Many foreign investors, unfortunately, look at the Baltic states as a more or less integrated region with similar segments. However, though the historical development of all the three countries is very similar, they are different countries with national identity and different ways of implementing economic reforms.
Different starting points
There were different conditions for the formation of the securities market in each of the countries due to different ways of privatization.
Lithuania was the first to start mass privatization and securities market creation. The Securities Commission (SC) was established in September 1992. The main objectives of the SC are to monitor how principles of fair trading and competition are observed in public trading of securities, and to enforce the legal acts regulating the Lithuanian securities market, and to supervise the compliance of the market participants with the effective laws.
In the beginning of 1993, the first non-banking financial brokerage firms were established. The National Stock Exchange (NSEL) which started its trading operations in 1993 will celebrate its 5th anniversary on Sept. 11 this year.
The Depository started its activities as a subdivision of the NSEL, and became an independent institution on Feb. 25, 1994.
The privatization rates and volumes during 1991-1993, when 70 percent of state owned companies were privatized, determined the Central Depository(CD) and securities accounting model.
Taking into account the great number of the newly emerged small shareholders (around 1 million) the CD opened personal accounts, while the account managers opened personal securities accounts fixing the ownership right to securities.
The advantage of this system is that responsibility is divided among market participants and such an accounting system is implemented very quickly. Such a system met the requirements of the developing securities trading system.
In order to be able to trade on the Stock Exchange, one must transfer securities from personal accounts managed by the issuers into the accounts managed by the intermediaries of public trading in securities.
The fundamental law of the Lithuanian securities market, the law on Public Trading in Securities, was passed on Jan. 16, 1996.
This law defines the main aspects of securities clearing and settlement. Securities accounting is regulated by the General Securities Accounting Rules approved by the Securities Commission and by the Depository instructions.
The securities clearing and settlement in Lithuania is subject to the tripartite agreement between the NSEL, Central Depository and the Central Bank of Lithuania.
The development of the securities system in Estonia differed from that in Lithuania. Privatization in Estonia started later than in Lithuania, when banks had gained strength and acted rather successfully as securities market players.
Privatization generated a manageable amount of shareholders and therefore Estonia has chosen a single level securities accounting system. The Estonian Central Securities Depository (ECSD) was established on Nov. 14, 1994. It functions in compliance with the Statute of the Estonian Central Register of Securities.
The ownership right to securities is fixed in the accounts of the ECSD as Central Register. The securities market clients may deal with the ECSD only through the so called account operators or commercial banks.
The ECSD had functioned as the securities trading system before the establishment of the Tallinn Stock Exchange and these functions have still remained in the OTC market.
One of the main advantages of such securities trading system is the possibility for the authorities to monitor clients' securities accounts, to be able to find all information on securities holders in one place.
There are more similarities than differences between Latvia and Lithuania. The same may apply to their securities markets. It's a pleasure to mention that my Latvia colleagues have managed to analyze the errors in the development of the Lithuanian securities market and avoid them.
The basis for the regulation of the Latvian securities market is the Law on Securities which was passed on Jan. 7, 1995. It became the legal framework for the establishment of the Latvian Central Depository (LCD) which started its first operations on June 27, 1995.
The securities accounting system in Latvia is similar to the one in Lithuania. It is a two-tier system and the ownership right to securities is fixed in accounts of account managers, who in Latvia are mainly banks.
The main difference in the securities accounting systems of Latvia and Lithuania is the Register of shareholders of privatized companies which is managed by the LCD and which includes all shareholders of the privatized companies.
It should be noted that when shareholders keep their property with this Register, their rights are restricted and they do not get dividends. In fact, dividends are transferred to the special LCD account and paid out to the shareholders only after the latter have transferred their securities to the personal accounts with the account managers.
The Latvian system has a very important advantage. The LCD avoids permanent and difficult relationships with the large number of issuers(privatized companies, which became public) in supervising their securities accounting.
Furthermore, shareholders are stimulated to transfer their securities to account managers which boosts trading in the securities market.
The attention should be paid to the differences relating to the process of transferring the title to securities in Lithuania, Latvia and Estonia.
Having concluded a transaction or off-exchange in Estonia, the ownership right to the securities and cash is transferred on the settlement day after the ECSD has made corresponding entries in the Register. The settlement cycle for the TSE transaction consists of T+3 days, for off-exchange transactions it is from T+1 to T+30.
The change of beneficial ownership in Latvia is executed on the trade day. It means that an intermediary of public trading in securities having made a transaction in the central market (Riga Stock Exchange) is obliged to make corresponding entries in the clients' personal securities and cash accounts on the transaction day.
However, real transfers in the securities accounts of intermediaries are made only on settlement day. On the day before the settlement day, however, the LCD checks whether there are enough securities in the accounts of the intermediary with the LCD and in their corresponding accounts with the Bank of Latvia.
Laws in Lithuania state that the ownership right of the acquirer of the property under contract shall originate from the moment of the transfer, unless the law or contract provides otherwise. Using this provision, the day beneficial ownership's change depends on the type of transaction.
The ownership right shall be transferred on the transaction day in cases when an intermediary concludes central market transactions on the NSEL, irrespective of the duration of the settlement cycle(T+3 for equities and T+1 for T-bills).
An agreement on direct transaction (block trading) executed on the NSEL specifies that the day of change of beneficial ownership is the settlement day. The settlement cycle for direct transactions made on the NSEL may be from T+0 to T+5 days for all securities.
Cash settlement and clearing
Cash settlement and clearing procedures are conducted through the clearing centers of the central banks in all Baltic states. However, there are many differences as well.
All intermediaries of public trading in securities in Estonia must have cash accounts with commercial banks which are most often ECSD account operators. Cash settlements are managed by the ECSD which is entitled to credit or debit corresponding accounts of commercial banks with the Clearing Department of the Bank of Estonia where funds are accumulated for settlements for transactions concluded on the TSE or off-exchange.
Clearing systems in Estonia and Latvia are very similar. The LCD is also responsible for the clearing of central market transactions. Intermediaries of public trading in securities are obliged to have accounts with commercial banks. Through their correspondent accounts with the Bank of Latvia settlements for transactions concluded on the RSE and off-exchange are carried out.
In Lithuania all intermediaries (bank and non-bank brokers) must open clearing accounts with the payment center of the Bank of Lithuania. The clearing accounts are segregated there in accordance with their purpose.
Usually intermediaries hold a general clearing account and special clearing accounts for servicing the primary government securities (T-bills) and NSEL transactions.
Some banking brokerage departments also have special clearing accounts for the accounting of off-exchange transactions. The accounts of this type are mainly used in dealing with off-exchange transactions with T-bills between the Bank of Lithuania and commercial banks.
In Lithuania while executing settlements for transactions made on the NSEL, the special clearing account of secondary trading may be debited only by the NSEL.
An intermediary of public trading in securities must accumulate cash for settlement of securities transactions made on the NSEL. The information on the balances of such accounts is provided through the NSEL to the Depository, which reconciles the balances in securities accounts and informs the NSEL only about possible shortage of securities in the accounts.
Having received no information on securities default by 3 p.m. (GMT + 1), the NSEL places orders to debit the special secondary trading account of the selling intermediary and to credit the general clearing accounts of the buying counterpart. The Depository simultaneously executes securities transactions between securities accounts.
The Depository may service the OTC special clearing accounts in accordance with the same rules (without NSEL interference).
One of the most important goals ïf the Depository is by the end of 1998 to take over direct management of cash settlement of the securities transactions concluded on the NSEL.
Delivery versus payment
The securities trading systems of all the three Baltic states ensure DVP transfers of securities and cash while the Guarantee Fund insures the implementation of settlements of central market transactions.
Links between depositories
All securities market infrastructure institutions of the three Baltic states maintain close relations and exchange information since their first meeting in 1994. The Depositories of Lithuania and Estonia signed a Protocol of Intent in November 1995, while the Depositories of Latvia and Estonia signed a cooperative agreement in the summer of 1997 and opened securities accounts for each other.
The participants of the Lithuanian securities market are cautious and reserved toward the integration of the Baltic securities markets, as the legal framework in each country is still to be harmonized with the European directives, and the market lack regulation. Besides, Lithuanian investors direct their interests to the larger and more developed markets.
The depositories of all the Baltic countries are going to join the Central and Eastern European Central Securities Depository Association. The participation in this Association will widen the cooperation between the central depositories of Central and Eastern Europe. This association is planning to use the experience of the central depositories of the EU countries.
(Saulius Budzinauskas is the director of the securities operations department in the Central Securities Depository of Lithuania.)