SELF ASSESSMENT OF LATVIAN CENTRAL DEPOSITORY’S

SECURITIES SETTLEMENT SYSTEM

against ESCB/CESR recommendations for securities settlement systems

August 2012

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TABLE OF CONTENTS

TABLE OF CONTENTS ............................................................................................................................ 2

Introduction ............................................................................................................................................... 3

Background information ............................................................................................................................ 3

LCD‟s services .......................................................................................................................................... 4

Summary of the assessment of the observance ....................................................................................... 5

RECOMMENDATION 1: LEGAL FRAMEWORK ...................................................................................... 7

RECOMMENDATION 2: TRADE CONFIRMATION AND SETTLEMENT MATCHING .......................... 11

RECOMMENDATION 3: SETTLEMENT CYCLES AND OPERATING TIMES ...................................... 13

RECOMMENDATION 4: CENTRAL COUNTERPARTIES (CCPS) ........................................................ 16

RECOMMENDATION 5: SECURITIES LENDING .................................................................................. 17

RECOMMENDATION 6: CENTRAL SECURITIES DEPOSITORIES (CSDS) ........................................ 20

RECOMMENDATION 7: DELIVERY VERSUS PAYMENT (DVP) .......................................................... 23

RECOMMENDATION 8: TIMING OF SETTLEMENT FINALITY ............................................................ 25

RECOMMENDATION 9: CSD RISK CONTROLS TO ADDRESS PARTICIPANTS‟ FAILURES TO

SETTLE .................................................................................................................................................. 27

RECOMMENDATION 10: CASH SETTLEMENT ASSETS .................................................................... 28

RECOMMENDATION 11: OPERATIONAL RISK ................................................................................... 32

RECOMMENDATION 12: PROTECTION OF CUSTOMERS‟ SECURITIES ......................................... 36

RECOMMENDATION 13: GOVERNANCE ............................................................................................. 40

RECOMMENDATION 14: ACCESS ....................................................................................................... 45

RECOMMENDATION 15: EFFICIENCY ................................................................................................. 47

RECOMMENDATION 16: COMMUNICATION PROCEDURES, MESSAGING STANDARDS AND

STRAIGHT-THROUGH PROCESSING (STP) ....................................................................................... 49

RECOMMENDATION 17: TRANSPARENCY ......................................................................................... 50

RECOMMENDATION 19: RISKS IN CROSS-SYSTEM LINKS OR INTEROPERABLE SYSTEMS ...... 52

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Introduction

The document comprises self-assessment of the Latvian Central Depository‟s (LCD) securities settlement system against the European System of Central Banks (ESCB) and the Committee of European Securities Regulators (CESR) recommendations for securities settlement systems of May 2009 (referred as ESCB/CESR recommendations for CSDs and CCPs). In total there are 19 recommendations for CSDs and the assessment is based on answering the key questions and the extent of the observance of each recommendation is determined. Each recommendation has key issues identified that should be evaluated together with the key questions related to the procedures and policies of the settlement system. The degree of the observance can be following: observed, broadly observed, partly observed, not observed or the recommendation can be deemed as „not applicable‟. For the convenience of the reader, the questions put forward in the ESCB-CESR questionnaire are reproduced in italic typeface and key issues are in grey box.

Background information

According to the Financial instruments market Law the Latvian Central Depository is a sole central securities depository in Latvia, responsibilities of which include providing accounting and safe custody of public securities registered in Latvia, and providing delivery-versus-payment (DVP) services for all trades executed on the stock exchange NASDAQ OMX Riga (RIG) and DVP and free of payment (FOP) services for the trades concluded over the counter. Clearing and settlement for securities is managed by LCD in its in house built securities settlement system called DENOS (hereinafter also as LCD SSS). Cash settlement related to the settlement of the securities is done in the Central Bank money using the Bank of Latvia. The trades can be traded and settled in foreign currency as well. In this case LCD uses cash corresponding commercial banks. The procedures of clearing and settlement and other LCD‟s services are set in the LCD rules that are applicable to LCD participants and other players in the financial market in Latvia (e.g. issuers, investors). LCD rules are publicly available on the LCD‟s website. Financial instruments market Law, LCD rules and rules of the stock exchange NASDAQ OMX Riga form the legal framework for the Latvian financial market.

A financial institution (commercial bank or brokerage company) or foreign securities depository can become a LCD participant – account holder by signing a participation agreement with LCD.

LCD has established corresponding links with two other Baltic securities depositories - the Estonian Central Depository for Securities and Central Securities Depository of Lithuania, and Clearstream Banking Luxembourg, allowing LCD participants to act as custodians with regard to the financial instruments registered with a counterpart depository. In 2012, LCD has established a link with Polish Central Securities Depository.

The operations of the Latvian Central Depository are supervised by the Financial and Capital Markets Commission. The Bank of Latvia performs oversight of the security settlement systems in Latvia.

There are two types of settlement used by LCD to settle trades: net settlement and gross settlement. LCD offers delivery-versus-payment (net and gross) and free of payment to settle securities transfers between LCD participants. Simultaneous net settlement of cash and gross settlement of securities (DVP) is used to settle the RIG auto-matched trades and negotiated trades with settlement day T+1 and more. Automatically matched NASDAQ OMX Riga trades, as a default, are settled on the third day after the trade (T+3), where T is the day of conclusion of the transaction. The ownership right to securities is transferred on the settlement day. NASDAQ OMX Riga negotiated deals may have a settlement day between T+0 (inclusive for local members, exclusive for cross-members) and T+40. Gross settlement of securities and cash (DVP) is used to settle the RIG trades on the real time basis (T+0) and trades which are concluded on the over the counter (OTC) market.

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The LCD‟s SSS is open for the securities settlement from Monday to Friday from 8:30 to 18:00 except

the national holidays. Securities settlement on DVP basis can be completed during the operating hours

of the Bank of Latvia.

NASDAQ OMX Riga is a 100% owner of the Latvian Central Depository. Latvian Central Depository is a part of NASDAQ OMX Group, Inc.

LCD’s services

Registration and accounting of public financial instruments

According to the Law on the Financial Instruments Market, Latvian Central Depository is responsible for

making book entries of and account financial instruments that are in public circulation. In the capacity of

a member of Association of National Numbering Agencies, LCD assigns ISIN (International securities

identification number) and CFI (classification of financial instrument) codes to registered securities.

Accounting and safe-custody of financial instruments

All securities registered with LCD are in book-entry form. LCD provides safe-custody of financial

instruments for intermediaries – banks and brokerage companies and maintains both their proprietary

and customer accounts.

Clearing and settlement for securities trading

LCD organizes clearing and settlement for NASDAQ OMX Riga stock exchange trades and OTC

transactions. As LCD participants have their corresponding financial instrument accounts with LCD,

LCD settles the securities leg of a transaction. The cash leg is settled by the Bank of Latvia according to

LCD instructions. LCD is authorized by its participants to debit/credit their corresponding cash accounts

with the Bank of Latvia for the settlement of securities trades.

Maintenance of the Initial Register of shareholders

LCD keeps the initial lists of shareholders for privatized companies until the owners of securities have

opened their own securities account with a LCD participant – a bank or a brokerage company. The

initial lists of shareholders are kept in the Initial Register maintained by LCD.

Corporate action services

LCD provides corporate action services for financial instruments registered with LCD.

Shareholder registrar services for non-listed companies

LCD may act as a shareholder registrar also for non-listed joint stock companies. The service is

available both to companies having registered and bearer shares. LCD:

may make book-entries of a company's registered and bearer shares either on a separate LCD register or on bank accounts;

mitigates the shareholders' risks related to proving the title to securities and monitoring their ownership status;

performs the function of a custodian for a collateral in bank-shareholder deals; settles securities on behalf of customers, making the transactions absolutely safe.

Corresponding depositories

LCD has signed cooperation agreements with the Estonian Central Securities Depository, the Central

Securities Depository of Lithuania and Clearstream Banking Luxembourg, allowing LCD participants to

act as custodians with regard to the financial instruments registered with a counterpart depository.

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Summary of the assessment of the observance

LCD observes 17 recommendations. Recommendation 4 is partly observed as NASDAQ OMX Riga Guarantee Fund is not assessed against the relevant guarantee arrangements by the supervisors. Recommendation 9 is not applicable, as LCD does not extend intraday credit. As Recommendation 18 is related to the regulation, supervision and oversight (responsibility of regulators and supervisors) LCD has not assessed the compliance level of the key issues stated there. The overall status of the observance is summarized into the table below.

Assessment category Recommendations number

Observed 1, 2, 3, 5, 6, 7, 8, 10, 11, 12, 13, 14, 15, 16, 17, 19

Broadly observed -

Partly observed 4

Not Observed -

Not Applicable 9

Recommendation 1 - Legal framework The laws, regulations, rules and procedures, and the generally applicable, non-negotiable contractual provisions governing the operation of SSSs, are clearly stated, understandable, public and accessible to system participants. The legal framework demonstrates a high degree of legal assurance for each aspect of the clearing and settlement process. The rules and contractual arrangements related to the operation of the securities settlement systems and the entitlement to securities are valid and enforceable, even in the event of the insolvency of a system participant. LCD SSS meets the criteria of the Settlement Finality Directive. Recommendation 2 - Trade confirmation and settlement matching A high percentage of trades between direct market participants are confirmed on T+0. Settlement instructions have to be matched for settlement purposes. Recommendation 3 - Settlement cycles and operating times Rolling settlement occurs no later than T+3. Market practices, regulations or SSS rules provide incentives to settle on the contractual date. Adequate measures are taken to mitigate the risk of fails. Operating hours and days of the SSS coincide with the operating hours and days of the payment system of the Bank of Latvia. Recommendation 4 - Central counterparties (CCPs) There is no CCP introduced in Latvian securities market though the benefits and costs of establishing a

CCP have been assessed carefully proving that costs to introduce a CCP exceeded benefits for the

market. There is a Guarantee Fund facility (for cash settlement fails) provided by Operator of Regulated

Market (Stock Exchange) and it may be used only for ensuring execution of the settlement instructions.

The Guarantee Fund is not assessed against the checklist for guarantee arrangements.

Recommendation 5 - Securities lending Securities lending and borrowing is not provided by LCD as a cost-benefit analysis and market survey has demonstrated that this is not needed. Securities lending activities are available among market participants without LCD‟s direct involvement. There are no impediments to the development and functioning of securities lending in Latvia. Recommendation 6 - Central Securities Depositories (CSDs) Dematerialisation is achieved and securities are transferred by book entry in LCD. The recording and transfer of securities is based on a robust accounting scheme. LCD avoids credit or liquidity risk to the greatest possible extent. LCD does not offer CCP services.

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Recommendation 7 - Deliver versus Payment (DVP) LCD‟s technical, legal and contractual framework ensures DVP. Final transfer of securities and payment is simultaneous and the time-lag between the blocking of securities/cash and their final settlement does not as a rule exceed one hour. Recommendation 8 - Timing of settlement finality The timing of settlement finality is clearly defined in the LCD rules, i.e. the time at which the deliveries of securities and/or cash become both irrevocable and unconditional; final settlement occurs during the settlement day and the legal framework that applies to the system and any links with other systems support the timing of settlement finality. LCD settlement system provides both real-time settlement as well as batch processing (only for Stock Exchange trades). The securities transferred through each of the system‟s links can be reused by the recipients during the day. LCD‟s settlement processes takes into account the closing time of the relevant payment systems. Recommendation 9 - CSD risk controls to address participants’ failure to settle LCD does not extend intraday credit to participants thus the key issues in this recommendation are not applicable. Recommendation 10 - Cash settlement assets LCD settles the cash payments in LVL using central bank money, USD & EUR settlement is ensured through settlement bank correspondents. Recommendation 11 - Operational risk LCD maintains a high degree of security & operational reliability. Business continuity plans and disaster recovery plans are in place. Crisis management structures are established. Recommendation 12 - Protection of customers’ securities

LCD employs accounting practices and safekeeping procedures that protect participants assets held in

custody. These arrangements are supported by the legal framework.

Recommendation 13 - Governance LCD‟s governance arrangements are clearly specified and information about them is publicly available. Recommendation 14 - Access LCD‟s membership criteria permit fair and open access. Recommendation 15 - Efficiency LCD has in place various procedures to review effectively and regularly pricing and cost. LCD performs client satisfaction surveys annually and reviews the service levels. Recommendation 16 - Communication procedures, messaging standards and straight - through processing (STP) Communication procedures and standards are compliant with the international standards and market standards. LCD would implement ISO 200022 standard in the future. Recommendation 17 – Transparency LCD provides market participants with information for them to identify and evaluate risks and costs with using the LCD service. Recommendation 19 - Risks in cross-system links or interoperable LCD‟s cross-border links have been designed to reduce risks associated with cross border settlements.

LCD‟s self-assessment against ESCB-CESR recommendations in a form of questions and answers is provided further in this document.

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RECOMMENDATION 1: LEGAL FRAMEWORK

Are the laws, regulations, rules and procedures and the generally applicable, non-negotiable contractual

provisions governing the operation of the SSS clearly stated, understandable, public and readily

accessible to system participants?

Yes. LCD‟s main functions, rights and obligations are stipulated by the Law on Financial Instruments

Market. Specific provisions governing the settlement system and collateral issues are stipulated in the

Law on Settlement Finality in Payment and Securities Settlement Systems and in the Financial

Collateral Law.

The rules and procedures which apply specifically to the LCD SSS and its participants are set out in the

LCD rules, which are available on the LCD website LCD (www.lcd.lv).

Provisions of establishing the links are stipulated by the Law on Financial Instruments Market. The

operation of links is governed by bilateral link agreement concluded by involved depositories. LCD has

published in its website the procedures in accordance with which the settlement are made and

The recommendation Securities settlement systems, links between them or interoperable systems should have a well-founded, clear and transparent legal basis for their operations in the relevant jurisdictions. Key issues 1. As a general rule, laws, regulations, rules and procedures, and generally applicable, nonnegotiable contractual provisions governing the operation of securities settlement systems, links (see Recommendation 19) and interoperable systems, should be clearly stated, understandable and readily accessible to participants and the public. 2. The legal framework should demonstrate a high degree of legal assurance for each aspect of the clearing and settlement process, including legally valid and enforceable arrangements for netting and collateral. 3. The rules and contractual arrangements related to the operation of the securities settlement systems and the entitlement to securities should be valid and enforceable, even in the event of the insolvency of a system participant, a participant in a linked or interoperable system, or the operator of the system or operators of linked or interoperable systems. 4. The operators should identify the relevant jurisdictions for each aspect of the clearing and settlement process, and should address any conflict of law issues for cross-border systems. 5. All eligible CSDs governed by the law of an EEA Member State should apply to have their securities settlement systems designated under the European Directive 98/26/EC on settlement finality in payment and securities settlement systems, as amended (hereinafter referred to as the Settlement Finality Directive). The relevant authorities should actually designate the systems that meet the criteria of the Settlement Finality Directive. 6. For systemic risk purposes, the relevant public authorities should support the harmonisation of rules so as to minimise any discrepancies stemming from different national rules and legal frameworks.

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corporate actions are executed with the securities registered with the link depositories. The mentioned

procedures are binding on the participants of the LCD SSS.

Does the legal framework demonstrate a high degree of legal assurance that:

a. there is a clear and effective legal basis for immobilisation or dematerialisation of securities and for

transfer of securities by book entry?

Yes. LCD rules provide the legal basis for the dematerialization of securities and the transfer of

dematerialized securities in LCD SSS. Starting from 1 January, 2010, in accordance with Commercial

Law of Latvia, only dematerialized shares could be issued.

b. each aspect of the settlement process is valid and enforceable?

Yes. Law on Settlement Finality in Payment and Securities Settlement Systems and LCD rules provide

legal basis for each aspect of settlement process.

c. netting and collateral arrangements are valid and enforceable?

Yes. Law on Settlement Finality in Payment and Securities Settlement Systems and Financial Collateral

Law provide legal basis for settlement and collateral. Netting is also the part of LCD rules regulated

clearing and settlement procedures. LCD ensures the registration of pledge securities in LCD SSS only

if both parties (pledgee and pledger) are LCD participants.

In addition to the requirements of Recommendation 17, do CSDs provide market participants with

information, where relevant, on several specific issues regarding the legal framework of the operator of

the SSS?

LCD consults with LCD participants on every change in LCD rules. The consultation procedure

depends on the nature of changes. Before introduction of new functionalities or other material changes

in existing functionalities prior to make a draft of amendments to LCD rules, LCD makes consultation

meetings with LCD participants. After the consultation meetings, LCD prepares amendments to the LCD

rules and sends the draft of amendments to all participants for comments and proposals.

Are the rules and contractual arrangements related to the operation of the SSS enforceable in the event

of the insolvency of a system participant, of a participant in a linked or interoperable system, of the

operator of the system, or of the operators of linked or interoperable systems, wherever they are

located?

LCD rules and contractual arrangements are enforceable only towards LCD participants, also in the

case of insolvency of a LCD participant. According to the Law on Financial Instrument Market (FIML)

and LCD rules, LCD ensures that a LCD participant‟s clients‟ accounts shall be transferred to other LCD

participant if the first participant does not comply with the requirements of the FIML or the LCD

regulations binding to the LCD participant.

Taking into account the provisions of Link Agreement, if linked system‟s operator fails to perform its

functions due to insolvency, the securities shall be withdrawn from accounts opened in linked system,

the linked system operator shall provide all services mentioned in Link Agreement until all securities

accounts are closed.

If LCD fails to perform its functions due to insolvency, liquidation or other reasons, the status of LCD

shall be assigned to another commercial company in a tender procedure. LCD shall continue its activity

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until the LCD functions are vested with a commercial company that has been granted the status of

national Central Depository. That activity shall be financed from the budget of the Financial and capital

market commission (FCMC) and it shall supervise the current LCD as long as it settles in full amount its

liabilities to its participants and until the functions of the Central Depository are vested with a

commercial company that has been granted the status of national Central Depository.

Notwithstanding the bankruptcy or insolvency of an individual system participant, of one of its

customers, of an intermediary or a component of an SSS, do the system, direct system participants,

other intermediaries and their respective customers have a high degree of legal certainty regarding:

a. rights and interests in the securities and other assets held in or through the system?

Yes. LCD has two-level account keeping system and all LCD participants‟ clients‟ financial

instruments are kept separately from financial instruments owned by the LCD participant itself.

b. which law is applicable in respect of:

(b.1) contractual and proprietary aspects?

For securities to which LCD is the issuer depository Law on Financial Instrument Market, Law on

Settlement Finality in Payment and Securities Settlement Systems and Financial Collateral Law are

applicable.

(b.2) the right to use collateral?

Legislation of Latvia: Law on Settlement Finality in Payment and Securities Settlement Systems

and Financial Collateral Law.

(b.3) transfer property interests?

Legislation of Latvia: Law on Financial Instruments Market, LCD rules.

(b.4) making and receiving payments?

Legislation of Latvia. Law on Financial Instruments Market, Law on Settlement Finality in Payment

and Securities Settlement Systems and LCD rules.

Have the claims of the SSS or of a system participant against collateral posted by a participant within a

system priority over all other claims of non-system creditors?

Yes. In accordance with the Law on Settlement Finality in Payment and Securities Settlement Systems

the collateral posted by system participant shall not be affected by insolvency proceedings against the

participant which provided the collateral. Such collateral shall be realized immediately for the

satisfaction of the SSS or other systems participants‟ rights and the restrictions to realize collateral set

by legal acts do not apply for such collateral. Financial Collateral Law provides similar rights as the Law

on Settlement Finality in Payment and Securities Settlement Systems. LCD does not grant the loans

and therefore doesn‟t accept the collaterals from its participants.

Has a court in the jurisdiction ever failed to uphold the legal basis of these activities/arrangements? And

if so, for what reasons?

LCD has no information about such cases.

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Is there a significant level of cross-border participation in the SSS through linkages, interoperable

arrangements, remote participants, or by operating through foreign offices?

No. LCD has established in-bound/out-bound links only with two Central Securities Depositories

(CSDs):

Estonian CSD;

Lithuanian CSD.

The link agreements with mentioned CSDs enable LCD participants to hold and settle transactions with

certain securities issued under the laws of Estonia and Lithuania.

Additionally LCD has established in-bound link with international CSD – Clearstream Banking

Luxembourg. Linkage with Clearstream enables LCD participants to hold and settle transactions with

securities eligible in Clearstream SSS.

There is no conflict of law issues for cross-border systems. LCD agrees with each link depository which

law should govern the contractual relationship and legal opinion is obtained from local legal counsel.

Have all eligible CSDs been designated by the relevant competent authorities under the Settlement

Finality Directive?

Yes. SSS operated by LCD is designated system under Settlement Finality Directive.

Have the relevant authorities designated the systems that meet the criteria of the Settlement Finality

Directive?

Yes.

Is the harmonisation of rules promoted by relevant public authorities with the aim of minimising

discrepancies stemming from different national rules and legal frameworks?

LCD rules and procedures (also amendments in them) governing SSS operated by LCD shall be sent to

FCMC for their opinion before they are approved by the LCD‟s Management Board. FCMC shall

scrutinize the draft of LCD rules and procedures (and any amendments thereto) as to their compliance

with laws, the requirements of other regulatory provisions and successful carrying out of the functions of

LCD, and prepare an opinion within 30 days of the submission of the draft. At the European Union (EU)

level public authorities ensure harmonization by adopting EU directives. For systemic risk purposes

Latvian public authorities implemented the legal norms of the Directive 98/26/EC on settlement finality in

payment and securities settlement systems and Directive 2002/47/EC on financial collateral

arrangements, as amended.

How many jurisdictions govern the proprietary and the contractual aspects of an SSS? Are the

applicable laws identical to the law governing the system?

The proprietary and contractual aspects of LCD SSS are governed by legislation of Latvia.

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RECOMMENDATION 2: TRADE CONFIRMATION AND SETTLEMENT MATCHING

What percentage of trades between direct market participants is submitted to a trade confirmation

system on trade date (T+0)?

Most of the trades (~ 90%) submitted to LCD‟s SSS are already in a status `„confirmed‟. A separate

confirmation by market participant is required in case the participant has intentionally marked trade as

„to be confirmed‟ in trading platform.

On a trade day after receipt of the settlement instructions from the stock exchange, LCD shall

immediately control and assess whether the transactions for which the settlement instructions have

been submitted require a confirmation (consent to make settlements) from the LCD participant which in

accordance with the information indicated in the settlement instruction provides the settlement related to

the transaction.

If a confirmation is required, the LCD shall immediately send a request for confirmation to the relevant

LCD participant, indicating the required type of confirmation.

More than 99.99% of OTC DVP trades are submitted to LCD‟s SSS in a status „confirmed‟.

How soon after submission are problems communicated to the appropriate parties?

The problems are communicated immediately.

Are trade confirmation procedures in place that are capable of comparing trade information between

direct and indirect market participants by T+1?

There are no indirect participants at the LCD.

The recommendation Confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than trade date (T+0). Where confirmation of trades by indirect market participants (such as institutional investors) is required, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1. Settlement instructions should be matched as soon as possible and, for settlement cycles that extend beyond T+0, this should occur no later than the day before the specified settlement date. Key issues 1. Confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than T+0. 2. When confirmation/affirmation of trades by indirect market participants is required by regulators, clearing systems or market participants, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1. 3. Settlement instructions should be matched prior to settlement and no later than the day before the specified settlement date for settlement cycles longer than T+0. This does not apply to free-of-

payment transfers in those systems where matching is not required.

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Trade information is comparable by direct market participants as soon as it is submitted to the LCD

system.

Is use of the system mandatory?

It is mandatory for direct participants.

Does the CSD require settlement instructions to be matched prior to settlement and no later than the

day before the specified settlement date for settlement cycles longer than T+0?

Stock Exchange settlement instructions are delivered as „already matched‟ to the LCD‟s SSS on T date.

LCD executes DVP settlements on the basis of a settlement instructions submitted by the Stock

Exchange, i.e. on T day the Stock Exchange prepares and sends to LCD the settlement instructions as

already matched in compliance with the procedure as determined in the agreement entered into

between LCD and the Stock Exchange. For settlement cycles longer than T+0 only OTC settlement

instructions can be matched on the settlement day.

OTC DVP instructions are matched as soon as both seller and buyer side has submitted them to LCD‟s

SSS.

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RECOMMENDATION 3: SETTLEMENT CYCLES AND OPERATING TIMES

Are trades settled on a rolling basis of T+3?

LCD supports any settlement cycle as defined by the market for a given instrument or trade type, i.e.

rolling settlement at T+3 is the current LCD minimum standard for automated trades on the stock

exchange. LCD settles government securities at a shorter period, i.e. T+1 or T+2.

If the stock exchange has not indicated another settlement period in the settlement instruction, DVP

settlements by net position are executed within the settlement period T+3.

If settlement is on an account period basis or on a rolling basis at T+3 or longer, have the benefits and

costs of a rolling cycle or a shorter settlement cycle been evaluated?

No.

What percentage of trades (by number and value) fails to settle on the contractual date?

LCD monitors and evaluates the frequency, duration and value of settlement failures. According to

monitoring more than 99.99% of trades both in number and value are settled on contractual date

What is the average duration of fails (by number and value)?

More than 99.99% of trades both in number and value are settled on fail + 1 or fail + 2.

What are the operating hours of the SSS?

The recommendation Rolling settlement should be adopted in all securities markets. Final settlement should occur no later than T+3. The benefits and costs of EU-wide settlement cycles shorter than T+3 should be evaluated. The operating hours and days of CSDs should be open at least during the operating time of the relevant payment system (at least during TARGET2 operating times for transactions denominated in euro). Key issues 1. Rolling settlement should occur no later than T+3. Further harmonisation and/or shortening of settlement cycles need to be considered in the interest of ensuring more efficient EU markets. Any such harmonisation and/or shortening should take account of the instruments and markets in question and should be based on a cost-benefit analysis. 2. The frequency, duration and value of settlement failures should be monitored and evaluated by the operator of the securities settlement system. 3. The opening hours and days of CSDs should be open at least during the operating times of the relevant payment system (at least during TARGET 2 operating times for transactions denominated in euro). The emergency plans of CSDs should allow them to extend operating hours to ensure safe and complete settlement in case of emergency. 4. The risk implications of fail rates should be analysed and actions taken that reduce these rates or mitigate the associated risks.

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Operating hours of LCD are from 8.30 to 18.00. Operating hours and days of LCD fully coincide with the

operating hours and days of the relevant payment systems.

And in case of an emergency plan?

There is an emergency netting cycle available at LCD. In case of emergency, LCD prolongs operating

hours as necessary according to each specific situation.

At what time is the final netting cycle completed under normal circumstances?

The final netting cycle under normal circumstances is completed at 13.00. RTGS settlement is available

up to the closing of the payment system of CB.

Up to what time does the system remain open for receiving same-day settlement instructions?

LCD‟s SSS remains open for FOP settlement instructions up to closing hours of the LCD, i.e. the LCD

executes instructions if the delivery instruction and receiver‟s confirmation, if necessary, have been

submitted to LCD before 18.00 on settlement date.

What are the operating days of the SSS?

Operating days of the LCD fully coincide with the operating days of the relevant payment systems, i.e.

payment system of the Central Bank.

Is the SSS open when the relevant payment system is closed?

Board of LCD may decide to open its settlement system when relevant payment system of the Central

Bank (CB) is closed.

If so, are there special settlement arrangements for these days or time intervals?

FOP settlements and DVP settlements in commercial bank money are only available for the market

participants.

How are cross-border settlement instructions handled on the days it is closed while other EU SSSs are

open?

When payment system of CB is closed, cross-border FOP settlement instructions and DVP settlements

in commercial bank money only are provided to other EU SSSs.

When LCD SSS is closed but linked SSS are open the settlement instructions with linked SSS's

securities, if any, are entered and processed into the LCD SSS on its next business day. When LCD

SSS is closed no settlement instructions with LCD registered financial instruments can be entered and

processed in the LCD‟s SSS.

Do market practices, regulations or SSS rules provide incentives for counterparties to settle their

obligations on the contractual date?

Regulation of Operator of Regulated Market provides incentive for counterparties to settle on the

contractual date.

What forms do these incentives take – for example, are penalties assessed for failing to settle?

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Different forms of penalties (warning, cash penalty) are applied by Operator of Regulated Market to

failing counterparties.

LCD does not charge penalties for settlement fails.

What steps, if any, are taken to mitigate the risks of fails?

To mitigate the risk of fails Operator of Regulated Market offers a Guarantee Fund facility which is

integrated with settlement.

Are fails required to be marked to market?

No, fails do not have to be marked to market. The decision is made case by case by the Board of

Operator of Regulated Market.

Are open positions required to be closed out at market prices if the duration of the fail exceeds a

specified number of business days?

There's no requirement at LCD to close out fails which have exceeded a number of business days.

Operator of Regulated Market is responsible to decide whether open positions, by the mechanism of

Guarantee Fund, are closed out at market prices if the duration of the fail exceeds a specified number of

business days.

What entity or entities establish, monitor and enforce these requirements?

LCD monitors the settlement process and informs Operator of Regulated Market on the failed

settlement instruction on the intended settlement date.

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RECOMMENDATION 4: CENTRAL COUNTERPARTIES (CCPS)

Has a CCP mechanism (or a guarantee arrangement) been introduced?

There is no CCP introduced in Latvian securities market. There is a Guarantee Fund facility (for cash

settlement fails) provided by Operator of Regulated Market (Stock Exchange). The Guarantee Fund

does not have the status of a legal entity. The resources, which have been paid into the Guarantee

Fund, may be used only for ensuring execution of the settlement instructions.

If so, what types of financial products and market participants are covered?

Guarantee Fund facility covers all the members of Regulated Market and only towards automated stock

exchange trades. The Member has obligation to join the Guarantee Fund in accordance with the

procedure of Operator of Regulated Market. Joining the Guarantee Fund means an installment by the

Member into the account specified by the stock exchange in the amount and in accordance with the

procedure provided by stock exchange.

If no such mechanism has been introduced, have the benefits and costs of such a mechanism been

evaluated?

The benefits and costs of establishing a CCP have been assessed carefully. The outcome of the

assessment proved that costs to introduce a CCP exceeded benefits for the market.

If there is a guarantee mechanism, have the benefits and costs of transforming this arrangement into a

CCP been evaluated?

No.

Has the CCP or the guarantee arrangement been assessed against the ESCB-CESR

Recommendations for CCPs or against the checklist for guarantee arrangements respectively?

No.

The recommendation The benefits and costs of establishing a CCP should be evaluated. Where a CCP mechanism or guarantee arrangement has been introduced, it should be assessed against the ESCB-CESR Recommendations for CCPs or against the checklist for guarantee arrangements18

respectively. Key issues 1. If there is no CCP, the balance of the benefits and costs of establishing a CCP should be carefully assessed. If a guarantee arrangement has been introduced, the benefits and costs of transforming this arrangement into a CCP should be analysed. 2. A CCP should be assessed against the ESCB-CESR Recommendations pertaining to CCPs that are included in Part 2 of this report. A guarantee arrangement that in terms of significance, function and risk management tools is comparable to a CCP should be assessed against the relevant ESCBCESR Recommendations for CCPs and other guarantee arrangements should be evaluated on

the basis of the checklist for guarantee arrangements.

17

RECOMMENDATION 5: SECURITIES LENDING

Are markets or facilities for securities lending (or repurchase agreements and other economically

equivalent transactions) clearly supported by legal, regulatory, accounting and tax systems?

Local regulations do not impede development and introduction of securities lending and borrowing.

If impediments to the development and functioning of securities lending exist, are steps being taken by

public authorities to remove them?

N/A

Are there markets or facilities for securities lending (or repurchase agreements and other economically

equivalent transactions)? If so, are they used as a method to expedite securities settlement?

The recommendation Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) should be encouraged as a method for avoiding settlement failures and expediting the settlement of securities. Barriers that inhibit the practice of lending securities for this purpose should be removed. The arrangements for securities lending should be sound, safe and efficient. Key issues 1. The relevant public authorities should remove any impediments (e.g. legal, tax and accounting framework) to the development and functioning of securities lending. 2. Securities lending and borrowing should be encouraged as a method for expediting securities settlement and reducing settlement failures. Where they exist, securities lending arrangements should meet the requirements of the particular market in order to minimise settlement failures. Securities lending services, in connection with securities settlement processes, can be arranged bilaterally or as an automated and centralised facility. 3. A centralised securities lending facility can be an efficient mechanism for reducing settlement failures. However, in markets where the number of settlement failures remains low, centralised securities lending arrangements may not be justified from a cost-benefit perspective. 4. Supervisors and overseers should have policies and procedures to ensure that risks stemming from securities lending activities are appropriately managed by entities subject to their supervision and oversight. 5. In order to preserve its financial integrity, the principal to centralised securities lending arrangements should apply adequate risk management and mitigation measures in line with the requirements set out in Recommendation 9. 6. Entities providing securities lending for securities settlement should in no case be allowed to run debit balances or to create securities. Clients‟ assets should only be used with their explicit consent. See also key issues 5 and 6 of Recommendation 12.assessed against the relevant ESCBCESR Recommendations for CCPs and other guarantee arrangements should be evaluated on the basis of

the checklist for guarantee arrangements.

18

There is no central and automated lending and borrowing system at the LCD. LCD system allows OTC

securities loans between participants of LCD, these operations being issued at their own initiative.

LCD had introduced SLB program for its market participants in 1998, however it was later closed due to

the lack of business case for the market.

How wide is the range of securities and participants involved in the markets?

OTC operations, being issued at participants own initiative, are not limited neither by range of securities

nor range of participants.

Do securities lending arrangements meet the requirements of the particular market in order to minimise

settlement failures?

Securities lending arrangements minimise settlement failures. Positive answers to Recommendation‟s

No 3 questions can be brought as verification to the statement.

Is securities lending arranged bilaterally or as an automated and centralised facility at the level of the

settlement system(s)?

Securities lending is arranged bilaterally by market participants at the level of the LCD settlement

system.

Are the costs and conditions for the use of the centralised facility transparent to the customers?

N/A.

If a centralised securities lending facility has not been introduced to reduce settlement failures in the

particular market, was this decision based on a (cost-benefit) study of the needs of the market?

LCD, in cooperation with colleagues from other Baltic CSDs, had carried out a cost-benefit study in the

past years. The study approved that introduction of automated SLB is not feasible from cost-benefit

perspective. As well as see previous answers regarding previous initiative in 1998.

Do bilateral facilities exist?

Securities lending is arranged bilaterally by market participants at the level of the LCD settlement

system.

Do supervisors and overseers review risk management procedures for securities lending?

N/A

Do they have policies with respect to these activities?

N/A

Do they ensure that entities offering such activities are or can be included within the scope of their

supervisory or oversight authority?

N/A

If credit risk is taken by the provider of the service, are adequate risk management measures applied in

line with the requirements set out in Recommendation 9, in order to preserve its financial integrity?

19

N/A

Is any credit risk in such arrangements fully collateralised?

N/A

If not, are other risk-mitigating measures employed to address any residual risk?

N/A

How are risks mitigated – for example by conducting credit evaluations, marking exposures and

collateral to market daily, and employing master legal agreements?

N/A

Do entities providing securities lending for securities settlement ensure that they do not run debit

balances or create securities?

In accordance with the LCD rules, debit balances are not allowed to the accounts as well as clients‟

assets may only be used with their explicit consent, approved by source documents presented by the

client.

20

RECOMMENDATION 6: CENTRAL SECURITIES DEPOSITORIES (CSDS)

Are securities issued on a dematerialised basis or as physical certificates?

Both Latvian and foreign securities handled at the LCD system are dematerialised. Within the

accounting system of LCD, financial instruments are kept in custody as book-entries in financial

instruments accounts.

If the latter, are they immobilised in a CSD to facilitate settlement?

If an issuer has issued physical certificates, they are immobilised before registered with LCD.

What percentage of securities issued domestically (i.e. at country level, considering all entities

performing all or some of the CSDs’ functions) is either immobilised or dematerialised, and what is the

trend?

All securities for which LCD acts as primary depositary are immobilised. It is allowed that non-listed

company, which is not registered at LCD, issues physical certificates.

Is the transfer of securities carried out by book entry, or does it require any form of physical delivery?

All transfers of securities at LCD‟s SSS are carried out by book entry only.

Is the recording and transfer of securities based on a robust accounting scheme, such as best

accounting practices and end-to-end audit trails?

LCD Rules No 3 “On Financial Instruments Accounting” stipulates the accounting procedure of financial

instruments within LCD. These Rules are developed pursuant to Article 94, paragraph two, clause one,

five, six, and eight of the Law on the Financial Instruments Market.

The recommendation Securities should be immobilised or dematerialised and transferred by book entry in CSDs to the greatest possible extent. To safeguard the integrity of securities issues and the interests of investors, the CSD should ensure that the issue, holding and transfer of securities are conducted in an adequate and proper manner. Key issues 1. Immobilisation or dematerialisation and transfer by book entry in CSDs should be implemented to the greatest possible extent. 2. The recording and transfer of securities issued in a CSD or an entity which performs CSD functions should be based on best accounting practices and end-to-end audit trails, which will help to ensure the integrity of the issue and safeguard the interests of the investors. 3. As CSDs uniquely combine the provision of final settlement with the recording of changes in legal title resulting from securities transactions they should avoid credit and liquidity risk to the greatest possible extent. CSDs have to mitigate their associated risks in accordance with the requirements set out in these recommendations. Besides, the risks involved in offering CCP services are of a different nature to those raised by performing CSD activities and therefore require exceptionally high levels of

risk management that necessitate separating the CCP services into a distinct legal entity.

21

According to the rules above, securities accounting is administered by LCD and the LCD participants.

The total financial instruments accounting system comprises two accounting levels:

a) accounting administrated by LCD - issue accounts and correspondent accounts of LCD

participants with LCD as well as direct accounts with LCD;

b) accounting administrated by the LCD participants – correspondent financial instruments

accounts with LCD and financial instruments accounts of clients of the LCD participant.

There is a continuous reconciliation between balances of accounts of LCD and the LCD participants

carried out by LCD.

Is the level of cooperation between all entities involved in some or all of these activities of CSDs (as

described above in Section C.1 and clarified in explanatory note 3) satisfactory enough to ensure the

rights of both issuers and investors (especially by helping to ensure the integrity of the issues of

securities)?

LCD opens securities issue accounts for all LCD participants with the issuer status as well as

correspondent accounts for the LCD participants. According to the rules of LCD:

a) LCD opens a separate issue account for each totality of fungible securities;

b) LCD opens a separate correspondent account for each totality of fungible securities

accounted by the LCD participant.

Any transfer, which creates or changes the ownership rights for the securities, must be book-entered by

the LCD participant in securities account of its client with the same book-entry date on which the

operation has been registered with LCD in the correspondent account of respective LCD participant.

Does the CSD have plans in place which ensure that market participants will continue to obtain access

to CSD functions even if it becomes insolvent?

In accordance with the Article 92‟ of “Law on the Financial Instruments Market”, in order LCD would

ensure that the CSD functions in Latvia are performed and all necessary information is stored properly,

LCD has developed a plan for ensuring continuity of its activity.

Furthermore, if LCD fails to perform its functions as set out in the Law due to insolvency, liquidation or

other reasons, the status of the CSD shall be assigned to another commercial company in a tender

procedure. The current CSD shall continue its activity until the functions of CSD are vested with a

commercial company that has been granted the status of the CSD.

Is there a lag between settlement and registration, and what are the implications of the time-lag for

finality?

There is no lag between settlement and registration – according to DVP principle, settlement is carried

out simultaneously with registration in the LCD‟s SSS.

Is the CSD allowed (on a statutory or a regulatory basis) to enter into arrangements that carry credit or

liquidity risks?

In accordance with legislation LCD is not prohibited to enter into arrangements that carry credit or

liquidity risks. But taking into account LCD‟s practice, risks management policies, LCD doesn‟t enter in

such type of agreements.

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If the CSD is allowed to conduct non-core business including credit or liquidity risks, does it have in

place an adequate risk management process that is properly organised and has sufficient resources

allocated?

In accordance with legislation LCD is not prohibited to enter into arrangements that carry credit or

liquidity risks. But taking into account LCD practice, risks management policies, LCD has identified

credit or liquidity risks related with cash pay – outs derived from the corporate actions. According to the

LCD rules an issuer is obliged to transfer entire amount of cash payable as dividends, coupons,

principal and other cash proceeds to LCD account by 11:00 on the payment day, but some issuers

practice to transfer cash couple of days before (2011: 3,2% out of total amount payable or 13 MLVL

(cash pay-outs in LVL) and 75% out of total amount payable or 54 MLVL (cash pay-outs in foreign

currencies) were transferred to LCD account prior payment date.). LCD plans to amend its rules setting

that the amount payable has to be transferred to LCD account on the payment date.

Are these risks mitigated according to Recommendations 5 (securities lending), 9 (Credit and liquidity

risks controls) and 10 (Cash settlement assets)?

N/A

Considering that CSDs have a central function in the overall settlement process for securities, does the

CSD minimise the operational risk according to Recommendation 11 (operational reliability)?

Contingency plans are in place for all core services and are tested with involvement of market

participants on a regular basis. The IT platforms are highly secure as they run on two synchronous and

one asynchronous data centers.

The Contingency plans includes ability to quickly recover from a backup site, which is located in another

part of the city, i.e. in a safe distance to secure data if disaster takes place in the region of headquarter

as well as to react as quickly as possible to ensure continuous core service.

Is the CSD directly involved in offering CCP services?

No.

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RECOMMENDATION 7: DELIVERY VERSUS PAYMENT (DVP)

Does the technical, legal and contractual framework ensure that delivery of securities takes place if, and

only if, payment is received?

The technical, legal and contractual framework ensures that delivery of securities takes place only if

payment is received.

If so, how?

In accordance with the rules and practices of LCD, settlement of financial instruments is made only and

exclusively when the related money settlement is made.

Does the DVP facility ensure a sound and effective electronic connection between the two legs of the

transactions settled?

LCD‟s SSS controls the availability of securities provisions before executing the cash instructions at the

Bank of Latvia (which are sent exclusively by LCD when securities positions are blocked in the account

of seller).

If money or the securities are not available on the accounts of the participants, the settlement

transaction is not processed while money or securities are sufficient. If money or the securities are

available, the settlement instructions are settled and simultaneous transfer of money and securities is

carried out.

What DVP model is provided?

According to BIS settlement models, the LCD provides Model 1 (Securities and funds are transferred on

a simultaneous, irrevocable and real-time gross settlement (RTGS) basis) and Model 3 (Securities and

cash is settled on a net basis). When stock exchange transactions are settled, LCD calculates securities

positions on a net basis, though settlement on the accounts (recorded transfers of securities) is carried

out on a gross basis.

Are all cash against securities transactions between direct participants and the CSD settled on a DVP

basis?

Yes.

The recommendation Principal risk should be eliminated by linking securities transfers to fund transfers in a way that achieves delivery versus payment. Key issues 1. The technical, legal and contractual framework should ensure DVP. 2. All securities transactions against cash between direct participants of the CSD should be settled on a DVP basis. 3. The length of time between the blocking of the securities and/or cash payment and the moment

when deliveries become final should be minimised.

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Is the moment when payment and securities become final simultaneous?

In case of LVL settlements, LCD system provides DVP settlement in central bank money, with

simultaneous and irrevocable transfer of money and securities. Legal ownership of the securities is

transferred as soon as money settlement confirmation is received from the Bank of Latvia and

immediate securities settlement is carried out by the LCD.

If not, how long is the time-lag between the final transfer of payment and securities?

In average, maximum time-lag between the final transfer of payment and securities is 5-10 minutes.

How long is the time-lag between the blocking of securities and/or cash and the moment they become

final?

The maximum time-lag between the blocking of securities and the moment they become final as a rule

does not exceed one hour.

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RECOMMENDATION 8: TIMING OF SETTLEMENT FINALITY

Does the system permit final settlement of securities transfers on a delivery-versus-payment, free of-

payment and delivery-versus-delivery basis during the settlement day?

LCD‟s SSS permits final settlement of securities transfers for DVP and FOP transfers during the

settlement day.

Do the rules of the system clearly define the timing of settlement finality to mean the time at which the

transfer orders of securities and/or cash become both irrevocable and unconditional?

Yes. The moment of irrevocability and finality is set in the LCD rules No 4, Articles 4.10. and 4.20., LCD

rules No 5, Articles 2.6. and 2.7., LCD Rules No. 6, Articles 2.9. and 7.5., LCD rules No 15, Articles 2.8.

and 7.5.

Does the legal framework that applies to the system and to its links, if any, with other systems support

the timing of settlement finality?

Yes. LCD‟ SSS and its links with Estonian CSD, Lithuanian CSD and Clearstream Banking Luxembourg

have been designated by the relevant competent authorities under the Settlement Finality Directive.

Does the system provide final settlement of transfers on a real-time basis and/or through multiple-batch

processing during the settlement day?

LCD‟ SSS provides both real-time settlement as well as batch processing (only for stock exchange

trades).

If the latter, what is the frequency of the batches and within what time frame do they operate?

DVP settlement instructions by net positions (in batch) are processed one time per settlement day at

12.00, if according to the net positions the necessary amount of money and securities is provided. The

The recommendation Intraday settlement finality should be provided through real-time and/or multiple-batch processing in order to reduce risks and allow effective settlement across systems. Key issues 1. The timing of settlement finality has to be clearly defined in the rules of the systems, which require transfer orders and deliveries of securities and payment to be irrevocable, enforceable and supported by the legal framework. 2. Settlement finality should be provided in real time and/or by multiple-batch processing during the settlement day. Where multiple-batch processing is used, there should be a sufficient number of batches distributed across the settlement day so as to allow interoperability across systems in the EU and to allow securities transferred through links to be used during the same settlement day by the receiver. 3. The settlement system and its participants should execute the transactions without undue delay as soon as securities and cash are available. 4. The rules of the system should prohibit the unilateral revocation of unsettled transfer instructions

late in the settlement day.

26

contingency batch of DVP settlement instructions occurs (at 13.30, ending at 14.30) only if the first

batch has not been executed due to insufficient amount of money on the account of participant.

Does the time of processing in the afternoon take into account the closing time of the relevant payment

system, so that participants have time to react?

Time of processing is in line with the Bank of Latvia‟s payment system‟s operation hours allowing

participants to react until end of day period.

If multiple batches are used, does the number and distribution of batches throughout the day ensure

that securities transferred through each of the system’s links can be reused by the recipients during the

day?

No multiple batches are used.

Does the system promote early settlement during the day through appropriate measures?

There are no specific promotion activities (e.g. rebates to participants for early settlement) carried out by

LCD. LCD‟ SSS is open throughout the settlement day from 8.30 until 18.00. DVP settlement is

provided throughout the working hours of payment system of the Bank of Latvia.

If not, how does the system ensure that it is not subject to gridlock due to participants delaying

settlement until late in the day?

To avoid gridlock situations LCD and Operator of Regulated Market (stock exchange) offers Guarantee

Fund facilities to reduce the risk of clients failing settlement due to lack of cash. LCD offers possibility to

transform net (batch) settlement instruction into real-time settlement instruction that reduces fails for

lack of securities and prevents gridlock situations.

Do the rules of the system prohibit the unilateral revocation of unsettled transfer instructions on the

settlement day?

According to the LCD rules, if LCD has not started execution of settlement, OTC settlement instruction

may be cancelled upon an initiative of the buyer or the seller, by sending to LCD notification about

cancellation of the settlement instructions. LCD‟ SSS doesn‟t allow unilateral cancellation of settlement

instructions if they are in status “matched”.

OTC settlement instructions, which have not been settled on settlement day, are cancelled by LCD at

the end of settlement day.

Does the system receive provisional transfers of securities from any other systems?

No.

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RECOMMENDATION 9: CSD RISK CONTROLS TO ADDRESS PARTICIPANTS’ FAILURES

TO SETTLE

As LCD does not offer credit to its participants, overdraft and debit balances in securities are not

allowed therefore the recommendation is not applicable.

The recommendation CSDs that extend intraday credit to participants, including CSDs that operate net settlement systems, should institute risk controls that, as a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. The most reliable set of controls is a combination of collateral requirements and limits. Key issues 1. A CSD that extends intraday credit to participants should, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. Risk controls should be imposed to control potential losses and liquidity pressures from participants‟ failures to settle. 2. Overdrafts or debit balances in securities should not be permitted and there should be no artificial creation of securities. 3. The probability and potential impact of multiple settlement failures should be evaluated relative to

the costs to ensure settlement in such an event.

28

RECOMMENDATION 10: CASH SETTLEMENT ASSETS

For transactions denominated in the currency of the country where the settlement takes place, is the

cash payment settled in central bank money?

Yes. Cash settlement in central bank money is managed by LCD by sending the money transfer instructions to the Bank of Latvia‟s payment system. Bank of Latvia debits or credits respective cash accounts opened in its payment system. The LCD participants have to be either the participants or have to have a settlement bank which is a participant of Bank of Latvia‟s payment system in order to be able to settle DVPs in central bank money.

Is this also the case within the EU, when the domestic CSD is not located in the country of issue of the

currency? If not, why is this not feasible or practicable?

LCD is located in the country of issue of the currency.

The recommendation Assets used to settle payment obligations arising from securities transactions should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect the participants in the system from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose. Key issues 1. For transactions denominated in the currency of the country where the settlement takes place, CSDs should settle cash payments in central bank money whenever practicable and feasible. For this reason, central banks may need to enhance the operational mechanisms used for the provision of central bank money. 2. If central bank money is not used as asset to settle obligations in a currency, steps must be taken to protect participants from potential losses and liquidity pressures arising from the failure of the cash settlement agent in which the cash balances are held for that purpose. Where both central and commercial bank money facilities are offered, the choice to use commercial bank money should be at the sole discretion of the participant. 3. Only regulated financial institutions with robust legal, financial and technical capacity, in accordance with EU prudential (or equivalent) regulation, should be allowed to act as cash settlement agents. When central bank money is not used, the CSD acting as cash settlement agent should put in place adequate risk measures as described in Recommendation 9 in order to protect participants from potential losses and liquidity pressures. There should be sufficient information for market participants to identify and evaluate the risks and costs associated with these services. 4. The proceeds of securities settlements should be available for recipients to use as soon as possible on an intraday basis, or at least on a same-day basis. 5. The payment systems used for interbank transfers among settlement banks should observe the Core Principles for Systemically Important Payment Systems (CPSIPS).

29

Are central banks taking any steps to offer enhanced mechanisms for settlement in central bank

money?

Yes. The procedures and legal measures are in place for smooth cash settlement in central bank money. Cash settlement of the stock exchange trades, OTC DVP and money transfers stemming from the execution of the corporate actions in central bank money is managed by LCD by sending the money transfer instructions to the Bank of Latvia‟s payment system.

Are costs and conditions for the use of central bank money and commercial bank money transparent to

customers?

Yes. Conditions and costs for DVPs in either central bank money or commercial bank money are set in the LCD rules.

If settling takes place in a foreign currency, what steps has the central bank or the CSD taken as

settlement agent to ensure that the settlement assets pose little or no credit or liquidity risk?

Currently LCD offers cash settlement in two foreign currencies – Euro and US dollars acting as a settlement bank who maintains cash accounts with the settlement agent in order to settle payment obligations arising from LCD‟s participants‟ securities transfers or execution of the corporate actions. The cash correspondents are used for cash settlement. LCD rules set the procedure how DVP in foreign currency is managed. LCD settles cash only upon receipt of cash credit confirmation from its corresponding bank. LCD‟s cash corresponding banks are supervised institutions with good reputation and favorable ratings.

If the central bank is not used, what steps have been taken to protect CSD members from failure of the

cash settlement agent?

LCD uses Bank of Latvia for the settlement of the transactions denominated in the currency of the

country where the settlement takes place, i.e. LVL, and commercial banks as cash correspondents for

the settlement of the transactions denominated in Euro and US dollars. The cash correspondents are

regulated and supervised institutions with strong legal, financial and technical capacity.

99.9% of the trades were settled in central bank money in 2011.

If settlement takes place on the books of the CSD, is it itself a regulated financial institution with robust

legal, financial and technical capacity, in accordance with EU prudential (or equivalent) regulation?

Does it strictly limit any risks associated with nonsettlement activities?

N/a as cash settlement does not take place on the books of LCD.

If settlement is offered in both central and commercial bank money, is the choice to use commercial

bank money left to the sole discretion of the participant?

No. A LCD participant has no choice as the cash settlement in Latvian Lats is done using the Bank of

Latvia and the cash settlement in foreign currency is done using the cash agents – commercial banks.

When central bank money is not used, what risk measures have been put in place by the CSD acting as

cash settlement agent to protect participants from potential losses or liquidity pressures?

N/A.

30

Are EU-settlement banks regulated financial institutions with robust legal, financial and technical

capacity, in accordance with EU prudential (or equivalent) regulation?

Yes. LCD uses Deutsche Bank AG as a cash settlement agent for Euro currency, which is regulated

financial institution with robust legal, financial and technical capacity and with good reputation.

Are non-EU settlement banks subject to prudential supervision by government authorities equivalent to

EU banking requirements?

Yes. LCD uses Deutsche Bank Trust Company Americas that is part of Deutsche Bank group.

Who determines which institutions can be active as settlement banks?

The corresponding relationships are established on a case-by-case basis with effort to minimise risks

and maximise efficiency. LCD‟s management board takes final decision on which commercial bank will

be used for the cash settlement in commercial bank money (foreign currency).

What are the criteria?

The corresponding banks are chosen taking into the account its financial, reputational and regulatory

criteria. The corresponding bank has to be a major player in the financial market and with excellent

reputation in the market.

If multiple settlement banks can be used in principle, how many are used in practice?

LCD uses one cash settlement agent for each accepted foreign currency.

How concentrated are payment flows? On an average day, what percentage of total payments is

credited to accounts at the institution that accounts for the largest share of payment flows?

99.90 % of the cash settlement were settled with the Bank of Latvia (in Latvian Lats), 0.09% - with Euro

cash correspondent bank and 0.01% - with US dollars cash correspondent bank in 2011.

What is the financial condition of that institution (for example, its capital ratios and its credit ratings)?

Deutsche bank‟s credit ratings are available here: http://www.db.com/ir/en/content/ratings.htm

Are the concentration of exposures and the financial condition of the settlement banks monitored and

evaluated?

Yes, trade by trade, because volume of such transactions is small. LCD monitors the ratings of its

corresponding banks.

If so, by whom?

Clearing and settlement department.

How quickly can recipients use the proceeds of securities settlements – on the same day?

The proceeds of securities settlements can be used as soon as the proceeds are credited on a

recipient‟s account.

Intraday?

Yes.

31

Does the payment system used for interbank transfers among settlement banks observe the CPSIPS?

The Bank of Latvia evaluates their systems‟ compliance with the Core principles and the systems are

compliant.

32

RECOMMENDATION 11: OPERATIONAL RISK

Does the operator of the securities settlement system regularly identify, monitor, assess and minimise

the sources of operational risk in settlement activities and related functions/services?

Yes. The risks are identified and assessed twice a year and monitored on a daily basis. The sources of

the identified risk are minimised.

Are operational risk policies and procedures clearly defined?

The recommendation Sources of operational risk arising in the clearing and settlement process should be identified, monitored and regularly assessed. This risk should be minimised through the development of appropriate systems and effective controls and procedures. Systems and related functions should (i) be reliable and secure, (ii) be based on sound technical solutions, (iii) be developed and maintained in accordance with proven procedures, (iv) have adequate, scalable capacity, (v) have appropriate business continuity and disaster recovery plans that allow for the timely recovery of operations, and (vi) be subject to frequent and independent audits. Key issues 1. Sources of operational risk in clearing and settlement activities (including systems operators) and related functions/services should be regularly identified, monitored, assessed and minimised. Clear policies and procedures should be established to address those risks, including risks from those operations that are outsourced to third parties. 2. Operational risk policies and procedures should be clearly defined, frequently reviewed and updated and tested to remain current. The responsibilities of the relevant governance bodies and senior management should be clearly established. There should be adequate management controls and sufficient (and suitably well-qualified) personnel to ensure that procedures are implemented accordingly. Information systems should be subject to periodic independent audit. 3. There should be business continuity and disaster recovery plans to ensure that the system is able to resume business activities, with a reasonable degree of certainty, a high level of integrity and sufficient capacity as soon as possible after the disruption. Contingency plans should, as a minimum, provide for the recovery of all transactions at the time of the disruption to allow systems to continue to operate with certainty. A second site should be set-up in order to meet these obligations. Business continuity and disaster recovery plans should be tested on a regular basis and after any major modifications to the system. Adequate crisis management structures, including formal procedures, alternative means of communication and contact lists (both at local and crossborder level) should be available. 4. All key systems should be reliable, secure and able to handle stress volume. 5. CSDs should only outsource settlement operations or functions to third parties after the approval of the relevant competent authorities, if it is required by regulation. If it is not required, they should at least notify in advance the relevant competent authorities, and should ensure that the external providers meet the relevant recommendations. Appropriate change management procedures which give the relevant outsourcing entities the power to require, control and approve changes to the outsourced services should be in place.

33

Yes, the procedures and policies are clearly defined. Twice a year LCD identifies, describes, assesses,

and evaluates the risks it has. One responsible person from the organization is appointed to prepare

risk assessment document where the identified risks are described and assessed (impact, probability of

occurrence, actions, if any, to be taken). The risks are identified by conducting interviews with key

employees in the organization. Action types (e.g. monitor, reduce) and responsible persons who

mitigate the risks are assigned to each identified risk. The appointed person is responsible for setting

actions in order to minimize the sources of the risk and reduce potential impact on the operations.

How frequently are they reviewed, updated and tested?

Every 6 month.

Are there well-defined, transparent and consistent lines of responsibility for operational risk?

Yes. Each identified risk has responsible employee (on a management level) assigned who is

responsible for monitoring the risk and reducing the impact of this risk.

What are the governance bodies, and what are the relevant senior management responsibilities with

regard to the oversight of operational risk mitigation policies?

Risk assessment document is reviewed and approved by the management board of the organization.

The document is sent to the responsible for risk control employees at the NASDAQ OMX group.

Are there sufficient personnel (who are suitably well-qualified) to ensure that procedures are

implemented accordingly?

Yes. The risk control procedures and policies are set by the group and it is conducted on the highest

professional level.

Are systems and related functions subject to periodic independent (internal or external) audit?

Yes, once a year internal audit (conducted by NASDAQ OMX group) is performed. The systems and

business procedures are audited.

Does the system operator have contingency plans and disaster recovery plans?

Yes. LCD has a business recovery plan which is updated at least once a year. The document is

applicable to all employees and sets the procedures and gives guidance in case of various emergency

situations.

Do these ensure that the system is able to resume business activities as soon as possible after the

disruption occurs?

Yes. Each critical business line has responsible employee/-s and actions to be taken in order to resume

the business activities as soon as possible.

How long does this take?

Depends on the affected business activity, maximum allowable time of the downtime of clearing and

settlement is resumed in 4 hours.

Does the system operator have a second processing site?

Yes.

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Where is it located?

Backup office facilities in remote location in Riga.

When does business resumption occur after a disruption to the primary site?

Within an hour.

Do contingency plans provide for the recovery of all transactions at the time of the disruption to allow

the system to continue to operate with certainty?

Yes.

In particular, does the system allow transactions that have been entered into the system before the

disruption occurred to be carried out?

Yes.

Does the contingency plan include a definition of the core activities that should be resumed immediately

after the restart of the activities and that need to be completed by the end of the business day, and

other activities which completion can be postponed?

Yes, the critical business activities are defined and maximum acceptable time of downtime is set for

each business activity.

Do the procedures provide for the preservation of all transaction data?

Yes.

How does the system operator ensure the integrity of messages?

Messages (one or many) are filed and files are digitally signed.

Have Service Level Agreements been implemented?

The LCD participants and LCD have signed an agreement on participation and cooperation and the

service level provided is set in the LCD rules. According to the bilateral agreement the LCD rules are

mandatory to the LCD participants.

Have critical functions been identified and processes within those functions categorised according to

their criticality?

Yes. According to the internal contingency and business recovery plan.

Does the system have in place accurate and clear information flows within the institution in order to

establish and maintain an effective operational risk management framework?

Yes. For each business activity there is a responsible employee assigned and in case of emergency this

person has to be informed within the organization.

Does the system have adequate crisis management structures, including formal procedures and

identified personnel; alternative means of communication and contact lists (both at local and cross-

border level)?

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Yes. The internal contingency and business recovery plan includes identified business activities,

responsible employees in case of emergency, contact list and means of communication.

Have these procedures been developed with other relevant institutions (e.g. telecommunications,

regulators/overseers, etc.)?

Yes, LCD internal procedures and internal rules on system‟s security are developed according to the

regulator‟s regulation on information systems‟ security.

How many times has a key system failed in the last year? What is the most common cause of failure?

How long did it take to resume processing? How many transaction data, if any, were lost?

None major issue.

Does the system operator have capacity plans for key systems, and are key systems tested periodically

to determine whether they can handle stress volume?

LCD‟s SSS is capable to handle the volumes much greater than the current settlement volumes within

the business day. Key systems are tested periodically to determine whether they can handle stress

volume.

Has the system outsourced any clearing and settlement operations or functions to third parties?

No.

Does the system have the approval of the relevant competent authorities if this is required by the

applicable regulatory regime?

N/A, however, approval of the relevant competent authorities is mandatory if LCD outsources settlement

activities.

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RECOMMENDATION 12: PROTECTION OF CUSTOMERS’ SECURITIES

What arrangements are used to protect customer securities from theft, loss or misuse and to ensure

that they will not become subject to claims of the creditors of the entity holding securities (for example:

are segregation, insurance or compensation schemes used)?

According to the Financial instruments market law and LCD rules the banks‟ own securities and its

clients‟ securities have to be segregated (mandatory to all financial instruments registered with LCD).

LCD rules No 3 on Financial Instruments accounting prescribes that LCD participant is not allowed to

use financial instruments entered in the financial instruments account without consent from the owner of

The recommendation Entities holding securities in custody should employ accounting practices and safekeeping procedures that fully protect customers’ securities. It is essential that customers’ securities be protected against the claims of the creditors of all entities involved in the custody chain. Key issues 1. An entity holding securities in custody should employ best accounting practices, and should segregate in its books customers‟ securities from its own securities so as to ensure that customer securities are protected, particularly against claims of the entity‟s creditors. 2. At regular intervals, and at least once a day, entities holding securities in custody should reconcile their records (e.g. with the issuer CSD, the investor CSD or a custodian bank, depending on the tiering of the custody chain) so as to ensure that customer claims can be satisfied, in line with the implementation of the MiFID. 3. In addition to Key Issue 1, national law should ensure that customer securities are kept immune from any claims made by creditors of the entity holding the securities in custody or by entities upstream in the custodial chain. 4. Entities holding securities in custody should audit their books on a regular basis to certify that their clients‟ individual securities holdings correspond to the global clients‟ positions that the entities register in the CSD‟s, registrar‟s or depository‟s books. Entities should submit audit reports to supervisory and oversight authorities upon request. 5. Entities holding securities in custody must not use customer securities for any purpose unless they have obtained the customer‟s express consent. Their records shall include details of the client and of the financial instruments that they may have used to enable the correct calculation in any loss allocation mechanism that might be applicable. 6. In no case should securities debit balances or securities creation be allowed by entities holding securities in custody. 7. When securities are held through several intermediaries, the entity with which the customer holds the securities should ascertain whether adequate procedures for its customers‟ protection are in place (including, where relevant, procedures applicable to all upstream intermediaries), and should inform the customers accordingly. 8. Entities holding securities in custody should be regulated and supervised.

37

the relevant financial instruments account for settlements on behalf of the LCD participant or a third

person.

Besides that each operation with financial instruments and book-entries in accounting documents shall

be carried out only on the grounds of justification documents.

Following arrangements are in place to protect customers: - segregation;

- compensation schemes (deposit protection scheme in case of funds held on a bank balance

sheet, and investor protection scheme in case of financial instruments);

- internal control systems (incl. accounting, organisational requirements (i.e. separation of

duties), system of controls and checks);

- external audit checks.

Are those arrangements based upon specific laws and regulations?

Yes. Financial instruments market law and CSD rules.

In the event of the insolvency of the entity holding securities, do those arrangements enable a

customer’s positions to be moved by a receiver to a solvent intermediary?

Yes. LCD rules No 1 on LCD participants set that the LCD participant shall be under obligation, upon

request of the LCD, to deliver bookkeeping of financial instruments to the LCD, if it is necessary for the

protection of interests of the LCD participant‟s clients or if the LCD participant has not delivered

bookkeeping of financial instruments to another LCD participant(s) within term stated by the LCD in

case of annulment of the LCD participant status.

Do entities holding securities in custody employ robust accounting procedures including double-entry

accounting?

Yes. LCD rules No 3 on Financial Instruments accounting set minimum mandatory requirements – one

of them is double entry requirement for the accounting procedures when each operation with financial

instruments shall be recorded in two financial instruments accounts. One entry shall be done in the debit

side and the other in the credit side of the account. The entries shall be done at the same time and both

entries shall be done about a similar amount of financial instruments. LCD rules No 3 set minimum

account plan as well.

Do the accounting procedures, including the records maintained by intermediaries, enable the

identification of the customer’s holding of securities at any time and without delay?

Yes. LCD rules No 7 set the procedures on the identification of the owners of the securities.

How often do the entities holding securities in custody reconcile their records (e.g. with the issuer CSD,

the investor CSD or a custodian bank, depending on the tiering of the custody chain)?

LCD at the beginning of the business day sends the account statements showing previous day‟s starting

balance, transactions completed and ending balance. The statements are sent only to those LCD

participants who had at least one movement on the accounts on the previous day.

Baltic CSDs reconcile the balances at the end of each business day (the balances of each Baltic

security with Investor CSD is available via Baltic link in for that dedicated data base).

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LCD reconciles the balances of the securities held on the omnibus account with Clearstream every time

when there was a securities transfer but not less than once a month.

Does the legal framework support the segregation of the customer’s assets or other arrangements for

protecting customer securities in order to ensure that these securities are kept immune from any claims

made by creditors of the entity holding securities in custody or by entities upstream in the custodial

chain?

Yes. Financial instruments market law sets obligation to the financial institutions that keeps customer

securities that they have to ensure that the financial instruments of clients and their own financial

instruments are permanently kept separately. The Law says that “financial instruments, which belong to

a client of an investment brokerage company or credit institution, may not be utilised for the satisfaction

of claims by the investment brokerage company or credit institution. This requirement also applies to

cases where the investment brokerage company or credit institution has been declared insolvent in

accordance with the procedures specified by law.”.

Do entities holding securities in custody audit their books on a regular basis to certify that their clients’

individual securities holdings correspond to the global clients’ positions that the entities have in custody

with issuer CSDs, investor CSDs and custodians?

LCD electronically sends statements of the accounts to each LCD participant on a daily basis if a LCD

participant has had transactions on a previous business day. The LCD participants upon their request

can get statements of the accounts and statement of its portfolio with LCD on exact date in paper form.

LCD rules No 3 on Financial Instruments accounting prescribe that each LCD participant shall be

responsible for the correctness of the accounting of financial instruments it administers and settlements

regarding financial instruments transactions.

Do such entities submit audit reports to supervisory and oversight authorities upon request?

According to the Article 129.2 of the Law on Financial instruments market an investment brokerage firm

and a credit institution shall ensure that at least once a year an official auditor inspects whether the

measures taken are sufficient to meet the requirements of the Law on Financial instruments market. An

official auditor shall submit to the Financial and capital market commission (supervisory authority in

Latvia) a report in writing regarding above inspection. Such audit reports should be submitted on annual

basis, as required by LFIM Article 129.2

Are the entities holding securities in custody subject to mandatory internal or external audits, or both, to

determine if there are sufficient securities to satisfy customer claims?

LCD rules No 1 on LCD participants set that LCD shall have the rights to inspect a LCD participant, e.g.

the accuracy of financial instruments accounting and settlements regarding financial instruments

transactions and that the said activities are performed in compliance with the LCD rules. Additionally

LCD rules No 3 On Financial instruments accounting set that a LCD participant shall carry out regular

and sudden audits, as well as detailed documental audits of financial instruments accounting and

settlement. During the audits, the conformity of financial instruments accounting to the LCD rules and

the LCD participant‟s description of financial instruments accounting and settlement shall be controlled.

The management of the LCD participant shall be informed about each documental audit of financial

instruments accounting. LCD has the rights to get acquainted with the results of the internal control

(audit) of the LCD participant‟s financial instruments accounting and settlement.

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What arrangements are used to protect a customer from entities holding securities in custody using the

customer’s securities for any transaction unless they have obtained the customer’s explicit consent?

The Article 125 of the Law on Financial instruments market and LCD rules No 3 on Financial

Instruments accounting prescribes that a LCD participant is not allowed to use financial instruments

entered in the financial instruments account without consent from the owner of the relevant financial

instruments account for settlements on behalf of the LCD participant or a third person. However,

arrangements used to o protect a customer are up to a LCD participant. The breaking of the Law on

Financial instruments market leads to the initiation of the administrative case.

Do entities holding securities in custody have procedures that prohibit debit balances or securities

creation?

Debit balances and securities creation are not allowed in the LCD SSS.

LCD SSS‟s instructions‟ validation and settlement engine is developed so the LCD participants cannot

transfer securities more than they have on the account (no debit balances) and the securities transfer

instruction is automatically rejected by LCD if the ISIN used is not registered with LCD (no securities

creation). However, arrangements used to protect a creation of the debit balances in the LCD

participants systems are up to a LCD participant.

Does an entity with which the customer holds the securities make sure that adequate procedures for its

customers’ protection are in place, also when securities are held through several intermediaries?

As far as all entities involved in upstream intermediaries‟ chain are subject to the same requirements,

this ensures customer securities protection.

Are these procedures, where relevant, applicable to all upstream intermediaries?

Yes.

Are the customers informed accordingly?

Yes. Customers should be informed in a clear, comprehensive and not mis-leading way about all risks

related to holding of their securities.

Is the clients’ explicit consent obtained prior to the use of their assets in such activities?

Yes. It is mandatory.

Are the entities holding securities in custody subject to prudential supervision and regulation?

Yes. According to Financial Instruments Market Article 101 only authorized and regulated entities may

provide custody services. According to the LCD rules No 1 and participation agreement LCD shall have

the rights to inspect a LCD participant. The investment firms - LCD participants have to obtain a license

from the Financial supervisory authority. All the investment firms in Latvia are supervised and regulated

by Financial and capital market commission.

Do regulatory reviews examine the procedures and internal controls used in the safekeeping of

securities?

Yes, by Financial and capital market commission.

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RECOMMENDATION 13: GOVERNANCE

What are the governance arrangements of the CSD?

LCD is a private sector company, fully owned by NASDAQ OMX Riga (stock exchange) that indirectly

owned by NASDAQ OMX Inc., listed company. LCD‟s governance legal framework consists of

statutory provisions (Commercial Law and the Law on Financial Instruments Market), as well as Articles

of Association, contractual agreements between LCD and its participants. Law on the Financial

Instruments Market defines responsibilities of LCD as the recognized national central depository. LCD is

run by the Management Board and the Council (Supervisory Board). Council consists of 5 members and

the Management Board consists of 3 members. The Council is elected by Shareholders Meeting, but

the Management Board is elected by the Council.

Major decisions are approved by the Council. The Council approves the implementation of new IT

systems or IT solutions, introduction of major new services.

The functions of the LCD Council are the following:

1) to elect and recall members of the board of directors and to continually supervise the activities of the

Management Board;

2) to monitor that the business of LCD is conducted in accordance with law, the Articles of association

and the decisions of the shareholders meeting;

3) to examine the annual accounts of LCD and the proposal of the Management Board for the use of

the profits and to submit them, together with its own report, to the shareholders meeting;

The recommendation Governance arrangements for CSDs should be designed to fulfill public interest requirements and to promote the objectives of owners and relevant market participants. Key issues 1. Governance arrangements should be clearly specified and transparent. 2. Objectives and major decisions should be disclosed to the owners, relevant market participants and public authorities involved. 3. Management and the Board of Directors (“the Board”) should have the incentives and skills needed to achieve objectives, and should be fully accountable for their performance. 4. The Board or the relevant governance body should have the required expertise and take all relevant interests into account. 5. Governance arrangements should include the identification of conflicts of interest and should use resolution procedures whenever there is a possibility of such conflicts occurring. 6. When appropriate, the relevant appropriate decision-making level of the CSD should approve the limits on total credit exposure to participants, and on any large individual exposures. When there is a risk of a conflict of interests, such a decision should be taken with due regard to this conflict of interests.

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4) to represent LCD in a court in all actions brought by LCD against members of the Management

Board as well as in actions brought by the Management Board against LCD and to represent LCD in

other legal relations with members of the Management Board;

5) to approve the concluding of transactions between LCD and members of the Managemnet Board or

the auditor;

6) to examine in advance all issues which are within the competence of the shareholders meeting or

which, pursuant to the proposal of members of the Management Board or of the Council, have been

proposed for discussions at the meeting, and to provide its opinion on such issues.

The Council shall have a decision-taking power if more than a half of the members are present at the

Council meeting.

The Council shall pass its resolutions with a simple majority of votes of attending members.

The Management Board is the executive institution, which manages and represents LCD.

The Management Board supervises and manages the affairs of LCD and is responsible for the

commercial activities of LCD, as well as for accounting, in compliance with law.

The Management Board administers the property of LCD and shall act with its means according to the

requirements of law, the Articles of Association and decisions of the shareholders meeting.

Apart from the obligations specified before and stipulated by the Commercial Law, the Management

Board shall:

approve LCD rules and the fees for the services provided by LCD;

resolve on accounting of the financial instruments;

resolve on approving or revoking LCD participant status, as well as on suspension of

participant status;

assure the compliance with Company Rules;

evaluate the quality of the services provided to financial instrument market participants; decide

on quality enhancement.

As well the Management Board fulfills any other obligations pursuant to the provisions of the Law on

Financial Instrument Market other legal acts and LCD Rules.

The Management Board shall have a decision-taking power if more than a half of the Management

Board members are present at the meeting. Management Board shall pass its resolutions with a simple

majority of votes of attending members.

What information is publicly available regarding the system, its ownership and its Board and

management structure, and the process by which major decisions are taken and management made

accountable?

The responsibilities of the LCD‟s Management Board are set in Law on the Financial Instruments

Market and LCD‟s rules. The information on the LCD‟s Management board and Council structure and

members of the Management Board and Council, LCD‟s owners is available on the LCD‟s website

www.lcd.lv.

Taking into account that LCD SSS is governed by LCD rules, the information about the system (i.e. LCD

rules) are publicly available on the LCD‟s website www.lcd.lv.

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Please see also answer to the first question of this recommendation.

Are the system’s public interest, financial and other objectives clearly articulated and public? What are

they?

Yes. The information on LCD‟s public interest, financial and other objectives are available on the LCD‟s

website www.lcd.lv. LCD operates a “cost plus” approach, where costs are covered and an additional

profit mark is included for future developments. For each financial year LCD defines its objectives and

tasks that have been approved by the Council and are published in the LCD Annual report. LCD‟s aim

is to provide efficient and high quality services for market participants.

Do the system’s objectives reflect the needs of relevant market participants as well as owners?

Yes. LCD regularly organizes the meetings with market participants to familiarize them with the planned

tasks as well as to listen market participants‟ views about the necessary improvements.

How is the public interest taken into account?

LCD provides services to market participants in accordance with the Law on the Financial Instruments

Market and LCD rules.

LCD consults with the LCD participants on every change in the LCD rules. The consultation procedure

depends on the nature of changes. Before introduction of new functionalities or other material changes

in existing functionalities prior to make a draft of amendments to LCD rules, LCD conducts consultation

meetings with LCD participants. Taking into account the view of market participants LCD prepares

amendments to the LCD rules and sends the draft of amendments to all participants for comments and

proposals.

Can the system’s participants or the public influence the system’s decision-making process?

Market participants are represented in the Council (2 members are elected by the LCD‟s participants)

and according to the Law on Financial Instruments Market, LCD has to carry out a public consultation

with market participants prior introduction of changes in LCD's system rules.

How are major decisions communicated to owners and relevant market participants?

The major decisions are approved by the Council of LCD. The Council is the supervisory institution,

which represents the interests of shareholders during the time periods between the shareholders

meetings and supervises the activities of the Management Board within the scope specified in this Law

and the Articles of Association. The Council consists from the representatives of shareholders and 2

representatives from market participants. Taking into account aforementioned, the communication on

major decisions is realized via Council members. Please refer also to the answers above. The

information about the decisions that could have a significant impact on the LCD SSS or its participants,

are communicated also with supervisory institutions (FCMC and the Bank of Latvia).

What steps are taken to ensure that management has the incentives and skills needed to achieve the

system’s objectives and is accountable for its performance?

Requirements are stipulated by Law on the Financial Instruments Market: the Council and the

Management Board member should be sufficiently competent in the sphere he/she will be responsible

for; should have the necessary education and at least three years of work experience at a commercial

43

company, an organization or an institution; should have impeccable reputation; should not be deprived

of the right to engage in commercial activities.

Day-to-day activities of LCD are managed by the Management Board. Members of the Management

Board are elected by the Council.

The Management Board at least quarterly shall report to Council for their performance and achievement

of the LCD objectives in particular period. Performance against agreed objectives and goals assigned

individually to each Management Board member are major points taken into account to calculate the

remuneration of the members of the Management Board.

How is the composition of the Board determined?

The composition of the Council and the Management Board is determined in the Articles of Association

of LCD. The Articles of Association and each amendment in them shall be approved by the

Shareholders Meeting. The Management Board Members are appointed by the Council. The Council

members are elected by the Shareholders Meeting.

What steps are taken to ensure that board members have the necessary skills, and represent or take

into account in their deliberations the full range of shareholder and user interests as well as the public

interest?

The Management Board members are elected taking into account requirements stipulated in Law on the

Financial Instruments Market and on the basis of each person‟s particular knowledge and experience,

with the aim to ensuring balanced Management Board and to ensure the proper fulfillment of the LCD‟s

tasks and the Management Board duties.

Does the Board of the CSD, or in a group structure, the board of the parent company, include

independent members?

Yes. In the Council (Supervisory Board) 2 members are elected by the LCD‟s participants – 1 from the

issuers and one from the custodians.

The Management Board consists only from 3 members and the prime criteria for candidates of the

Management Board are their professional knowledge, experience and good reputation.

If yes, how many independent members are currently on the Board and how are they usually

appointed?

Two members in the Council are independent. They are appointed from the LCD‟s participant side once

a year in the LCD‟s participants‟ meeting that shall be convened by LCD before LCD‟s annual

shareholders meeting where whole Council is elected.

Do the governance arrangements enable the identification of possible conflicts of interest?

Yes. LCD was founded and acts in accordance with Commercial Law. Commercial law defines the

situations of conflict of interests and procedures that the Management Board and the Council members

shall follow up.

Additionally the Management Board of LCD approved internal rules specifying the procedures that

Members of the Management Board are required to follow in situations where they have interests that

may conflict with the interests of LCD.

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The situations of conflict of interests and the procedure of avoidance of such situations are governed

also by the Code of Ethics.

The Code of Ethics is applicable to NASDAQ OMX Group, Inc and all its subsidiary companies

employees, directors, managers.

Are the categories of conflicts of interest peculiar to the CSD described and what are they?

In accordance with the Code of Ethics, all employees of NASDAQ OMX Group and its subsidiaries must avoid or resolve conflicts of interest -- personal or financial -- that arise in the course of their work, as well as situations that may appear to others to present conflicts of interest. Employees must disclose to their supervisor any potential conflict of interest that arises in the course of their work. Supervisors will inform the Ethics Team of the conflict, and together resolve the conflict. The employees of LCD:

may not engage in any outside employment or other activity that would create an actual or apparent conflict of interest with NASDAQ OMX employment. Any outside employment, paid or unpaid, shall be allowed with prior approval by employees supervisor.

may not enter into a financial relationship or obtain a loan from a person or entity doing business or seeking to do business with LCD and receive terms more favorable than those offered to members of the public.

If an employee or its affiliate family member has an ownership interest that exceeds five percent of employees net worth in a business that solicits or does work with LCD, the employee must inform its supervisor and provide a written certification that employee will not participate in any decisions, conversations, meetings or assignments relating to that business. Supervisors are required to inform the Ethics Team of the interest. Once a conflict of interest has been identified, what kind of resolution procedure is to be applied? LCD‟s internal procedures describe the resolution procedures that must be applied.

Has that procedure been already used, in what circumstances, and has it proven efficient? The procedure has not been applied: no situations of conflict of interest have been identified yet. When appropriate: Is there a clear separation between the reporting line to the Board for credit risk

management subjects and those for other operations? Does the Board include a risk committee that

reports to the Board? Is the credit risk management process featured to earmark any large individual

exposure or group of such exposures inducing possible conflicts of interest? How is the Board informed

of the record of any credit exposure that is inducing conflicts of interest? Once the Board has been

informed, who is in charge of initiating the resolution procedure mentioned above in key question 5?

Does the Board, or any other appropriate decision-making level of the entity, approve the limits on the

total credit exposure and on any large individual exposure?

Questions are not applicable.

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RECOMMENDATION 14: ACCESS

What are the access criteria for the system?

The criteria are set in the Law on Financial Instruments Market (article 95) and LCD rules - LCD rules

No 1 on LCD Participants sets the framework for the custodians and No 2 – for the Issuers. Only those

institutions fulfilling the requirements set in the applicable Latvian Laws and LCD rules can become a

LCD Participant.

Are access rules/criteria objective, communicated to the relevant authorities and clearly disclosed to all

potential applicants?

Yes. LCD rules are available on LCD‟s website www.lcd.lv. Prior the rules or amendments to the rules

are approved by the LCD‟s Management Board they are distributed among the LCD‟s Participants for

consultation and approval. The rules are approved by relevant supervisory authorities.

In the event of refusal of access, does the CSD justify the denial decision to the applicant in writing?

Yes. The applications are reviewed by the LCD‟s Management Board and the Board makes the

decision. The applicant is informed in writing on the decision made.

Are the same rules applied regardless of the identity, type and location of the applicant?

Yes. All the LCD‟s participants and applicants are treated equally regardless of their identity, type and

location.

Is the fee structure discriminatory according to the location of the participants and their type of activity?

No.

Can discretionary treatment with regard to fees be justified by factors such as dedicated technical

support or by the number of transactions (e.g. a degressive fee structure)?

Yes, it is justified as the LCD‟s fees are set in the rules and are applicable to every client.

The recommendation CSDs should have objective and publicly disclosed criteria for participation that permit fair and open access. Rules and requirements that restrict access should be aimed at controlling risk. Key issues 1. Criteria should be objective, clearly stated, communicated to the relevant authorities and publicly disclosed. 2. Access should be granted to all participants that have sufficient technical, business and risk management expertise, the necessary legal powers and adequate financial resources so that their activities do not generate unacceptable risks for the operator or for other users and their customers. Denial of access should only be based on risk-related criteria or other criteria as set out in EU law and should be explained in writing. 3. Procedures facilitating the orderly exit of participants – for example, those that no longer meet

membership criteria – should be clearly stated and publicly disclosed.

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Can differing restrictions on access to the system be justified in terms of the need to limit risks, to

ensure satisfactory technical expertise and legal powers to perform the activity, to ensure that the

system operator or other users have adequate financial resources, and to counter money laundering or

otherwise by EU law?

N/A.

Provided that Recommendation 19 is applied, is access to other CSDs allowed?

Yes. The Law on Financial instruments market allows LCD to open omnibus accounts with other CSDs

and vice versa.

Under what conditions can participants terminate their membership?

Exit procedures are set in the LCD rules No 1 “On LCD participants” and No 2 “On Book-entry of

Financial Instruments and Execution of Corporate Actions”.

For the custodians status of an LCD participant may be annulled:

a) upon initiative of an LCD participant;

b) upon initiative of the LCD, if the LCD participant has substantially breached the LCD

regulations or has not eliminated breaches detected by the LCD, and also in case if the

LCD participant does not comply with the requirements of the Law or the LCD regulations

applying to an LCD participant.

For the Issuers status of an LCD participant may be annulled:

a) upon initiative of an Issuer; b) upon initiative of the LCD if the Issuer breached the agreement with LCD or if all financial

instruments of the relevant Issuer are deleted from LCD‟s books and the Issuer has not book-entered any other financial instruments with the LCD during the last three months since cancellation of the last financial instruments.

The participant‟s status can be annulled upon the request of the regulatory authority.

What arrangements does the system have in place to facilitate the exit of members which no longer

meet the participation requirements?

The LCD‟s Management Board can decide to annul a participant‟s status thus facilitating the exit of a

member.

In the event of a participant failure, is there an effective procedure which is designed to smoothly

transfer the safekeeping of investors’ assets to another participant?

Yes. The procedure is set in the LCD rules No 1 “On LCD Participants”.

Is there an explicit and compulsory suspension procedure?

Yes. The procedure is set in the LCD rules No 1 “On LCD Participants”.

Are these arrangements publicly disclosed?

Yes. LCD rules are publicly available.

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RECOMMENDATION 15: EFFICIENCY

Does the CSD have in place procedures to control costs (for example, by benchmarking its costs and

charges against other systems that provide a similar service and by analysing the reasons for significant

differences)?

Yes. According to the European Code of Conduct for clearing and settlement LCD discloses annually costs and incomes for each unbundled service and prepares self-assessment report. The independent auditors perform an audit and hand in the assurance report on how LCD complies with the stipulations set in the Code of Conduct. The self-assessment report and auditors report is presented to the supervisory authority. LCD as signatory of European Code of Conduct for clearing and settlement complies with the requirements set in it and each year LCD‟s prepared self-assessment report and auditors report is presented to the Financial and capital market commission. LCD conducts a comparison of CSD fees between Baltic CSDs on a regular basis and the results are

internally analyzed by the Management Board of LCD.

Does the CSD have in place procedures to review regularly pricing levels against operating costs?

Yes. Please see the answer to the first question.

Does the CSD regularly review its service levels and quality, including regularly surveys of its users?

LCD ensures that the provided service to its customers is outstanding on a daily basis. The customer‟s

complaints, if any, are dealt immediately when received.

CSD conducts on a regular basis face to face meetings with the participants in order to get the feedback

on LCD service level.

LCD also performs client satisfaction surveys annually.

Does the CSD have in place procedures to review regularly operational reliability, including assessment

of its capacity levels against projected demand?

Yes, LCD has a business continuity plan that is reviewed and amended on annual basis. IT department

assesses the capacity levels at least once a year and takes appropriate measures.

What outcomes has this review had: have they led the CSD to take measures to improve the level of

service?

The recommendation While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users. Key issues 1. CSDs should have in place the mechanisms to review regularly their costs and pricing. 2. CSDs should have in place the mechanisms to review regularly their service levels and operational

reliability.

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Based on the capacity assessment LCD takes appropriate measures in order to ensure business

continuity and quality of the provided services. Recently the servers were changed to the newer ones

ensuring greater capacity and eliminating the risks of failing.

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RECOMMENDATION 16: COMMUNICATION PROCEDURES, MESSAGING STANDARDS

AND STRAIGHT-THROUGH PROCESSING (STP)

Do entities providing securities clearing and settlement services and participants in their systems apply

international communication procedures and standards as well as relevant recommendations relating to

securities messages, securities identification processes and counterparty identification when

implementing new system facilities and upgrading existing systems?

Yes. The existing messaging standard is compliant with those set in the ISO 15022. The securities

registered with LCD are identified by ISIN code and CFI code according to the ISO.

Insofar as such standards are presently not applied, does the market have a timetable consisting of

relevant targets and deadlines for their adoption in a way that balances the costs and benefits?

LCD complies with the present industry standards. Furthermore, as LCD takes a part in the Target 2

Securities (T2S) project which aims to harmonize the messaging and settlement standards across

Europe, it is foreseen that CSDs working on the T2S infrastructure will adapt new messaging standards

based on ISO 20022. LCD intends to introduce new message formats (ISO 20022) prior starting

operations in the T2S.

Are service providers working towards implementing STP in a manner that is consistent with efforts to

achieve greater interoperability between systems, so that market participants can move swiftly and

easily from one system to another?

Yes. Baltic CSDs common IT solution Link Gateway enables STP of cross border trades conducted

both OTC and on the regulated market in all three Baltic countries.

LCD takes a part in the Target 2 Securities project which aims to ease and harmonize messaging and

information flow across Europe.

The recommendation CSDs and participants in their systems, should use or accommodate the relevant international communication procedures and standards for messaging and reference data in order to facilitate efficient clearing and settlement across systems. This will promote straight-through processing (STP) across the entire securities transaction flow. Key issues For this recommendation to be effective, it also needs to be applied either directly or indirectly by other providers of securities communication services, such as messaging services and network providers. 1. International communication procedures and standards relating to securities messages, securities identification processes and counterparty identification should be applied.

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RECOMMENDATION 17: TRANSPARENCY

Does the CSD make clear disclosures to market participants about its rules, regulations, relevant laws,

governance procedures, its services offered, any risks, risks arising either to participants or to the

operator, any steps taken to mitigate those risks, its balance sheet data, main statistics and prices/fees

associated with securities clearing and settlement services?

Yes. The information is available either on LCD‟s website www.lcd.lv or upon request contacting LCD directly. Has the CSD completed and disclosed the questionnaire set out in the CPSS/IOSCO Disclosure Framework? Yes. It is available on LCD‟s website www.lcd.lv. Have the CSD publicly and clearly disclosed their risk exposure policy and risk management methodology? Is the level of disclosure of risk control measures based on the concept of materiality? Yes. All the relevant information on the risk policy and risk management is available on LCD‟s website www.lcd.lv (for example, the information can be found in the annual reports, various market questionnaires publicly available on the website). Level of disclosure of risk control is based on the concept of materiality. How is this information made available? On the LCD‟s website www.lcd.lv. In what language or languages?

The recommendation CSDs should provide market participants with sufficient information for them to identify and accurately evaluate the risks and costs associated with securities clearing and settlement services. Key issues 1. CSDs shall provide market participants with the information necessary to evaluate the risks and prices/fees associated with the CSDs‟ settlement service; this information should include the main statistics and the balance sheet of the system‟s operator. 2. CSDs should publicly and clearly disclose their risk exposure policy and risk management methodology. 3. Information should be publicly accessible, for example via the internet, and not restricted to the system‟s participants. Information should be available in formats that meet the needs of the users, in a language commonly used in the international financial markets as well as in at least one of the domestic languages. 4. CSDs should complete and disclose the answers to the key questions (other than those on Regulation, Supervision and Oversight) of this report. The accuracy and completeness of disclosures should be reviewed at least once a year by the CSDs. Information should be updated on a regular basis.

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Latvian and English. In what formats? All the relevant documents are published on the LCD‟s website in .pdf format.

What steps are taken by the CSD to ensure that the disclosures are complete and accurate? LCD provides market participants with yearly updates of publication such as the AGC (Association of Global Custodians) questionnaire, the annual report of LCD. Information on evolutions of the System (e.g. new services) is communicated to participants prior to their introduction. The answers on key questions of these recommendations will be published on LCDs website www.lcd.lv. Questionnaires, disclosure frameworks are updated and will be updated (including these given answers) if needed due to the changes in the procedures of the services provided and operations. Are there regular reviews to ensure they remain current? Yes, the information is updated at least once a year.

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RECOMMENDATION 19: RISKS IN CROSS-SYSTEM LINKS OR INTEROPERABLE

SYSTEMS

What kinds of links are in operation (see explanatory note)?

There is common Baltic CSD link enabling to transfer among all three Baltic CSDs all the securities

registered in one of them. Thus, LCD has a direct bilateral link with the Estonian CSD (EVK) and the

Lithuanian CSD (CSDL). LCD has established a direct unilateral link with an international CSD -

Clearstream Banking Luxembourg (CBL) enabling the LCD participants and their clients to transfer the

international securities registered with CBL to Latvia. In 2012, LCD established a link with Polish Central

Securities Depository(KDPW) enabling to transfer the securities registered with LCD to KDPW.

Links with EVK and CSDL ensures securities settlement using free-of-payment (FOP) and delivery

versus payment (DVP) instructions.

Link with CBL ensures securities settlement using free-of-payment (FOP) and delivery versus payment

(DVP) instructions.

Link with KDPW ensures securities settlement using free-of-payment (FOP) instructions.

Has the CSD implemented relayed links?

No.

The recommendation CSDs that establish links to settle cross-system trades should design and operate such links so that they effectively reduce the risks associated with cross-system settlements. They should evaluate and mitigate the potential sources of risks that can arise from the linked CSDs and from the link itself. Key issues 1. CSDs should design links or interoperable systems to ensure that settlement risks are minimised or contained. A CSD should evaluate the financial integrity and operational reliability of any other CSD with which it intends to establish a link. It should evaluate and mitigate the potential sources of risks that can arise from the linked CSD and from the link itself. The resulting arrangements should be designed such that risks are mitigated and the CSD remains able to observe the other recommendations contained in this report. The risk assessment should be kept updated. 2. Provisional transfers across a link should be prohibited (or at least retransfers, until the first transfer is final), and DVP should be achieved. CSDs should achieve DVP for links that process transactions against cash. The length of the settlement cycle and the achievement of DVP with intraday finality should not be jeopardised by the establishment of a link (see Recommendations 7 and 8). 3. Any credit extensions between CSDs should be fully secured and subject to limits. Liquidity management arrangements should be implemented to address operational inefficiencies and potential defaults. 4. Relayed links should be designed and operated in a way that minimises or contains settlement

risks and does not impede the efficiency of cross-system settlement.

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Has the CSD conducted a risk analysis covering the legal, contractual, financial and operational

elements of the design of the link and the financial and operational integrity of the linked CSD?

Yes. LCD conducted an analysis and according to the Law on the Financial Instruments Market LCD

has to inform supervisory authority on establishing relationship with other CSD.

What is the methodology used?

Conducting bilateral meetings, analyzing legal framework, technical and operational possibilities.

Was this analysis conducted when the link was established, and has it been updated since, especially

after any modifications to the design of the link?

Yes. Over the past years Baltic CSDs are worked on harmonizing processes and procedures as much

as possible and the service via Baltic link was expanded covering now full service package (DVP (both

OTC and Stock exchange) and FOP settlement) and appropriate modifications to the design of the link

were done. Respective analysis was conducted prior modifications.

Are applicable laws and risks for the participants that stem from the links clear and transparent?

Yes. LCD has developed and approved procedures for cross border settlement and execution of the

corporate actions with the securities registered with Estonian and Lithuanian central depositories and

procedure for settlement with the international securities via LCD‟s omnibus account opened in

Clearstream ICSD. The LCD participants have to follow the procedures when there is cross border

settlement in place and LCD rules as far as it is applicable to cross border settlement.

The Baltic link is designed in such way that the cross border securities settlement is as efficient and

effective as domestic. The cross border settlement risk is minimized to the level of domestic settlement.

What is the impact for the participants of the relayed links in terms of risks and efficiency, and does it

increase the risk and reduce the efficiency of the whole cross-system settlement?

N/A.

How is DVP achieved?

DVP settlement process is managed based on the message and information flow between Issuer CSD

and Investor CSD. Each CSD settles the money for those DVPs where it is Issuer CSD. The Issuer

CSD starts money settlement only when both instructions (buy and sell) are matched and the securities

are blocked on the seller‟s account. Upon receipt of money confirmation securities are settled in both

Issuer CSD and Investor CSD SSS. Settlement of financial instruments is made only and exclusively

when the related money settlement is made.

Is the finality of settlement provided on a real-time basis or at least through several batches a day?

Both – on real time (OTC DVP) and through a batch (stock exchange DVP).

Does the link permit provisional transfers of securities across the link? If so, is the retransfer of these

securities prohibited until the first transfer is final?

No. All the settlements are final and irrevocable.

If the CSD extends credit to a linked CSD, are credit extensions to the linked CSD fully secured and

subject to limits?

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LCD does not provide a credit to a linked CSD.

Are risk controls and liquidity resources adequate to address liquidity risks posed by the link?

N/A.