Israel’s New Securitization Dilemma: How to Succeed in Business without Taking a Bloodbath

/ By Ron Stein and Adrian Filut/

The Joint Team to Promote Securitization in Israel seeks to avoid the flaws that triggered the 2008 financial crisis.

After years of discussion and deliberation, securitization could soon become an accepted and important financial tool in Israel. Yesterday, the Bank of Israel, the Israel Securities Association, the Ministry of Finance, the Ministry of Justice, and the Israel Tax Authority, released the interim report of the Joint Team to Promote Securitization in Israel.

This is a renewed effort by Israel’s financial regulators to promote a securitization market, following previous attempts by the Haimovitz-Asher committee a decade ago and later by Prof. Zvi Eckstein. These initiatives were frozen for several years in the wake of the huge financial crisis that hit the world in 2008 and that, among other things, exposed the problematic nature of these instruments.

The Joint Team, whose report is now available for public comment, recommends forming the appropriate legislative basis for promoting securitization and removing obstacles such as taxation problems. All the same, the renewed process of launching a securitization market in Israel is still not close to its end. Legislation is required in the form of a bill for regulating securitization deals, amendment of the Securities Law, amendment of the Income Tax Ordinance, and additional special rules to be drafted by the financial regulators.

It is estimated that the legislative procedures for implementing the recommendation of the report should take about four months, so that, barring any extraordinary event, securitization could be introduced within less than a year.

Securitization is an important tool for spreading and transferring risk in the financial system. In a securitization transaction, securities are issued backed by a predictable and defined cash flow from a loan portfolio or a group of financial assets, through a legally separate special purpose vehicle that receives the underlying assets from the securitization originator. Use of the special purpose vehicle is designed to facilitate investment for which the associated risk is confined to the underlying assets only, without the general risk associated with the originator.

The securitization market in Israel is not developed, and is in fact tiny and insignificant, because the appropriate regulatory, legislative, taxation and accounting infrastructure is lacking. Elsewhere in the world, the joint team says in explaining the importance of reviving the subject in Israel, the securitization market is similar in size to the corporate bond market. The World Economic Forum ranks Israel’s securitization market in 54th place out of 59 countries that were surveyed. “Securitization transactions are expected to increase the ability of businessesin particular, small and midsized businessesto raise funds. Securitization transactions are expected to contribute to increased sophistication of the capital market by diversifying credit risk among additional entities in the financial system, and accordingly, to reduce the cost of funding, ” the report says.

The background to the financial crisis of 2008 was that many banks securitized loans, chiefly mortgage loans, and sold them in the market. These instruments received high ratings. But when the crisis began, it emerged that the banks had pushed high-risk loans onto the market, and the default rate was correspondingly high, so that the value of the instruments plummeted, leading to a loss of confidence in this market.

The Joint Team seeks to form a stable securitization market, neutralizing the risk that stems from originators transferring the entire risk in the underlying assets to investors by making the originator (i.e., the bank or other financial body that granted the underlying loans) a party to the risk undertaken by those holding the asset-backed securities in a securitization transaction. It recommends:

Imposing an obligation on the entity which is selling the right to receive cash flows from defined assets to retain 10 percent of the securitized portfolio;
A securitization transaction is to be classified, from a legal standpoint, as a true sale and not as a loan, provided that specific conditions detailed in the report are met. This separates the originator’s risks related to the assets transferred in the securitization transaction from other risks inherent in its operations;
Neutral taxation of securitization transactions, which will not create an excess burden on the originator or on investors, yet at the same time will not provide a tax incentive;
Establishing the terms for a public offering of securitization transactions, with increased transparency, and imposing legal responsibility on the various participants in the securitization transaction;
Establishing directives which regulate the rights of borrowers in loans transferred within the framework of securitization transactions.
The reports sates that ” The team paid considerable attention to learning lessons from the global crisis that broke out in 2008, and placed special emphasis on changes in securitization market regulation in various countries around the world. The team recommends that at this stage, only plain vanilla (traditional) securitization transactions merit legal certainty and regulation.”

Published by Globes [online], Israel business news – www.globes-online.com