April 23, 2013
The Israel Securities Authority released its 2012 Annual Report, with a view to the future: more market development, less stringent regulation
This morning, Professor Shmuel Hauser, the Chairman of the Israel Securities Authority, presented the 2012 Annual Report of the Authority to the Minister of Finance and the Chairman of the Knesset Finance Committee. The Report presents the Authority’s wide range of activities to protect investors, develop the local market and increase the confidence of the public in the capital market.
The recommendations of the R&D Committee appointed by the Chairman of the Authority are expected to be published next month. The Committee’s mandate was to investigate alternatives for the encouragement of investment in publicly traded companies involved in R&D. According to the Chairman of the Authority: “The importance of creating greater access for raising capital on the Tel Aviv Stock Exchange lies in, among other things, keeping the center of activity of the hi-tech companies in Israel, the creation of employment and the contribution to economic growth.”
As an additional step in the efforts of the Authority to develop the capital market, the Chairman of the Authority announced this morning that he has appointed a public committee chaired by Professor Ben Horin for the upgrading of trade and encouragement of liquidity on the Stock Exchange and stated: “Improving liquidity is a necessary condition for developing the primary market and increasing the accessibility of the capital market as an alternative for raising capital by the business sector.”
Professor Shmuel Hauser, the Chairman of the Israel Securities Authority: “We are committed to the roadmap which was published a few months ago, which included, among other things, an easing of restrictions on supervised entities, without compromising on the protection of investors. In recent months, the plenum of the Authority has begun approving proposed amendments to legislation that are intended to make things easier for supervised bodies and next month, we will for the first time present a comprehensive set of amendments and facilitations to the government and Knesset for approval”.
Hauser added that: “At the same time, we have recently completed a series of steps in the area of market development. Thus, for example, we brought about a significant reduction in the distribution fees for mutual funds and worked to remove barriers and open the market to leveraged ETFs. In the near future, the recommendations of the committee I appointed for the encouragement of investment in publicly traded companies involved in R&D will be released. The recommendations of the Committee are expected to remove barriers and to create incentives and I am convinced that their implementation will lead to a transformation of the local stock exchange and the Israeli capital market into a center for new R&D companies”.
Hauser also added: “Another important objective that we have set for the development of the market is the upgrading of trade and an increase in liquidity of the Stock Exchange. To this end, I have today appointed a public committee chaired by Professor Ben Horin which is composed of representatives of the regulatory bodies and the Stock Exchange and experts from the market. The Committee will examine how to advance and develop the Israeli stock exchange and I wish it success in its mission”.
This morning, the Chairman of the ISA reviewed the activity of the Authority during this past year, as described in the Annual Report, and presented the perspective of the Authority and its strategy for the future. The Chairman of the Authority referred to, among other things, the challenges facing economic regulators in Israel and stated that: “We are in a period of major economic challenges, against the background of the crisis in Europe and the dangers in the US. Therefore, investment in real and financial markets is still exposed to not insignificant risks. The low interest rates and the fact that they are in a downtrend increase the appetite for risk, as was perhaps the case prior to the crisis in 2008. In view of this reality, Israel is exposed to global economic developments and its situation is fragile due to the budget deficit, which must be covered”.
The situation in the markets
The Annual Report of the Authority describes the situation as of 2012 with respect to the capital market in Israel, while relating to publicly traded companies, bond companies, mutual fund managers, exchange traded fund managers, portfolio managers and investment advisors.
The data presented indicated, as of the end of 2012, that there are 611 companies listed for trade on the Stock Exchange, of which 72 have issued only bonds. During that year, there was a reduction in the volume of capital raised and debt issued in the local capital market. The business sector in Israel raised about NIS 2784 million in shares during the year (in comparison to NIS 3988 million in the previous year) and about NIS 25,479 million in bonds (in comparison to about NIS 31,979 million in the previous year).
During this year, there were no new companies raising equity capital on the Stock Exchange and 45 companies were delisted from trading, of which 11 asked to be delisted. The rest were merged or no longer fulfilled the preservation rules.
Similarly, there is an upward trend in the public’s funds invested in mutual funds and ETF’s. The value of assets held in mutual funds as of the end of 2012 totaled about NIS 170.1 billion, in comparison to about NIS 142.3 billion as of the end of 2011. The value of the public’s holdings in ETFs at the end of 2012 totaled about NIS 68.9 billion, in comparison to NIS 56.8 billion at the end of 2011.
The Annual Report describes a worrying situation with respect to debt restructuring. Thus, in 2012, about 28 corporations started negotiations with bondholders for debt restructuring. The Authority points out in this context that in view of the large volume of redemptions expected in 2013 and 2014, it is estimated that the large number of corporations starting negotiations with bondholders for the purpose of debt restructuring will remain at a high level. In an attempt to deal with the occurrence, the ISA has developed a regulatory “toolbox” that is meant to increase the protection of investors in times of crisis and to alert them at an early stage of the financial situation of companies. This will assist investors in the decision making process. During the past year, the Authority has worked to encourage the trustees of bonds of publicly traded companies and institutional investors to take a more active role in debt restructuring, under the assumption that without their active involvement it is probably not possible to maximize the protection of investor rights in the case of debt restructuring.
The issue of debt restructuring is also worrying given the number of companies with going concern references or warnings. During this past year, the number of companies with going concern references grew from 55 to 89. Similarly about 180 companies (one-third of the companies traded on the Stock Exchange) include going concern references or warnings. This data is an indication of the large exposures of investors and the fact that investment in real and financial markets is still subject to not insignificant risk, primarily due to the fact that Israel is exposed to global economic developments and is in a fragile situation due to its budget deficit – which must be covered.
Publishing of the conclusions of the Committee for Encouraging Investment in Publicly Traded Companies involved in R&D
In September 2012, the Chairman of the ISA appointed an inter-ministerial committee to investigate measures for encouraging investment in startup companies involved in R&D via the Stock Exchange and the transformation of the Stock Exchange into a “specialist” for startup companies. This is to be done without compromising on protecting the interests of the investing public and the orderly trading.
The Committee looked into the following: the potential advantages of increased access of startup companies to the Stock Exchange, including the diversification of sources of capital for these companies; the opening of a channel for the raising of capital from the public during a stage in which the company is still not ready for issuing on the NASDAQ; strengthening the connection of the company to Israel (thus increasing the chance that the headquarters and productive activity, and therefore also the intellectual property rights, will remain in Israel); and support of the development of the Israeli capital market and creation of international interest in the Israeli Stock Exchange. The importance of creating access for the raising of capital on the Tel Aviv Stock Exchange lies in keeping the centers of businesses of the hi-tech companies in Israel, in creating employment and in the contribution to economic growth.
Next month, the Committee will submit its recommendations to the Chairman of the Authority, which will include recommendations that will facilitate the proper pricing of startup companies and will reduce their costs. The recommendations will include legislative amendments and regulatory modifications in a number of areas: creation of tax incentives, state guarantees, less stringent rules for listing on the Stock Exchange, modification of disclosure requirements (including the possibility to report in English), less stringent corporate governance rules, encouragement of independent analysis, greater access for foreign investors, market tradability and involvement of institutional investors. In addition to the aforementioned, the Committee will present an advanced model of listing for trading by venture capital funds and also external funding solutions such as crowd funding and investor clubs.
Creation of the Committee for Upgrading of Trading and Encouragement of Liquidity on the Stock Exchange
The Israel Securities Authority recognizes the need to consider the possibilities and means to develop the Tel-Aviv Stock Exchange. The global capital markets have experienced large fluctuations in recent years. The financial crisis that began in 2008 has not yet over and its effects are still being noticed in the Western economies. One of the results of the crisis is the consistent drop in volumes of trade on stock exchanges worldwide. The effect of the crisis has not skipped over the Stock Exchange in Israel and we have witnessed during the last four years a decline in the volume of trading in shares and in bonds relative to the pre-crisis period.
A low volume of trading on the Stock Exchange harms the liquidity and efficiency of the secondary market in securities and also indirectly affects the primary market. This result is liable to reduce the accessibility of the capital market as a sustainable alternative for the raising of capital by the business sector. Therefore, the Authority is considering measures for encouraging trade and liquidity on the Stock Exchange, which will increase the sources of capital for entrepreneurs as a leverage for economic growth, without compromising on efficient supervision whose purpose is first and foremost the protection of the interests of investors and ensuring the existence of an efficient capital market in Israel over the long run.
Against this background, the Chairman of the Authority announced this morning the appointment of a public committee whose purpose is to investigate and propose alternatives for the upgrading of trading and liquidity of securities listed for trading on the Tel-Aviv Stock Exchange. Within this framework, the Committee is being tasked with the mission to consider and examine, among others, the following issues: launching of new financial products; high frequency trading; methods of trading and trading orders; the structure of trading fees; creation of a lending pool for securities; and the encouragement of foreign investors.
The Committee will be chaired by Professor Moshe Ben Horin and its members will include Professor Avi Wahel, Yehuda Ben Asiag, David Baruch, Yoram Sirkiss, Ruby Godenberg, Hila Ben Haim, Itzik Shorki and Dr. Gitit Gur Gershgoren.
Projects being implemented by the ISA
The Annual Report describes a series of projects that are to be found on the Authority’s agenda and the timetable for their implementation. These include:
- Project for easing of restrictions.
- Creation of a supervisory body for auditing done by CPAs (PCAOB).
- Simplifying the periodic reports and shortening them.
- Criteria and conditions for the distribution of dividends.
- Regulation of proxy advisors.
- Regulation of trading venues.
- Regulation of credit rating agencies.
- Regulation of general investment advice (analysis).
- Regulation of ETFs – transition from a reporting regime to a supervisory regime.
- Regulation of broker-dealers.
- Reform of underwriting.
- Creation of an electronic voting system.
- The international arena: mutual recognition agreements and opening of the Israeli capital market to foreign investors and foreign companies.
- Financial education.
Facilitations for supervised entities
The Authority has published, within the framework of the “Road Map”, dozens of proposals for easing restrictions on the supervised entities. These include the cancelation of certain duplications in disclosure requirements, standardization of types of reporting and cancelation of requirements that overly burden the supervised bodies without providing real benefit to investors. The restrictions to be eased have been carefully chosen, since the obligation of the Authority to protect the investing public is its guiding principle.
In recent months, the plenum of the Authority has approved proposals for legislative amendments that are expected to facilitate the activity of supervised entities and they will be submitted for the approval of the Knesset and the government at the end of the period for public comments. Within this context, the following facilitations, among others, have been approved by the plenum of the Authority:
Cancelation of the requirement to re-sign financial statement in a prospectus (dual dating); change in the format of the interim financial statements attached to IPO prospectuses; reduction of the disclosure requirements in the financial statement regulations.
In addition, it is expected that a comprehensive set of legislative proposals for the facilitation of regulatory requirements will be presented for approval to the plenum of the Authority in May 2013. These include approval of the recommendations of the R&D Committee; the extension of the shelf prospectus period; cancelation of the proposal chapter in a shelf prospectus; reduction of description of particulars required in prospectuses (company bylaws and the like); facilitations related to the inclusion by reference in a shelf proposal report; and facilitation for completion of reporting requirements.
Cancelation of the requirement to prepare financial statements according to IFRS; a change in the threshold of materiality for the purpose of discussion by the Board of Directors of the fund manager in material transactions; easing of conditions for lending and borrowing of securities; and creation of a legal framework for deposits and loans fund.
In addition, staff positions were published regarding the holding of bonds whose rating had declined to less than an investment grade in violation of the investment policy of the fund manager, and on the issue of the change in definitions for calculating remuneration levels and average rates of addition for a related party fund.
|Licensees ||Reducing the required frequency for an annual update for the needs of a client; reduction in disclosure requirements for banking corporations regarding the publication of a notification that informs of the connection of the corporation to marketed products; less stringent rules for reporting to the Authority regarding the holding of issued capital or voting rights in the corporation; easing of the prohibition of compensation for investment analysis; easing of rules for participation of investment advisors in conferences; less restrictions on banking corporations regarding the publication of analyses; easing of restrictions on the board of directors of large fund managers. |
In addition, it is the intention of the Authority to determine a scaled regulation that will enable special exemptions for small reporting corporations and small portfolio management companies. An example is the proposal to exempt small companies from the long and expensive process of ISOX auditing of financial statements by an auditor.
Initiatives for consumer protection
The Annual Report placed special emphasis on consumer initiatives that the Authority is advancing, with the goal of creating competition and reducing costs for investors and households. The steps taken by the Authority in this context reflects a perspective according to which the Authority's function, as the body responsible for protecting the interests of the investing public, is not just the classic role of supervision and enforcement, but also includes responsibility for removing barriers to creating a more competitive environment for the benefit of the investors.
An example of the Authority’s "consumer" activity can be found in the area of mutual fund products. This involves products that are found in the portfolio of the general public and as a result the Authority decided to take a series of steps to reduce costs and improve competition. For example:
1. Reducing distribution fees – Reducing management fees for mutual funds by removing barriers to their reduction (amendment of the regulations at the initiative of the ISA was recently approved by the Knesset Finance Committee).
2. Deposits and loans funds – Launch of a money fund that can be offered to the investor as a substitute for short-term deposits. The product is meant to be such that the Investment Advisors Law does not apply to it and thus it is more accessible to the public.
3. Alternative distribution channel – This will enable investors to acquire mutual funds at significantly cheaper prices (for example, without a deposit fee) and also to receive a monetary refund on their investment for more than one half of the distribution fee.
4. Opening of the market to foreign mutual funds – A model that is meant to allow a high level of access to high-quality and inexpensive products from abroad, with implementation of a mechanism for protecting the interests of the investor.
In this context, it should be mentioned that at the same time the ISA is working to remove barriers that will allow Israeli mutual fund managers to operate abroad and thus to help the Israeli financial industry to become part of the global financial and capital market.
The structure of supervision in Israel
The Chairman of the Authority spoke at length this morning with respect to 2013 requiring regulators in Israel to meet similar challenges to those that currently occupy the regulators of financial and capital markets worldwide. One of the most important of these issues is the structure of regulatory supervision and the possible tension arising from the regulatory dilemma of stability versus disclosure. Professor Hauser has opposed those calling for the centralization of supervisory powers of stability, disclosure and management of financial entities in the hands of an “Integrated regulator” that would bring together under one roof the powers currently given to the Israel Securities Authority, Bank Supervision Unit and the Capital Markets Division in the Ministry of Finance. According to his words: “This is an idea that is dangerous to the Israeli economy. It should be vigorously opposed”.
According to Hauser, global experience has proven that the integrated supervision model bears a natural systemic risk of supervisory failure since if the integrated regulator “errs” there is a potential for the mistakes to spread throughout the financial and capital market, rather than being restricted to a particular financial sector or to a group of financial products. Moreover, a shift from the existing model to the integrated model will require that the supervised entities adjust to the new model and it is not inconceivable that such an adjustment will create costs for the supervised bodies.
Essentially, the supervisory viewpoint worldwide is that there is no one model that is necessarily correct. Each model has its advantages and disadvantages. One of the models that is becoming increasingly adopted in other countries is the two-fold or Twin Peaks model. This model differentiates between two types of supervision: market prudential which is intended to reduce the concern of the collapse of financial bodies and market conduct supervision which is meant to regulate aspects of disclosure and transparency, alongside aspects related to the management of financial entities with regard to the market and their customers.
The main advantage of the two-fold supervisory model (formal or informal) is related to the ability of each of the supervisory powers to focus on the function intended for it: stability on the one hand and protection of the consumer on the other. In this way, internal conflicts are avoided that might have arisen in the case of an integrated supervisory authority, since each regulator acts to advance the goals over which he is responsible and the built-in tension between the regulators is what creates the proper balance for the economy. A variety of opinions is critical for optimal decision making process in comparison to a situation in which there is only one opinion.
Disclosure as an important layer of increased stability
A complementary issue to the discussion of the regulatory structure relates to the interests for which the regulators are responsible. Thus, for example, it is not inconceivable that the regulatory goal of protecting investors will conflict in certain cases with the regulatory goal of preventing the concern of instability for a particular financial institution. In other words, this is a conflict in theory between the principle of disclosure and the principle of stability. It is the position of the Authority that apart from in exceptional cases the principle of disclosure should serve as the guiding principle. The capital market without appropriate disclosure and without transparency cannot enjoy the confidence of the public and companies will have difficulty finding a channel to raise capital and obtain credit. Therefore, a supervisory structure that separates between the regulator of stability and the regulator of disclosure and consumer protection ensures that there will be no internal conflict within one entity between the goal of protecting investors on the one hand and the goal of maintaining the stability of supervised institutions on the other. The tension between regulators is healthy tension and the solution of the dilemma consists of coordination and cooperation between the Israel Securities Authority which is responsible for disclosure and the Banking Supervision which is responsible for stability, with each body representing the interests for which it is responsible. In this way a correct balance will be achieved for the benefit of the economy.