Israel
29 March 2011
Securities lending has been a relatively closed shop in Israel.
But the tide is turning
Image: Shutterstock
Although some investors take political considerations in mind when looking whether to operate in Israel, the market has done surprisingly well over the past few years.
It’s one of the few countries to have survived the credit crisis relatively unscathed - Israeli investors are comparatively conservative and didn’t invest in the riskier markets that have brought down their international counterparts.
“Israel is one of the strongest markets in the world, and has recently become an OECD member as well as being part of the MSCI developed world indices and has hardly been affected at all by the credit crisis,” says Ofer Abarbanel, CEO at Contact (ISR) Management and Consulting. “Clients have made only a few very simple CDOs and the CDS transactions we have done have tended to be the vanilla-type trades, we’ve steered clear of the complicated structures both as funded and unfunded trades.”
Israel has a vibrant technology and medical services sector, with an educated workforce and an international outlook when it comes to financial markets. It’s also a comparatively wealthy market, with large numbers of well-to-do retirees moving to the state.
Cautious investments
Although short selling and securities lending are established and approved features of the Israeli market, local investors have traditionally avoided short sales - the cautious culture of investors means they are just not a popular investment option.
Short selling is permitted provided that a corresponding securities lending transaction is in place to cover the short position, in accordance with the Tel-Aviv Stock Exchange rules.
“We’ve been able to have a successful market without short selling being a major factor,” says one manager. “However, the fact that it is available adds stability - we certainly wouldn’t want to see the option taken away from us.”
Two tier
While securities lending is alive and kicking within Israel, there are two distinct types of market. The first is the local trading, which is pretty much controlled by the Israeli banks. Here, they tend to trade within themselves, with few external transactions taking place.
In part, this is down to the way the banks work. There is little standardisation even between the local banks, let alone with the international players. Industry standard contracts are not common, and are often in Hebrew, while the technology for securities lending transactions is not the same as that seen in the rest of the world.
“We have a large pool of funds and we don’t have a problem fulfilling the requirements of our clients,” says a representative of one local player. “As securities lending has developed, we have created a large amount of liquidity and reduced the risks as much as possible for our clients so that they are comfortable with the transactions we manage - our market profile is one of the reasons Israeli investors did so well during the downturn.”
But this system, says Abarbanel, is inefficient and expensive. “The bank driven market is only for Israeli securities and is very limiting with respect to foreign investors who are hardly in this market,” he says. “It’s a large market, but it’s an internal market, between Israeli banks and on Israeli securities.
“It’s an expensive trade and haircuts are high, because banks dominate the market - it’s a closed space. The banks are custodians to those mutual funds and they’re kept as hostages - they can’t do OTC trades without the say so of the banks.”
The alternative is the OTC market, which has attracted a more international range of clients, as well as different lenders within the Israeli market. International and local pension funds, provident funds and insurance companies - mostly from Israel and Canada, the two Western financial markets that have done the best out of the credit crisis.
“What we’ve done is created relationships with these players and made GMSLA agreements on all types of US, European and Israeli securities, both equities and fixed income,” explains Abarbanel. “We don’t act as a counterparty, but as a middle office introducing broker. It’s being the brains behind the trade - it’s more sophisticated than the bank-driven trading.
“In the Israeli bank system, it’s lenders who get low lending fees. We do payment in cash and payment in additional securities - so lenders get a five per cent lending fee and the ability to profit from those additional securities. This market is more attractive because it has lower haircuts and is more profitable for both sides.
“We also do a lot of re-use of collateral. Unlike Israeli banks where there is no netting and no re-use of collateral, we can do that and it creates a competitive environment for both lenders and borrowers.”
As Israeli banks tend not to have the infrastructure - or the will - to trade internationally, the two markets complement each other well. There is, says Abarbanel, little desire on the part of the banks to change their systems, and they are happy to work with the OTC market.
“The banks are not looking to develop securities lending,” he explains. “One reason for this is the fact that any time you try to develop a market it creates competition within that world.
“They are maintaining the market but they’re not making the effort to improve it. Their systems don’t work with other systems. We use systems that are up to international standards. It’s two different attitudes.
“We are not trying to get the international market to transact with Israeli banks, but with Israeli pension funds and insurance companies. There are more securities for us to work with than all the Israeli banks have put together. The pension fund and mutual fund market is valued at $1.2 trillion, that amount is more than enough for everyone.”
Regulation
Securities lending is permitted. At present, the SECH is not a party to the lending transaction. TASE rules prohibit intentional short selling unless there is a lending/borrowing agreement in place prior to the short sale. TASE regulations require that all intentional short sales not covered by a securities lending agreement, be covered within 24 hours of the creation of the position.
The regulations for short selling and securities lending appear in the TASE and SECH regulations. As noted above, the SECH is not a party to securities lending transactions. These are concluded between members and their customers or between two customers directly. All securities lending agreements must be reported to the SECH, whether they are transacted directly between two end customers without the involvement of the local custodians, or whether the lending is from the custodian.
The requirement to report stock borrowing transactions applies only in the event of short positions at the borrower’s account. If borrower and lender made an agreement overseas and the lender delivers shares to the borrower’s account, the borrower is not is short position, and in this case- the borrower’s local custodian does not need to report the transaction to SECH as borrowing transaction.
Israeli companies trading on the Tel Aviv Stock Exchange will now be able to list on European stock exchanges without publishing an additional prospectus. An Israeli company seeking to list on one of Europe’s stock exchanges will be able to use its Israeli prospectus, with an additional list of 15 disclosures required by the ESMA. Finance Minister Yuval Steinitz welcomed the decision, saying that the EU’s regulatory standards were an “international yardstick.” The ISA sees the ESMA decision as historic. After it was announced, ISA Chairman Prof. Zohar Goshen said that the Israeli market had “taken a great step forward in allowing Israeli companies to list their stocks for trading or raise capital in Europe.”
It’s one of the few countries to have survived the credit crisis relatively unscathed - Israeli investors are comparatively conservative and didn’t invest in the riskier markets that have brought down their international counterparts.
“Israel is one of the strongest markets in the world, and has recently become an OECD member as well as being part of the MSCI developed world indices and has hardly been affected at all by the credit crisis,” says Ofer Abarbanel, CEO at Contact (ISR) Management and Consulting. “Clients have made only a few very simple CDOs and the CDS transactions we have done have tended to be the vanilla-type trades, we’ve steered clear of the complicated structures both as funded and unfunded trades.”
Israel has a vibrant technology and medical services sector, with an educated workforce and an international outlook when it comes to financial markets. It’s also a comparatively wealthy market, with large numbers of well-to-do retirees moving to the state.
Cautious investments
Although short selling and securities lending are established and approved features of the Israeli market, local investors have traditionally avoided short sales - the cautious culture of investors means they are just not a popular investment option.
Short selling is permitted provided that a corresponding securities lending transaction is in place to cover the short position, in accordance with the Tel-Aviv Stock Exchange rules.
“We’ve been able to have a successful market without short selling being a major factor,” says one manager. “However, the fact that it is available adds stability - we certainly wouldn’t want to see the option taken away from us.”
Two tier
While securities lending is alive and kicking within Israel, there are two distinct types of market. The first is the local trading, which is pretty much controlled by the Israeli banks. Here, they tend to trade within themselves, with few external transactions taking place.
In part, this is down to the way the banks work. There is little standardisation even between the local banks, let alone with the international players. Industry standard contracts are not common, and are often in Hebrew, while the technology for securities lending transactions is not the same as that seen in the rest of the world.
“We have a large pool of funds and we don’t have a problem fulfilling the requirements of our clients,” says a representative of one local player. “As securities lending has developed, we have created a large amount of liquidity and reduced the risks as much as possible for our clients so that they are comfortable with the transactions we manage - our market profile is one of the reasons Israeli investors did so well during the downturn.”
But this system, says Abarbanel, is inefficient and expensive. “The bank driven market is only for Israeli securities and is very limiting with respect to foreign investors who are hardly in this market,” he says. “It’s a large market, but it’s an internal market, between Israeli banks and on Israeli securities.
“It’s an expensive trade and haircuts are high, because banks dominate the market - it’s a closed space. The banks are custodians to those mutual funds and they’re kept as hostages - they can’t do OTC trades without the say so of the banks.”
The alternative is the OTC market, which has attracted a more international range of clients, as well as different lenders within the Israeli market. International and local pension funds, provident funds and insurance companies - mostly from Israel and Canada, the two Western financial markets that have done the best out of the credit crisis.
“What we’ve done is created relationships with these players and made GMSLA agreements on all types of US, European and Israeli securities, both equities and fixed income,” explains Abarbanel. “We don’t act as a counterparty, but as a middle office introducing broker. It’s being the brains behind the trade - it’s more sophisticated than the bank-driven trading.
“In the Israeli bank system, it’s lenders who get low lending fees. We do payment in cash and payment in additional securities - so lenders get a five per cent lending fee and the ability to profit from those additional securities. This market is more attractive because it has lower haircuts and is more profitable for both sides.
“We also do a lot of re-use of collateral. Unlike Israeli banks where there is no netting and no re-use of collateral, we can do that and it creates a competitive environment for both lenders and borrowers.”
As Israeli banks tend not to have the infrastructure - or the will - to trade internationally, the two markets complement each other well. There is, says Abarbanel, little desire on the part of the banks to change their systems, and they are happy to work with the OTC market.
“The banks are not looking to develop securities lending,” he explains. “One reason for this is the fact that any time you try to develop a market it creates competition within that world.
“They are maintaining the market but they’re not making the effort to improve it. Their systems don’t work with other systems. We use systems that are up to international standards. It’s two different attitudes.
“We are not trying to get the international market to transact with Israeli banks, but with Israeli pension funds and insurance companies. There are more securities for us to work with than all the Israeli banks have put together. The pension fund and mutual fund market is valued at $1.2 trillion, that amount is more than enough for everyone.”
Regulation
Securities lending is permitted. At present, the SECH is not a party to the lending transaction. TASE rules prohibit intentional short selling unless there is a lending/borrowing agreement in place prior to the short sale. TASE regulations require that all intentional short sales not covered by a securities lending agreement, be covered within 24 hours of the creation of the position.
The regulations for short selling and securities lending appear in the TASE and SECH regulations. As noted above, the SECH is not a party to securities lending transactions. These are concluded between members and their customers or between two customers directly. All securities lending agreements must be reported to the SECH, whether they are transacted directly between two end customers without the involvement of the local custodians, or whether the lending is from the custodian.
The requirement to report stock borrowing transactions applies only in the event of short positions at the borrower’s account. If borrower and lender made an agreement overseas and the lender delivers shares to the borrower’s account, the borrower is not is short position, and in this case- the borrower’s local custodian does not need to report the transaction to SECH as borrowing transaction.
Israeli companies trading on the Tel Aviv Stock Exchange will now be able to list on European stock exchanges without publishing an additional prospectus. An Israeli company seeking to list on one of Europe’s stock exchanges will be able to use its Israeli prospectus, with an additional list of 15 disclosures required by the ESMA. Finance Minister Yuval Steinitz welcomed the decision, saying that the EU’s regulatory standards were an “international yardstick.” The ISA sees the ESMA decision as historic. After it was announced, ISA Chairman Prof. Zohar Goshen said that the Israeli market had “taken a great step forward in allowing Israeli companies to list their stocks for trading or raise capital in Europe.”
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