May 28, 2020 / Sivan 5, 5780

ISA Chairwoman Anat Guetta, "The public bond market in Israel grew significantly in the past decade, and constitutes a genuine alternative for bank lending. As a tradable market that is open to the entire investing public, the debt market is different from all other global bond markets, and the quality of information available to the investing public over the life of a bond is significant and critical if bond prices are to adequately reflect investment risks. Dual credit ratings have become the standard in developed markets, and although there is no regulatory requirement, dual ratings are an accepted prerequisite in the investment culture of institutional investors. In Israel, however, the bond market's investment culture has not managed to develop a similar standard. From our perspective, this is an example of a market failure that calls for reinforced security and information mechanisms available to investors operating in the public bond market. Our first step is to create incentives to adopt the dual rating standard over the entire life of a bond. The recent period has been characterized by sharp fluctuations in the markets that create extreme stress scenarios that require special caution and prudence in managing the public's money and making investment decisions. The dual rating standard will give investors another tool to help them do so. I am aware of the developments in the market, and alongside the supervisory and enforcement measures we are taking to protect the investing public's interests in the public debt market, in the near future we expect to publish new tools that will bolster investors' toolbox for credit risk management, which is an inherent part of investing in bonds".

On May 25, 2020, ISA Staff, headed by ISA Chairwoman Anat Guetta, published a position paper to promote the use of two credit ratings by fund managers in order to increase market efficiency and enhance the information available to investors. Dual ratings are prevalent in most of the world's developed markets and are published either in response to requirements imposed on institutional or other investors, or voluntarily by the issuers themselves, who believe that it will expand their potential investor base. Consequently, alongside additional moves that the ISA is advancing to increase disclosure and reporting of material information to investors, the ISA is taking steps to encourage the market and mutual fund managers to make use of dual credit ratings.

Furthermore, the ISA is taking steps to incentivize companies that voluntarily elect the dual rating track. The ISA Staff Position on this issue will be published in the near future.

The ISA stresses its view that the optimal benefits of dual rating are achieved when dual ratings are maintained over the entire life of the bond. Therefore, it is important that investors use the tools that are legally available to them and use their influence to optimally design bond trust deeds.

Based on a study conducted by ISA Staff , approximately 87% of the all bond issues in North America and Europe (in monetary terms) are rated by one of the three major rating companies (S&P, Moody's, and Fitch), and 77% of the value of these series are rated by at least two of these three rating companies.

In contrast, in Israel, no significant market for dual ratings has developed, and only few companies have adopted dual rating. For example, 46% of the monetary value of the bonds issued to the public have a dual rating – but these are bonds that were issued by a mere 15% of all reporting entities that issue bonds, and most belong to the financial sector (banks and insurance companies).

The ISA will encourage including dual ratings over single rating, dual ratings as one of the parameters that a mutual fund manager should take into account in their investment decisions to expose the fund to bonds. In view of the benefits of considering two ratings rather than one, the use of dual ratings is instrumental in developing a market standard that gives preference to dual ratings in view of their benefits. 

The ISA stresses that it is not calling on fund managers to change the degree of their reliance on a company's credit rating when making investment decisions. Moreover, the ISA stresses that in any event of a material change in the company's business or the terms of its bonds, fund managers have a duty to conduct a discussion in a debt forum or other forum, as relevant. Therefore, fund managers should not rely exclusively on companies' ratings but should monitor companies' reports and assess their effects on default risks. At the same time, fund managers should attend to modifications made to the credit ratings themselves, and to irregular events, such as the discontinuation of ratings by a rating company, and should conduct discussions in the relevant forums when making decisions with respect to the securities in question

The ISA recently published a document on hybrid bonds, and illustrated the enormous importance of dual ratings at issuance. This dual rating norm also applies to new debt instruments that the ISA may approve in the future.

Following are several benefits related to dual credit ratings that are relevant to investment decision making:

• - Dual ratings provide accessible information and a second opinion on a company's financial position, and improve the ability to make investment decisions and price the credit risk that bonds represent.

• - Dual ratings offer two opinions that are based on different methodologies. For example, Midroog may rate bonds directly, using a local rating scale, while Ma'alot first calculates a global rating scale, which is then converted into the local scale, based on the conversion table published on Ma'alot's website.[1]

• - A credit downgrade by one of the two rating companies constitutes a warning indication that informs investors' decision making. The use of this information is even more important during a crisis on the capital market in general, and specifically during periods of significant uncertainty in the capital market.

• - Dual rating reduces concerns of the inherent conflict of interest that accompanies ratings shopping, taking into account the terms of the agreements between rated and rating companies ("rating shopping"). Furthermore, dual ratings improve price discovery in the market, especially in a market as unique as the Israeli bond market, which is open to retail activity and is traded continuously.[2]   

• - Investors' reliance on ratings of bonds in Israel has a significant effect on the design of deeds of trust for stress events. Therefore, defining adequate protection mechanisms in deeds of trust that include a requirement to maintain a dual rating, may improve investors' situation.

• - Encourage competition in the rating market - markets that have established a multiple rating regime established a foundation for additional rating companies who may examine the economic feasibility of their operations in Israel.

The ISA is nonetheless aware of the potential shortcomings of a dual rating regime, mainly in terms of the added costs to which companies may be subject, especially in the current rating market in Israel, which comprises two rating companies. Nonetheless, the ISA believes that a cost-benefit analysis shows that adopting the dual rating standard create clear and significant value for the public.   

[1] According to the conversion table, the global rating of A- is equivalent to the highest local rating of ilAAA.

[2] Rather than OTC in transactions among institutional investors, as is the case in the majority of the developed bond markets across the globe.