (mill. DKK, 2000−2005)
  - Accumulative (2000−2005): 11,711; 74,737; 57,097; 67,478; 155,554; 247,362.
  - Distributive (2000−2005): 245,490; 198,698; 207,190; 267,904; 328,198; 450,881.
  - Pension funds (2000−2005): 0; 8,922; 20,190; 28,890; 35,445; 35,653.
  - Total (2000−2005): 257,201; 282,334; 284,477; 364,272; 519,196; 733,896.
- Taxation and regulatory liberalization
  - Taxation rule changed on July 1, 2005—investors in funds (including regulated hedge funds and foreign funds), rather than investment companies, will be taxed on dividend distribution and unrealized capital gains.
  - Mutual fund law liberalization in the late 1990s allowed establishment of “Special Purpose Associations” (nonUCITS) and later “restricted associations” for one or few institutional investors.
- Hedge funds and hedge associations
  - Since July 2004, Denmark-based hedge funds allowed as (nonUCITS) “Other Collective Investment Schemes” (Chapter 7 funds), required to register with the DFSA.
  - Effective July 2005, a new regulatory regime for regulated onshore hedge funds (hedge associations) introduced.
  - Regulated hedge funds must:
    - Clearly set out their risk profile and risk-taking policy;
    - Establish specific risk limits decided by their board of directors and notify investors of changes;
    - Report any breach of risk limits to the supervisor and to investors;
    - Be open for issue and redemption at least once a month.
  - Supervision focuses on custodians: assets and funds must be held by a custodian company; the custodian must be a Danish bank or a branch of an EU-based credit institution approved by the Danish supervisor.
  - Danish approach gives hedge fund managers more flexibility than the Swedish model and differs from Finnish and Norwegian approaches; Denmark and Norway regulatory changes may support development of a Scandinavian hedge fund industry.
  - Financial stability assessment: assets under management with hedge associations expected to remain limited; not expected to pose financial stability concerns. Supervisory priorities: establish clear responsibilities in custodian and asset valuation practices.

### Liquidity in Danish bond and equity markets — key findings and metrics
- High-level findings
  - Liquidity is excellent in the newest and largest government bonds and in parts of the mortgage bond market; liquidity in the corporate bond market is poor; liquidity in the equity market is improving except for the smallest issues.
  - Liquidity measures overlap and should be combined with qualitative judgment and market participant views; instrument heterogeneity complicates comparisons.
- Tightness (spreads)
  - MTS: spread for treasury bonds with 2, 5, and 10 year maturity was less than 0.05 percentage point, with spreads increasing with longer maturity.
  - CSE: spreads typically between 0.1 and 0.2 percentage point for various maturity segments.
  - Mortgage bonds (market making agreement): spread never higher than 0.1 percentage point for covered series; spreads can go down to 0.03-0.04 percentage point for the shorter maturities (one year) non-callable series. The agreement defines lots of DKK 25 or 100 million depending on the series.
  - Equities: spread for the 20 most liquid shares on the CSE was 0.22 percent (down from 0.26 percent in the same period in 2004 and 0.39 percent in 2003). Mid-cap and small-cap spreads were 0.40 percent and 1.35 percent respectively.
- Immediacy (order coverage)
  - Order coverage: MTS about 95 percent of the business day; CSE about 95 percent of the trading day.
  - Mortgage bonds (most liquid series): 100 percent from 8:30 a.m. to 4:30 p.m. in the 12 most liquid series.
  - Equities: 100 percent during opening hours for the most traded shares on CSE.
- Breadth (turnover as percent of market capitalization)
  - Bond market turnover ratio fluctuated between 4.2 and 2.4 during 1997 to 2004; in 2004 it was 2.5.
  - Mortgage bond turnover ratio: ranged between 3.4 to 2.3 on an annual basis from 1997 to 2005, and was 2.9 in 2005.
  - Listed shares turnover ratio: between 0.5 and 0.8 from 1998 to 2005.
- Depth (amounts tradable at best prices)
  - MTS (early 2004): possible to trade around DKK 100−150 million in the 5 to 10 year maturities and DKK 300−350 million in 2 year maturity at the best bid-ask prices.
  - CSE: around DKK 4−6 million can be traded at best bid-and-ask price.
  - Mortgage bonds (typical): usually possible to trade DKK 200 to 500 million at the best bid-and-ask price.
  - Equities (2005): possible to trade DKK 3½ million at best prices, up from DKK 1½ in 2003 in the most liquid shares.
- Market-efficiency coefficient (MEC)
  - Blue chip MEC typically just below one; the all share MEC index is above one, indicating some illiquidity in small and medium capitalization stocks.

### Danish bond markets — issuance strategy, market making, and risks
- Government debt and issuance strategy (end-2005)
  - Government’s net debt represented 27 percent of the GDP at the end of 2005.
  - 2005 issuing strategy key points:
    - An outstanding amount in the two- and five-year maturity segment of government bonds of DKK 35 billion;
    - An outstanding amount in the 10-year maturity segment of government bonds of DKK 60 billion;
    - Zero net financing contribution from T-bills;
    - Foreign currency borrowing by five-year maturity bullet loans amounting to Euro 1.5–2 billion.
  - Danmarks Nationalbank conducts secondary market buy-back operations to support liquidity and smooth redemption profiles.
  - 14 primary dealers for government bonds and 12 primary dealers for T-bills on MTS; CSE organized with six primary dealers acting as market makers.
- Risks and transparency considerations
  - Electronic platform architecture and pre-trade transparency raise questions about resilience of quoted liquidity and potential for “artificial” liquidity.
  - “Citigroup incident” August 2004: large simultaneous orders overwhelmed the system and market makers withdrew commitments, illustrating exposure to a “sweep of liquidity.”
  - Open question whether higher pre-trade transparency leads to more dealer liquidity or migration to less transparent venues.
- Mortgage bond market features and investor base
  - Danish mortgage system applies a strict balance principle; mortgage bonds are pass-through securities transferring market risk from mortgage banks to bond investors.
  - About 2000 outstanding mortgage bond series; most illiquid; a small number of series (10–15) reach high outstanding amounts and are very liquid.
  - Investor holdings of mortgage bonds:
    - Financial sector: about 48 percent.
    - Pension funds: estimated 21 percent.
    - Private/retail investor sector: 11 percent.
    - Public sector: 6 percent.
    - Foreign investors: 14 percent overall; higher among the highest liquid bonds (20 percent).
    - Foreign holdings of callable mortgage bonds: callable mortgage bonds represented about 57 percent of total holdings of mortgage bonds held by foreign investors at the end of 2004.
    - Foreign holdings of short term noncallable bullet mortgage bonds denominated in DKK: 6 percent; same type issued in euro: 22 percent at the end of 2004.
- Product complexity, prepayment risk, and hedging
  - New loan types (interest-only, interest rate guarantees, capped-floaters, floating-to-fixed) increase embedded option complexity and require sophisticated risk management.
  - Investors use government bonds and derivatives (interest rate swaps, swaptions, foreign exchange derivatives) for hedging.
- Policy and structural challenges
  - Declining supply of government bonds requires continued innovative issuing policy to secure a diversified domestic and foreign investor base.
  - Increasing heterogeneity of mortgage bonds risks fragmenting liquidity and reducing appetite by foreign investors, possibly limiting formation of a homogeneous mortgage bond yield curve.
  - European Capital Adequacy Directive may require amendments to the Danish mortgage framework for covered bond 10 percent risk-weighting treatment; authorities face divergent demands between commercial banks and mortgage banks.
  - Careful attention needed to preserve consumer protection, transparency, and flexibility if frameworks are amended.
  - Footnote preserved: loan-to-value requirements and limits differ in the Danish system (they are based on the value of the covered assets at the origination of the loan) and in the Directive (the directive requires that LTV calculations be performed, and the respect of the stated LTV limits be fulfilled, over the full life of the covered loan).

### Market-making, repo market, corporate bonds, and equity concentration
- Market-making arrangements and repo market
  - Nine or ten banks via the Danish Bankers Association provide bid-and-ask prices on workdays from 8:30 a.m. to 4:30 p.m. for the most liquid mortgage bond series.
  - Agreement covers 60 series issued by five mortgage banks; treated as 12 different series due to identical characteristics.
  - Active repo market supports efficient position management; mortgage bonds eligible collateral for central bank operations.
- Corporate bond market
  - A deep liquid market in corporate bonds has never developed in Denmark; explanations include industrial structure with many small firms, and extensive bank and mortgage bank borrowing.
- Equity market concentration and liquidity-provider initiatives
  - Out of close to 180 listed companies, the 20 comprising the OMXC20 index account for about 80 percent of total turnover.
  - As of early April 2006, more than 56 percent of turnover among OMXC20 components over the preceding 12 months was concentrated among four stocks: AP Møller, Novo Nordisk, Danske Bank and Vestas WS; AP Møller alone represented 21.4 percent of total turnover.
  - CSE sponsors “liquidity provider agreements”; about 60 such agreements concluded, mostly with small- and medium-sized companies.
  - Evidence indicates liquidity improved after introduction of liquidity provider agreements (narrower spreads, lower volatility, better order coverage, increased turnover).
  - Concentration risk: 55 percent of liquidity agreements signed with two market makers, two-thirds with three members—risk if a major liquidity provider withdraws.

### Policy recommendations and supervisory priorities (implied by analysis)
- Maintain and adapt issuance strategy to preserve government bond liquidity despite declining supply:
  - Concentrate issuance in a few large liquid series (examples: DKK 35 billion in 2–5 year and DKK 60 billion in 10-year segments).
  - Use primary dealership, market making systems, electronic trading, and buy-backs to support secondary market liquidity.
- Monitor and manage mortgage market fragmentation and product complexity:
  - Ensure disclosure, valuation, and custodian responsibilities are clearly defined for complex mortgage bonds and related derivatives.
  - Evaluate implications of EU Capital Adequacy Directive on mortgage bond recognition and consider targeted amendments while preserving balance principle features and consumer protection.
- Strengthen supervisory resourcing and cross-border cooperation:
  - Ensure DFSA resourcing is commensurate with responsibilities to attract and retain experienced staff.
  - Continue MOU-style cooperative supervision for integrated market operators (e.g., OMX Group) and centralize key approvals (prospectuses, takeover bids) with the supervisory agency.
- Preserve investor protection as alternative markets expand:
  - Monitor FirstNorth and similar segments to balance access for SMEs with adequate transparency and investor protection.
  - Apply “comply-or-explain” and enhanced disclosure practices to maintain market confidence.
- Hedge fund and mutual fund oversight
  - Focus supervision on custodian responsibilities, asset valuation practices, and risk-limit reporting for regulated hedge associations.
  - Continue monitoring growth in mutual funds and institutional investor participation to assess any systemic implications.

*IMF staff report — "Capital Markets in the Nordic Countries 2000─June 06" (selected sections).*

### 1. Capital Markets in the Nordic Countries 2000─June 06 ...............................................5

### Capital Markets in the Nordic Countries 2000─June 06

### I. Review of Danish capital markets — structure and size
- Distinctive dominance of mortgage bonds:
  - At end-2005, bond market capitalization amounted to 193 percent of GDP.
  - Of the 193 percent: 142 percentage points represented mortgage bonds; 40.3 percentage points represented government securities; other bonds amounted to 10.7 percentage points (including 3 percentage points for corporate bonds).
  - Danish bond market size comparison: almost three times larger than its Swedish counterpart and seven times larger than the Norwegian bond market.
  - Market capitalization of bonds has grown by 27 percentage points of GDP, while market capitalization of government securities declined by almost 10 percentage points of GDP (to 27 percent at the end of 2005).
  - Central-government debt has been on a declining trend since 1995, when it stood at about 50 percent (of GDP).
- Equity market size and composition:
  - At end-2005, Danish equity market capitalization was €156 billion, representing around 17 percent of the combined capitalization of the region’s equity markets and equivalent to about 77 percent of domestic GDP.
  - Stockholm and Helsinki markets each represent more than 130 percent of domestic GDP and together account for 61 percent of market capitalization in the region.
  - SMEs constitute the vast majority of listed companies on the Copenhagen Stock Exchange (CSE), while trading activity is dominated by a handful of large corporations.
  - In Copenhagen, combined turnover in TDC, Copenhagen Airport, and AP Møller accounted for more than 52 percent of total turnover on the exchange.
- Derivatives and cross-border access:
  - Danish derivatives market (futures and options) developed in the mid-1980s but never fully took off.
  - Clearing and settlement of futures and options on Danish securities moved from FUTOP (owned by CSE) to the Stockholm Stock Exchange (SSE) after merger into OMX Group AB.
  - In 2005, the Swedish market represented 94 percent of all listed contracts traded on the Swedish, Danish, and Norwegian markets; Oslo and Copenhagen accounted for 5 percent and 1 percent respectively.
  - The peg of the Danish Krona to the euro provides easy and cost-effective access to euro area listed and OTC derivative markets, enabling Danish participants to benefit from euro market liquidity.

### II. Prudential framework and market supervision
- Adherence to international supervisory principles:
  - DFSA regulatory framework was reviewed with reference to the key IOSCO Objectives and Principles of Securities Regulation; a formal principle-by-principle assessment was not undertaken.
  - Area for further attention: adequacy of resources. The international standard requires supervisory authorities be adequately funded to meet all supervisory objectives and to attract and retain experienced staff.
  - DFSA has improved ability to attract mid-level and senior staff by appointing them as experts with higher salaries, but more could be done to ensure resources are commensurate with responsibilities.
- Legal and institutional framework:
  - Strong legal framework in place; as an EU member, Denmark has been one of the fastest states to integrate EU law into domestic legislation.
  - By December 2005, Denmark was among only five countries that had achieved complete transposition of the Financial Services Directives where their deadlines had passed.
  - DFSA generally has sufficient authority to promulgate regulations to complement laws.
- Danish Securities Council (DSC):
  - DSC involves private sector in design and implementation of securities regulation while preserving DFSA autonomy.
  - DSC responsibilities include: overall responsibility for the securities market framework; advising DFSA on best trading practices and issuing regulations; ensuring compliance of issues listed or traded with accounting regulations in annual and interim reports.
  - DSC acts as an independent authority for enforcement activities; DFSA and the Danish Commerce and Companies Agency provide secretariat functions.
- Enforcement and supervision:
  - DFSA has demonstrated effectiveness in enforcement, achieving the most convictions in insider trading cases among European countries in recent years.
  - Enforcement benefits from active cooperation between government investigators and market operators; suspicious situations identified by the stock market are reported to DFSA for further investigation and, after legal assessment and consultation with DSC, may be reported to police.
  - DFSA is a unified regulator with no supervisory coverage gaps found by the mission. DFSA organization: 10 operational divisions and 4 staff divisions; dedicated divisions for securities, investment management companies and UCITS, and mortgage, credit, and investment companies.
  - DFSA has “expert centers” allocated among divisions and effective internal cooperation and communication arrangements.
- Supervision of exchanges and cross-border cooperation:
  - CSE is under primary supervision of DFSA; recent change in ownership of CSE did not affect DFSA’s supervisory responsibility.
  - Memorandum of understanding (MOU) on cooperation in supervision of OMX Group signed in July 2005 with Swedish Finansinspektionen and Finnish Rahoitustarkastus to ensure comprehensive supervision of OMX and its systems.
  - Under the MOU, supervisors may undertake activities in their jurisdiction on behalf of participating supervisors and form cooperative supervisory teams.
  - Delegation arrangements: DFSA delegated some supervisory responsibilities to CSE via a delegation agreement; to align with EU prescriptions, the agreement was amended so responsibility to approve listing prospectuses and review takeover bids is to be centralized with the supervisory agency as of September 2006. The delegation granted to the Danish AMP regarding takeover bids will also be revoked.

### III. Regional integration and market infrastructure
- Integration trends:
  - CSE has pursued closer cooperation and possible integration with other Nordic and Baltic stock exchanges; strategic alliance (Norex) and consolidation (OMX) created a more homogeneous regional trading environment.
  - Further scope for integration in clearing, settlement, and depository infrastructures remains debatable.
- Table 1 (selected indicators and trends from 2001−Jun-06):
  - Bond market capitalization to GDP (selected end-year and Jun-06 figures):
    - Copenhagen Stock Exchange: 166.0, 178.4, 182.8, 190.7, 187.3, 160.1
    - Stockholm Stock Exchange: 65.3, 63.3, 66.9, 60.8
    - Oslo Stock Exchange: 30.1, 36.0, 32.8, 33.8, 28.3, 27.0
  - Stock market capitalization to GDP (selected end-year and Jun-06 figures):
    - Copenhagen Stock Exchange: 55.8, 45.2, 51.6, 60.0, 74.9, 70.0
    - Stockholm Stock Exchange: 125.9, 75.6, 94.9, 106.0, 131.0, 128.6
    - Helsinki Stock Exchange: 159.3, 107.5, 109.7, 106.5, 130.8, 130.4
    - Oslo Stock Exchange: 44.4, 33.1, 44.2, 55.2, 73.5, 82.4
  - Bond market turnover to end-year market capitalization (selected figures):
    - Stockholm Stock Exchange: 6.3, 6.0, 6.7, 7.2, 8.1
    - Copenhagen Stock Exchange: 2.5, 2.5, 2.7, 2.6, 2.9, 2.2
  - Stock market turnover to end-year market value (selected figures):
    - Copenhagen Stock Exchange: 0.7, 0.6, 0.6, 0.7, 0.8, 1.1
    - Stockholm Stock Exchange: 1.4, 1.5, 1.1, 1.2, 1.1, 0.8
- Derivatives contract distribution (as of August 2005; OMX totals reported afterwards):
  - Number of contracts traded per business day (OMX total historical): 266,291; 258,595; 308,093; 396,180; 394,719; ...
  - Composition (Stockholm + Helsinki share of OMX totals): 94.2, 94.2, 94.0, 94.0, 93.7, ...
  - Share options and futures: 54.4, 57.4, 58.0, 62.2, 58.2, ...
  - Index options and futures: 29.3, 28.2, 27.3, 25.2, 27.8, ...
  - Short-term fixed income products: 8.3, 5.8, 6.4, 4.5, 5.4, ...
  - Long-term fixed income products: 2.2, 2.8, 2.3, 2.0, 2.2, ...
  - Oslo Stock Exchange share of OMX derivatives: 5.8, 4.9, 5.0, 5.3, 5.5, ...
  - Copenhagen Stock Exchange share of OMX derivatives (small): ... 0.8, 1.0, 0.7, 0.8, ...

### IV. Corporate governance and market practices
- Corporate governance framework:
  - Rather than strictly following the OECD Principles of Corporate Governance, the Nørby Committee developed disclosure recommendations for companies listed on the CSE based on a “comply-or-explain” approach.
  - The Danish corporate governance framework is largely compliant with the OECD Principles and in some areas goes beyond these standards by being more specific and regulating areas not included in the OECD Principles.
  - An annex in the source discusses specifics of the Danish corporate governance framework in detail.

*IMF staff report — "Capital Markets in the Nordic Countries 2000─June 06" (selected sections).*

### 15.      Despite the recent correction, the Danish stock market has posted one of the

### _cr07121 - 15.      Despite the recent correction, the Danish stock market has posted one of the

### Nordic stock performance and recent history
- The Danish market gained 38 percent in 2005.
- Since end-2000, the increase in the local market index has only been exceeded by Iceland, and Norway in the most recent months, thanks to the rise of its large energy sector.
- These Nordic markets have outperformed the major U.S. and European stock markets.
- The Swedish stock market performance has been in line with the British Footsie and the U.S. S&P 500; losses experienced until late 2003 were only erased by early 2006.
- The Finnish stock market lagged, dominated by a single telecom issuer.
- Overall: Scandinavian stock markets performed better than continental Europe stock markets, indicating stronger economic dynamism in the region in recent years.

### Turnover, liquidity, and market structure
- Despite strong price performance, turnover on the Copenhagen Stock Exchange (CSE) has been lower than in the other Nordic countries, with the exception of Iceland.
- Possible contributing factors:
  - Relatively recent equity investors in Denmark favor a “buy and hold” attitude.
  - Strong rise in equity prices did not encourage active portfolio management.
  - Lack of sufficient liquidity and high concentration of activity in a limited number of stocks.
  - Relatively low P/E ratios exhibited by CSE stocks suggest concentration and limited trading activity.

### Listings and delistings
- In 2005, CSE listings and delistings:
  - 6 new companies were listed on the CSE in 2005.
  - 15 companies left the market in 2005.
- The number of delistings from the Danish exchange has exceeded the number of new listings every year since 1999.
- The delisting trend is part of a broader Western Europe and U.S. phenomenon after 1999: new listings dropped significantly and have remained limited thereafter.
- Drivers of delistings:
  - Bursting of the “internet bubble” and related financial distress in the IT sector.
  - Increased mergers and acquisitions activity.
  - Greater regional integration and elimination of cross-listings (notably within the Norex alliance).
  - Favorable economic environment reducing corporate need to raise capital.
- Strategic choice not to list:
  - For many companies, especially SMEs, perceived costs and increased corporate governance and disclosure requirements outweigh benefits.
  - Increased capacity of the private equity industry provides an alternative to public listing.
  - The European Prospectus and Transparency Directives may have made the listing framework seem excessively cumbersome and expensive for medium-sized corporates and startups.

### Alternative market segments and investor protection
- Exchanges launched “organized” but unregulated market segments (relative to European Directives) to address issuer concerns while offering investor guarantees beyond “free markets”:
  - Dansk Authoriseret Markedsplads A/S (Danish AMP) in Denmark.
  - CSE launched an “alternative market place” (First North) in December 2005.
- First North (Denmark) characteristics and status:
  - Market aimed at small companies with a market value of DKK 400–500 million.
  - Companies are not required to have at least three years of operations, are not required to report under IFRS, and are not subject to specific corporate governance rules.
  - By the time of reporting, three companies had issued shares on FirstNorth in Denmark.
- Observed benefits and risks:
  - Such markets can attract additional companies and serve as a launching pad (evidence from AIM in the United Kingdom and Alternext in Paris).
  - Risk: they can foster opaque, unlisted markets that weaken investor protection and reduce benefits of the new transparency framework.

### The Norex Alliance and OMX Group consolidation
- Norex strategic goal: establish a common marketplace for Nordic and Baltic securities to increase regional attractiveness for local and international investors.
- Norex history and structure:
  - Established in 1999; initially between Danish and Swedish exchanges; now includes all Scandinavian and Baltic stock exchanges.
  - Members have common rules for listing and trading and use the same trading system (Saxess).
  - Cross-membership facilitated by removal of entry fees and harmonization of membership criteria.
- OMX Group developments:
  - Acquisition of the CSE by the Swedish OMX Group in 2005.
  - OMX already owns six out of eight stock markets in the Nordic-Baltic region.
  - September 2006: OMX and ICEX concluded a Letter of Intent regarding acquisition of the Iceland Stock Exchange.
  - October 2006: OMX announced purchase of a 10 percent stake in Oslo Børs Holding ASA.
  - A common “Nordic List” (large, medium, small capitalizations and by industry) will replace Swedish, Finnish, and Danish equity lists in October 2006.
  - CSE and other OMX markets developed share indexes based on the Global Industry Classification Standard (GICS).
- Expected effects:
  - Consolidation within a single group expected to improve competitive position internationally by increasing visibility and facilitating trading.
  - Listing requirements will be harmonized on the three exchanges.

### Rapid growth of mutual funds
- Drivers of mutual fund sector growth:
  - Regulatory changes enabling better-designed mutual fund products.
  - Attraction of institutional investors.
  - General increase in retail investor wealth and competitive management solutions.
- Key statistics:
  - Institutional investors represent 47 percent of the total value of the mutual fund market.
  - Total assets under management by investment funds at end-2005: EUR 106 billion.
  - Increase from end-2004: 37 percent from EUR 77 billion.
  - At end-2005, assets managed by nonUCITS funds amounted to EUR 42.7 billion, representing 40 percent of total net assets under management of investment funds.
- Pension-related developments:
  - Pension legislation changes allowed pension funds to invest in mutual funds.
  - In 2004 the large Special Savings Pension Scheme allowed pension investors to invest in mutual funds.
  - June 2005: Lønmodtagernes Dyrtidsfond (LD) invested all its assets in mutual funds, resulting in an increase of 12 percent of total net asset value under management in one month.

### Selected mutual fund size data (mill. DKK)
- Retail funds (2000−2005): 177,957; 177,722; 188,028; 249,505; 297,560; 390,888.
- Institutional funds (2000−2005): 72,117; 98,184; 91,203; 108,660; 215,500; 332,423.
- Foreign funds (2000−2005): 7,127; 6,429; 5,256; 6,069; 6,136; 10,584.
- Total (2000−2005): 257,201; 282,335; 284,487; 364,272; 519,196; 733,896.

### Accumulative, distributive, and pension mutual funds (mill. DKK, 2000−2005)
- Accumulative (2000−2005): 11,711; 74,737; 57,097; 67,478; 155,554; 247,362.
- Distributive (2000−2005): 245,490; 198,698; 207,190; 267,904; 328,198; 450,881.
- Pension funds (2000−2005): 0; 8,922; 20,190; 28,890; 35,445; 35,653.
- Total (2000−2005): 257,201; 282,334; 284,477; 364,272; 519,196; 733,896.

### Taxation and regulatory liberalization impacting fund structure
- Tax change: Taxation rule changed on July 1, 2005—investors in funds (including regulated hedge funds and foreign funds), rather than investment companies, will be taxed on dividend distribution and unrealized capital gains.
- Mutual fund law liberalization:
  - End-1990s: allowed establishment of “Special Purpose Associations” (nonUCITS).
  - Later: allowed “restricted associations” for one or few institutional investors (outsourcing portfolio management).

### Hedge funds and hedge associations: regulatory framework and outlook
- Timeline and registration:
  - Since July 2004, Denmark-based hedge funds allowed as (nonUCITS) “Other Collective Investment Schemes” (Chapter 7 funds), required to register with the DFSA.
  - Effective July 2005, a new regulatory regime introduced for regulated onshore hedge funds (hedge associations).
- Key regulatory features effective July 2005:
  - Open-ended funds receiving funds from the public (or large groups of investors) required to obtain a license from the DFSA.
  - Regulated hedge funds are not subject to particular investment regulation or limits on short-selling and leverage, but must:
    - Clearly set out their risk profile and risk-taking policy.
    - Establish specific risk limits decided by their board of directors.
    - Notify investors of changes in such limits.
    - Report any breach of risk limits to the supervisor and to investors.
  - Regulated hedge funds must be open for issue and redemption at least once a month.
  - Supervision will focus on the role of custodians: assets and funds must be held by a custodian company responsible for ensuring the fund complies with its own risk policy.
  - The custodian must be a Danish bank or a branch of an EU-based credit institution approved by the Danish supervisor.
- Comparative approach and regional implications:
  - Danish approach gives hedge fund managers more flexibility than the Swedish model (which required disclosure of portfolio holdings to the supervisor until recently).
  - Differs from Finnish and Norwegian approaches which set minimum investment amounts and (in Finland, formally) prohibit leverage.
  - Denmark and Norway regulatory changes may support development of a Scandinavian hedge fund industry.
  - Ongoing revamping of UCITS regulations may lead to a more homogeneous EU-wide approach to alternative asset management.
- Financial stability considerations:
  - Assets under management with hedge associations expected to remain limited; not expected to pose financial stability concerns.
  - Specifics of the Danish financial system warrant monitoring:
    - Dominance of the bond markets.
    - “Fixed” exchange rate between the krone and the euro.
  - Supervisory priorities: establish clear responsibilities in custodian and asset valuation practices (currently remain with the funds).

*Source: _cr07121 - 15.      Despite the recent correction, the Danish stock market has posted one of the*

### 33.      This section reviews liquidity in the Danish bond and equity markets. Liquidity

### _cr07121 - 33.      This section reviews liquidity in the Danish bond and equity markets. Liquidity

### Overview of liquidity concepts and high-level findings
- Liquidity defined as the ability to promptly convert instruments into legal tender without adverse price impact.
- Different liquidity indicators tend to be overlapping and should be supplemented with qualitative judgment and market participant views.
- Measuring liquidity across sub-segments is complicated by instrument heterogeneity.
- Summary finding: Liquidity in the newest and largest of government bonds and in parts of the mortgage bond market is excellent; liquidity in the corporate bond market is poor; liquidity in the equity market is improving except for the smallest issues.

### Standard liquidity measures (summary of Table 5)
- Tightness (transaction costs / spreads)
  - MTS: the spread for treasury bonds with 2, 5, and 10 year maturity was less than 0.05 percentage point, with the spreads increasing with longer maturity.
  - CSE: spreads typically ranging between 0.1 and 0.2 percentage point for the various maturity segments.
  - Mortgage bonds (market making agreement): spread never higher than 0.1 percentage point for covered series; spreads can go down to 0.03-0.04 percentage point for the shorter maturities (one year) non-callable series. The agreement defines lots of DKK 25 or 100 million depending on the series.
  - Equities: spread for the 20 most liquid shares on the CSE was 0.22 percent—a decrease from 0.26 percent in the same period in 2004 and 0.39 percent in 2003. The spread for mid-cap and small-cap companies were, respectively, 0.40 percent and 1.35 percent.
- Immediacy (speed of execution / order coverage)
  - Order coverage: MTS: about 95 percent of the business day. CSE: about 95 percent of the trading day.
  - Mortgage bonds (most liquid series): 100 percent from 8:30 a.m. to 4:30 p.m. in the 12 most liquid series identified in the agreement between the 9 or 10 banks via the Bankers Association.
  - Equities: 100 percent during opening hours for the most traded shares on CSE.
- Breadth (turnover as percent of market capitalization)
  - Bond market turnover ratio fluctuated between 4.2 and 2.4 during 1997 to 2004, when it was 2.5.
  - Mortgage bond turnover ratio: consistently ranged between 3.4 to 2.3 on an annual basis from 1997 to 2005, when it was 2.9.
  - Listed shares turnover ratio: between 0.5 and 0.8 from 1998 to 2005.
- Depth (amounts immediately tradable at best prices)
  - MTS (early 2004): possible to trade around DKK 100−150 million in the 5 to 10 year maturities and DKK 300−350 million in 2 year maturity at the best bid-ask prices.
  - CSE: Around DKK4−6 million can be traded at best bid-and-ask price.
  - Mortgage bonds (typical): usually possible to trade DKK 200 to 500 million at the best bid-and-ask price.
  - Equities (2005): possible to trade DKK 3½ million at best prices, up from DKK 1½ in 2003 in the most liquid shares.
- Market-efficiency coefficient (MEC)
  - Definition: MEC = Var (R_t) / (T * Var (r_t)), where Var (R_t) = variance of the logarithm of long-period returns, Var (r_t) = variance of the logarithm of short-period returns, and T = number of short periods in each longer period.
  - Government securities: NA
  - Mortgage bonds: NA
  - Equities: The blue chip MEC has typically been just below one (Table 11), while the all share MEC share index (Table 10) is above one, indicating some illiquidity in small and medium capitalization stocks.

### A. Danish Bond Markets — structural evolution and government securities
- Historical context
  - Market historically dominated by mortgage bonds; public debt has declined.
  - Mortgage bonds account for about two-thirds of the capitalization of the Danish bond market (Table 6).
- Government debt and issuance strategy (end-2005 context)
  - Government’s net debt represented 27 percent of the GDP at the end of 2005.
  - Recent issuance concentrated in a few large liquid series with minimum outstanding amounts of DKK 35−60 billion to preserve liquidity.
  - Illustration of 2005 issuing strategy key points:
    - An outstanding amount in the two- and five-year maturity segment of government bonds of DKK 35 billion;
    - An outstanding amount in the 10-year maturity segment of government bonds of DKK 60 billion;
    - Zero net financing contribution from T-bills;
    - Foreign currency borrowing by five-year maturity bullet loans amounting to Euro 1.5–2 billion.
- Market infrastructure and liquidity support measures
  - Danmarks Nationalbank (DNB) conducts secondary market operations (buy-back of government securities issues) to support liquidity and smooth redemption profiles.
  - 2003 initiatives: electronic trading and distribution, primary dealership system with market-making requirements for the wholesale market.
  - 2005: similar market making arrangements introduced for T-bills.
  - Government securities traded on MTS and CSE using a system of primary dealers; MTS provides real time quotations and automatic electronic execution. MTS Denmark is a special segment of MTS Associated Market; there are 14 primary dealers for government bonds and 12 primary dealers for T-bills.
  - CSE trading organized similarly with six primary dealers acting as market makers and quoting bid-and-ask prices; CSE price-quoting scheme allows private and small investors to trade government securities in the same manner as the wholesale market.
- Risks and transparency considerations
  - The architecture of electronic platforms and pre-trade transparency arrangements raise questions about resilience of quoted liquidity and potential for “artificial” liquidity.
  - Reference to the “Citigroup incident” of August 2004: large simultaneous orders overwhelmed the system, rapidly leading market makers to withdraw from their market making commitments, illustrating exposure to a “sweep of liquidity.”
  - Open question: whether higher pre-trade transparency leads dealers and large participants to provide more liquidity or to migrate trading to venues with less transparency.

### Mortgage bond market: features, liquidity, and investor base
- System characteristics
  - Danish mortgage system implements a strict balance principle; mortgage bonds are pass-through securities transferring market risk from mortgage banks to bond investors.
  - Historically shielded from default risk by strict property appraisal rules and credit risk management.
- Market structure and liquidity concentration
  - About 2000 outstanding mortgage bond series; most are not liquid.
  - A small number of series (10–15) reach high outstanding amounts and are very liquid.
  - Mortgage banks often match technical characteristics of bonds across issuers so bonds trade as if belonging to the same series.
- Call and delivery features
  - Fixed-rate mortgage loans can be callable or noncallable; callable loans may be prepaid before maturity.
  - Adjustable interest loans and index-linked loans are always noncallable but can be prepaid by delivering underlying bonds.
  - Prepayment and delivery options create pre-payment risk for bond investors; probability of callability affects liquidity across series and can change quickly.
  - Conversion dynamics affected by trend and volatility of interest rates, borrower composition and behavior.
- Increasing complexity and hedging
  - New loan types increase option complexity embedded in mortgage bonds, requiring sophisticated risk management systems.
  - Investors use government bonds for hedging due to similar volatility patterns; use of derivative products (interest rate swaps and swaptions, foreign exchange derivatives) is developing.
- Investor composition (holdings of mortgage bonds)
  - Financial sector: about 48 percent of bonds in circulation.
  - Pension funds: estimated 21 percent of outstanding mortgage bonds.
  - Private/retail investor sector: 11 percent.
  - Public sector: 6 percent.
  - Foreign investors: 14 percent overall; higher among the highest liquid bonds (20 percent).
  - Foreign holdings of callable bonds: callable mortgage bonds represented about 57 percent of total holdings of mortgage bonds held by foreign investors at the end of 2004.
  - Foreign holdings of short term noncallable bullet mortgage bonds denominated in DKK: 6 percent; same type issued in euro: 22 percent at the end of 2004.
- Product innovation and maturities
  - Since mid-1990s new mortgage loan types introduced; adjustable interest loans reintroduced in 1996.
  - Interest-only loans (installment free period up to 10 years) introduced in 2003 as adjustable interest loans or fixed rate loans.
  - Mortgage loans with interest rate guarantees introduced in 2004; two types of mortgage bonds with guarantee:
    - Floating-to-fixed: conversion when 6-month CIBOR reaches the cap; remains fixed thereafter even if market rate declines.
    - Capped-floater: interest rate reduced if rate later declines; combines fixed-interest loan with interest reset features based on variable interest bonds adjusted over CIBOR every six months.
  - Underlying bond maturities range from 5 to 30 years; entire loan refinanced when the bond matures.

### Table excerpts and historical figures (from Table 6 and related text)
- Bonds (outstanding amounts as percent of GDP, selected years listed in table): Dec-97 172.6; Dec-98 173.5; Dec-99 160.6; Dec-00 156.7; Dec-01 166.0; Dec-02 178.4; Dec-03 182.8; Dec-04 190.7; Dec-05 193.1.
- Government bonds (percent of GDP): Dec-97 63.1; Dec-98 60.2; Dec-99 54.0; Dec-00 49.3; Dec-01 46.0; Dec-02 46.7; Dec-03 45.5; Dec-04 45.3; Dec-05 37.6.
- Treasury bills (percent of GDP): Dec-97 4.4; Dec-98 4.1; Dec-99 3.5; Dec-00 3.0; Dec-01 3.9; Dec-02 4.6; Dec-03 4.8; Dec-04 4.7; Dec-05 2.7.
- Mortgage bonds (percent of GDP; note change in definition around 2002): Dec-97 72.5; Dec-98 76.9; Dec-99 73.5; Dec-00 76.8; Dec-01 84.8; Dec-02 93.8; Dec-03 117.3; Dec-04 121.5; Dec-05 142.1.
- Listed equities (percent of GDP, selected entries): Dec-98 70.0; Dec-99 82.2; Dec-00 70.1; Dec-01 55.8; Dec-02 45.2; Dec-03 51.6; Dec-04 60.0; Dec-05 71.6.
- Corporate bonds: entries sparse; some values shown as 2.0, 2.4, 3.0 in later years.
- Other: Dec-97 32.5; Dec-98 32.3; Dec-99 29.5; Dec-00 27.6; Dec-01 31.3; Dec-02 33.2; Dec-03 13.3; Dec-04 16.9; Dec-05 7.7.

### Observations on policy and market development
- Authorities have succeeded in maintaining attractiveness and liquidity of government bond market despite declining supply by:
  - Concentrating issuance in a few large series.
  - Adopting primary dealership and market making systems.
  - Promoting electronic trading and active secondary market management (including buy-backs).
- Challenge highlighted: declining supply of government bonds requires continued innovative and proactive issuing policy to secure a diversified domestic and foreign investor base.
- Similarities noted between Danish approach and strategies used in various small eurozone countries.

### Main features of Danish mortgage bond types (Table 7 summary)
- Noncallable Bullet Bonds
  - Interest payments: Annual
  - Repayment: Bullet
  - Coupon: Fixed
  - Currency: DKK and €
  - Maturities: 1─11 years
  - Issuance: Tap and auction, throughout maturity
- Callable Bonds
  - Interest payments: Quarterly
  - Repayment: Annuity or IO
  - Coupon: Fixed
  - Currency: DKK and €
  - Maturities: 10, 15, 20, 30 years
  - Issuance: Tap, first 3 years
- Capped Floaters
  - Interest payments: Quarterly
  - Repayment: Annuity or IO
  - Coupon: Floating, capped
  - Currency: DKK
  - Maturities: 30 years
  - Issuance: Tap, first 3 years
- Floating to Fixed Bonds
  - Interest payments: Quarterly
  - Repayment: Annuity or IO
  - Coupon: Floating, fixed
  - Currency: DKK
  - Maturities: 30 years
  - Issuance: Tap, 3 years

*Source: IMF staff summary of the section titled “This section reviews liquidity in the Danish bond and equity markets. Liquidity” from the provided content unit.*

### 47.      Liquidity conditions and the volume of activity varies significantly among the

### _cr07121 - 47.      Liquidity conditions and the volume of activity varies significantly among the

### Mortgage bond market liquidity and market structure
- Liquidity conditions and the volume of activity varies significantly among the numerous outstanding issues.
- Traditional mortgage bonds are traded in a “uniform” market: mortgage bonds with a given coupon and maturity are regarded as (perfect) substitutes, including in the market making arrangement organized by the main dealers.
- Capped rate and deferred amortization bonds do not have such a degree of homogeneity and therefore do not benefit from similar market making commitments, although market making activities have recently been organized for some of these issues.
- While mortgage bonds are quoted on the CSE, the turnover is just a small fraction of the total turnover among market makers; the large majority of mortgage bonds are traded OTC, by phone and electronically.
- The CSE provides the information system for the market makers; banks that are market-makers and quote bid-and-ask prices on mortgage bonds can see the depth and prices for the bonds in the elektrobrokersystem on the CSE.

### Market-making arrangements and the repo market
- Nine or ten banks have entered into an agreement through the Danish Bankers Association to provide bid-and-ask prices on workdays from 8:30 a.m. to 4:30 p.m. relating to the most liquid series of mortgage bonds.
- The agreement covers 60 series of mortgage bonds issued by five different mortgage banks, for pre-agreed standard transaction sizes.
- As these series have often been issued with identical characteristics, they are treated by the market as 12 different series only.
- The market for Danish mortgage bonds benefits from an active repo market, allowing mortgage banks, investors, and other participants to efficiently manage their positions.
- Mortgage bonds are eligible collateral for central bank operations.

### Trends, risks, and potential future changes in mortgage markets
- The overall mortgage credit market has continued to expand; development of new types of loans with corresponding new mortgage bonds has not translated into a reduction of the outstanding stock of traditional callable fixed-rate mortgage bonds, where the most liquid issues are concentrated.
- Concern: increased diversity of mortgage loans offered to borrowers may result in smaller and more heterogeneous bond issues and pricing conditions, possibly to an extent where liquidity in mortgage bond issues will be more and more difficult to maintain.
- Potential effects:
  - May affect the appetite of foreign investors (mostly institutional investors and hedge funds) for Danish mortgage bonds.
  - May limit the formation of a complete, homogeneous mortgage bond yield curve in the long run.
- Competitive and regulatory pressures:
  - Competition from commercial banks has increased; “Priority mortgage” loans have been aggressively marketed by commercial banks and have rapidly built a significant market share.
  - The introduction of the new European Capital Adequacy Directive has the potential to pose transitional challenges for mortgage financing in Denmark.
  - For mortgage bonds to be recognized with the 10 percent risk-weighting treatment granted to covered bonds in the Directive, the current Danish mortgage framework would need to be amended.
  - Authorities face divergent demands: commercial banks seek significant reconstitution of the existing framework to create a level playing field with European covered bond issuers; mortgage banks insist on preserving essential characteristics of the current mortgage system.
- Governance and design considerations if amended:
  - The extent to which the current system will be adapted (through new definitions of the balance principle and of eligible collateral in particular) remains unclear.
  - Careful attention will be needed concerning consumer protection and the transparency and flexibility characterizing the existing system.
  - The strict application of the balance principle currently makes Danish mortgage bonds true pass-through securities, transferring market risk from mortgage borrowers to mortgage bond investors, and limiting mortgage banks’ risk to credit risk.
  - When amended according to EU regulations, some attractive features would be traded off against potential benefits; to realize benefits it would be important to ensure continued effective disclosure and transparency and a level playing field among market participants.
- Footnote detail preserved verbatim:
  - In particular, loan-to-value requirements and limits differ in the Danish system (they are based on the value of the covered assets at the origination of the loan) and in the Directive (the directive requires that LTV calculations be performed, and the respect of the stated LTV limits be fulfilled, over the full life of the covered loan).

### Corporate bond market
- A deep liquid market in corporate bonds has never developed in Denmark.
- Possible explanations: general industrial structure with many small and a few large businesses; extensive borrowing from banks and mortgage banks may have reduced demand for corporate bond lending.
- While the bulk of mortgage lending is housing related, a part benefits the agriculture sector and small offices and shops.

### Equity market liquidity and concentration
- Equities traded on the CSE are, with the exception of a few large issues, relatively illiquid; turnover varies dramatically among listed shares.
- Out of close to 180 listed companies, the 20 comprising the OMXC20 index account for about 80 percent of the total turnover.
- As of early April 2006, more than 56 percent of turnover among the components of the OMXC20 over the preceding 12 month period was concentrated among four stocks: AP Møller, Novo Nordisk, Danske Bank and Vestas WS.
  - AP Møller alone represented 21.4 percent of the total turnover.
- The recent withdrawal from the index of the telecom operator TDC, traditionally the most active stock, may have contributed to depress further liquidity and turnover on the exchange.
- Comparable regional patterns:
  - The five most active shares listed on the local stock market represent more than a third of the total turnover, and more than a quarter of the total capitalization of the local market in other Nordic and Baltic equity markets.
  - In terms of concentration, the Danish stock market appears to be more concentrated than its Swedish and Norwegian counterparts, but is less so than the Baltic, Finnish, and Icelandic stock markets.

### Market efficiency and liquidity-provider initiatives
- The CSE sponsors “liquidity provider agreements” whereby listed companies can conclude agreements with members of the stock exchange; in exchange for a fee the member will commit to make a market in the shares of the company.
- About 60 such agreements have been concluded, mostly with small-and medium-sized listed companies (and are related to listing in “plus segments” and inclusion in the Smallcap + and Midcap + indexes).
- Evidence on impact:
  - Various studies concluded that overall liquidity improved following the introduction of liquidity provider agreements, highlighting a narrowing of spreads, a decline in stock volatility, better order coverage, and increased turnover.
  - Market participants note that narrow bid/ask spreads and high transaction volumes can be misleading or incomplete gauges of secondary market liquidity.
  - The commitment of market makers to provide two-way prices is a positive development, but behavior in market stress remains uncertain.
- Concentration risk among liquidity providers:
  - More than half (55 percent) of the existing liquidity agreements have been signed with two market makers, and two-third of them with three members.
  - This concentration could be a specific element of weakness should one of these market makers withdraw from the market.

### Corporate governance framework for listed companies
- Denmark developed special Danish Recommendations for corporate governance (the Nørby Committee), rather than directly following the OECD Principles of Corporate Governance (most recently revised in 2004).
- The Nørby Committee provided 31 recommendations in seven main areas:
  1. Role of the shareholders and their interaction with the management of the company;
  2. Role of the stakeholders and their importance to the company;
  3. Openness and transparency;
  4. Tasks and responsibilities of the board;
  5. Composition of the board;
  6. Remuneration to the directors and the managers; and
  7. Risk management.
- Implementation approach:
  - Recommendations were voluntary and non-binding (“comply-or-explain” approach).
  - The CSE incorporated the Nørby Committee’s Recommendations in its disclosure requirements for listed companies.
  - A large majority (72 percent) of the listed companies address corporate governance in their annual reports or other stock exchange announcements, compared to 31 percent prior to the Recommendations.
- Revisions and alignment with EU developments:
  - The stock exchange committee revised and suggested amendments to the Recommendations in light of the recent evolution of European regulatory framework on corporate governance.
  - The revised recommendations have been added to disclosure requirements imposed on listed companies and have taken effect for annual reports for fiscal years beginning on or after January 1, 2006.
  - Revisions incorporate the EU’s “comply-or-explain” principle and recommendations on board independence and directors’ remuneration; audit has been added to the existing seven areas and the total number of recommendations increased.
- Comparison with OECD Principles:
  - The revised Danish Recommendations are different from the OECD Principles (2004); a main difference is their starting point—OECD Principles include norms that belong to modern corporate law, while Danish Recommendations exclude norms provided by Danish corporate law.
  - Specific OECD Principles not included in the Danish Recommendations but found in Danish laws include:
    - OECD Principle I. Ensuring the Basis for an Effective Corporate Governance Framework.
    - OECD Principle II. The Rights of Shareholders and Key Ownership Functions (including provisions on disclosure by institutional investors acting in a fiduciary capacity; these issues are regulated by mutual fund law in Denmark).
    - OECD Principle III. The Equitable Treatment of Shareholders (insider trading and abusive self-dealing are dealt with in Danish legal framework).
    - OECD Principle V. Disclosure and Transparency (material company information disclosure is part of Danish capital markets law).

*Source: _cr07121 - 47.      Liquidity conditions and the volume of activity varies significantly among the*

### 64.      Areas where the Danish Recommendations are more advanced than the OECD

### 64.      Areas where the Danish Recommendations are more advanced than the OECD Principles

### The Shareholders’ Role
- OECD Principle II, The Rights of Shareholders and Key Ownership Functions parallels Danish Recommendations I. The Role of the shareholders and their interaction with the management of the company.
- OECD Principles state “anti-take-over devices should not be used to shield management and the board from accountability.”
- Danish Recommendations address take-over situations in detail:
  - The supervisory board should not, without the acceptance of the general meeting, attempt to counter a takeover bid by making decisions which in reality prevent the shareholders from deciding on the takeover bid.
  - Shareholders should be given the opportunity to decide whether or not they wish to dispose of their shares in the company under the terms offered. The recommendation includes implementing capital increases or allowing the company to buy its own shares on the basis of any previously given authority.
- Danish Recommendations require the supervisory board to, at appropriate intervals, assess whether the company’s capital and share structures continue to be in the interests of the shareholders and the company and that the supervisory board account for this assessment in the company’s annual report.
- Danish Recommendations promote more detailed shareholder engagement practices:
  - Holding investor meetings;
  - Evaluating on an ongoing basis whether information technology can be used for improving investor relations, including using part of the company’s website to deal with corporate governance-related issues;
  - Making all investor presentations accessible on the Internet in real time.

### Role of stakeholders
- Both the OECD Principles and the Danish Recommendations recognize the role of stakeholders in corporate governance, underscoring the need for cooperation and ongoing dialog between the parties and protection of the stakeholders’ interests.
- The OECD Principles and the Danish Recommendations are similar in substance on this point.

### Disclosure and transparency
- OECD Principle V (disclosure and transparency) parallels Danish Recommendation III (openness and transparency) but differ in emphasis on urgency of information to shareholders and investors.
- Danish Recommendations require procedures for immediate publication to shareholders and the financial markets of all essential information of importance to evaluate the company.
- OECD Principles require that the company has established channels for disseminating information in an equal, timely, and cost-efficient way.
- Danish Recommendations go beyond OECD on annual report content:
  - Consider to what extent generally accepted accounting standards other than those required, such as US-GAAP, shall be applied as a supplement to the annual report when that is relevant for comparability or other reasons for the recipient of the information.
  - Should decide whether it is expedient that the company publishes details of a non-financial nature, including internal knowledge resources, ethical and social responsibilities, and health and safety policy.
- Danish Recommendations advise that companies should publish quarterly reports (no similar requirement in the OECD Principles).

### The Responsibilities of the Board
- OECD Principles address board responsibilities, election, and composition; Danish Recommendations split these into The task and responsibilities of the supervisory board and The composition of the supervisory board.
- Danish Recommendations are more specific, suggesting:
  - Training and introduction for members of the board are provided;
  - The number of members of the board is adjusted to facilitate a constructive and effective decision making debate.
- Detailed independence requirements under Danish Recommendations:
  - At least half of the supervisory board members elected by the general meeting should be independent persons.
  - An independent supervisory board member elected by the general meeting may not:
    - be an employee of the company or have been employed by the company within the past five years;
    - be or have been a member of the executive board of the company;
    - be a professional consultant to the company or be employed by, or have a financial interest in, a company which is a professional consultant to the company;
    - have some other essential strategic interest in the company other than that of a shareholder;
    - be related, in terms of business or in any other way, to the company’s major shareholder;
    - have family ties with a person not regarded as an independent person.
- Recommendations state members of the executive board of a company should not be key executives in the same company.
- Annual report should contain information about supervisory board members:
  - Occupation of the individual supervisory board member;
  - Other managerial positions or directorships held by the supervisory board member in Danish and foreign companies as well as demanding organizational tasks performed by that individual;
  - Number of shares, options and warrants held by the supervisory board member in the company and group enterprises as well as changes in the member’s portfolio of the mentioned securities having taken place during the financial year.
- Recommendations limit the number of directorships and chairmanships that can be held by the same person and promote setting a retirement age for members of the board.

### Remuneration
- OECD Principles require:
  - Shareholders should be able to make their views known on the remuneration policy for board members and key executives. The equity component of compensation schemes for board members and employees should be subject to shareholder approval (C. 3. in II. The Rights of Shareholders and Key Ownership Functions).
  - Disclosure should include remuneration policy for members of the board and key executives, and information about board members, including their qualifications, the selection process, other company directorships, and whether they are regarded as independent by the board (A. 4. in V. Disclosure and Transparency).
  - The board is responsible for aligning key executive and board remuneration with the longer term interests of the company and its shareholders (D. 4 in VI The Responsibilities of the Board).
- Danish Recommendations devote a chapter to Remuneration of members of the supervisory board and the executive board and include more detailed requirements:
  - Remuneration of board members and key executives should be limited within a range of what is considered fair and reasonable and the amount is properly disclosed.
  - The company should develop a remuneration policy that reflect the interests of the shareholders and the company, match the specific conditions of the company and be reasonable in relation to the tasks and responsibilities of the members of the executive board and the supervisory board and that it promotes long-term behavior, is transparent, easy to understand, and that valuation be made according to generally accepted methods;
  - The remuneration policy should include a statement explaining basic pay, the basis on which bonus’ are calculated, price-related incentive schemes, pension schemes and other benefits as well as the relationship between basic pay and such benefits;
  - The company’s remuneration policy reporting should include a statement explaining how such a policy was implemented in the past financial year, how such a policy is implemented in the current financial year, and how the company plans to implement it in the next financial year;
  - The annual report should include information about the amounts of total remuneration of the individual members of the supervisory board and the executive board, as well as other benefits of a material nature provided or granted to such members by the company or other companies within the same group;
  - Details should be provided in respect of defined-contribution pension schemes for contributions made or to be made by the company for an executive in the relevant financial year and for defined-benefit pension schemes that details be provided for changes in benefits saved for the individual during the relevant financial year;
  - Only the general meeting can agree to include a share option scheme as part of the remuneration to a board member or key executive;
  - Share or subscription option schemes should be set up as roll-over schemes (i.e., options are allocated and expire over a number of years) and that the redemption price be higher than the market price at the time of allocation;
  - The notice convening a general meeting to consider the introduction of share or subscription options or any other share-based incentive scheme, should include an easy-to-understand statement for the shareholders explaining such decisions and that the statement should include information about the most important terms and conditions of the scheme and list the names of the members of the supervisory board and the executive board participating in the scheme. The statement could, among other things, include:
    - details to shed light on whether the schemes are consistent with the overall remuneration policy;
    - information outlining how the company intends to provide the shares needed to fulfill the company’s obligations in connection with the incentive scheme, including details specifying whether the company intends to acquire the necessary shares in the market, whether the company currently holds such shares in its portfolio, or whether it will issue new shares; and
    - information about the total costs of the scheme, including direct as well as indirect costs.
  - Information about the most important aspects of severance schemes should be disclosed in the company’s annual report.

### Risk management
- Danish Recommendations include a chapter on risk management; substance is similar to OECD Principles:
  - It is the responsibility of the board to review the company’s risk policy;
  - The board must ensure that the system for risk management is in place;
  - Foreseeable risk factors are properly disclosed.

### Audit
- Danish Recommendations have a separate chapter on audits with detailed requirements; OECD Principles deal with audits more generally.
- OECD annotations explain the use of a separate audit committee but do not recommend appointment of an audit committee. Danish Recommendations state that companies with complex accounting and audit conditions should consider establishing an audit committee to assist the supervisory board in accounting and audit matters.
- Danish Recommendations promote establishment of a nomination committee to prepare elections of members to the board and a remuneration committee, including detailed rules regarding the mandate and process for running these committees.
- Proposed exemption from audits for smaller companies (to save costs) with credit risk implications:
  - Only companies which for two successive years do not exceed two of the following thresholds may refrain from having the annual financial report made subject to auditing:
    - a balance sheet total of DKr 1.5 million;
    - a net turnover of DKr 3 million; and
    - an average number of full-time employees during the financial year of 12 persons.
  - This exemption is not available to holding companies and commercial foundations.
  - The right to exercise the exemption may be subject to further conditions.
  - Financial institutions may decide to ask for additional information to evaluate the credit risk.

*Source: _cr07121 - 64.      Areas where the Danish Recommendations are more advanced than the OECD*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07121.pdf_