2003 - Finanssivalvonta

ANNUAL2003REPORT

4 Contents4 Director General’s review 44 The Financial Supervision Authority’s operating strategy 7Reliable functioning of markets and good corporate governancein supervised entities 7Promotion of markets’ access to information and sound market practices 10Promotion of regulatory system based on exibility and accountability 134 Operating environment in 2003 154 Supervision 20Prudential supervision 20Market supervision 22Marketplaces and market systems 24Markets 264 International activities 284 Regulation 35Disclosure requirements 35Functioning of markets and competition neutrality 38Control of market abuse 40Revision of the capital adequacy of framework 414 Development of the FSA’s activities 444 The FSA in brief 474 Appendices 53AnnualReport20033

4 Director General’s reviewDirectorGeneral’sreview4Regrettably, in financial market terms, 2003 canbe described as the year of market abusescandals. From the point of view of an efficientmarket economy, public confidence in financialmarkets is essential. The result of severalaccounting scandals, however, is a reduction inconfidence levels. Even though the cases havebeen clear examples of deliberate criminal andfraudulent acts, which have been difficult – ifnot impossible – for the respective supervisoryauthorities to discover at the time, the instancesof Enron, Skandia and Parmalat have providedcause for concern as to how the security mechanismswithin market economy systems still needto be improved in order that there would be adecrease in the probability of such situationsrepeating themselves as well as a reduction inthe severity of their repercussions. Despite thesize of these cases, the objectionable nature ofeach of them does not, as such, mean that theynecessarily would pose a destabilising orsystemic risk to the financial system. Confidencein the system has inevitably suffered a blow,which in turn has weakened the efficiency ofthe financial system by increasing the cost ofcapital. This, in turn, may cause sluggish growthand a slowing in the global market’s ability tocreate new jobs and improve living standards.It is therefore understandable that the decisionmakersofmany industrialised nations are seekingways of reinforcing supervision, accounting,auditing and overall corporate governance rules.There isalways the danger,ofcourse, that theregulatory process could go too far and find itselfbeing the cause of adecline in the efficiency ofthe functioning of the markets. Finding thebalance is indeed achallenging task.There are currently several key projects beingundertaken, not only atEUlevel but also globally,that aim at ensuring the reliability of the financialsystem.The most important of these are probablythe new directives created to improve thesecurities markets, implementation of the IFRS/IAS financial reporting standards and the developmentof supervisory procedures associated withthese standards, improved auditing approaches,new company law initiatives as well as the BaselCommittee’s New Capital Adequacy Accordconcerning banks and investment firms.These areall bound by the common thread of an increase inthe market’s access to information and anenhancement in transparency.Not to mention theaim of gaining improvements in the quality andreliability of information.The past year was less dramatic for Finlandthan for many other countries. However, therewere –regrettably –many cases of suspectedinsider trading and similar misdemeanours thatneeded to be investigated. Occasionally itfelt as ifethics and integrity were words whose meaninghad been forgotten altogether by too many of

those inleading positions. Or is it merely that theexploitation of insider information is still notunderstood to be acrime?From the Financial Supervision Authority’sperspective, the most significant events of 2003were,however,the restructuring that occurred inFinland’s financial market and the regulatorydevelopments that were brought about.Thestability of the financial system was not underthreat in any way.Banks’ profitability in 2003 wasgood. Intensifying competition on the housingloans market lead to overheating which has beenevident in rising housing prices in Finland’sgrowth centres. It is to be hoped that economicgrowth would continue its steady upward trend,as an increase in unemployment rates and arisein interest rates could, at worst, drive manyhouseholds into dire straits with their housingloans. Even during the banking crisis of the 1990s,banks did not experience alot of loan losses onhousing loans and are probably not going to befaced with many now,either.However,socialproblems could be exacerbated if many familieswere faced with giving up their homes with themarket value of the home falling below itscollateral value. Caution becomes the by-word onthe housing loan market; for both the granters andreceivers ofthe loans.The debt ratio for Finnish companies remainsrelatively low.Itistobehoped that the proposedtax reforms donot significantly weaken thecompanies’ funding structures. One would alsohope that demand for business credit would pickup to finance productive investments rather thanfor the funding of dividend payments.TheEuropean Union’s Financial Services Action Plan(FSAP) is progressing well.The objective oftheAction Plan is the achievement of asingle financialmarket.There is, however, along way togoyetbefore that has been fully accomplished.Althoughthe principle behind the creation of the singlefinancial market is the unity of it, still supervisionis driven by the home-country control principle.In my opinion we should question whether thisapproach will work within the framework of aunified market, once it is achieved.A single,unified financial market requires unified supervisionand regulatory frameworks.This is, indeed,the objective ofthe so-called Lamfalussy Processthrough which supervisory authorities, using aharmonised commitology approach, makeproposals for legislation and European Union-levelregulations. Cooperative mechanisms in bankingand insurance supervision are taking shape.As faras the securities markets are concerned, thesemechanisms are somewhat further developed andthe Committee of European Securities Regulators(CESR) has achieved concrete results. Despite this,it not yet possible to say whether the key supervisoryissues within the EU have been resolvedyet. For the integration of the financial marketsinto a27-country group (25 EU countries, as of1May 2004, as well as Iceland and Norway) aconsiderably more robust joint supervisory andregulatory framework is required, in which itispossible to centralise decisions concerning theregion.A consensus-style approach and cooperationbased on recommendations does not suffice,particularly should there becrises that were tothreaten the stability of the financial system. Onemight fear that only once the supervisory andregulatory framework is faced with acrisis thatmoves would be made to bring about arenewal.Aconcrete example of the problems associatedwith the changing structure ofaconvergingfinancial market can be found in Nordea Group’splans to merge its various parts into one bank,domiciled in Sweden, and creating aso-calledEuropean Company with branch offices in othercountries.There are many practical obstaclesbefore the plan can be realized and, accordingly, itwill probably becompleted in 2006, at theearliest. It is, without doubt, agood thing that thebank’s juridical and business operational structuresare nearing each other. This can only clarifythe division of responsibilities and enhance thebank’s operations.Nordea holds more than athird ofthe marketshare inFinland while it is also asignificantmarket participant in Sweden, Denmark andNorway.Inthe branch office model, homecountry supervision principles leads to supervisoryresponsibility being transferred totheSwedish authorities for the entire group.Apparently itisalso possible that considerationregarding emergency funding by acentral bankwould also be transferred tothe remit of theSwedish central bank and consequently, in acrisissituation, the Swedish Government would have todebate any possible capital support.An additionalDirectorGeneral’sreview5

DirectorGeneral’sreview6issue isthe nationality of the deposit guaranteefunds.The existing regulations regarding depositcover is, juridically, considered to be the responsibilityof the home country.With the change innature ofthe banks to the branch office approach,all Nordea’s deposits would come under theprotection of Swedish deposit guarantee arrangements.For the Swedish deposit guarantee systemthis would mean anotable addition to its burdenof responsibility.At the same time, the fundsNordea has paid into the Finnish, Norwegian andDanish deposit guarantee systems would be left tosecure the deposits of the remaining banks inthese countries. It is quite clear that this is not awholly satisfactory situation; rather it may serve tohinder asound plan to establish abranch officenetwork.The Nordea case has implications for theEuropean market as whole, as it has brought tolight how EUnational systems and regulations arenot sufficiently up-to-date, if the real aim is toachieve asingle financial market.The statute governing the new EuropeanCompany format enables, at least in principle, asignificant pan-European bank to switch homecountry without bigger difficulties and thereforeswitch over toanother supervisory authority.Thesupervisory authority in the new home countrymay not possess the resources or interest, necessarily,to supervise abanking colossus whose mainoperations are situated elsewhere inthe EuropeanUnion, if not further afield.We need newEuropean supervisory structures.The creation ofsuch structures would, however, take years tocomplete and in the meantime it is vital toestablish acooperative Nordic solution to thesupervision of the Nordea Group.These arguments are equally asvalid in termsof the convergence of the securities markets.Withthe Stockholm and Helsinki stock exchangescoming under the joint ownership of OMHEX Ltd,alisted company inSweden, we have to agree ontheir supervision and create ajoint supervisorypractice. It is unlikely that these developmentswill stop with the Nordic and Baltic countries.TheSampo Group is also in the process of becoming amore international financial conglomerate. Italready owns noteworthy banking operations inFinland and the Baltic countries. In addition it isreturning back toholding significant marketshares in the Norwegian and Swedish marketswhen it announced its intention to buy aclearmajority holding in the Swedish non-life insurancecompany If. At the same time, Sampo plans todistribute record dividends.These actions,however, place astrain not only onthe capitaladequacy of the Group but also on its funding.The FSA will intensify its close cooperation withthe Finnish Insurance Supervision Authority aswell as the Swedish, Norwegian and Balticsupervisors over ensuring effective supervision ofthe Sampo Group as awhole.The European Union’s single financial marketand currency –the euro –have lead to thesituation where the Finnish financial market, inthe strict sense of the word,does not exist, assuch. In terms of regulation and supervision this isthe cause of considerable adjustment pressures.There isaparticular emphasis on EU-levelcooperation. For small countries like Finland, theresources and costs required for cooperation poseachallenge.As cross-border branching-out and thecross-border supply offinancial services gainsgreater market shares, it is not possible to downgradesupervision at the same rate as theresources available for it diminish.There are somehard choices ahead of us.What is the balance wewish to strike in Finland’s participation levels atthe European level regarding supervisory andregulatory activities within the financial marketsand who will pay for participation if the significanceof Finland as legal domicile for financialenterprises is considerably reduced? The challengesfacing us help to maintain asharp focus onour work.The challenges posed to the FSA andthe focus they bring seem set to bringing intensifiedmotivation to the organisation for theforeseeable future.The entire staff ofthe FinancialSupervision Authority deserves thanks for the wayin which they are rising to meet these challenges.This seems to be the pattern set for the future,too.Helsinki, February 2004

to withstand external disruptions looks more thansatisfactory.The FSA also monitors the supervised entities’risk bearing capacity in relation to their riskprofile is adequate and that the risk managementsystems they have inplace are appropriate.According to the risk analyses undertaken by theFSA in 2003, supervised entities in Finland haveimplemented satisfactory risk managementsystems.The assessment and management systemsassociated with operational risk are still in theprocess of development in many ofthe supervisedentities and continue to require attention inthe coming years.Supervision directed at key and morerisk-sensitive institutions and systemsDuring the year,the Financial SupervisionAuthority paid particular attention to recognisingmarket risk factors and analysis of their effect onthe supervised entities. Competition in the marketfor housing loans, the narrowing of the interestmargins and the failure ofbanks to meet collateralrequirement levels have attracted the supervisors’concern regarding the risk around correct pricing.For the present, however, the housing loansituation has not given rise to loan losses.The electronification of payments transfersand payment services as well as contagionsensitivity to outside disruptions has set highthresholds of expectations on the management ofdata and payment systems, operating under bothnormal and contingency operating conditions.TheFSA has made regularly inspections of the largersupervised entities’ payment systems and theircontinuity plans.The systems have been tested byboth power cuts and computer virus attacks,which have served toreveal the shortcomings ofthe systems. However, no economic damage wascaused to their customers.Tight competition has forced credit institutionsto undergo rationalisation of their operationsby pruning back the overgrowth andmoving towards centralisation.The production ofmany ofthe services provided has beenoutsourced, with cost efficiency in mind.Outsourcing can be associated with certain risksthat have not previously occurred. Some of themore usual examples of which can be the uncertaintyin the provision of the service concerned,the tenability of the contract itself and thequestion of duty to the customer.Were outsourcingto become even more generalised than ispresently the situation, the FSA would be facedwith informing the supervised entities of thespecific outsourcing-related problem areas andbringing the associated risks under control.Corporate governance becomes keyarea of supervisors’ monitoringThe supervised entities’ internal control andmonitoring procedures have asignificant role toplay ingetting the organisation to work withinthe bounds of reinforced objectives and operatingprinciples. Internationally, failure ofinternalcontrols and unclear divisions of responsibility arethe most common reasons behind the problemsexperienced by credit institutions.On the basis of information accumulatedfrom its inspection visits, the FSA has gathered theimpression that the supervised entities’ internalcontrol mechanisms and risk managementprocedures are currently operating at asatisfactorylevel. In the future, the FSA plans to alsopay particular attention to the reliability of thesupervised entities’ corporate governance and therole played bythe organisations’ various bodies.Already for several years, the FSA’s emphasisin its supervisory function has been directed atthe monitoring of internal control, corporate-levelrisk management and evaluation of the functionalityof the internal control processes that are inplace.The FSA’s most recent standard inits newset of regulations on the establishment andmaintenance of internal control and risk managementbrings greater systemisation and elasticity tothis assessment area.Cross-border sectoral restructuringraises question of future supervisoryrequirementsThe European Union’s objective istohelp fosterthe creation of asingle financial market. 1 Theestablishment of cross-border companies is1 This is supported by the action plans drawn up for the developmentof nancial services and company law as well as strategiesconcerning nancial reports and auditing.The FSA’soperatingstrategy9

The FSA’soperatingstrategy10progressing and the so-called ‘European Company’format for alimited company will be possiblefrom autumn 2004.In various contexts, in both domestic and EUfora,the Financial Supervision Authority hasbrought up the issue of the challenges posed byan organisation established in the EuropeanCompany format regarding both regulation andsupervision. Nordea has become the first tomakethe decision to become aEuropean Company.Thecompany’s plans include transfer of the group’sparent company toSweden and continuation ofbanking activities in the other Nordic countriesthrough it network ofbranch offices.This willhave anoticeable effect on the division of dutiesfor the Nordic countries’ supervisory authoritiesand poses acentral challenge tothe effectivenessof home state supervision within the EU.Similarly,the authorities will find they have toassesswhether deposit guarantee systems that havebeen based on the national framework areactually capable ofadaptation to the requirementsand accompanying demands of acompanyoperating at the pan-European level.Within the Nordic countries, action iscurrently underway to propose feasible solutionsfor the supervision of Nordea. Meanwhile, at theECB, following aNordic initiative, investigation isbeing made concerning the question of problemsrelated to deposit guarantee arrangements.Asregards Nordea, the FSA’s objective toistofind asupervisory solution that enables the Authority toacquire the information and influence it needs toensure financial market stability.Another significant cross-border supervisorychallengeisthat of the integration of the Helsinkiand Stockholm stockexchanges.From earlyautumn2003 these twostockexchanges have been underthe ownership of the Swedish public limitedholding companyOMHEX.The FSA has negotiatedthe supervisoryduties concerning the group withthe Swedish supervisoryauthority. The aim hasbeen to ensurethat eachofthe supervisoryauthorities is ensured adequate opportunities forinformation acquisition from the holding company.PROMOTION OF MARKETS’ ACCESSTO INFORMATION ANDSOUND MARKET PRACTICESIn its operations, the FSA fostersmarkets’ access toinformation and sound market practice.The FSAplaces particular emphasis on maintaining theexisting high levelofconfidence in Finland that isplaced in financial information. Preservation ofconfidence relies on financial information guidedby clear and sound regulations. It is also essentialthat the management of issuersiscommitted tofollowing regulations and that supervisorshaveeffectiveregulatorytools enabling them to interveneif anyanomalyisdiscovered.During 2003, the FSA took part inseveral EUlevelregulatory projects whose objective was theharmonisation of the disclosure requirementsplaced on issuers and financial service providers.The objective ofharmonisation was also to ensureequal investor protection when offering investmentservices or securities cross-border as well asto enhance market functions through greatercomparability of the companies involved.Thiswork included harmonisation of the disclosurerequirements concerning listing particulars,implementation of the IFRS/IAS accountingstandards and definition of information requirementsin asimplified mutual fund prospectus. Ontop of which, the Committee of EuropeanSecurities Regulators (CESR) finalised its recommendationson how listed companies should beinformed of the changeover tothe internationalaccounting standards prior to their becomingmandatory in2005.In terms of the monitoring of issuers’ disclosurerequirements,the FSA’s objectiveistoensurethat investorshaveaccess to essential andadequate information in order to allowareasonedassessment of asecurity and its issuer.In2003 theFinancial Supervision Authority undertook asurveyto establish to what extent listed companiescomplywith disclosurerequirements in theirinterim reports.The results of the surveyconfirmed that the levelofcompliance with thedisclosurerequirements in these interim reportswasgenerallygood.Therewere, however, someshortcomings regarding the statements on thecompanies’ forecasts and in the evaluation of someof the operational risks.The newself-regulatory

Chart 1.The efcient implementation process of nancial reporting standardsHigh quality of financial reporting standardsInterpretations and application guidanceStatutory auditEnforcement conductedby authoritiesEU Commission’s financial reporting strategySource: Financial Supervision Authority.corporate governance recommendation will serveto improvethe companies’ transparency,harmonisationof information giventoinvestorsaswell asto enhance the flow of information in general.The FSA has been actively involved in improvinginvestors’ awareness levels of the risksassociated with financial services, by participatingin various events directed at investors and bypublishing informative pieces on its Internet site,under the auspices of the FSA Newsline.TheAuthority aims to set up acomprehensive anduser-friendly information site, sometime during2004, through which itcan reach the banks’clients and retail investors alike.Comparable, reliable and transparentfinancial reporting as the basis forwell-founded investment decisionsAccording to the international accountingstandards (IFRS/IAS), the primary role offinancial reporting is to support the investor’sdecision-making process.The comparability,reliability and transparency of financial reportsare all prerequisites for providing investors withthe means for making informed investmentdecisions on securities offered bycompaniesoperating in various countries.The FSA monitorsthe preparations beingmade by listed companies to conformtothe forthcomingaccounting standards (IFRS/IAS),as publiclytraded companies aretopreparetheir financialreports in accordance with the standards by thebeginning of the financial period starting in 2005.Supervision of the compliance of the financialinformation with the IFRS standards is currentlybeing set up in Finland. In spring 2003, theMinistry ofTrade and Industry’s IAS workinggroup proposed that the Financial SupervisionAuthority be responsible for this function.According to the proposal, the FSA could alsorequest opinions from the Finnish AccountingBoard onissues before it.The working groupproposal broadens the supervision of disclosureobligations imposed on listed companies, toinclude the supervision of the accounting issues.The FSA is already responsible for supervision ofaccounting issues in credit institutions andinvestment firms.The preparation of the legislationstarted at the beginning of 2004.Implementation of the International FinancialReporting Standards and related supervision isone part ofthe European Commission’s FinancialServices Action Plan (FSAP), which aims atcreating an efficient and competitive capitalmarket in Europe. In addition to the high levelfinancial reporting standards and monitoring bysupervisors, statutory audit as well as timelyinterpretations and implementation guidance areseen as being part ofanefficient enforcementinfrastructure (Chart 1).The FSA’soperatingstrategy11

6International Financial Reporting Standards emphasise managements’ responsibility forproviding information to investorsImplementation of the International Financial Reporting Standards (IFRS/IAS) is part of the EuropeanCommission’s Action Plan, aimed at creating competitive, efficient and transparent capital markets in Europe by2005. A central prerequisite of which is that companies’ financial reporting is based on high quality accountingstandards, the compliance of which is also supervised.The IFRS/IAS standards highlight the responsibility held by a company’s management when producinginformation for investors. Management is accountable to investors and, in turn, investors make decisions on boththeir holdings and on issues that directly affect management based on the information they receive. Theunderscoring of the responsibilities borne by management is expected to lead to an improvement in companies’corporate governance and to an enhancement in the quality of information issued to the markets.The FSA’soperatingstrategy12FSA aim to intervene in worst casesof business conduct breachesAprerequisite of customer confidence in thefinancial markets is their belief that the financialservice provider’s conduct of business practices issound.The Financial Supervision Authority intervenedin what it identified as bad conduct ofbusiness both using inspection procedures as wellas through its participation in the Advisory Officefor Bank Customer and the Securities ComplaintsBoard.The shortcomings in service providers’conduct of business have not been severe andhave mainly concerned the documentation of theapplication of the ‘Know-Your Customer’ principle(KYC) and the information to be provided tocustomers aswell as some shortfalls in internalcontrol and risk management in investmentservices. More importantly, the FSA was facedwith the fact that there was an increase in theprovision of financial services without the properlicense. In such cases the FSA was incontact withthe home country supervisory authority as well asthe service provider in question.The Securities Complaint Boardisconsidered asplaying asignificant guiding role in the conduct ofbusiness of the financial service providers.TheBoardhas alreadybeen operating forjust over ayear,during whichtime it has made almost 50 recommendationsin response to customer complaints.Focus on importance of neutrality incompetition between financialservices providersArepresentative from the Financial SupervisionAuthority has been actively involved in the socalledSIVAWorking Group, whose objective istopromote alevel playing-field across the financialsector (see page 39).The FSA’s standpoint in theworking group has been that promotion ofcompetitive neutrality and of investor protection,independent of the service provider.The FSA alsotakes the stance that all service providers oughtto meet similar requirements as to information tobe provided to customers. Offering long-termsavings products backed by tax incentives shouldbe allowed, not only tolife insurance companies,but also to banks, fund management companiesand investment firms. Similarly, investors shouldbe given the opportunity to channel these typesof long-term pension savings with the support ofequivalent tax incentives, into not only lifeinsurance but also deposits, fund units and othersecurities and, where sodesired, to change theservice provider they use.

Suspected market abuse inspection –rights of access to information andto hear personsThe Market Abuse Directive iscurrently beingimplemented into Finnish national legislation. It isthe Financial Supervision Authority’s opinion thatthe implementation procedure should be accompaniedby the granting of adequate rights to therespective authorities to have access to informationand to have the right to hear persons, whichwould enable supervisory and investigative workto proceed in aplausible manner.Inits investigativework, the FSA ought to be able to acquiresufficient and adequate evidence and the investigativeprocedure should be brought to apromptconclusion, in order to have apreventative effect.As in earlier years, the FSA took an active rolein investigating suspected cases of market abuse.Of particular concern tothe FSA was the need tomake extensive investigations of suspected abuseof insider information in connection with almostevery take-over bid.PROMOTION OF REGULATORYSYSTEM BASED ON FLEXIBILITY ANDACCOUNTABILITYLegal certainty, proactivity andtransparency as the foundation forregulationsFrom the supervised entities’ perspective itisessential to be able to know inadvance what theFSA expects from asound and cautious businessoperator and on what grounds the supervisoryauthority makes its decisions. For this reason theFSA underlines proactivity,transparency andconsistency in its set of regulations which allserve to the goal of legal certainty for the entitiessupervised by the FSA.The FSA’s ongoing renewalof its set of regulations has been characterised bythe attention paid to the clarity of the regulationsand guidelines being issued and to bringing themas closely aspossible in line with the principleslaid out in similar regulations both within theEuropean Union and more broadly, internationally.The renewal has been used to align soundcorporate governance and the boundaries ofpermissible business activity,toclarify theguidelines steering market practices as well as togo over the principles concerning disclosure andprogress in the comparability of the financialreports produced by the so-called IAS and non-IASbanks.The new capital adequacy frameworkinfluences such processes that allow supervisorsto evaluate the relationship between the supervisedentities’ risk-taking and risk-bearing capacities.Sound risk management procedures andstrategies covering the acquisition of equitycapital are emphasised, in particular.On top of which, the FSA ensures that its ownfindings are established explicitly and consistently.The Authority emphasises continuous dialogueand consultation with the market participants inthe development of the regulations and interpretationof the legislation.The FSA has also adoptedthe so-called statement of response approach,whereby itinforms those concerned of themanner in which the details and issues gatheredhave been taken into account when forming thenew set of regulations and guidelines.Principles behind supervisory powersare clearThe newAct on the Financial SupervisionAuthority came into force atthe beginning of July,bringing with it new supervisory powers.Theseinclude the right to issue public admonitions orwarnings and the right to bar aperson fromacting as board member or managing director of afinancial institution.The FSA was also granted theright to grant or cancel the operating licencesissued to credit institutions, investment firms andpawnbrokers.The Financial Supervision Authority hasplaced emphasis on the principles behind the useof these new powers asmuch asonthe creationof systematic licensing and disciplinary processes.Aparticular priority has been placed on theapplication of these rights within the constraintsof fundamental civil and human rights.FSA has influence on nationalenforcement of EU legislationWithin the European Union, the procedure toestablish anew constitution is currently underway.The aim of the European Constitution is toThe FSA’soperatingstrategy13

simplify the Union’s statutes and separate themfrom legislative power and implementationpowers from each other.The FSA through itsmembership of the European supervisorynetwork has the stated objective ofusing itsinfluence to ensure that the implementation ofregulations under the new European Constitutionmeet national requirements.In particular,the FSA has directed its energiestowards work involved in the development ofdirectives on the securities markets and renewalof capital adequacy requirements. It has alsoplaced emphasis on developing anational systemequivalent to the committology approach totheso-called Lamfalussy process for implementing asecurities market regulatory system (see page 30).The FSA’soperatingstrategy14

4 Operating environment in 2003In the first half of 2003, global economicdevelopments were clouded by various uncertainties,such as the Iraq war and the SARSepidemic. However, economic growth picked upconsiderably from the early autumn, mainlydriven by the improved outlook for the USeconomy. Towards the end of the year growthwas also affected by improved prospects forAsian countries, especially China and India. Asfor the financial sector, the key factor is thesustainability of the US economic growthbecause of the risks still contained in it.US economy grew –uncertaintyabout the sustainability ofgrowth remainedincreased, whereas investment in machinery andequipment had not yet started to recover. Housingconstruction was also seen to increase. Competitivenessin the United States remained robust asthe dollar depreciated, productivity growthstrengthened and unit labour costs decreased.This did not, however, contribute to US exportssignificantly.The main risks to the sustainability of the USeconomic growth stem from the notable fiscaldeficit and employment developments. Jobvacancies increased towards the end of the yearand unemployment rate started to decline. Fiscaland current account deficits worsened during theyear,contributing to aweakening of the dollarand arise in interest rates.Operatingenvironmentin 2003Economic growth in the United States strengthenedmarkedly towards the end of 2003. Growthwas consumption-driven and resulted mainly fromlow interest rates and growth of householdpurchasing power, fuelled by tax reductions. Inaddition, stock price increases strengthenedconsumer confidence in the future and boostedconsumer demand. Industrial production pickedup from June, leading main industrial confidenceindicators toimprove markedly towards the endof the year.Despite signs of recovery,UScorporate investmentremained weak owing to low level ofcapacity utilisation. Investment in ICT technologyEuro area growth still sluggishEuro area economic growth was weak in the firsthalf of 2003, although some signs of recoverycould be seen during the second half of the year.The moderate improvement in economic growthwasreflected in consumer and business indicators.Consumer confidence strengthened onlyslightly,however, and the indicatorsremained at lowlevels.In contrast, somewhat clearer improvement wasobservedinthe business indicatorswith shareprices rising towardsthe end of the year.Private consumption strengthened somewhatat the end of 2003, compared with the previous15

Operatingenvironmentin 200316year.Private consumption has important implicationsfor economic growth since it accountsalmost for 60% of the euro area GDP.Euro areaunemployment remained slightly below 9%in2003.Finland’s economic growth followedworld economic developmentsAs expected, the growth of GDP in Finland wassluggish at the beginning of 2003, owing to weakglobal economic developments reducing exportsand to decreasing investments. Growth improvedslightly during the second half of the year.Exportprices fell markedly during 2003 and, at the sametime, imports remained weak. Companies alsoinvested carefully; investments were mainlydirected at sustaining output, rather than atincreasing capacity.Despite the acceleration in economic growthtowards the end of 2003, employment fell slightly.Unemployment did not increase, however, aspeople left the labour force and became students,for instance. Labour demand in the private sectorwas restricted by low product sales and higherthan-expectedreal wage increases.The laboursupply remained broadly unchanged.Household confidence in their own financialsituation remained high, which supported privateconsumption. Housing demand continued to berobust, driven by low interest rates, stable incomedevelopments and banks’ competition on lendingrates.The increase in house prices moderatedonly slightly from 2002. Household indebtednessrose somewhat in 2003.Industrial production developments weresubdued, largely due to problems faced byexports. Output in the electronics industry continuedto fluctuate significantly, in turn affectingoverall industrial production figures.According tothe Business Outlook Indicator of theConfederation of Finnish Industry and Employers,industrial companies’ business outlook improvedsomewhat in autumn.There were, however, significantdifferences between industrial branches.Corporate lending increased rapidly in2003.However, corporate indebtedness was significantlylower than at the beginning of 1990s.According to the Bank Barometer of the FinnishBankers’Association, banks expect the amount ofcorporate lending to rise further in the nearfuture. In the period between January andNovember 2003, the number of bankruptciesdeclined by 4.2% from the same period ayear ago.Longer-term money market ratesincreased at end-2003Money market rate developments showed anuneven pattern in2003. Short-term money marketrates were higher than longer-term money marketrates at the beginning of the year.Until June, both

short and longer-term money market rates fellsmoothly.The fall came to ahalt in the last half of2003 as aresult of favourable economic outlooks.Short-term money market rates remained broadlyunchanged during the rest of the year,whereasthe longer-term money market rates started torise.The slope of the money market yield curveturned positive inAugust.At the end of 2003, thetwelve-month and three-month Euribor stood at2.305% and 2.124% respectively.Owing to reduced inflationary pressures, theEuropean Central Bank lowered its key interestrates twice during 2003.At the beginning ofMarch they were reduced by 25 basis points to2.50%, and afurther reduction of 50 basis pointsfollowed inJune.After the reduction in June, thekey ECB interest rates remained unchanged at2.00% until the end of the year.Bond yields increased in euro areaand the United StatesAs with money market rates, the developments oflong-term bond yields were also contrasting in theeuro area and the US in 2003. Except for ashortlivedincrease from March to April, ten-year bondyields declined at the beginning of 2003. FromJune onwards long-term interest rates rose, as theglobal economic growth showed signs ofimprovement.At the end of 2003, German tenyeargovernment bond yield, which isused as theeuro area reference, stood at 4.29% and thecomparable US government bond yield at 4.25%(Chart 2).Euro strengthened markedlyagainst the dollar inthe fourth quarter of 2003The euro appreciated significantly against thedollar in 2003, by agood 20%.This was associatedwith market concerns regarding growing US fiscaland current account deficits.The strong exchangerate of the euro weakened corporate pricecompetitiveness in the euro area relative totheUS, which was mainly reflected in sluggishexports.The euro appreciated against theJapanese yen inthe second half of the year inparticular,despite an improved outlook foreconomic growth in Japan. At the end of 2003,the euro stood at USD 1.2630 and JPY 135.05.Fall in share prices came to ahaltbut share turnover declinedAfter three consecutive years offalling shareprices, the expectations of economic recoverypushed share prices upwards on the HelsinkiExchange.The HEX-All-Share Index increased byalmost 5% during 2003.The rise was not as strongas in other world exchanges, since it was dampenedby the fall in the price of Nokia shares.TheOperatingenvironmentin 200317

Operatingenvironmentin 200318HEX-Portfolio Index, in which the weight of anindividual share can amount to 10% at maximum,rose by 16% during the year (Chart 3).The totalmarket capitalisation of Helsinki Exchanges grewto EUR 150 billion in 2003 (EUR 151 billion in2002).Almost all sectoral indices rose in 2003.Themost pronounced increase was experienced bythe media and publishing index, which rose byalmost 70%.The banking and finance index roseby 20%. In contrast, telecommunication andelectronics index fell by few percentages.Despite the share price increases in thesecond half of 2003, the total turnover ontheHelsinki Exchange declined by over one-fifth, tostand at EUR 146 billion, down from EUR 189billion in 2002 (Chart 4).The number of trades inshares declined by almost 10%, but the increase oftrades in warrants kept the trade volume on alevel close to that of 2002.The number of derivativestrades grew somewhat during 2003. Incontrast, trade volumes in Finnish derivatives onEUREX fell by one-third.At the end of 2003, there were 44intermediariesoperating on the Helsinki Exchange (43 atthe end of 2002), 28 (26) of which were remotebrokers. Remote brokers increased their share inthe trading on the Helsinki Exchange. In 2003they accounted for over 50% of the total turnoveron the Exchange.The share ofbanks and investmentfirms belonging to bank groups in the totaltrading on the Exchange was about 20% at end-2002, ie few percentage points higher than in theprevious year.The number of listed companies continued tofall and, at the end of 2003, there were inall 145listed companies on the Helsinki Exchange (149in 2002).As aresult of corporate restructuring,five companies delisted and one company listedon the Exchange. Corporate restructuring saw anew phenomenon in the form of competingpublic bids. Public bids were made for twocompanies.Primary market remained subduedThere were only few initial public offerings andshare issues in 2003 owing to alack offaith inmarket demand.The number of public offeringsdeclined further.Shares were mainly offered tolong-standing shareholders orasaconsiderationas part ofacorporate restructuring package.Public financing was primarily sought via bondmarkets. In terms of volume, central governmentsector was the dominant issuing sector.Thefinancial institution sector was another importantissuer,whereas new corporate bond issuesremained weak.Mutual funds investmentcontinued to growThe volume of capital invested in mutual fundassets increased by 40% to EUR 23.3 billion in2003 (Chart 5).The difference between mutualfund subscriptions and redemptions grew markedlyfrom the previous year,and most of thegrowth of mutual fund assets originated in newsubscriptions. Short-term funds maintained theirattractiveness under the volatile market conditionsprevailing in early 2003. In the autumn,however, new subscriptions shifted towardsequity funds.Supervised entities’ future prospectspositiveFinnish banks were highly resilient during theeconomic slowdown.The profitability and capitaladequacy of the banking sector remained good,and, in spite of the slowdown, loan lossesremained very low.The low level of interest ratescontributed to easing of loan servicing but, on theother hand, reduced banks’ net income fromfinancial operations. Banks’ present share holdingsare quite limited, but fluctuations in share pricesare transmitted to financial conglomeratesthrough share holdings of life insurance companies.Thus,share price increases in 2003 improvedthe profitability of financial conglomerates. Incontrast, at that time, some investment firms werestill unable torecover from the difficult marketsituation.There were still problems in this sector,but they should unwind once the market situationstarts to improve.Supervised entities appear to operate in abrighter environment at the beginning of 2004than ayear ago.There have been signs of improvementin both US and euro area economies. Finnisheconomic growth has also started to follow an

upward trend. Share price developments supportthe view ofaturn inthe business cycle.Thefinancial sector will naturally profit from theeconomic recovery,ascustomers’ debt servingability improves and the demand for financialservices increases during economic upswing.Future prospects for supervised entities can beconsidered positive aslong as economic growthdevelops as expected.According to the European Central Bank(ECB), the EU-area banking sector profitability isgenerally satisfactory. Economic recovery is themain factor affecting bank profitability in thefuture.The expected gradual improvement ineconomic activity also strengthens the EU-areabanking sector.Inaddition, cost control, if continued,would also support banking sectors’ stabilityover the medium and longer term. Over the pastfew years banking sector has seen structuralreforms inthe EU area and especially inGermany.Banks have reduced the number of branches andstaff sizes which has led to amarked improvementin their cost efficiency.Weaker than expected economic growthwould have implications for important incomesources in retail banking.The quality of banks’credit portfolios is not regarded as very problematicin the EU area at the moment. However, somebranches and the rapid growth of householdcredit are still considered to contain risks incertain countries.Operatingenvironmentin 200319

4 SupervisionSupervision20The FSA aims to identify pressures for changeand risks inherent in the financial markets andcontribute to the development of marketstructures and practices supporting stability andconfidence.The FSA seeks to promote the developmentof a culture of corporate governance in thesupervised entities, particularly regarding thefunctioning of control and risk managementsystems. The purpose of the regulatory supervisionis to ensure that the supervised entitiesare professionally managed and that theyoperate according to ethically and professionallyqualitative business principles and practices.PRUDENTIAL SUPERVISIONThe FSA focused its prudential supervisionparticularly onentities of importance to financialstability.The most important risk areas weredetermined on the basis of the new capitaladequacy accord under revision in the BaselCommittee on Banking Supervision and the EU.These risk areas are credit risks, market risks,liquidity risk and operational risks. Risk assessmentwas also more clearly extended to thesupervised entities’ governance and controlfunctions, such asmanagement, organisation andinternal control. On its inspection visits, the FSAstarted to examine how the supervised entitiesdevelop their Capital Adequacy AssessmentProcesses (CAAP), which are processes of significantimportance in the proposed framework forcapital adequacy supervision.The financial status and risks of banks andcredit institutions were monitored and analysedregularly onthe basis of the reports submitted bythe supervised entities.The inspections of thelargest supervised entities focused on management,organisation of internal control and riskmanagement, credit risks, market risks, andbusiness continuity planning. Inspection ofoperational risks was commenced as part oftheinspection of all risk areas and functions. On itsinspection visits, the FSA also examined howbanks had prepared for the changeover tocompliance with the international financialreporting standards (IFRS/IAS).Supervisory information submitted by theSavings Bank Inspectorate was utilised in thesupervision of savings banks. In the supervision oflocal cooperative banks, the FSA not only monitoredthe banks itself but also utilised the supervisoryfindings of the association of local cooperativebanks. Regular discussions between the FSAand the management of supervised entities on thestrategies of the entities were introduced.Thisnew practice makes it easier for the FSA tocommunicate its supervisory goals to the supervisedentities.

Narrow interest rate marginsburdened bank profitabilityDue to the low level of interest rates, there was astrong growth in new bank loans. Housing loansincreased by 14% compared to the previous year.The tight competition for customers kept loanmargins low.Thus the increase in loans did notimprove bank profitability,which largely remainedat 2002 levels.There were nolarge unexpected loan lossesand the recoveries of previous losses were largerthan the new losses incurred. However, during theongoing supervision it was found that banks, intheir competition for customers, occasionally hadlowered their requirement of collateral for loans.The FSA assessed this as an increased risk of loanlosses and athreat against bank profitability in thelonger term. On its inspection visits the FSAcommented on situations where the banks’internal instructions on collateral were inadequatewith respect to the market situation.On average, the relative interest rate risk ofthe banking sector for the year remained at theend-2002 level. Banks were only able topartlyfinance the rapid credit growth with deposits,while part ofitwas financed through issuingcertificates of deposit.Although this caused thebanks no liquidity problems, the FSA considered itnecessary tocheck, in the course of its inspectionvisits, that the internal control of the liquidity riskwas sufficiently well organised in the banks.Investment firms’ income was mainly attributableto fee income, the development of whichwas affected by the turnover and price developmentin the securities market. On average, theincome was atthe 2002 level, but it variedsignificantly from one company toanother.TheFSA monitored investment firms reporting thelowest profitability particularly closely, meaningthat the effects of profitability on the capitaladequacy could be estimated at an early stage.Banks’ risk-bearing capacitystill sufficientThe FSA supervises that the banks’ risk-bearingcapacity is sufficient in relation to their risktaking.The risk-bearing capacity is affected by thebank’s degree ofrisk taking, the quality of the riskmanagement systems, and the capital buffers forcovering the risks.On average, the capital adequacy of thebanking sector remained very good and the capitalbuffers were sufficient in relation to bank risks. 2Similarly, the average capital adequacy ratio ofinvestment firms was also good. However, thecapital adequacy of some investment firmsdeteriorated so much in the unfavourable marketconditions that the FSA required the firms toattend to the situation.Credit risks under controlLoan losses in the banking sector were very lowand nonperforming assets smaller than in theprevious year.Inthe course of the inspectionvisits it was found that the risk for loan lossesfrom corporate loans had increased slightly, butgenerally inindividual fields of activity.Thegrowth in new bank loans focused on housingloans, which generally involve nohigh risk of loanlosses due to the real collateral.The inspections revealed some shortcomingsin the systems for management of credit risks.Thebanks’ risk management systems did not fulfil allrequirements of independent risk control and thecredit granting process was not always clear andcomprehensive. In some banks shortcomings wererevealed in the internal control of credit risks, andthe FSA demanded that theybecorrected.Systems for management ofoperational risks are currentlybeing designedAccording to the proposed new capital adequacyframework,the supervised entities should havecapital to cover their operational risks as well.There are operational risks in nearly all bankingfunctions, such asITsystems, accounting systemsand personnel.Operational risks were found when inspectingcredit and market risks, payment systems, andbusiness continuity plans.The observed riskswere for example deficiencies in internal instructions,in the organisation of risk control and inrisk reduction.They caused the supervised2 In September 2003, the capital adequacy ratio of the bankingsector was 19.9%.Supervision21

6What are operational risks?Operational risks refer to risk of loss resulting from inadequate or failed internal processes, people and systemsor external events. Such losses are not always measurable and some risks can also materialise after a time lag,causing indirect effects, for example through tarnished reputation or less appreciation.By nature, operational risks deviate from credit and market risks. As a rule, they are managed throughminimisation. However, a distinction between different risk areas is not always possible. For example the variousstages of the credit granting and trading processes comprise both operational risks and credit and market risks.Supervision22entities arisk of loss, but they did not lead to anysignificant losses.Although the banks madeincreased efforts tomanage the operational risks,the control of them in the banks is not yet atthelevel required in international standards.Banks report on their riskmanagement more comprehensivelyOnce ayear,the FSA studies how banks report ontheir risks and risk management in their financialstatements. In 2003, the FSA also surveyed howcomprehensively they reported on their corporategovernance systems, that is on their governancestructures, the tasks of their different bodies,the election system for selecting members tothebodies and the bonus and control systems.The FSA survey, which focused on the largestbanks, showed that those banks reported on theirrisk management systems fairly comprehensivelyand that the financial information as awholerepresented European average.The quantity of corporate governanceinformation in the financial statements variedconsiderably.As arule, enough information wasprovided on the operations of the board ofdirectors, but on the other hand the informationon the bonus systems for the top managementwas very scarce. Neither was the information onthe banks’ internal control systems particularlyextensive, except for the risk management.According to the FSA, banks should startproviding more information on corporate governance.TheFSA standards on corporate governanceand sound management currently under preparationwill lay the foundation for abetter provisionof information.The financial information of local cooperativebanks and savings banks improved, because theshortcomings of previous years had beencorrected at the request of the FSA.MARKET SUPERVISIONCode of conductAs one of its tasks, the FSA supervises the code ofconduct of the service suppliers under its supervisionboth in their mutual relations as well as intheir dealing with customers.The code of conductshall comply with laws, international standardsand sound practice.A clear and uniform code ofmarket conduct facilitates the activities of thecounterparties and reduces conflicts. It alsoprovides acommon basis for all service suppliersto pursue their business.In 2003, in its ongoing supervision andinspections, the FSA paid special attention to theadequacy of its supervised entities’ internalcontrol and code of conduct.

Minor flaws in methods of calculatingnet asset value of mutual fundsIn 2003, the FSA inspected the method of calculatingthe net asset value of mutual funds in 12management companies.The purpose wastocheckthe functioning of the net asset value (NAV)calculation.TheFSA also wanted to examine howthemanagement companies ensurethe reliability oftheir NAVcalculation, meaning howthe internalcontrol of the calculation worksinthe companies.The inspections revealed minor flaws ininternal control and methods of NAV calculation.On the basis of its inspection findings, the FSA gavethe management companies recommendationsconcerning internal instructions on the NAVcalculation, the audit trail of the phases of the NAVcalculation, the role of the Board ofDirectors ininternal control, and the correction of errors in theNAV calculation.Preparation for pending changes inthe Mutual Funds ActThe FSA made preparations forthe pending changesin the Mutual Funds Act by meeting representativesof all management companies and examining whatprojects on the amendments of the act the managementcompanies had under way. In cooperation withthe Finnish Association of Mutual Funds aseminar onthe amendments wasarranged forall managementcompanies and other interested parties.Arevision of the reporting on mutual fundswas started in 2003. In the new system, the relevantinformation is automatically transferred from themanagement companies’ own systems to thereporting program.The collected information alsobecomes more comprehensive and satisfactorilymeets the FSA’s,the Bank of Finland’s and StatisticsFinland’s needs for reports in the future.control and, aboveall, the compliance control ininvestment firms.Attention is paid in particular tothe management of risks in corporate governanceand legal compliance of operations.According to preliminaryinformation, investmentfirms’ internal control do not yetfullyfulfil therequirements set by the FSA in its standardonestablishment and maintenance of internal controland risk management. Shortcomings and the needforadditional effort mainlyseem to exist in perceivinghowextensivethe control of operational risksand compliance to internal instructions is and howitshould be taken into consideration.Banks’ conduct in supplyinginvestment services to nonprofessionalinvestors was inspectedIn spring and late autumn an inspection wascarriedout on banks’conduct in supplying investmentservices,in their offices and units,to non-professionalinvestors.The inspection comprised an analysis of themechanisms with whichthe banks trytoensurethatthe investment services aresupplied to customersincompliance with valid legislation and of the setup ofbanks’risk management and internal control from thisviewpoint.The inspection will be continued in 2004.The inspection revealed that, when providinginvestment services, banks comply with the ‘Know-Your-Customer’ principle and the duty to provideinformation to the customer,asspecified in theSecurities Markets Act. In addition, banks haveswitched to computer-based investor and/or riskprofile surveys to ensure auniform practice.However, reason for improvements was foundin the documentation of the application of the’Know-Your-Customer’ principle and the informationto be provided to customers, in the managementof the risks in investment services and ininternal control.SupervisionInvestment firms’ internal control wassurveyedNumber of written requests forinvestigation continued to fallIn aseparate enquiry, the FSA surveyedinvestmentfirms’ internal control and system forcontrol of legalcompliance and compliance to internal instructions.3 The enquirywill be followedbyindividualinspection visits in 2004.The goal of the enquiryandinspections is to examine the levelofthe internalThe number of written requests for investigationreceived by the FSA fell clearly and amounted to a3 Inthe compliance control, attention should be paid to that externalrules and appropriate methods are complied with internally and incustomer relations. The control shall be reliable and independent.23

6The Advisory Ofce for Bank Customers and the Securities Complaint BoardThe services of the Advisory Office for Bank Customers are accessible to private and small corporate customers in questionsconcerning banking activities. Advice is provided for example on the interpretation of agreements between the bank and itscustomers. The Advisory Office also provides information on the contents of the banking legislation, the application of terms ofagreement, and other matters of banking practice. The Advisory Office’s services are provided to customers free of charge.The Securities Complaint Board gives recommendations on decisions in disagreements about security investments. It givesadvice and assistance in questions concerning the contents of the securities markets legislation and related official regulationsand the application of terms of agreement, sound securities trading practice, and other securities-related topics. The service isfree of charge and it is available to all non-professional investors that are customers of any bank, investment firm or managementcompany providing investment or fund services.The Advisory Office for Bank Customers was established by the Consumer Agency, the Finnish Bankers’ Association and theFSA. The Securities Complaint Board was set up by the FSA, the Finnish Bankers’ Association, the Finnish Association ofSecurities Dealers, the Finnish Association of Mutual Funds and the Finnish Shareholders’ Association.Advisory Office for Bank Customers, Museokatu 8 A 7, 00100 HelsinkiOpen Mon–Fri 9am–2pm, Tel. +358 9 4056 1230, Fax +358 9 4056 1235E-mail: pankkialan.asiakasneuvonta@rahoitusalankl.fiThe Securities Complaint Board, Museokatu 8 A 7, 00100 Helsinki, Tel. +358 9 4056 1230, www.arvopaperiltk.net/engSupervisiontotal of100 (177 in 2002). Of the requests 91 (167in 2002) concerned credit institution activitiesand 9(10 in 2002) securities markets activities.The customer complaints focused on deposits,insurance savings and insurance investments.In the area of securities markets activities, themajor customer complaints concerned domesticand foreign service providers’ illicit service supply.Telephone enquiries on the operations ofcredit institutions were mostly directed to theAdvisory Office for Bank Customers, whichdecreased the number of calls received by theFSA.The Advisory Office was approached 2,084times (2,208 in 2002). Most of the approachesconcerned use of accounts, payments and loans.FSA commented on bank marketingOn several occasions during the year the FSAcommented on the marketing undertaken bysome banks.The FSA requested the banks tocomply with an appropriate code of conduct forexample in their marketing of insurance productsand mutual fund units, in the use of the bank’sname in the marketing, and in the transfer ofcustomers from one bank to another.The basis for calculating exchange rates inforeign currency purchases and withdrawals wasalso commented on.The transactions in questionhad been made using payment and credit cards.The FSA recommended that the basis for calculatingexchange rates be specified in the banks’payment card agreements and marketing material.The consumer ombudsman also commented onthe same matter.In its ongoing supervision, the FSA emphasisedthe importance of auniform and detailedcode of conduct concerning customer identificationand Know-Your-Customer awareness. Such acode is necessary for example for assignment ofweb login credentials and for the increasinglycommon telephone services of various kinds.TheFSA continues to monitor the situation.MARKETPLACES ANDMARKET SYSTEMS24Inspections of payment and IT systems focusedon the domestic payment systems of the mostimportant banks and on their business continuityplans. In late 2003, the foreign exchange settlementrisks in the largest banks were inspected.Cooperation with the Bank of Finland in oversightand supervision of payment and settlementsystems continued according to adopted practice.No significant risks or deficiencies indomestic paymentsIn 2003, the FSA reinspected banks’ domesticpayment systems, which had previously beeninspected 3-4 years earlier.The purpose was to

gain an idea of what measures the banks hadtaken with regard tothe admonitions arisen outof the previous inspection, particularly concerningrisk management, internal control and continuityplanning. In addition, the division of responsibilitiesand activities between the banks’ differentdepartments was checked.The FSA alsoinspected banks’ monitoring of covering funds incustomers’ payment accounts and how banksmanage the risks in those payment accounts thathave no intraday monitoring.The inspections revealed some relativelyinsignificant deficiencies in banks’ paymentsystems, in their management of risks in paymenttransfer,their continuity plans and practicalinternal control.The banks were requested toremedy these deficiencies before specifieddeadlines.They were also requested to conductregular tests and drills based on their continuityplans for the various departments. For managingthe risks arising from not monitoring coveringfunds in customers’ payment accounts, the banksused intraday limits.Continuity planning increasinglyimportant in the banksIn 2003, the FSA continued its series of inspectionsof banks’ continuity planning, begun in late autumn2002.The purpose wastoexamine the banks’organisation, general principles and process forpreparing their business continuity plans as well astheir IT system recovery planning. In addition, thecontinuity plans established forsome of the mostimportant business areas were also inspected.The inspections revealed that banks haveincreased their efforts incontinuity planning withplanning projects being established as well ascontinuity plans being updated. However, thework was not yet completed. Deficiencies werefound in the coordination of the continuityplanning and in carrying out tests and drillsconcerning individual continuity plans. In addition,it was noted that some continuity plansshould be more detailed and steer the operationsmore accurately inpossible disruptive situations.In the course of the inspections, the FSA emphasisedthat the continuity planning should not belooked upon as anon-recurrent project but as anongoing process.Banks’ foreign exchange settlementrisks have decreasedIn late 2003, the FSA conducted follow-up inspectionsof the foreign exchange settlement risks inthe four largest banks.The purpose was toexamine how the banks had changed theirdefinition, measurement, systems for and monitoringof settlement risks since the previous inspectionsand to what extent the banks had been ableto reduce their settlement risks and lower thelimits reducing them. Earlier correspondinginspections had been carried out in 1997 and2000.The inspections are part ofthe commoninternational efforts ofcentral banks and supervisoryauthorities to decrease the FX settlementrisks and thus the danger of systemic risk in thefinancial markets.The inspections revealed that the banks,through measures of their own, had reduced theirFX settlement risks considerably.Inaddition, twoof the banks use the settlement service of theinternational CLS Bank (Continuous LinkedSettlement Bank). Settlement risks are expected tocontinue to decrease with the growing use of theservices of the CLS Bank and the increased supplyof settlement currencies.Integration of OM and HEX closelymonitoredThe FSA closelymonitored the progress of theintegration of the OMHEX group.The purpose wasto ensurethat the necessaryconditions forsupervisionalso remain in the newgroup structure.Introduction of the new HEXClearsecurities clearing and settlementsystemIn November-December HEX switched to the newHEXClear system for clearing and settlement ofsecurities.At the same time it was aswitch fromsettlement once aday to anew system where thetransactions can be settled both through real-timegross settlement and through batch settlement.The introduction of the new clearing and settlementsystem reduced the settlement risks significantly,because in the new system the FinnishCentral Securities Depository (APK) is no longerSupervision25

Supervision26responsible for the net payments of the transactionsor,for that matter,for the security deliveries.The FSA supervised the development andintroduction of the new system both in the APKand through inspection visits at the participantsof the system.The postponement of the introductionfrom the original time in spring 2003 to theautumn gave the participants enough time toprepare themselves for the new system.Thechangeover went without major disturbances.MARKETSIncreased number of suspected casesof abuse of insider informationIn 2003, the FSA investigated 57 (65 in 2002)suspected cases of abuse or negligence in thesecurities market sector.Ofthem, 28 (24) weresuspected cases of abuse of insider information,11 (11) suspected manipulations and 18 (30)suspected cases of negligence of the disclosureobligations. Based on these investigations, 7(6)requests for investigation were submitted to thepolice and 10 (13) informal admonition letterssent off (see Chart 6and Table 1).As compared to previous years, an increasednumber of suspected cases of abuse of insiderinformation occurred in2003. Partly this was dueto the increased number of public bids. Severalbids were preceded by price hikes and raisedvolumes before the bid was published, whichindicates use of unpublished information.Due to the increased market share ofremotebrokers and the increased number of systems fororder routing, 4 the FSA increasingly had to turnto foreign authorities to gain information on thebeneficial owners inthe transactions.The FSAsubmitted 14 requests for judicial assistance toforeign authorities. Sometimes these requestscould form long chains, as in some cases additionalintermediaries in athird oreven fourthcountry could be revealed behind the first foreigncounterparty.These requests for foreign assistanceextended the investigation times.The number ofinvestigated cases of disclosure ofinformation onlisted companies was slightly smaller.The significance of international cooperationin the supervision of securities trading and disclosureobligationsconcerning listed companies hasincreased.An efficient investigation of marketabuse requires official cross-border cooperation.Variations in listed companies’preparedness for internationalfinancial reporting standardsIn spring 2003, the FSA surveyedhow listedcompanies were preparing to commence applying4 Order routing is a technical system, in which the investors’ electronicorders are automatically transferred via the intermediary’ssystem to the trading system of the stock exchange.

Table 2.The main laws for which compliance is supervised by the FSACredit Institutions Act (30.12.1993/1607, Ra 107)Act on Commercial Banks and other Limited Liability Credit Institutions (28.12.2001/1501, Ra 108)Savings Bank Act (28.12.2001/1502, Ra 109)Act on Cooperative Banks and other Cooperative Credit Institutions (28.12.2001/1504, Ra 110)Act on Foreign Credit and Financial Institutions in Finland (30.12.1993/1608, Ra 112)Mortgage Bank Act (27.12.1999/1240, Ra 112 a)Act on Mortgage Societies (8.12.1978/936, Ra 113)Securities Markets Act (26.5.1989/495, Ra 116)Act on Trading in Standardised Options and Futures (26.8.1988/772, Ra 117)Mutual Funds Act (29.1.1999/48, Ra 118)Investment Firms Act (27.7.1996/579, Ra 119)Act on Foreign Investment Firms’ Right to Provide Investment Services in Finland (26.7.1996/580, Ra 119 a)Act on the Book Entry System (17.5.1991/826, Ra 120)Act on the Book Entry Accounts (17.5.1991/827, Ra 122)Act on the Supervision of Finance and Insurance Conglomerates (25.1.2002/44, RA 115); joint supervisionwith the Insurance Supervision AuthorityPawnshops Act (18.12.1992/1353, Yr 204)Act on the Prevention and Detection of Money Laundering (30.1.1998/68, Ri 308); burden of responsibility with supervision entitySource: Financial Supervision Authority.the IFRS/IAS standards.The purpose of the surveywastoget ageneral viewofhow the companiespreparefor the transition to the standards andwhat problems possibly adheretothe implementationand application of the standards.According to the survey, some listed companiesplan to switch toIFRS/IAS-based reportingearlier than requested. However, most of thecompanies have informed that they will preparetheir first IFRS/IAS financial statements for 2005.Small listed companies with aturnover belowEUR 100 million had started to prepare theirchangeover plans and thus embarked on theirprojects quite recently, while the projects of largelisted companies had progressed further.Theanswers revealed that the companies postponedacquainting themselves with the standardsbecause they were not completely updated.Listed companies’ interim reportsbasically satisfactory –informationessential to investors could be improvedThe FSA also surveyed how listed companies fulfilthe requirements of regular reporting.The surveycomprised 32 listed companies’ interim reportsfor the period 1January 2002 –31March 2003. Itgave an assessment of how well the reportsfulfilled the requirements on the contents of thereporting. In particular,the survey focused on theexplanatory statement of the reports and on howwell the information provided by listed companiesfulfil the needs of the investors for data fordecision-making.According to the results of the survey, theinterim reports mostlyfulfil the requirements onregular reporting fairlywell,but the rationale behindthe information disclosed should be moreextensive.As arule, the information on the division ofthe turnover was comprehensive and up to date.Most companies provided quite alot of informationon the division of operations between theirdifferent units.The companies’ description oftheir financial status fulfilled the official requirementsin several cases, but for example thestructure oftheir cash flow and related factorshad not been analysed very clearly.Most companies had sought to analyse theirprospects, but there were obvious deficiencies inthe rationale behind the estimates.The companiesshould try toprovide amore exhaustive descriptionof the changes in their environment and thefactors affecting their profitability.Inpractice, theinterim reports contain no comments at all onbusiness risks.Although there are no officialrequirements on the disclosure ofsuch informationin the interim reports, as opposed to therequirements on prospectuses, the FSA considerssuch information significant to the investors.Supervision27

4 International activitiesInternationalactivities28International cooperation in the field of EUfinancial market supervision and regulation isbecoming increasingly important. The need forcommon regulatory frameworks, a code ofconduct for supervision and the exchange ofinformation is growing all the time.Pressure for international harmonisation ofsupervision and regulation stems from threesources. First, the supervision and regulation offinancial companies and conglomerates, whichhave come into being as aresult of cross-borderand cross-sector mergers, poses growing challengesto supervisory authorities, calling forclosely targeted cooperation. This is true today forexample of financial conglomerates and will, inthe future, also be true of European companies.Second, the aim is to make it easier forinvestors and customers to benefit from theprovision of financial services on an EU-wide basis.This, however, calls for harmonised codes ofbusiness conduct in the context of cross-bordertrading and in the provision of investment andbanking services. The long-term objective shouldbe to harmonise consumer and investor protectionas well as deposit guarantee schemesthroughout the EU, to the extent possible.Third, a common regulatory and supervisoryframework is a prerequisite for the existence ofan effective level playing field for all financialinstitutions, providers of investment services andissuers of securities throughout the EuropeanUnion. Regulatory arbitrage, which means thatfinancial companies move their businesses tocountries with less stringent supervision andregulation, should, however, be kept to aminimum at the same time.Principles for internationalcooperationThe principles for international cooperation wereadopted by the board ofthe Financial SupervisionAuthority (FSA) in November (see page 33).In accordance with the guidelines of theboard, the FSA will focus in particular onEuropean cooperation. In the field of bankingsupervision, it takes part inthe work of theEuropean System of Central Banks (ESCB) withinthe framework of the Banking SupervisionCommittee (BSC). It also contributes to theGroupe de Contact, the body for cooperationbetween the banking supervisory authorities ofthe EEA countries, and to the Committee ofEuropean Banking Supervisors (CEBS) thatcommenced operations at the beginning of 2004.In the supervision of securities markets, theFSA is represented on the Committee of EuropeanSecurities Regulators (CESR).The Member States of the European Unionalso cooperate in the working groups of theEuropean Council and the European Commission.Furthermore, the FSA is involved in the work of

the Money Laundering Contact Committee of theEuropean Commission, attends the meetings ofthe Financial Action Task Force onMoneyLaundering (FATF) and participates in the work ofthe FATF Committee for Finland. In addition to theEuropean Union, other cooperation partners ofmajor importance to the FSA include theInternational Monetary Fund, the World Bank, theBank for International Settlements, the BaselCommittee on Banking Supervision and theInternational Organisation of SecuritiesCommissions (IOSCO).Commission proposals for moreeffective EU financial regulation andsupervisionIn the European Commission’smost recentassessment of November 2003, the objectiveoftheEuropean Council to have all the projects of theFinancial Services Action Plan (FSAP) completed bythe end of 2005 will be achievedaccording to plan.However, because of the interruption caused bythe European parliamentaryelection, it is welladvised to complete all pending projects in April2004, ie beforethe election.The aim of the EU is to harmonise financialsupervision and regulation and to develop EUlegislation towards greater flexibility.For thisreason, it has been proposed that the Lamfalussymodel be extended to banking and insurance inaccordance with the example set by the regulationand supervision of securities markets. InNovember 2003, the European Commission issuedaproposal for measures extending the Lamfalussyprocess to the entire financial sector.The proposalsare largely based on the report 5 prepared bythe EU’s Economic and Financial Committee(EFC) at the request of Ecofin.The report proposes the establishment of twonew committees of supervisors. One of them, theCommittee of European Insurance andOccupational Pensions Supervisors (CEIOPS),started work towards the end of November 2003,whereas the other new committee, theCommittee of European Banking Supervisors(CEBS), commenced operations at the beginningof 2004. Both new committees are level three5 EFC report on nancial regulation, supervision and stability, 28November 2002.committees, ie of the same level asthe Committeeof European Securities Regulators (CESR).Next step for EU: global integrationof financial marketsWithin the EU,the focus has so farbeen on theharmonisation of regulation and supervision in theEU area and the creation of asingle market.Thefollowing step will be to encourageglobal integration,whichmeansthe emergence of aglobalfinancial market and greater harmonisation ofsupervisoryand regulatorypractices across theworld.The FSA contributes to the work of the globalgroups through direct involvement,as well asindirectlythrough the EU.Although the FSA,eitherbecause of membership restrictions or lackofresources,cannot participate directlyinthe activitiesof all these fora,itnevertheless endeavourstoobserve,inits activities,the standards and recommendationsadopted by the international community.Work of committees in the field ofbanking supervision and regulationIn 2003, the main area of responsibility of theBanking Advisory Committee (BAC) was therevision of the capital adequacy frameworkapplicable tocredit institutions and investmentfirms.Another major task was the work on thefinancial reporting regulations applicable tocreditinstitutions.The FSA participated in the work ofthe Banking Advisory Committee, together withthe Bank of Finland and the Ministry ofFinance.The BAC assists the European Commission in thepreparation of EU legislation on financial institutionsand provides advice and guidance on othermatters related to EU banking regulation andsupervision.The FSA also, together with the Bank ofFinland, takes part inthe work of the BankingSupervision Committee (BSC) of the ESCB. One ofthe key responsibilities of the Committee was toanalyse the trends in the financial system andbanking sector stability.The European Central Bankpublished two reports on banking sector stability 6prepared by the BSC.The reports assess the6 EU banking sector stability, 24 February 2003 and 19 November2003.Internationalactivities29

6Other proposals from the European CommissionThe European Commission has proposed that the current Banking Advisory Committee (BAC) be replaced withthe European Banking Committee (EBC), which would be a level two regulatory committee.The Commission also proposes the transfer of matters concerning the supervision and regulation of mutualfunds to the European Securities Committee (ESC) and the Committee of European Securities Regulators (CESR).These issues are currently dealt with by the UCITS Contact Committee.Internationalactivities6The Lamfalussy process explainedWithin the EU the aim has been to reform regulation and supervision of financial markets in line with theapproach proposed by the Committee of Wise Men. This approach is also referred to as the Lamfalussy model.The proposed reforms are designed to intensify and speed up the preparation and application of EU regulationin the context of financial market issues, strengthen supervisory practices in EU financial markets and promotethe harmonisation of supervisory and regulatory practices within the EU. To ensure greater transparency,extensive consultation of market participants should be undertaken in the course of the various preparatorystages of EU legislation.In keeping with the four-level approach of the Lamfalussy process, the EU’s primary legislation, ie Directivesand Regulations, should focus on key provisions only (Level 1), whereas more detailed technical implementingmeasures would be adopted through the commitology procedure (Level 2). The various committees of regulatorsand supervisors assist the Commission with proposals for implementing measures. Supervisory authorities shouldupgrade cooperation and issue common administrative guidelines, recommendations for interpretation andstandards to achieve greater harmonisation of supervisory measures (Level 3). Level 4 concerns the monitoring ofcompliance with EU legislation, which is the responsibility of the European Commission, in particular.An evaluation of the effectiveness of the Lamfalussy process is undertaken by the Inter-InstitutionalMonitoring Committee, which includes experts nominated by the European Commission, the European Counciland the European Parliament. It will publish its report in 2004.30

financial position and risk bearing capacity of theEU banking sector.Another important achievement of theBanking Supervision Committee wasthe conclusionof aMemorandum of Understanding (MoU)on high-levelprinciples of cooperation in crisismanagement situations between the bankingsupervisorsand central banks of the EuropeanUnion at the beginning of March 2003.Thecooperation is aimed at pursuing the commonobjectiveofbanking supervisorsand central banksof ensuring the stability of the financial system.TheMoU sets out the principles and procedures forcross-border cooperation between bankingsupervisorsand central banks in crisis situations.These principles concernegthe identification ofthe authorities responsible forcrisis management,the exchangeofinformation between the authoritiesinvolved and the practical conditions forsharing information at the cross-border level.TheMoU is not apublic document.In 2003, Groupe de Contact, the unofficialbodyfor cooperation between the bankingsupervisoryauthorities of the EEA countries,prepared coreprinciples forsupervision in thecontext of the revision of the EU capital adequacyframework.The FSA participated in the group’swork.The mission of Groupe de Contact is topromote cooperation and the exchangeofinformationbetween banking supervisors. Comparisons ofnational supervisorypractices and workingmethods areundertaken with aviewtoharmonisingbanking supervisorypractices between EEAmember states. In recent years, Groupe de Contacthas increasinglyassumed the role of formulator ofsupervisoryprinciples and best practices in thefield of supervision.Within the neworganisationalstructureofEUbanking supervision built upon theLamfalussy process, Groupe de Contact will besubordinate to the Committee of EuropeanBanking Supervisors(CEBS).First implementing measures undercommitology procedure adopted byEuropean Securities CommitteeIn the course of autumn 2003, the EuropeanSecurities Committee (ESC) adopted part ofthetechnical implementing measures under theMarket Abuse Directive (MAD) and the ProspectusDirective inthe form of Commission Directivesand aCommission Regulation.The Committee ofEuropean Securities Regulators (CESR) advisedthe Commission on the drafting of the proposalsby issuing their substantiated opinions on areas ofregulation.The work of the Committee ofEuropean Securities Regulators isessentiallycharacterised by transparency and consultationwith various market participants during variousstages ofthe work.Transparency is aimed at byproviding for rounds of consultation and hearingsand by setting up ConsultativeWorking Groupsconsisting of professional market participantswith special expertise in the areas concerned.The detailed provisions issued on the basis ofthe Market Abuse Directive relate to the definitionsof inside information and market manipulation,the issuer’s obligation to disclose insideinformation, the requirements concerning theproduction and dissemination of investmentanalyses and the safe harbour provisions applicabletoshare buy back programmes for own sharesand stabilisation of financial instruments.Theadvice of CESR on the Prospectus Directive were,in turn, related to the content requirements for aprospectus, the format of aprospectus, publicationand availability,the information that can beincorporated by reference into aprospectus, themethod of publication of the annual document,and advertising of securities being issued oradmitted to public trading in aregulated market.Discussion of the EU Investment ServicesDirective (ISD) continued in the EU Council andParliament.The Directive will contain anumber ofareas which are subject to implementing measuresunder the commitology procedure. Inpreparation of the consultation procedure, theCommittee of European Securities Regulators(CESR) set up three working groups.TheIntermediaries Group concentrates on theorganisation of the activities of investmentservices providers and the code of businessconduct applicable tothe provision of theseservices.The Markets Group focuses on tradingand the requirements for admitting securities totrading on aregulated market.The Cooperationand Enforcement Group addresses cooperationbetween the authorities and the reporting ofsecurities transactions to the authorities.Themandate given bythe Commission to CESR inInternationalactivities31

Internationalactivities32early 2004 sets out the key contents of theassignments of the various working groups andthe deadline for consultations.In the course of autumn 2003, public consultationswere launched on the proposals of thejoint working group of the Committee ofEuropean Securities Regulators and the EuropeanCentral Bank on standards for securities clearingand settlement systems in the European Union.The work is based on the recommendations ofthe BIS Committee on Payment and SettlementSystems and the International Organisation ofSecurities Commissions (IOSCO), which aredesigned to minimise systemic risk and ensuresecure clearing and settlement. Respondents paidspecial attention to the working group’s proposalto expand the scope of application of the recommendationsbeyond clearinghouses to alsoinclude major custodian banks, with aview toensuring alevel playing field.In addition to the consultation procedure,CESR also engages insupervisory cooperationwithin the framework of two permanent committees,CESR-Pol and CESR-Fin. In the year,CESR-Polfocused on the formulation and harmonisation ofprocedures in the context of cross-border informationflow requests and joint investigations.Other responsibilities of the working groupincluded revision of the multilateral Memorandumof Understanding (MoU), definition of uniforminvestigation criteria, development of supervisorypractices for on-line securities transactions, andrelations with non-cooperative states.The workinggroup focused special attention on the challengesposed by the European Convention of HumanRights to securities market supervision.A decisionwas taken to start toexchange information onpending cases.CESR-Fin,inturn, coordinates the cooperationof supervisoryauthorities in the enforcement oflisted companies’ financial statements, interimreports and other financial reporting.The aim is todesign common enforcement principles that willbe observedbyall the member organisations ofthe Committee of European Securities Regulatorsas well by other supervisoryauthorities. Closercooperation between supervisoryauthorities iswarranted as the introduction of harmonised IFRS/IAS financial reporting standards requires consistentsupervisorydecisions and actions by Europeansupervisors.This servestopromote uniformapplication of international financial reportingstandards by listed companies and to prevent theemergence of national interpretations.The enforcementprinciples areset out in the standards issuedby the Committee of European SecuritiesRegulators. Enhancement of the enforcement offinancial information standards is also closelyrelated to the standardsetting process.Amongother things, CESR-Fin comments on the draftstandards of the IASB (International AccountingStandards Board) from the perspectiveoftheEuropean securities markets, seeking to influencethe contents of the standards to ensurethat thefinancial reporting standards that will be in use inEurope as of 2005 will be of as high quality aspossible, giving due consideration to investors.Committee of European SecuritiesRegulators reviews implementationof its recommendationsIn order to ensure effective financial marketswithin the EU it is vital that the necessary provisionshave been implemented by all MemberStates and that the supervisory authorities ofindividual member states apply the same proceduresand evaluation principles in their activities.The European Commission bears primary responsibilityfor the enforcement of EU legislation.However, CESR plays an important role in ensuringappropriate harmonisation of the practices ofsupervisory authorities. CESR also prepares andadopts recommendations of its own, the harmonisedcompliance with which byall memberstates is necessary.CESR set up apanel to review the implementationand degree ofharmonisation of regulationsacross member states.The review panel is chairedby Kaarlo Jännäri, Director General of the FSA.Thefirst tasks undertaken by the panel were reviewsof the Standards forAlternativeTrading Systems(ATS) adopted by the Committee as well as ofcompliance with the Standards for the EuropeanRegime of Investor Protection.The panel agreedon uniform review principles.The results, whichare based on self-assessment undertaken by eachmember of CESR, will be published on theCommittee’s website in early 2004.

6The Financial Supervision Authority’s principles for international cooperationUnder section 10, paragraph 3, of the Act on the Financial Supervision Authority, the Board shall decide on theprinciples to be employed by the Financial Supervision Authority (FSA) in international cooperation. In keeping withthe opinion of the Economic Committee of Parliament, the provision shall be applied so that the Board decides on thegeneral principles to be employed by the FSA in the preparation of EU regulations and in any other internationalcooperation in which coordinated preparations across the relevant authorities is necessary for Finland to be able toexercise an active influence (Economic Committee Report 27/2002).International cooperation of the Financial Supervision Authority (FSA) here refers to the FSA’s involvement ininternational bodies and other international cooperation in the field of financial market supervision and regulation.The FSA engages in international cooperation as an independent and impartial supervisory authority. The FSA’sDirector General or a person appointed by him represents the FSA in international bodies.The Director General informs the Board of matters that have surfaced in the context of international cooperationand refers the strategic directions on international cooperation, as well as other major principle guidelines, for reviewby the Board.The principles for international cooperation are based on the FSA’s strategic directions on supervision andregulation adopted by the Board by virtue of section 10, paragraph 1 of the Act on the Financial Supervision Authority.Accordingly, the following objectives of international cooperation apply:Regional prioritisation– The FSA prioritises supervisory and regulatory cooperation at European and Nordic levels.– The FSA also contributes to the development of a global financial market through its involvement in selectedsupervisory and regulatory projects (eg IASB, FATF, Basel Committee on Banking Supervision and IOSCO).InternationalactivitiesAn integrated EU: towards effective nancial markets– The FSA seeks to actively promote harmonisation of supervision, regulation and the code of market conductacross the European Economic Area.– The FSA supports the efforts to provide investors with more effective and secure investment outlets in atransparent market and to improve European companies’ prospects for raising capital.– In its capacity as national supervisory authority and member of the EU network of supervisory authorities,the FSA promotes financial stability within the EU and sustained confidence in the operation of EU financialmarkets.Finnish nancial markets: a competitive part of the EU– The FSA promotes the efficiency of Finnish financial markets, with a view to ensuring that Finnish financialmarkets are a competitive part of the EU single market.– The FSA promotes legal certainty and a clear code of market conduct in Finnish financial markets within theframework of European integration.– The FSA seeks to contribute to a level playing field in the national implementation of EU supervisory andregulatory principles.– The FSA contributes to ensuring that the special characteristics of Finnish financial markets and legislation arerecognized in the formulation of EU supervisory and regulatory principles.Organisation of EU supervision– The FSA supports the efforts to enhance EU financial market supervision and the organisational structure ofsupervision towards greater efficiency.– The FSA fosters the debate on the adequacy of the principle of home country supervision.Continues on the following page.33

6Crisis prevention and management– In cooperation with other authorities, the FSA promotes the formulation of clear principles of crisis preventionand management and a clearer division of responsibilities at EU level, with particular focus on the Nordiccountries.Cooperation with other authorities– The FSA maintains active, effective and synergetic relations with other Finnish authorities. Major cooperationpartners include the Ministry of Finance, the Ministry of Social Affairs and Health, the Ministry of Justice, theMinistry of Trade and Industry, the Bank of Finland and the Insurance Supervisory Authority, in particular.– In the context of international cooperation, the FSA contributes to ensuring adequate advance preparations andmaintaining an open flow of information between the national authorities. The FSA puts forward its ownopinions actively and at as early a stage of domestic preparation of national and EU regulations as possible toensure that Parliament and the Council of State will be able to consider them in their legislative work.Openness– The FSA promotes the openness of the EU regulatory process and regulatory guidelines.– In its involvement in the drafting of new regulations within the EU network of supervisory authorities, the FSAseeks to ensure broad consultation.InternationalactivitiesInuence– The FSA seeks to actively advocate its competence and experience (eg in the context of cross-border supervision),particularly in the various EU committees of supervisors.– The FSA supports the secondment of its own experts to EU bodies and for other international supervisory andregulatory duties.– The FSA maintains an effective dialogue with key committees of the Finnish and European Parliaments.– In the field of training cooperation, the FSA focuses on cooperation with neighbouring areas. Trainingcooperation is adjusted to the financial resources available.34

4 RegulationThe Financial Supervision Authority’s (FSA)objective is to promote a regulatory frameworkbased on flexibility and accountability. Thismeans that the FSA’s approach to regulation isthat of regulatory principles rather thandetailed rules and that a binding regulatoryframework is supplemented by proceduralguidelines and instructions for application.Regulation based on flexibility and accountabilityalso highlights the following aspects:– Supervisory powers enable the exercise ofdiscretion by the supervisor within the limitsof generally recognised rules of conduct.– The exercise of powers by the supervisor iscredible.– The supervisor is accountable for its actionsboth vis-à-vis legislators and the supervisedentities and the markets. This calls for transparency,predictabilityand legal certainty inthe activities pursued by the supervisor.The FSA supports the EU’s objectives ofincreased flexibility in legislation, more rapidresponse in the drafting of legislation andimproved enforcement coordination. The FSArecognises these objectives, as broadly aspossible, in its own regulatory activities. It alsomakes an active contribution to the harmonisationof legislation, supervision and proceduresat EU level.Regulation by the FSA is closely integratedwith international supervisory and regulatoryprinciples. The FSA’s set of regulations, which iscurrently under review, serves both as a regulatorytool and as a supervisory tool. In 2003,three standards were issued under the new setof regulations. These standards concern organisationof internal control and risk management,supervision of financial and insurance conglomeratesas well as reporting of large exposuresand risk concentrations.The new Act on the Financial SupervisionAuthority (FSA Act) became effective in earlyJuly 2003. The Act extended the FSA’s powers,entitling the FSA, for example, to imposeadministrative sanctions, such as public admonitionsand warnings, on supervised entities andother financial market participants defined inthe Act.DISCLOSURE REQUIREMENTSEasier access to capital within the EUThe new‘Prospectus Directive’ that entered intoforce inDecember 2003 7 facilitates access tocapital in the EU as awhole and also lowers thecosts incurredbyissuersand offerors of securities.7 Directive (2003/71/EC) of the European Parliament and of theCouncil of 4 November 2003 on the prospectus to be publishedwhen securities are offered to the public or admitted to tradingand amending Directive 2001/34/EC. The changes required underthe Directive must be implemented in national legislation no laterthan June 2005.Regulation35

6New FSA Act effective on 1 July 2003The new Act on the Financial Supervision Authority that entered into force in early July was instrumental inenhancing the accountability and transparency of the FSA’s activities by incorporating a provision on theobjectives of the FSA’s operations, by extending the role of the Parliamentary Supervisory Council as thesupervisor of the FSA’s operations and by clarifying the FSA’s governance and management system. In addition,the FSA was entrusted with new powers.Objective of the FSA’s activities:– The objective of the FSA’s activities is to promote financial stability and public confidence in the operationof financial markets.Role of the Parliamentary Supervisory Council:– The Parliamentary Supervisory Council supervises the overall appropriateness and efficiency of the FSA’soperations.– The Parliamentary Supervisory Council assesses how the FSA has managed to meet its statutory objectivesand how its staff levels and budgets have evolved in relation to its tasks and changes caused by legislativeand market developments.– The main supervisory tools available to the Supervisory Council are the FSA’s annual report and the Board’sreport on the objectives set for the activities of the FSA and their achievement.RegulationGovernance and management system:– The Board has overall policy and supervisory responsibility for the FSA’s operations. It decides, for example,on the FSA’s long-term stance of operations and objectives, and the principles for international activities.– The operations of the FSA are managed by the Director General. He is responsible for an efficient andappropriate discharge of duties devolving on the FSA, in accordance with Board instructions.– The Board deals with matters on the exercise of new powers prior to final decision by the DirectorGeneral.The FSA has powers to·– grant, restrict and annul licences;– impose public admonitions and warnings;– prohibit a person from acting as a board member, deputy member, managing director or deputymanaging director;– order a prohibition on revealing any ongoing investigation.In addition, the FSA has more extensive powers than before to perform inspections and obtain information.36

The purpose of the Directive istoharmoniserequirements for the prospectus to be publishedwhen securities are offered to the public or admittedto trading and to facilitate securities offeringsin across-border context within the EU.Aprospectus approved in asingle EUMember State allows future offering of securitiesin the EU as awhole, without an obligation toapply for separate approval of the prospectus ineach Member State.The costs to the issuer orofferor are also thereby lowered by the fact thatin cross-border offerings it will be possible to usean English-language prospectus with asummaryof the prospectus translated into the language ofthe relevant country. Moreover, the opportunity toincorporate information in the prospectus byreferring to one or more previously orsimultaneouslypublished documents (incorporation byreference) lowers the costs of raising capital.From the point of view ofinvestors, aprospectuscomplying with this Directive will increase theamount of information in connection withsecurities offerings.The Prospectus Directive replaces previousdirectives on listing particulars and public offerprospectuses.Adraft ‘Transparency Directive’ onthe obligation to provideinformation and the obligation todisclose major holdingsIn March 2003, the European Commissionsubmitted its proposal for a‘TransparencyDirective’ on listed companies’ obligation toprovide information and to disclose majorholdings as well as related monitoring.Withrespect to the obligation to provide information,the Directive would regulate the contents andpublication of annual financial reports and halfyearlyfinancial reports. In addition to annual andhalf-yearly financial reporting, the issuer should,during each half-year,provide at least averbaldescription of business development and of themain events during the period under review andtheir implications on the issuer’s financial standing.TheDirective would also reform the disclosurerequirements for major holdings. It also seeksto organise the dissemination and easy availabilityof information for investors throughout the EU.Currently, it seems that the Directive wouldbecome effective inautumn 2004, and therequired legislative changes to the Member States’respective national laws should be implementedin autumn 2006 at the latest.International Financial ReportingStandards to be adopted as part ofFinnish accounting legislationListed companies are required to prepare theirfinancial statements in accordance withInternational Financial Reporting Standards (IFRS/IAS) as from the accounting period starting in2005.The requirement applies to companieswhose securities have been admitted to tradingon regulated markets. Furthermore, theCommittee of European Securities Regulators(CESR) has issued arecommendation on howcompanies should, prior to 2005, communicate ontheir transition to the International FinancialReporting Standards.In the course of 2003, the FSA participated inthe development of IFRSs especially via Europeancooperation fora,the Securities RegulatorsCommittee and the Banking Advisory Committee.CESR prepared comments on the standards andinterpretations proposed by the InternationalAccounting Standards Board (IASB). In contrast tonormal procedure, the Banking AdvisoryCommittee issued its comments on macrohedgingof interest rate risk directly tothe IASB, as thismaterially affects the banking sector’s hedgeaccounting.The FSA also addressed its writtencomments on the matter to the IASB.An IAS Working Group set up by the Ministryof Trade and Industry toconsider the transpositionin Finnish law ofthe IFRS Regulation, the FairValue Directive and the ‘Modernisation Directive’of accounting rules, finalised its proposal in June.As credit institutions are both publicly quotedand non-quoted companies, in the future therewill be both credit institutions complying withIFRSs and credit institutions complying withnational financial reporting requirements. In orderto ascertain comparability of financial reporting, itis proposed that Finnish legislation includeprovisions under which all credit institutions andinvestment firms should comply with the FairValue Directive for treatment of financial instru-Regulation37

Regulationments inaccounting and in respect of theirseparate and consolidated financial statements.Furthermore, it is proposed that, on the basis ofthe ‘Modernisation Directive’, they could valuetheir investment property using either theacquisition cost or the fair value.Enforcement of financial informationstandards being set upThe FSA has taken part atEUlevel in the developmentof procedures, coordination and cooperationfor the enforcement of financial informationstandards.The Committee of European SecuritiesRegulators (CESR) published in spring 2003 itsfirst standard onthe enforcement of financialinformation on the EU securities markets.Thepurpose of this standard istoharmonise anddevelop supervision of listed companies’ financialinformation and, in particular the compliancewith IFRSs in Europe.The Committee published adraft for asecond enforcement standard inthelatter part ofthe year.The standard deals with theneed to step up coordination activities amongsupervisors inthe enforcement of financialinformation.The FSA was amember of aworking groupset up by the Ministry ofTrade and Industry thatgave in March 2003 its proposal on how theenforcement of IFRSs by supervisory authoritiesshould be organised in Finland.According to theworking group’s proposal, the FSA would be theauthority responsible for monitoring compliancewith IFRSs in Finland.The Finnish AccountingBoard would, in turn, be the body who, uponrequest from asupervisory authority,could givean opinion on arelevant issue, if needed. Suchmonitoring would cover all those companies whoare obliged to prepare their financial statementsin accordance with the IFRSs.The workinggroup’s proposal is based on enforcement principlesissued by CESR.Legislative preparations on organising theenforcement mechanism for financial informationcommenced in early 2004.Desire to enhance reliability offinancial informationAworking group set up by the Ministry ofTradeand Industry, that had been reflecting upon newauditing legislation, wants to impose stricterrequirements on auditors’ work in order to ensurereliability of financial information. In its legislativeproposal submitted in November 2003, theworking group emphasises the independence ofauditors and the contents of audit reports. Inexercising auditing tasks, lay auditors would nolonger be qualified to attend to the interests ofshareholders and other interest groups.The legislative proposal is currently beingcirculated for comment. New auditing legislationis under preparation in 2004, and the act itself isscheduled to become effective in2005, at theearliest. 8FUNCTIONING OF MARKETS ANDCOMPETITION NEUTRALITYBetter competitiveness ofmutual funds businessThe competitiveness of the mutual funds businessis being improved through amendments proposedto the Mutual Funds Act, which will implementthe amendments to the directive onlaws, regulationsand administrative provisions relating toundertakings for collective investment in transferablesecurities (the UCITS Directive) into Finnishlaw.The aim is to provide the framework formutual fund product development and developmentof other activities of fund managementcompanies, at the same time ensuring implementationof adequate investor protection.The revised Mutual Funds Act will extend thepermitted scope of business for fund managementcompanies from mutual funds business to theprovision of individual portfolio managementservices. Furthermore, fund management companieswill get aEuropean passport for carrying onbusiness in other member states of the EuropeanEconomic Area.To ensure investor protection,provisions on the capital adequacy and risk388 Further details in the FSA Neswline 6/2003.

management required of fund managementcompanies will be written into the Act.To improve the information provided toinvestors, asimplified prospectus must, in thefuture, be published on each mutual fund.Theprospectus must include material and adequateinformation on the objectives of the fund’sinvestment activities and related risks, coststructure and administration.The changes arescheduled to come into effect in February 2004. 9SIVA working group report publishedThe SIVA working group set up to review thecompetition neutrality between savings, investmentand life insurance products was able tocomplete its work in December 2003.Theworking group proposes that the right to ataxdeduction on contributions for personal pensionplans should be extended to investments madeunder bound long-term savings contracts indeposits and mutual fund units, as well as directinvestments in securities.These products areregarded as mutually competing savings products.Besides insurance companies, other serviceproviders would include deposit banks, investmentfirms and fund management companies.Savings accounts accruing from long-term savingswould not be covered bythe deposit guaranteescheme.According to the proposal, the obligation toprovide and request information adopted in thesecurities markets would be extended to coverinvestment instruments linked to pension insurance.Contrary tothe present conditions, thepension insurance contract and the bound longtermsavings contract proposed would be subjectto termination at least at regular intervals.The aimis to allow for change ofservice provider orinsurance company during the validity of thebound long-term savings contract.In terms of competition neutrality andcustomer protection, the Financial SupervisionAuthority (FSA) encourages the use of all mutuallycompeting savings products as permitted investmentinstruments.The FSA is in favour of awidefreedom of choice to change service provider,neutral taxation, ahigher capital requirement forservice providers toensure reliability of operationsand uniform obligations to provide informationwhen investors are offered identical productsinvestment wise.The FSA finds the broad and general approachto the review ofcompetition neutrality andcustomer protection under the mandate of theworking group to be of significance. Althoughthis time the working group primarily addressedbound long-term savings only, the broaderapproach should later be returned to, especiallywithout forgetting cross-sector examination ofregulations on the provision of investmentadvice. 10Revision of Investment ServicesDirective enters final phaseOne of the key projects of the EU FinancialServices Action Plan (FSAP) yet tobecompleted isthe revision of the Investment Services Directive(ISD).The Commission issued its proposal foramendment of the Directive inNovember 2002and final adoption of the Directive isset by April2004. 11 The current Directive from 1993 isoutdated at least in two senses. First ofall, it is toonarrow in scope and therefore does not correspondto developments in market structures.Secondly, the provisions of the Directive, such ascompliance with host-country provisions and the‘concentration rule’, ie the mandatory executionof transactions on aregulated exchange, do notpromote competition between the financialservice providers inthe market, nor the emergenceof asingle market.The new Investment Services Directiveregulates the provision of investment services byinvestment firms and credit institutions as well asthe operation of markets.The revised ISD willinclude more detailed provisions on the conditionsfor authorisation of investment firms, forinstance on the management of conflicts ofinterest.The provisions on conduct of business(COB) rules governing relationships with customerswill also be considerably extended.The COBrules are based on the recommendations adoptedby the Committee of European SecuritiesRegulators (CESR).The Directive will include new9-10 Further details in the FSA Newsline 6/2003.11 The Directive must be transposed in national law within 2 yearsfrom its adoption.Regulation39

Regulationrules on the provision of investment advice,which will be defined as core investment servicesubject to authorisation, as well as on commodityderivatives, which will be covered bythe scope ofthe Directive, subject to certain exemptions.The provisions on the conditions for authorisationof regulated markets and the organisationof market operations will be much more detailedthan in the present Directive. Likewise, there willbe new rules on market transparency.The major amendment to the Directive relatesto transparency and regulation of different tradingvenues. Except for provisions on regulatedmarkets, the Directive also includes rules on theoperation of Multilateral Trading Facilities (MTF).Regulated markets and MTFs will, in principle, besubject to equal transparency requirements. Onthe one hand, this means, publication of buy andsell offers (pre-trade transparency), while providing,on the other hand, for the prompt reportingof the volumes and prices of executed trades(post-trade transparency), with some exemptions.In addition, during the various stages ofpreparationof the Directive, views have differed astotheextent to which these transparency requirements(especially pre-trade transparency) should applyto investment service providers executing theircustomers’ orders within the company, outside aregulated market or an MTF (so-called internalisation).Working group proposal foranew Companies ActThe working group set up by the Ministry ofJustice issued its proposal for anew CompaniesAct in May 2003. Akey objective ofthe proposedAct is to provide sound operating conditions forsmall and growing companies.In its proposal, the working group found theenactment of anew Companies Act necessary.Theoperating conditions of limited liability companiesshould be improved by removing andrelaxing formal requirements, as well as increasingregulated operational alternatives and discretionaryprovisions.The position of creditors andminority shareholders would be safeguarded byemphasising the meaning of general principles,developing clear and effective legal safeguardsembodies amove towards amore flexible capitalsystem, the exemption of small companies fromstatutory audit and restriction of the publicity ofholdings.In their comments, the FSA voiced somereservations to the working group proposal. Inthe FSA’s view, it is important for the sake ofinvestor protection that companies’ financialstatements are audited and that the audits areconducted by approved auditors.The corporategovernance of supervised entities and listedcompanies, in particular,should be regulated inline with the proposals of the EuropeanCommission.This would enhance financialstability and confidence building in the financialmarkets.Work on the preparation of the newCompanies Act continues.The proposal for anewAct is scheduled for introduction to Parliament inthe course of 2004.The drafting of the Act hasbeen closely related to work performed withinthe EU. 12CONTROL OF MARKET ABUSEMarket Abuse Directive broadenspowers of investigation andenforcementThe Market Abuse Directive (Directive oninsidetrading and market manipulation) which providesfor broader powers of investigation and enforcementto competent authorities took effect in April2003. Under the new Directive, the competentauthorities must be provided with all the powersof investigation and enforcement necessary forthe performance of their duties.The competent authority may exercise thepowers under the Directive either directly itselfor together with other authorities, or it may referthe matter to the competent judicial authority.Itremains to be seen how the exercise of thesepowers will be provided for inpractice in Finnishnational legislation in connection with theimplementation of the Directive.The Directive islikely tobroaden the FSA’s current powers ofinvestigation and enforcement, at least in somerespects.1240 and clarifying regulations.The proposal alsoFurther details in the FSA Newsline 5/2003.

The Market Abuse Directive obliges MemberStates to ensure that they have inplace thepowers to take administrative action or introduceadministrative sanctions should the provisionsissued under the Directive beviolated. In practice,this could mean, for example, that the FSA would,under certain circumstances, be granted thepower toimpose administrative sanctions as aremedy for the violation of rules issued under theDirective. 13The Directive itself and other Directives andRegulations of the European Commission issuedby virtue thereof must be implemented inMember States by October 2004. Aworkinggroup set up by the Ministry ofFinance iscurrently drafting the necessary amendments tothe national legislation.Anti-money laundering regulationsrevisedAmendments to the Anti-Money Laundering Acttook effect in June 2003.The amendmentsconcern the scope of application, extension ofthe reporting requirements to also cover nonfinancialprofessions, as well as reporting requirements.Theamendments reflect the EU SecondAnti-Money Laundering Directive 14 and theSpecial Recommendations against the financing ofterrorism issued by the Financial Action TaskForce onMoney Laundering (FATF).The scope of application and objective oftheAct was enlarged toinclude not only the preventionand detection of money laundering but alsothe prevention of the financing of terrorism.Thereporting requirements now apply both totransactions suspected of being linked to moneylaundering and to transactions suspected of beinglinked to the financing of terrorism.The Penal Code was amended in April inrespect of the provisions on, for example,accounting offences, offences by debtors andmoney laundering offences.The amendmentsseek to ensure more effective detection offinancial crime. Under the newAct, aperson may13 Further details in the FSA Newsline 1/2003.14 Directive 2001/97/EC of the European Parliament and of theCouncil amending Council Directive 91/308/EC on prevention ofthe use of the nancial system for the purpose of money laundering.also be sentenced for negligent money laundering.The Penal Code now provides for specific crimedesignations for money laundering offences.Thedefinition of money laundering was extended toinclude conveyance of funds of criminal originand provision of assistance to another person inthe transfer of the funds and obliteration of theorigin of the funds.The Financial Action Task Force onMoneyLaundering (FATF) adopted 40 new recommendationsin June.The recommendations have gainedworld-wide recognition as standard rules for antimoneylaundering regimes and legislation.Although the new recommendations allow for theexercise of national discretion in their application,they call for revision of the Finnish regulations, aswell.The recommendations impose more detailedrequirements on the exercise of customer duediligence (CDD), ie customer identification andKnow-Your-Customer (KYC) procedures, as wellas on risk management. Aworking group was setup by the Ministry ofthe Interior in the autumnto draft amendments to the anti-money launderinglegislation and regulations. Arepresentative ofthe FSA participates in the working group.REVISION OF THE CAPITALADEQUACY FRAMEWORKRevision of capital adequacyrequirements still in progressWork on the new capital adequacy framework,Basel II, advanced as planned in the early part ofthe year. The reform is designed to enhance thestability of international financial markets byclosely aligning banks’ capital requirement withthe actual level ofrisks and by encouraging banksto adopt amore advanced approach toriskmanagement.The reform will place higherdemands on the transparency and accountabilityof operations. One major aspect of the newframework is that banks must have asystematicprocess for assessing how much capital they needbased on their overall risk profile and astrategy tomaintain their capital levels. For supervisors, BaselII introduces arequirement to review and evaluatebanks’ internal assessments and to considerown funds adequacy,taking into account thespecial features and uncertainties of each institu-Regulation41

Regulation42tion’s risk profile.The supervisor will have theright to set supervised entities acapital adequacyratio higher than 8%.In early 2003, the Basel Committee onBanking Supervision explored the effects of thereform on banks’ capital adequacy and own fundsrequirements (Third Quantitative Impact Study orQIS 3). It also launched consultations on its mostrecent detailed proposal for acapital adequacyframework built on three pillars 15 and publishedthe results of the Third Quantitative ImpactStudy. 16The responses to the Basel proposal supportthe objective ofthe reform as addressing risks infinancial operations more comprehensively andachieving better allocation of capital costs.Thegrowing risk sensitivity of capital charges iswidely accepted. Efforts toprovide incentives forbanks to improve ontheir risk management andinternal control processes on an ongoing basiswere also welcomed.The New Basel CapitalAccord allows banks to move from simplified tomore accurate and advanced approaches tocalculating capital requirements, in line with thesophistication of risk management systems. 17Banks can also make wider use of credit riskmitigation techniques.However, the proposal was criticised for theprofusion of detail and the costs arising from itsimplementation.The various national discretionoptions and possibilities for interpretations maymake the implementation of prudential supervisionmore heterogeneous.The potential procyclicaleffects of the framework have also beencriticised, as have the rules of calculation foroperational risk charge and possible additionalcapital requirements under Pillar 2. In severalresponses, major changes were proposed to thetreatment of expected losses under the InternalRatings-Based Approach ofcredit risk, while minor15 Pillar 1 includes capital charges for credit, market and operationalrisks, together with alternative methods of calculation.Pillar 2 requires that banks assess capital adequacy in relation toall material risks stemming from business activities and risks in theexternal environment as well as to the level of risk managementand internal control. The supervisor’s duty is to analyse banks’capital assessment processes and methods and address the issueof own funds adequacy in relation to risk-taking. Pillar 3 widensthe range of disclosure requirements and enhances the detail ofcontents with the aim of fostering market discipline.16 The publications of the Basel Committee are available on theCommittee’s website (www.bis.org/bcbs).17 Further details on the reform in the Bank of Finland Bulletin4/2003.changes were suggested to the treatment of creditcard receivables and securitisation and thecalculation of certain credit risk mitigationtechniques.In October,the Basel Committee on BankingSupervision announced that it would, on the basisof the responses received, allocate amaximum ofsix additional months to the finalisation of theproposal and publish its final proposal by the endof June 2004.The Basel Committee announced nochanges to the planned implementation of thereform,which is31December 2006.European Commission draft directiveon capital adequacy prepared in stepwith Basel AccordAt the beginning of July 2003, the EuropeanCommission issued adraft proposal for aDirectiveon arules-based capital adequacy regime, 18 whichis basically inline with the NewAccord proposedby the Basel Committee, although there are somedifferences.The EU reform will cover all banks andinvestment firms, irrespective oftheir size,whereas the Basel Accord will apply tolargeinternationally active banks only.The Commissionseeks to ensure that the framework will also beapplicable tosmall institutions with restrictedoperations and to consider the special features ofEU financial markets in other respects, as well.Similarly, the Commission seeks to promotecooperation between supervisory authorities inthe prudential supervision of groups operating inseveral countries and to enhance the transparencyof the activities of supervisory authorities.The FSA has actively contributed to thefinalisation of EU regulations within the frameworkof several working groups and committees,taken part inNordic cooperation with aview toharmonising implementation and participated inthe background work for the Basel II Accordundertaken by Groupe de Contact.The FSA hasalso been responsible for collecting and analysingthe Finnish contribution to the QIS3 study andcoordinated the Finnish authorities’ responses to18 The draft directive of the European Commission, the EU resultsof the impact study and the responses to the draft directive areavailable on the Commission’s website (http://europa.eu.int/comm./internal_market/).

oth the Basel Committee and the EuropeanCommission. Ajoint capital review workinggroup of the Finnish authorities started its work atthe beginning of 2003. Its main tasks are todraftnational legislation necessitated by the capitaladequacy reform,prepare the authorities’common responses and opinions and launch andundertake impact studies.As in 2002, the FSA organised regular informationand discussion meetings on the capitaladequacy reform for financial market participants.It also interviewed representatives of the industryon the current status of their internal capitaladequacy assessment processes and on thepreparations for meeting Pillar 2requirements.Towards the end of 2003, work started on thepreparation of advance guidance (interpretations)on the choices for national options, minimumrequirements under advanced credit riskapproaches and minimum requirements for theinternal capital adequacy assessment processes.Capital adequacy requirementslegislated for financialconglomeratesIn the future, capital adequacy should also becalculated at financial conglomerate level. Underthe provisions of the present Act, conglomeratesare not subject to aquantitative capital adequacyrequirement that is now proposed in abilldesigned to implement the capital adequacyprovisions of the Financial ConglomerateDirective innational law. It has been proposedthat detailed provisions on the calculation of thecapital adequacy of afinancial conglomerate beissued in aCouncil of State decree.According to the proposal, the total ownfunds of afinancial conglomerate must meet thecapital adequacy requirements applicable totheconglomerate.The total own funds of theconglomerate shall be calculated in accordancewith the principles of the sectoral rules governingthe financial and insurance companies in theconglomerate, while own funds adequacy shall becalculated on the basis of the sectoral capitaladequacy requirements. In amultinationalconglomerate, the methods for calculating capitaladequacy would be based on the legislation of thehome state of the company heading the conglomerate.The Directive isdesigned to harmonise thesupervisory practices applicable tofinancialconglomerates across EU member states.Theproposal put forward torevise the Finnish Actfocuses on the cooperation between the supervisoryauthorities of different member states in thesupervision of multinational financial conglomerates,in particular.Indrafting the legislativeproposal, Finland worked together with the otherNordic countries to ensure uniform interpretationof the Directive requirements. One of the aims isto harmonise national legislation in line with thelegislation of the other Nordic countries and toavoid overlapping supervision of Nordic multinationalconglomerates.To this effect, the scope ofapplication of the Act will be adjusted. 19Regulation19 Further details in the FSA Newsline 6/2003.43

4 Development of the FSA’s activitiesDevelopmentof the FSA’sactivities44Intensifying integration and changes in EUlegislation and the operating environment ingeneral place increasing demands on supervision.Implementation of the internationalaccounting standards (IAS) and the new capitaladequacy (CAD) regime as well as severalprojects relating to market supervision will, inaddition to day-to-day market supervisoryduties, require considerable resources over thenext few years.In 2003, the objective of developing theFSA’s activities was to further enhance thesupervision authority’s readiness to respond tochanges in the markets and the supervisedentities’ activities in an improved and morecost-efficient manner. Preparatory work wasfocused on the introduction of the IASstandards and the new CAD regime, as well ason carrying out projects relating to the EU’sFinancial Services Action Plan.Revision of corporate governancestructureThe FSA’s modes of operation are being enhancedon the basis of the requirements posed by theoperating environment and the newAct on theFinancial Supervision Authority.The revised actbroadened the FSA’s scope of competence andadded to its social responsibility,thus requiring afirst-rate corporate governance framework.The FSA revised its entire corporate governancestructure inaccordance with the goodpractices laid down by international standardsand the IMF’s recommendation on openness, andpublished the new structure onits website.TheFSA’s corporate governance structure isdefined inthe Act on the Financial Supervision Authority.Indefining and disclosing its corporate governancestructure, the FSA observes, where applicable, thesame international standards 20 on good practicesthat are applicable toits supervised entities.Organisational restructuringThe FSA announced its revised organisationstructureatthe beginning of June.The restructuringwasdesigned to enhance the FSA’s mode ofoperation and preparethe Authority forincreasingsupervisoryrequirements especiallyinviewofthenewCAD regime.The neworganisation structurereflects adivision along functional lines instead ofthe former division into operational sectors.The functions of the former CreditInstitutions Department and the Capital MarketsDepartment were divided into two new departments.Thecapital adequacy supervision of allsupervised entities was assigned to the new20 Enhancing Corporate Governance for banking Organisations,Basel Committee on Banking Supervision, September 1999, andthe IMF’s Code of Good Practices in Transparency in Monetary andFinancial Policies.

Prudential Supervision Department, while thenew Market Supervision Department encompassesmarket supervision, supervision of conductof business and of marketplaces and systems aswell as supervision of the HEX Group.Assigning responsibility for capital adequacysupervision to one single department ensuresequal supervisory treatment irrespective oftypeof institution. Likewise, transferring marketsupervision and supervision of conduct ofbusiness and of marketplaces and systems to onedepartment enhances uniform supervision of themodes of operation of all service providers,thereby enabling more efficient analysis of marketinfrastructure asasingle whole.Evaluation of achievement ofsupervisory goals enhancedPerformance evaluation was further developed inline with the objectives adopted by the FSA Board.The newAct on the Financial SupervisionAuthority also requires that the achievement ofgoals set for the operations be evaluated.The actfurther requires that the ParliamentarySupervisory Council monitors the appropriatenessand efficiency of the FSA’s operations. Inmonitoring the overall appropriateness of operations,the Parliamentary Supervisory Council must‘focus on evaluating how the FSA has succeededin meeting its statutory objective insofar as it hasbeen able to affect its performance within thescope of its statutory duties’. Observing theoverall efficiency of operations means ‘focus onmonitoring overall developments in the FSA’snumber of personnel and annual budget inrelation to the FSA’s functions and to any changesthereof,resulting from changes in legislation andmarket environment’.The FSA aims to enhance performance evaluationwith aview ofproviding the ParliamentarySupervisory Council and the FSA Board withsufficient information to evaluate the appropriatenessof the FSA’s operations.A further aim is toobtain an evaluation procedure that directsoperations to matters ofstrategic importance.Key supervisory tools for the ParliamentarySupervisory Council are the Board’s review oftheFSA’s performance in goal achievement, given atleast once ayear,aswell as the annual report.Improved use of new technologyenhances supervision and cuts costsThe standard onlarge exposures and risk concentrationsbecame effective atthe end of September2003.The related technical data collection systemwas revised and complemented with anewreporting application, which can be downloadedfrom the Internet service for reporting of dataknown as the Jakelu service.Jakelu was actively used throughout 2003,with 606 companies registering with the serviceduring its first operating year and the number ofapplication downloads amounting to 4,602.Theservice enables reporting institutions to downloadspreadsheet-based applications they need for thecompilation of reports and statistics to authorities.The service has been of great help to bothauthorities and reporting institutions as previouslyall reporting applications had to beprovided by disks.The service is available fromthe FSA’s website, and it was jointly designed bythe FSA, the Bank of Finland and Statistics Finland.During 2003, the FSA conducted apreliminarystudy onhow to compile data on securitiestransactions and trading parties, as in the future itwill no longer be possible to obtain such broadbasedinformation via the securities settlementsystem as it is now. Regulations on supervisionand the compilation of transaction data will alsochange inline with the EU’s harmonisationrequirements.When weighing the availableoptions, different trading and settlement partieswere interviewed and an outline of the newsystem was presented to them.The implementationof the new system known as KAVAKE waspostponed until 2004.As aconsequence, compilationof data under the new system is likely tobegin in 2005 at the earliest.During 2003, the FSA started online distributionof its key publications such asstandards,information releases to supervised entities andthe FSA Newsline. In this connection, the FSANewsline became an online publication only.FSA rated by stakeholdersIn summer 2003, the FSA conducted an imagesurvey among stakeholders.According to thesurvey, the FSA has made progress in goal achieve-Developmentof the FSA’sactivities45

Developmentof the FSA’sactivitiesment,and the overall image associated with theFSA has also improved somewhat. On ascale from4to10, the FSA was given a7.9 grade, up fromthe 7.8 grade it received in 1999.Of the interested parties surveyed, particularlythe supervised entities as well as authoritiesappreciated the FSA’s activities, while representativesof the press and to some extent of listedcompanies expressed amore critical attitude.The respondents hoped that the FSA wouldbe more proactive and open in its approach.Although FSA communications were consideredfunctional, it was hoped that communicationswould continue to develop amore activeapproach with improved clarity and understandability.21Focus areas in competencedevelopmentMajor areas that pose challenges on the competenceof the entire staff are the new CAD requirements(Basel II), IAS standards and participation inthe Committee of European Securities Regulators(CESR).More resources were allocated to internalpreparations relating to the Basel II developmentproject, comprehensive project steering and moreeffective use of project management tools.Internal training was arranged on the contents ofthe new CAD framework and the main features ofthe necessary supervision processes, and increasinglymore staff members participated in thereform projects relating to regulation and supervision.Members ofFSA staff also participated intrainings on Basel II and on best practicesemployed inbanks’ risk management and capitalplanning both in Finland and abroad.Knowledge ofthe IAS standards wasenhanced by arranging internal training and byparticipating in modifying national legislation andin international cooperation.The FSA also contributedto developing supervision of financialinformation relating to European securitiesmarkets.Internal training was further arranged onsupervision of payment systems, the newInvestment Services Directive and the amendedMutual Funds Act. Competence on securitiessettlement systems was enhanced at workshopsarranged jointly with the Ministry ofFinance, theMinistry ofJustice and the Bank of Finland.Members ofFSA staff also participated ininternational trainings on banking supervisionarranged by the Basel Committee and the Fed.Competence development was made moresystematic by preparing personal competencedevelopment plans for the entire staff.4621 Further details in the FSA Newsline 5/2003.

The FSA in briefThe FSA was established in connection with theBank of Finland in October 1993. The predecessorof the FSA was the Banking SupervisionOffice, which functioned under the Ministry ofFinance from 1922–1993.The FSA is connected administratively withthe Bank of Finland, but is an autonomousauthority in its decision-making and supervisionactivities. The FSA receives services from theBank of Finland, covering, for example,personnel and financial administration, informationmanagement, security and other areasof general administration.Administration and supervision ofoperationsThe FSA’s corporate governance system, definedin the Act on the Financial Supervision Authority,is supplemented by an audit performed by theBank of Finland’s auditors, selected by theParliament, an independent internal audit as wellas an internal guidance and control procedure.The internal audit is carried out by the Bank ofFinland’s Internal Audit Unit in accordance withthe principles adopted by the FSA Board, whichalso adopts the internal guidance and controlprocedure.The Parliamentary Supervision Councilsupervises the overall appropriateness andefficiency of the FSA.A key supervision tool is theFSA’s annual report aswell as areport preparedby the FSA Board atleast once ayear on the FSA’sprogress in achieving the goals set for the operations.TheParliamentary Supervisory Council may,at its discretion, include issues dealt with in thisreport inits own report onthe Bank of Finland itpresents to Parliament.The ParliamentarySupervisory Council also nominates the members,deputy members, chairman and vice chairman ofthe FSA Board and confirms its procedural rules.The FSA Board isresponsible for the steeringand supervision of the FSA’s operations, decideson long-term operating principles and objectivesand monitors their achievement. It also takesdecisions on matters likely tohave acrucialimpact on the activities of supervised entities orthe stability of the financial markets or affectingtheir development in some other manner.TheBoard also decides on the organisation andoperating units of the FSA.The FSA Board consists of six ordinarymembers and three deputy members, appointedon the basis of proposals by the Bank of Finland,the Ministry ofFinance and the Ministry ofHealthand Social Security.The Director General of theFSA and the Director General of the InsuranceSupervision Authority are exofficio members ofthe FSA Board. The Board members have athreeyearterm inoffice.The FSA is amonocratic organisation, withresponsibility for the operations resting with theThe FSAin brief47

The FSAin briefDirector General.The Director General is incharge of all matters not specifically assigned tothe Board. In this role he is responsible forensuring that the FSA performs all its duties in anefficient and appropriate manner and in compliancewith the instructions given bythe Board inorder to achieve its statutory objective. However,the Director General makes decisions on importantissues in Management Group meetings inconsultation with the Management Group.The Management Group is composed of theDirector General of the FSA, all Deputy DirectorGenerals, Head of Regulatory Governance, ChiefLegal Counsel and Advisor.The Bank of Finland’s Internal Audit Unit,which isindependent of the FSA, performs theinternal audit of the FSA according to the principlesand annual audit plan approved by the FSABoard.The audit is performed by the Bank ofFinland’s auditors, which have been selected bythe Parliament.The auditors report totheParliamentary Supervisory Council.The internal guidance and control procedureis part ofthe FSA’s corporate governance, and itmust provide the management with adequateinformation for the basis of decision-making andperformance evaluation.The principles of internalguidance and control are adopted by the FSABoard.The FSA Management Group is responsiblefor ensuring that internal control and risk managementare sufficient in view ofthe nature ofactivities.The internal control and risk managementprocedures are revised annually.Organisation and personnelThe supervisory functions concerning themarkets and supervised entities have beenassigned to two departments: PrudentialSupervision and Market Supervision. PrudentialSupervision is centrally responsible for theprudential supervision of all supervised entities,while Market Supervision is responsible formarket supervision, supervision of conduct ofbusiness and of marketplaces and systems,supervision of the HEX Group as well as forrelated regulation and its development.TheRegulatory Governance Unit is in charge of thepreparation of strategic objectives and principlesfor regulation and of guiding and controlling theachievement of these objectives. It is also responsiblefor granting authorisations and imposingsanctions.The Supervision Support Department isresponsible for the regulation of financial statementsand capital adequacy,communication anddocument services, information systems as well asplanning and internal control.At the end of 2003, the FSA had an operationalstrength of 138 persons (136 in 2002).Atotal of 54 employees worked in the PrudentialSupervision Department, 47 in Market Supervision,30 in Supervision Support and 9inRegulatory Governance.In 2003, the average turnover rate 22 was 6.5%(11.5%) for those entering the FSA’s service and5% (7%) for those leaving the FSA. FSA’s employeeswere 43 years old, on average.FinancingThe FSA finances its operations by levying fees onthe entities supervised by the FSA and issuers ofsecurities. Some FSA decisions and other measuresare subject to processing fees.In 2003, costs arising from the operations ofthe FSA amounted to approximately EUR 15million (EUR 14.2 million in 2002). Of these, EUR14.6 million were covered byperiodic fees, EUR0.5 million by processing fees (3.1%) and EUR0.008 million by other income (0.1%).4822 Turnover rate for those entering the FSA’s service = Number ofrecruited employees / average operational strength of personnelx 100. Turnover rate for those leaving the FSA’s service = Numberof employees who left the FSA’s service / average operationalstrength of personnel x 100.

6Table 3.FSA staff, income and expenses 2000–20032003 2002 2001 2000Number of staff employed 138 136 125 123Income and expenses, EUR millionOperating expenses 15,0 14,2 12,4 11,5Supervision feesPeriodic fees 14,6 13,7 11,7 10,8Processing fees 0,5 0,5 0,6 0,6Source: Financial Supervision Authority.The FSAin brief49

Chart 7.Financial Supervision Authority Organisation 31 December 2003Parliamentary Supervisory CouncilBoard of theBank of FinlandBoard of the Financial SupervisionAuthority*The FSAin briefMatti Louekoski (BoF), ChairmanPekka Laajanen (MoF), Vice ChairmanKaarlo Jännäri (FSA), MemberHeikki Solttila (MoF), MemberHely Salomaa (ISA), MemberTarmo Pukkila (MSAH), MemberDeputy Members: Ilkka Harju (MoF),Katriina Lehtipuro (MSAH),Heikki Koskenkylä (BoF)Director GeneralKaarlo JännäriInternalAuditRegulatory GovernanceHead of Unit**Liisa HalmeChief Legal Council**Markku LounatvuoriPrudential SupervisionDeputy DirectorGeneral**Kaiju KallioMarket SupervisionDeputy DirectorGeneral**Anneli TuominenSupervision SupportDeputy DirectorGeneral**Pirkko Pohjoisaho-AartiRegulatory StrategyLegal CounselChief Legal Adviser**Risto MäättänenCoordination ofInternational AffairsFinancial AnalysisJaana RantamaCredit andMarket RiskJuha SavelaOperational RiskSirpa NäkyväInstitutional SupervisionKaija KilappaMarketsJarmo ParkkonenConduct of BusinessTarja IkonenMarketplaces andSystemsAri VoipioRegulation ofFinancial Statementsand Capital AdequacyPaula LauniainenCommunications andDocument ServicesArja Lerssi-LahdenvesiInformationSystemsJaakko MauranenSupervisory EvaluationProcessesMonica AhlstedtPlanning andInternal ControlMia ErkkoRegulatory Governance ProcessesLicensing and Disciplinary Action Functions50* BoF = Bank of Finland, MoF = Ministry of Finance, FSA = Financial Supervision Authority,ISA = Insurance Supervision Authority, MSAH = Ministry of Social Affairs and Health.** Member of the advisory Management Group.

6Table 4.Financial Supervision Authority; expenses and income in 2002 and 2003, EUR thousandsActual Actual Budgeted2002 2003 2004ExpensesSTAFF EXPENSESWagesPermanent employees 6,012 6,708 7,224Fixed-term employees 684 584 244Holiday substitutes 86 72 79Other fees 81 68 926,864 7,432 7,639Other staff expensesStaff-related expenses 2,236 2,286 2,332Other staff expenses 109 119 1852,345 2,404 2,517Total staff expenses 9,209 9,837 10,156OTHER EXPENSESTraining 302 249 386Travel 442 391 464IT expenses 817 917 1,508Ofce expenses 590 756 834Real estate rents and maintenance costs 1,630 1,674 1,708Other expenses 1,151 1,206 1,4554,932 5,193 6,354The FSAin briefDEPRECIATIONSDepreciation on equipment and furnishing 25 15 3125 15 31Total expenses 14,166 15,045 16,540IncomeSUPERVISION FEESPeriodical fees –13,659 –14,564 –15,911Processing fees –493 –472 –630–14,152 –15,036 –16,540OTHER INCOMEMiscellaneous income –14 –8 0–14 –8 0Total income –14,166 –15,045 –16,540Source: Financial Supervision Authority.51

6Table 5.Fees charged to supervised entities in 2002 and 2003, EUR thousands2003 2002CREDIT MARKET FEESCommercial banks 6,049 5,782OKO Bank Group Central Cooperative,member banks 1,524 1,347Local cooperative banks 176 154Savings banks 252 221Aktia Savings Bank 201 171Other credit institutions 739 826Guarantee funds 34 31Representative ofces and branches offoreign credit institutions 48 53Credit institutions’ holding 15 13Pawnshops 7 8Total 9,044 8,606The FSAin briefCAPITAL MARKET FEESMarketplaces 660 532Firms offering investment services 1,787 1,987Management companies 1,024 780Book-entry system 507 403Issuers 1,273 1,107Keepers of insider registers 268 244Total 5,520 5,053PROCESSING FEESManagement companies 159 158Issuers 285 308Others 28 27Total 472 493TOTAL FEES 15,036 14,152Source: Financial Supervision Authority.52

4 Appendices6Journal 2003AppendicesMain items of the Journal 2003 2002Internal matters 60 45Administration of supervised entities 386 375Supervision 305 370Risk management 68 51Accounting, annual accounts and auditing 15 11Customer protection and safeguarding 178 233Inspections 41 65Other matters concerning supervised entities 40 39Other external matters 119 117Total 1,212 1,306Major categories of journal entries: 2003 2002Listing particulars 133 151Investigation requests concerning customer protection 100 166Regulations related matters 90 99Notications 84 139International cooperation 58 59Domestic cooperation 52 51Inspections by plan 41 63Contractual terms 39 44Prospectuses 30 42Items recorded in the journal 2002 of the Financial Supervision Authority amounted to 1,212 matters, broken down bydepartments as follows: Capital Markets Department 759, Credit Institutions Department 335, Support Services Department78 and the Regulation Strategy Unit 40.53

6Financial Supervision Authority’s key supervisory powers, 2003Authorisation*NumberNew authorisationsInvestment rm authorisation 1Investment rm 2Cancellation of authorisation** 2Other permitsAppendicesMutual fund rules 76Safe custody agreements for mutual funds 35Inter-authority statement-related matters (incl. special funds rules) 94Extension of consolidated nancial statements and consolidated group 3Exemption permit regarding depreciation of own funds 3Permit regarding obligation to inform, the publication of public-offer prospectusor listing particulars, compilation, contents and publication of interim reports 177Special insider register 3Signatory rights 3Authority report 4insider register-related applications and permits 6Other 10Measures related to the investigation of market abuse anddereliction of dutyInvestigations into suspected securities market abuse and neglect 57Request for police investigation 7Unofcial reprimand 10Administrative sanctionsPublic admonition or warning* 0Withdrawal of authorisation* 0Disclosure ban (during ongoing investigation)* 0Conditional ne (imposed by FSA) 0Conditional ne (imposed by nancial market tribunal) 1Customers’ requests for investigation into supervised entities’ practicesRequests for further investigation 109* From 1 July 2003** Credit institutions and pawnshops54

6Supervised institutions 1999–200331 Dec LP OPR POP SPY SP LL VR PLL UE ULS AOJ SIPA MP RYOthers Total1999 9 246 43 1 39 17 4 13 5 18 11 45 2 25 13 4912000 9 244 43 1 39 17 4 13 6 18 12 48 1 26 13 4942001 9 244 42 1 39 16 4 13 7 19 12 50 1 24 13 4942002 11 243 42 1 39 16 4 13 4 20 11 46 1 23 13 4872003 11 242 42 3 37 14 4 11 4 18 17 46 1 27 14 491LP Commercial banksOPR Amalgamation of cooperative banksPOP Local cooperative banksSPY Limited company savings banksSP Savings banksLL Credit institutionsVR Banks’ security fundsPLL PawnshopsUE Finnish representative offices of foreign credit institutionsULS Finnish branches of foreign credit institutionsAOJ Book-entry system participantsSIPA Investment firmsMP MarketplacesRY Management companiesOthers Deposit guarantee fund (1), Investor compensation fund (1), Holding companies of investment firms (8),Holding companies of credit institutions (3), OKO Bank Group Central Cooperative (1)Representative ofces abroad 1999 2000 2001 2002 2003AppendicesSubsidiaries 4 4 7 10 7Representative offices 16 16 11 7 4Branch offices 8 9 11 11 1155

PUBLICATIONS 2003These publications were released in English and can be found on the Financial Authority’s websitewww.rata.bof.fi.StandardsRA4.1Reporting of large exposures and risk concentrations1.5Supervision of financial and insurance conglomerates4.1Establishment and maintenance of internal control and risk managementRegulations and guidelinesAppendices106.6Regulation on the reporting of own funds and consolidated own funds203.23Regulation on the reporting of own funds and consolidated own funds105.15Mortgage banks’ management of balance sheet risksInterpretations– FSA interpretation of credit institutions’ treatment of credit derivatives in the calculation ofcapital adequacy and large exposures– FSA interpretation of non market price transactionsInformation releases– New schedule of specific fees to take effect on 1 January 2004 and new grounds for supervision fees– New schedule of specific fees to take effect on 1 October 2003– Standard on the supervision of financial and insurance conglomerates– FATF 40 recommendations on anti-money-laundering measures revised– Standard on establishment and maintenance of internal control and risk management56

PO Box 159FI-00101 Helsinki, FinlandTelephone +358 9 183 51Telefax +358 9 183 5328www.rata.bof.rahoitustarkastus@rahoitustarkastus.