Reforms in the Israeli capital markets post the global recession
Ehud Sol, Nir Dash and Shahar Levi
Herzog Fox & Neeman
Tel Aviv
Ehud Sol (Bio)
Nir Dash (Bio)
Shahar Levi (Bio)
The last twelve months have seen the Israeli regulators and lawmakers introducing some far reaching reforms, attributed in large part to the conclusions drawn from the 2008-09 global recession. These reforms were introduced despite the fact that the Israeli economy and specifically the financial institutions, demonstrated a considerable degree of financial stability during the crisis, followed by rapid growth which has exceeded the economic performance in almost all comparable markets among developed countries.
The steps taken by Israeli regulators and lawmakers have resulted in two significant reforms being introduced: the first reform, led by the Commissioner of Capital Market, Insurance and Savings in Israel (the Commissioner), is meant to put certain limitations on and to set ground rules for the investment of institutional bodies in non-governmental bonds. The second reform concerns the improvement in the efficiency of the Israel Securities Authority's (ISA) enforcement mechanisms.
The reform in the institutional bodies' investments in non-governmental bonds
Within the last few years the Israeli capital markets have undergone tremendous changes that have influenced the make-up of market participants and existing relationships in the market place. These changes include reforms with respect to the Israeli pension funds, which reduce the availability of designated governmental bonds and requires the pension funds, together with other institutional bodies, to invest the public long term savings in the capital markets. In addition, certain structural reforms in the Israeli capital markets which were presented by the regulators in 2005-06 have compelled the Israeli banks to sell their holdings in provident funds and mutual funds to private bodies, especially insurance companies and investment houses. These reforms have dramatically increased the volume and tradability of non-governmental bonds traded on the Tel-Aviv Stock Exchange and more specifically has made institutional investors key players in the market.
This fact, together with the development of their understanding of the characteristics and risk within this kind of credit business, has assisted these investors to develop a more sophisticated organisational infrastructure. Nevertheless, the global recession has demonstrated some basic weaknesses in the non-governmental bond market, emphasising the necessity to further improve and optimise the institutional bodies' investment and decision-making process.
In particular, a comprehensive comparative analysis of the market against parallel markets in developed countries, resulted in the conclusion that the non-governmental bond market in Israel continues to be deficient when it comes to guaranteeing bondholders rights. In addition, the analysis showed that many of the comparable markets had succeeded in applying voluntary and independent self-regulatory tools and creating standardisation mechanisms in the legal and contractual framework of the bond issue documents which were largely absent from the Israeli capital markets.
These inefficiencies led to the Commissioner convening a Committee for establishing parameters for institutional investors' investments in non-governmental bonds. Pursuant to the Committee's recommendations, in July 2010 the Commissioner published detailed and binding guidelines with respect to their investments in non-governmental bonds. These guidelines included a comprehensive set of rules with respect to the investment process of the institutional bodies, including requiring a defined analytical process prior to the purchase of the bonds, and an obligation to receive periodic reports even from issuers of unlisted bonds. Most importantly, the guidelines include 'best practices' with respect to the particular characteristics of the bonds in which the institutional bodies invest, such as contractual covenants in the issue documents (for example, change of control restrictions, negative pledges) and the requirement for certain financial covenants set forth in the guidelines.
Although the influence of the Commissioner's guidelines needs to be examined on a long-term basis, there are indications that they have already had a relatively strong impact on the market. There already exists a clear trend of standardisation of the legal documents and contractual covenants of issuers of public bonds towards the bond holders.
The improvement in the efficiency of the Israel Securities Authority enforcement mechanisms
Another far-reaching reform was the approval and enactment by the Knesset of the Improvement of Efficiency of the ISA's Enforcement Procedure (2011) (the Law). This Law has added an administrative procedure to the existing enforcement mechanisms in the capital market, which previously included mainly criminal procedures and administrative enforcement mechanisms. This allows the ISA to initiate administrative procedures against supervised entities and impose a heavy responsibility on publicly traded companies, their employees, controlling shareholders and officers, licensed investment advisers, trustees and portfolio managers. The sanctions for violating the Law can consist of financial penalties which can reach NIS1 million (approximately $292,000) for an individual and NIS5 million (approximately $1.46 million) for a corporation, and other sanctions such as suspension or even the cancellation of the license for investment advisers, trustees or portfolio managers, as well as prohibiting them from serving as officers of a supervised body for a fixed period of time.
The Law prohibits the provision of any insurance or indemnification against most administrative fines and other financial sanctions imposed under the Law. This prohibition was the subject of intense debate with practitioners who argued that the absence of insurance and indemnification provisions may have an adverse impact on the willingness of qualified persons to serve as officers in publicly traded companies.
The Law is without a doubt relevant to all publicly traded companies in Israel and to providers of financial services and products which are under the supervision of the ISA. The Commissioner is currently in the process of promoting a law which will grant him similar powers with respect to insurance companies and bodies engaged in long-term pension products.