## _cr1272 ## Source details **Canonical URL:** [_cr1272](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1272.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1272.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1272.pdf.json) --- ### Summary of Compliance with the Basel Core Principles (assessment November 2011) - Overall judgment: - Banking sector regulation and supervision is generally in line with international standards and stringent. - Authorities take a pro-active approach to supervision and correcting incipient problems. - Principal remaining deficiencies: regulation and supervision of interest-rate risk, market risk, and liquidity risk; and limited flexibility and autonomy in personnel management and budgets to attract and retain financial sector experts. - Information and methodology: - Assessment conducted in accordance with the Core Principles (CP) Methodology published in October 2006 by the Basel Committee on Banking Supervision (BCBS). - Qualitative assessment; ratings based solely on compliance with the “essential” criteria. - Assessors: Thierry Bayle (Banque de France) and Joel Shapiro (formerly of the U.S. Federal Reserve). - Institutional and market structure: - Main financial institutions: banks and insurance companies. - Post-Bachar reform (began in mid-2005), banks divested most non-commercial activities. - Banks’ assets amount to about 140 percent of GDP. - Supervisory responsibilities: - Bank of Israel (BOI) — Banking Supervision Department (BSD). - Israel Securities Authority (ISA). - Commissioner of Capital Markets, Insurance, and Savings (CCMIS) at the Ministry of Finance (MOF). - Tel Aviv Stock Exchange (TASE) — some supervisory responsibilities. - MOUs exist among BOI, ISA, and CCMIS; cooperation generally satisfactory in normal times but may be stretched in crisis. - Impact of the global crisis and financial soundness: - No domestic financial institution got into serious difficulties during the crisis. - Contributing factors: conservative bank management; limited inter-connectedness; lack of complex securitized markets; strong and intrusive bank supervision. - At mission time: average capital ratio for major Israeli banks reached 14 percent; Tier 1 capital ratio stood at around 8.5 percent. - Banks remain mainly deposit-funded, with customer deposits exceeding loans. - Preconditions for effective supervision and legal framework highlights: - Monetary policy: inflation targeting; BOI independence strengthened by the enactment of the 2010 BOI Law. - Banking legal instruments: Banking Ordinance, 1941; Banking Licensing Law, 5741 – 1981. - Listed companies and most nonbank financial institutions applied IFRS since 2008; banking system reports under BSD directives and Israeli GAAP. - Israel does not have formal deposit insurance; historically depositors received de facto protection in past bank failure events. - Main findings by clusters: - CP1: comprehensive laws and directives; MOF influence on BOI employee salary scale risks compromising independence. - CPs 2–5: licensing and structure framework clear; transfer of ownership defined; definitions of control exist in policy (not law). - CPs 6–18: regulatory framework fairly comprehensive but dense and complex; standardized approaches used in Pillar I; Pillar II significant but somewhat informal; areas for improvement: interest-rate risk in the banking book, market risk, liquidity risk. - CPs 19–21: evolving risk-based supervision; mix of on-site and off-site; extensive reporting on consolidated and unconsolidated basis. - CP22: disclosure requirements very strict; transition to IFRS planned. - CP23: corrective powers currently restrictive; expansion under consideration. - CPs 24–25: consolidated supervision satisfactory; gap in supervision of certain securities-related activities by banking corporations. ### Key statistics and exact values cited - Assessment timing: November 2011. - Banks’ assets: about 140 percent of GDP. - Average capital ratio for major Israeli banks: 14 percent. - Tier 1 capital ratio: around 8.5 percent. - IFRS adoption for listed companies and most nonbank financial institutions: since 2008. - BOI Law enactment strengthening independence: 2010. - Banking Ordinance year: 1941. - Banking Licensing Law referenced as: Banking Licensing Law, 5741 – 1981. ### Selected recommended action points (banking) - Objectives, autonomy, powers and resources: - Consider a more principles-based approach to directives for risk management policies and practices. - Formalize periodic review of banking law and reorganize into a comprehensive banking law. - Address MOF influence over BOI salary scale via in-house training, programmed rotation, secondments overseas, cash bonuses, and hiring retired bankers at entry- or mid-level positions. - Capital adequacy: - Dedicate more BSD resources to independent checking of capital adequacy reporting. - Strengthen SREP to be more forward-looking and prescriptive; ensure timely responses when ICAAP is insufficient. - Empower the Supervisor to require controlling shareholders to increase banks' capital. - Risk management, market, liquidity, and interest-rate risks: - Streamline the regulatory framework into a comprehensive rulebook. - Update credit risk regulation to incentivize development of internal ratings systems. - Increase resources for on-site examination of market risk and liquidity data processing and models. - Introduce specific regulation for interest-rate risk in the banking book and treat it separately from market risk in SREP. --- ### Risk management (section 7) - Overall: - Regulatory framework is "fairly comprehensive, but dense and complex." - BOI moving towards a more principles-based rulebook; upcoming reform opportunity to specify segregation of functions and settlement risk treatment. - Credit risk (CP 8): - Supervision based on many detailed directives and subject to close scrutiny. - Recommendation: move towards comprehensive regulation to incentiviz[e] banks to upgrade internal rating systems. - Problem assets, provisions, and reserves (CP 9): - Rules fully adequate; harmonization under way. - Accounting definition of impaired debts does not separately identify "debts to borrowers that are unlikely to repay, regardless of any collateral recollection." - Large exposures and related parties (CPs 10–11): - BSD enforces comprehensive large-exposure regulation; oversight could be enhanced by attention to correlation of risks. - Definition of related parties strictly delineated but leaves limited discretion to Supervisor. - Market risk (CP 13): - Capital purposes: only standardized methods allowed; VaR models and stress tests used for risk management. - BOI lacks sufficient independent capacity and resources to challenge banks' trading book eligibility, data systems, valuation methodologies, and internal models. - Assessment of market risk currently biased by amalgamation with interest-rate risk in the banking book. - Liquidity risk (CP 14): - Intensive oversight but based on solo information only. - Regulatory limits apply only to overall liquidity, not broken down by major currencies, and only over a one-month horizon. - Few resources devoted to on-site examination of banks' liquidity information systems and models. - Operational risk and internal control (CPs 15–17): - Rules scattered across directives; compulsory reporting excludes related material losses. - Legal and regulatory framework for internal control is "piecemeal" and inconsistent. - Gaps include scope of compliance function and access of internal audit to outsourced functions. - AML/CFT (CP 18): - AML/CFT provisions and practice generally of a high standard. - Needed legal amendments expected to be passed shortly; new regulation in process at time of assessment. - Supervisory approach and reporting (CPs 19–21): - Evolving risk-based approach; risk assessment products high caliber but sometimes duplicative and need streamlining. - Need to expand staff to fully implement risk-based supervision and Basel II initiatives. - Extensive reporting used appropriately and on consolidated and unconsolidated bases. - Accounting and disclosure (CP 22): - Disclosure requirements "very strict"; accounting standards currently a combination of U.S. GAAP and IFRS; core assets principally under U.S. GAAP. - Authorities plan to transition banking system solely to IFRS standards "by 2013 or later." - Corrective and remedial powers (CP 23): - Current law contains a "restrictive list" of remedies; expansion and stronger resolution tools under consideration. - Consolidated supervision and home-host relations (CPs 24–25): - Consolidated supervision overall satisfactory. - Gap in supervision of certain securities-related activities housed in bank subsidiaries; supervisory agreements with ISA required. - Formal written agreements with major host supervisors exist; one agreement needs expansion. ### Recommended risk-management–specific actions (selected) - Disentangle market risk from interest-rate risk in SREP and risk products. - Extend liquidity regulatory limits to breakdowns by major currencies and longer horizons. - Increase on-site resources to validate market risk, liquidity, and operational risk models and data systems. - Introduce specific regulation for interest-rate risk in the banking book and require stand-alone reporting to BOI. --- ### Supervisory (insurance, pension, CMISD) — main findings and recommendations - General assessment: - Insurance sector regulation and supervision is generally in line with international standards and stringent; regulation often goes beyond standards. - Regulation and supervision of insurance, pension fund, and provident funds generally of a high standard, but cross-border supervisory cooperation and information-sharing needs strengthening. - Policies on group capital adequacy, reinsurance and risk concentration, internal control mechanisms, and group-wide reporting "are not fully articulated"; holding companies escape adequate supervision. - Institutional context and market structure (as of June 30, 2011): - CMISD oversees 23 insurance companies, 11 “new” pension funds, 18 “old” pension funds, 65 management fund companies, with total assets of almost NIS 1 trillion as at June 30, 2011. - Five large insurance companies account for 90 percent of the insurance premium in the country. - Non-life insurance accounts for about 50 percent of total premiums; motor premium makes up about 50 percent of that total. - Strengths and best practices: - ICP 14: Commissioner can issue instructions on virtually any topic. - ICP 26: public information requirements are "extremely comprehensive." - Modern supervisory framework and formal insurer risk assessment process advanced; staff motivated and knowledgeable. - Areas needing strengthening: - Cross-border supervisory cooperation: MOUs and regular communication with foreign supervisors "should be in place"; CMISD should obtain supervisory filings from foreign parents annually. - Group supervision: lack of formal policies on group capital adequacy, reinsurance, risk concentration, internal controls, risk management systems, and group-wide reporting; work underway to adopt Solvency II paradigm. - Pace and burden of reforms: rapid reforms may generate operational risk; recommendation to supplement supervisory staff with seasoned professionals and conduct cost–benefit assessments before major regulation. - Composite insurers: recommendation to prohibit new composite insurers and plan for existing ones or change law to avoid legal problems at liquidation. - Insurance intermediaries: increase transparency where agents are owned by insurers; require "informed consent" and consider ownership/labeling changes. - Fraud: consumer insurance claim fraud common; recommend legal amendments to require more effective insurer actions and use of industry databases to detect fraud. - Supervisory process and on-site inspection: - On-site inspection fully complies with international standards; recommended to increase comprehensive company-wide inspections and consolidate person-days into extended visits; enhance cooperation with independent auditors and hold exit meetings. - Preventive, corrective, and exit regime: - Commissioner has extensive powers; work underway to develop a formal ladder of intervention. - Recommendation to amend law to allow CMISD to demand additional capital at any time deemed necessary to protect policyholders. - Consider amendments explicitly allowing ring-fencing of insurance companies belonging to a conglomerate being resolved. - Capital adequacy and solvency: - Current solvency regime: an enhanced Solvency I with some risk-sensitive elements; calibration of risks needs attention. - Recommendation: further develop stress testing, introduce standardized stress testing and technical provision stress testing; plan to adopt Solvency II adapted to Israel. - Reporting, liabilities, and derivatives: - Introduce regulation to monitor outsourced providers more closely. - Define parameters and methodology for Liability Adequacy Testing (LAT). - Maintain conservative supervisory approach to derivatives; review limits as market develops. - Recommended Action Plan (selected ICP items): - ICP 2: Reduce time lag to publication of Annual Report. - ICP 3: Consider independent budget for CMISD or audited financial statements to enhance transparency. - ICP 5: Establish stronger working relations with international supervisors and require annual supervisory filings from foreign-owned insurers. - ICP 6: Do not license composite insurers in the future; require formal segregation of unit-linked fund assets. - ICP 14 and ICP 23: Introduce ladder of intervention; finalize Solvency II–based regulations and stress testing requirements. - ICP 24: Require annual organizational chart of group entities controlled by controlling shareholder. - ICP 25 and ICP 27: Introduce cooling off period for pressured sales; require boards to adopt policies to detect and reduce claim fraud. - ICP 28: Adopt and implement the new AML/CFT regulation. ### Authorities' responses (CMISD) - CMISD expressed thanks and found the FSAP "highly beneficial"; generally agrees with assessment and is taking actions: - Signing MOUs and joining the MMOU with foreign counterparts; work plan completion within 2012. - Examining ring-fencing existing life insurance assets and considering law changes to separate life and non-life business. - Releasing outsourcing guidelines later in the year reflecting IMF-FSAP recommendations. - Improving group supervision as part of Solvency II adoption. - Finalizing regulatory procedures based on Solvency II principles. - Improving transparency in pension and insurance distribution via strengthening the Advice Law. --- ### Securities regulation and IOSCO assessment - Overall: - Overall level of compliance with the IOSCO principles is high; regulatory regime well developed and comparable to major jurisdictions. - ISA regulation and oversight described as robust and effective. - Significant gap: broker-dealer activity can be undertaken outside the regulatory framework if activity does not involve TASE membership, provision of advice services to retail clients, or a licensed bank; some OTC derivatives activity can occur outside the regulatory regime. - Information and methodology: - Assessment conducted in November 2011 within FSAP Update; used IOSCO Objectives and Principles and associated methodology adopted in 2003, updated in 2008. - Assessors reviewed legislation, ISA self-assessment, discussed with ISA and other authorities, and used experts. - Institutional and market structure highlights: - ISA: independent agency regulating securities sector. - Supervisor of Banks: prudential and consumer protection regulation of banks. - CMISD: regulation of insurance and retirement savings sector. - TASE: significant SRO, authorizes and supervises members; 29 members: 15 banks (including 3 foreign banks) and 14 nonbanks. - TASE markets and participants: - Over 600 issuers in equities market. - Over 250 issuers in corporate bond market. - ETNs expanded to 437 series at end of 2010 (up from 133 in 2006). - Portfolio management: NIS 242 billion managed on a discretionary basis at end-2010 (up from NIS 103 billion in 2005). - Banks account for two thirds of equity trading, 74 percent of bond trading and over 80 percent of derivatives trading. - Main findings mapped to IOSCO principle groups (selected): - Principles 1–5: ISA has clear mandate and high operational independence; gap on unregulated broker-dealer and OTC derivatives activity. - Principles 6–7: TASE plays significant SRO role; bank members also regulated by Supervisor of Banks. - Principles 8–10: ISA has comprehensive inspection, investigation and enforcement powers; recent enhancements to administrative sanctioning powers. - Principles 11–13: Major improvements in cooperation; MOUs required for international sharing; government approval readily given for MOUs. - Principles 14–16: Prospectus and disclosure regime in line with IOSCO; issuers prepare financial statements in accordance with IFRS (other than banks). - Principles 17–20: CIS subject to licensing; trustee requirement; ISA currently lacks power to examine adequacy of internal management procedures at licensing. - Principles 21–24: Licensing for intermediaries exists but some intermediaries remain outside authorization perimeter. - Principles 25–30: TASE is sole secondary market; clearing and settlement oversight aspects reviewed separately (CPSS). - Priority recommended action points (Table 6): - Close the regulatory gap permitting broker-dealer and OTC derivatives activity to take place outside the regulatory regime. - Give ISA power to examine adequacy of internal management procedures at time of CIS licensing. - Ensure all intermediaries are subject to an authorization process. - Consider excluding long-term non-subordinated debt from capital of TASE members. - Authorities’ response (ISA): - ISA thanks IMF staff and prioritizes regulation of broker-dealer activity; established internal working group to propose legislative framework coordinated with BOI. - Notes OTC derivatives activity largely performed within banks; retail exposure to OTC derivatives limited by law. - ISA acting to extend underwriter liability and proposes amendments to require an underwriter in every public offering for external due diligence. - ISA does not see need to change capital requirements for licensees given current activity profiles. --- ### Payments system (Zahav) assessment and recommendations - Overview and background: - Zahav (RTGS) implemented in 2007; Payment Systems Law enacted in 2008; BOI Law in 2010. - Key remaining challenges: complete development of payment system oversight, risk management and collateral arrangements, business continuity arrangements, and pricing of services. - Need to ensure multilateral net settlement systems that settle in Zahav benefit from full protection of the law and have suitable loss-sharing agreements. - BOI needs to define conditions for provision of emergency liquidity assistance (ELA), including to elements of the payments system. - Institutional and system structure: - Zahav is the only RTGS system in Israel; participants include BOI, the Postal Company, CLS Banks, and 15 commercial banks. - Four payment systems participate in Zahav: Maof Clearinghouse and Securities Clearinghouse (TASE clearing houses), Masav (ACH), BCH, and CLS. - Payment Systems Law 2008 established oversight and finality/irrevocability rules; MOU exists between BOI and ISA for oversight of TASE-CH. - Main findings by CP (selected): - CP I (Legal foundation): Legal framework covers most components but recommendations to cover foreign law risk, make explicit protection for TASE-CH multilateral net settlement, and unify legal framework for collateral arrangements. - CP II–III (Rules, procedures, credit and liquidity risks): Zahav Rules are clear and up-to-date; system is currently awash with liquidity; participants incur no credit or liquidity risk in-system due to RTGS finality. - CP IV–VI (Settlement and use of central bank money): Zahav settlement finality protected by law; settlement takes place across participants’ accounts in BOI. - CP VII (Operational reliability and contingency): BOI has comprehensive business continuity plans and regular tests; further integration and definition of contingency arrangements and testing ladder recommended. - CP VIII (Practicality and efficiency): Zahav reliable and efficient; BOI encouraged to identify dedicated and shared costs and review policy of not recovering costs from some participants. - CP IX (Access): Any financial sector institution eligible for Zahav membership; consider publishing high-level membership and eligibility criteria; membership of nonbanks raises question of ELA eligibility. - CP X (Governance): Governance would benefit from transparent allocation of fully allocated costs to stakeholders. - Recommended action plan sequencing (selected with time frames): - Cover foreign law risk — 24 months. - Unify legal framework for eligible collateral — 24 months. - Complete declarations for Masav and BCH — 6 months. - Model start-up liquidity in Zahav — 12 months. - Encourage readiness of interbank market — 12 months. - Redesign Masav/BCH loss sharing agreement — 12 months. - Define optimal contingency arrangements and test them — 24 months. - Draw up internal control objectives and prove them — 36 months. - Build and integrate Zahav business model and ensure minimum central bank subsidy — 36 months. - BOI response: - BOI welcomes recommendations and is establishing an oversight function expected to be completed in 2013. - BOI will review liquidity management tools, participant familiarity, intraday credit limits, and has begun implementing recommendations under CP7. - BOI prepared a pricing module for justified pricing tariff and will consider collecting hardware replacement costs from participants if decided. *Source: IMF FSAP Update — assessment conducted in November 2011.* ### 1. Summary of Compliance with the Basel Core Principles ..................................................... 8 ### 1. Summary of Compliance with the Basel Core Principles ### Overview - Assessment conducted in November 2011 as part of the Financial Sector Assessment Program Update for Israel. - Overall judgment: banking sector regulation and supervision is generally in line with international standards and stringent; authorities take a pro-active approach to supervision and correcting incipient problems. - Principal remaining deficiencies: regulation and supervision of interest-rate risk, market risk, and liquidity risk; and limited flexibility and autonomy in personnel management and budgets to attract and retain financial sector experts. ### Information and Methodology Used for the Assessment - Assessment conducted in accordance with the Core Principles (CP) Methodology published in October 2006 by the Basel Committee on Banking Supervision (BCBS). - Qualitative assessment of each CP; compliance with both “essential” and “additional” criteria was considered, but ratings assigned solely on the basis of compliance with the “essential” criteria. - Assessors: Thierry Bayle (Banque de France) and Joel Shapiro (formerly of the U.S. Federal Reserve). ### Institutional and Macroprudential Setting and Market Structure - Main financial institutions: banks and insurance companies. - Post-Bachar reform (began in mid-2005), banks divested most non-commercial activities and focus on traditional banking business. - Banks’ assets amount to about 140 percent of GDP. - Most banks have relatively little overseas activity; dollarization greatly reduced. - Foreign institutions play a minor role; financial sectors are highly concentrated. - Supervisory responsibilities: - Bank of Israel (BOI) — Banking Supervision Department (BSD) responsible for prudential oversight of banks and payments system oversight (operates Zahav RTGS). - Israel Securities Authority (ISA) — oversees securities sector. - Commissioner of Capital Markets, Insurance, and Savings (CCMIS) at the Ministry of Finance (MOF) — deals with insurance and pension sector. - Tel Aviv Stock Exchange (TASE) — some supervisory responsibilities for its members. - Memoranda of understanding (MOUs) exist among BOI, ISA, and CCMIS for information sharing; cooperation generally satisfactory in normal times but may be stretched in crisis. ### Impact of the Global Crisis and Financial Soundness - Global crisis affected Israel’s economy but no domestic financial institution got into serious difficulties during the crisis. - Contributing factors to resilience: conservative bank management; limited inter-connectedness; lack of complex securitized markets; strong and intrusive bank supervision. - Authorities implemented crisis-intervention measures; BSD tightened reporting, capital, and liquidity measures. - At mission time: average capital ratio for major Israeli banks reached 14 percent; Tier 1 capital ratio stood at around 8.5 percent. - Bank profitability: declined sharply in 2008 but recovered as loan loss provisions decreased and net interest income increased. - Banks remain mainly deposit-funded, with customer deposits exceeding loans. - Financial soundness indicators for insurance companies generally satisfactory. ### Preconditions for Effective Banking Supervision - Sound macroeconomic policy framework: - Monetary policy: inflation targeting framework. - BOI independence strengthened by the enactment of the 2010 BOI Law. - Budgetary policy: fiscal rule established to support fiscal consolidation plan. - Legal and public infrastructure: - Banking legal framework: Banking Ordinance, 1941; no dedicated bank bankruptcy provision. - Banking Licensing Law cited (Banking Licensing Law, 5741 – 1981). - Auditing and accounting: listed companies and most nonbank financial institutions have applied IFRS since 2008; Israeli banking system reports under BSD directives and Israeli GAAP (close to U.S. GAAP, with some IFRS elements for non-core activities). - Internal and external auditor independence assured by audit profession legislation, Banking Ordinance requirements, Internal Audit Law, Companies Law, and Accountants Law. - Payment and settlement: - BOI operates Zahav (real time gross settlement system), linked to banks’ paper-based clearing house (BCH), the automated clearing house (Masav), and the TASE clearing house. - Market discipline and access: - Competition encouraged; market open to foreign participation; no significant non-prudential barriers to entry. - Corporate governance governed by Companies Law and Securities Law; sectoral legislation also applies (e.g., Banking (Service to Customer) Law). - Public safety nets: - Israel does not have formal deposit insurance. - Historically, government and BOI provided de facto protection to depositors in past bank failure events (examples cited: 1985, 2001, and the early 1980s nationalization). ### Legal Framework for Supervision - Primary legal instruments underpinning BOI and Supervisor powers: BOI Law, Banking Ordinance, 1941, Banking Licensing Law, and Banking (Service to Customer) Law. - BOI Supervisor empowered to issue Proper Conduct of Banking Business Directives, instructions, and letters to implement prudential requirements. ### Main Findings (by principle clusters) - CP1 (Objectives, independence, powers, transparency, and cooperation): - Comprehensive laws and directives; BOI has significant de jure and de facto independence and accountability mechanisms. - MOF influence on BOI employee salary scale risks compromising independence and long-term supervisory capacity. - CPs 2–5 (Licensing and structure): - Legal framework clear on permissible banking and non-banking activities; licensing infrastructure in place. - Transfer of ownership well defined; explicit definitions for controlling interests exist in policy (not law). - Conditions for acquisition of non-bank financial institutions could be formalized further. - CPs 6–18 (Prudential regulation and requirements): - Regulatory framework fairly comprehensive, but dense and complex. - Capital adequacy framework based on international standards using standardized approaches to credit, market and operational risk in Pillar I; Pillar II significant but somewhat informal. - Banks use the “standardized approach” in determining risk weights. - BOI closely oversees concentration risks (single name, sectoral, geographic, collateral, product). - Areas for improvement: interest-rate risk in the banking book, market risk, and liquidity risk. - CPs 19–21 (Methods of ongoing supervision): - Risk-based approach implemented and evolving. - Mix of on-site and off-site supervision with extensive communication. - Extensive reporting requirements on consolidated and unconsolidated basis used appropriately in supervision. - CP22 (Accounting and disclosure): - Disclosure requirements very strict; external auditors ensure adherence. - Authorities planning transition of the banking system solely to IFRS standards. - CP23 (Corrective and remedial powers): - Current law contains a restrictive list of remedies (e.g., eliminating dividends). - Expansion of powers and resolution strategies under consideration to enable more flexible remedial measures and creative bank resolution approaches. - CPs 24–25 (Consolidated and cross-border supervision): - Overall satisfactory consolidated supervision program. - Gap exists in supervision of certain securities-related activities engaged in by banking corporations. - BOI engages in host-home country relationships commensurate with size and complexity of foreign operations; foreign bank operations in Israel are relatively low and relationships more ad hoc. ### Key Statistics and Exact Values Cited - Assessment timing: November 2011. - Banks’ assets: about 140 percent of GDP. - Average capital ratio for major Israeli banks: 14 percent. - Tier 1 capital ratio: around 8.5 percent. - IFRS adoption for listed companies and most nonbank financial institutions: since 2008. - BOI Law enactment strengthening independence: 2010. - Banking Ordinance year: 1941. - Banking Licensing Law referenced as: Banking Licensing Law, 5741 – 1981. *Source: IMF FSAP Update — Summary of Compliance with the Basel Core Principles (assessment conducted November 2011).* ### 7. Risk management ### 7. Risk management ### Key findings on risk management framework and oversight - The regulatory framework is "fairly comprehensive, but dense and complex." - BOI is commended for efforts "towards a more principles-based rulebook in this area." - The upcoming reform is an opportunity to further specify the principle of segregation of functions and to treat settlement risk. ### Credit risk (CP 8) - Credit risk supervision is based on "a large number of detailed directives and supervisory guidance" and is subject to "close and intensive scrutiny." - BOI is encouraged to move towards more comprehensive regulation to "incentiviz[e] banks to develop and upgrade their internal ratings systems." ### Problem assets, provisions, and reserves (CP 9) - Rules on problem assets, provisioning, and reserves are "fully adequate." - Further harmonization of rules relating to assets classification and provisioning is under way. - The accounting definition of impaired debts does not allow separate identification of "debts to borrowers that are unlikely to repay, regardless of any collateral recollection." ### Large exposure limits (CP 10) - BSD enforces comprehensive regulation to ensure management "correctly defines, measures, monitors, and controls large credit exposures or concentrations of other kinds (by sectoral, by geographic area, by collateral and by product)." - Oversight could be enhanced, particularly in the Pillar II context, by paying more attention to the correlation of risks. ### Exposure to related parties (CP 11) - The definition of related parties is "strictly delineated" but "does not leave much discretion to the Supervisor." ### Country and transfer risks (CP 12) - BOI "exerts proactive oversight" of country and transfer risks. ### Market risks (CP 13) - For capital purposes, "only standardized methods are allowed," while for risk management VaR models and stress tests are widespread. - BOI has not committed sufficient resources to challenge: - banks' trading book eligibility policies, - reliability of data information systems, - valuation methodologies, and - internal models. - It is "strongly recommended to get the independent capacity to do so." - Assessment of banks' exposure to market risks is biased by amalgamation with exposure to interest-rate risk in the banking book. ### Liquidity risk (CP 14) - BOI performs "intensive and on-going oversight" of liquidity risk, but oversight is based on information calculated on a solo basis only. - Regulatory limits apply only to overall liquidity, without breakdown by major currencies, and only over a one-month horizon. - BOI devotes relatively few resources to on-site examination of the reliability of information systems and models used by banks for measuring liquidity risk. ### Operational risk (CP 15) - Rules are "scattered across a large number of directives," failing to provide a comprehensive view and resulting in some loopholes. - Compulsory reporting focuses on events and "do not include the related material losses." - Relatively few resources are allocated to on-site examination of operational risk. ### Interest-rate risk in the banking book (CP 16) - No specific regulatory provisions exist except that banks must measure and disclose it. - BOI does not receive specific reporting on this risk; BOI assesses interest-rate risk as part of the whole balance sheet including trading book exposures. ### Internal control and audit (CP 17) - Legal and regulatory framework is "piecemal" and inconsistent. - BOI's initiative to make the rulebook comprehensive is commended. - Gaps include the need to expand the scope of the compliance function. ### Abuse of financial services / AML-CFT (CP 18) - Needed legal amendments expected to be passed shortly. - BOI's supervisory practice has led to sanctions for breaches of the Law; sanctioning breaches of BOI directives has not yet been demonstrated. - Intensity and depth of information-sharing with foreign supervisors have not yet been tested. - AML/CFT provisions and practice are "generally of a high standard." - A new regulation to complete and harmonize the regulatory framework was "in the process of being issued at the time of the assessment." ### Supervisory approach and techniques (CP 19–20) - BOI has implemented an evolving risk-based approach to supervision; efficiency improvements are critical to make it more pro-active and fully effective. - There is a mix of on-site and off-site supervision with extensive communication; the process is "fully integrated." - Risk assessment products are high caliber but sometimes duplicative and need streamlining. - Need to expand staff to fully implement risk-based supervision and Basel II initiatives. ### Supervisory reporting (CP 21) - An extensive array of reporting requirements provides a wide range of data on both consolidated and unconsolidated bases. - Information is appropriately used in the supervision process to evaluate risk and other objectives. ### Accounting and disclosure (CP 22) - Disclosure requirements are "very strict"; external auditors ensure adherence. - Accounting standards require a combination of U.S. GAAP and IFRS. - Core assets are principally accounted for under U.S. GAAP. - Authorities plan to transition the banking system solely to IFRS standards "by 2013 or later." ### Corrective and remedial powers (CP 23) - Remedial powers could be made more flexible; current law contains a "restrictive list" of remedies. - Expansion of powers and strategies concerning resolution of a problem bank is under consideration. ### Consolidated supervision (CP 24) - Overall satisfactory program of consolidated supervision. - Gap exists in supervision of certain securities activities by banking corporations; underwriting activities are ostensibly supervised by the ISA and require a supervisory agreement. - Closer scrutiny of intercompany and affiliated transactions would be valuable. ### Home-host relationships (CP 25) - BOI engages in host-home relationships commensurate with bank operations abroad. - Formal written agreements are in effect with major host supervisors, but one agreement needs expansion. - Foreign bank operations in Israel are at a relatively low level; home-host relations are more ad hoc. --- ### Recommended Action Plan (selected recommendations by reference principle) - 1. Objectives, autonomy, powers and resources - Consider a more principles-based approach to directives for risk management policies and practices. - 1 (1). Responsibilities and objectives: Consider a formalized periodic review of banking law and regulation and reorganization into a comprehensive banking law. - 1 (2). Independence, accountability and transparency: Address MOF influence over BOI salary scale via strategies such as in-house training, programmed rotation of staff, secondments overseas, cash bonuses, and hiring retired bankers at entry- or mid-level positions. - 2. Permissible activities - Add a provision to Section 10 of the Bank Licensing Law to enable BOI to approve introduction of new banking activities. - 4. Transfer of Significant Ownership - As best practice, move definitions of control into laws or regulations. - Consider a directive requiring banks to inform the Supervisor of Banks of material facts compromising suitability of a controlling owner. - 5. Major acquisitions - Consider reducing permissible investment in a non-financial investment to 5 percent of a bank's capital. - Apply formal criteria to acquisitions of non-bank financial companies located in Israel similar to those for foreign jurisdictions. - 6. Capital adequacy - Dedicate more BSD resources to independent checking of capital adequacy reporting. - Strengthen SREP to be more forward-looking and prescriptive; ensure timely responses when ICAAP is insufficient. - Empower the Supervisor to require controlling shareholders to increase banks' capital. - 7. Risk management process - Streamline the regulatory framework from piecemeal to comprehensive. - 8. Credit risk - Update credit risk regulation to be more comprehensive and incorporate guidelines for sound internal rating practices to upgrade banks' credit risk management and strengthen BSD oversight and forward-looking capacity; in the longer term pave way for advanced approaches for capital purposes. - 9. Problem assets, provisions, and reserves - Ensure consistency of applicable rules (Directive 314 and new Reporting to Public directives). - Consider requiring banks to submit information that clearly singles out assessment of a borrower's ability to repay from collateral collection. - 10. Large exposure limits - Enhance oversight of concentration risk by assessing potential concentration from distinct but correlated exposures. - Incentivize banks to analyze concentration of risk factors beyond single-name concentration and incorporate such analysis in ICAAP/SREP. - 11. Exposure to related parties - Extend BSD powers by providing more discretion in applying the definition of related parties, deducting such exposures from capital, or requiring collateralization. - 13. Market risks - Increase resources for on-site examination of market risk to assess data processing reliability, model design and implementation, and valuation prudence. - Disentangle off-site assessment of market risk from interest-rate risk in the banking book in risk-based supervision products and SREP. - 14. Liquidity risk - Extend regulatory limits from overall liquidity to breakdown by major currencies and longer horizons. - Devote more resources to checking quality of reported information and banks' data processing and models. - 15. Operational risk - Streamline framework on the basis of a Basel II-compliant definition of operational risk. - Broaden attention beyond IT and internal control over financial reporting to all sources of operational risk. - 16. Interest-rate risk in the banking book - Introduce specific regulation regarding treatment of interest-rate risk in the banking book. - Disentangle this risk from market risk in the SREP framework and consider it on a stand-alone basis. - 17. Internal control and audit - Streamline legal and regulatory framework related to internal control and audit. - Use upcoming revision to fill gaps regarding: - the organizational structure (segregation of critical functions, such as business origination, payments and settlements, reconciliation), - the scope of the compliance function, - the ability of a bank's internal audit to access any outsourced functions. - 18. Abuse of financial services - Ensure adequacy of banks' policies and processes to meet ethical and professional standards and prevent criminal use on a consolidated basis. - Adopt and implement the new AML/CFT regulation. - 19. Supervisory approach - Increase efficiency in application of the risk-based supervision program; eliminate duplicative processes and streamline risk-based products. - 20. Supervisory techniques - Expand staff to enable full implementation of risk-based supervision and Basel II initiatives. - 21. Supervisory reporting - With full conversion to IFRS under consideration, obtain plans and monitor banks' progress during conversion to ensure readiness on designated date. - 22. Accounting and disclosure - Consider rotation of external auditing firms to create competition given the minimal number of firms providing these services. - 23. Corrective and remedial powers of supervisors - Amend Section 8C of the Ordinance to enable the Supervisor to apply supervisory actions commensurate with deficiencies. - Consider a regulation governing relations with affiliates and intercompany transactions to enable ring-fencing. - Expand and strengthen authority under Section 8D of the Ordinance to afford flexibility in intervention strategies. - 24. Consolidated supervision - Reach a more detailed and operational agreement with the ISA on supervisory approach to securities-related activities housed in nonbank subsidiaries (such as asset management and underwriting). ### Authorities' response - The Israeli authorities expressed appreciation to the IMF and the assessment team and found the FSAP "a useful exercise." - Authorities "welcome the overall assessment that indicates a high level of observance of the BCP in Israel." - Authorities acknowledge that developments in global and Israeli financial sectors call for supervisory actions and will consider IMF recommendations carefully. - Regarding market risk (CP 13) and interest-rate risk in the banking book (CP 16), authorities acknowledge gaps with Basel methodology and accept recommendations but believe their practices are effective and commensurate with low volumes and characteristics of trading books. - Authorities note BSD covers interest-rate risk though not necessarily differentiated between banking book and trading book. - Authorities commit to devote more supervisory attention to market risk and interest-rate risk through on-site processes, and "will issue a regulation specifically concerning interest-rate risk in the banking book." *Source: _cr1272 - 7. Risk management* ### 29. Furthermore there are a number of recommendations and comments where the ### _cr1272 - 29. Furthermore there are a number of recommendations and comments where the ### Banking: Authorities' responses to CP recommendations - CP 1 (principle-based vs rule-based): Authorities seek a right balance; adopt principle-based approach in areas suitable to it but note that principle-based approach "is not right in some areas as it leaves too much discretion to the banks." - CP 5 (investment limitation in non-financial companies): Authorities "will consider the recommendation to set a lower regulatory limit on the investment in one such company." - CP 6 (capital adequacy): - Supervisor of Banks announced adoption of Basel III; BSD required hybrid instruments to comply with Basel III even before formal adoption. - Work on Basel 2.5 is in process. - Until now, BSD has preferred not to issue formal requests to banks to strengthen capital following supervisory review of bank's internal assessment; instead BSD engaged in dialogue with some banks which resulted in strengthening capital adequacy. - Authorities "feel comfortable from the capital adequacy perspective with the implementation of the standardized approach in pillar I calculation complemented by a rigorous implementation of risk sensitive forward-looking pillar II calculation." - BSD encourages banks to continue progress in implementing Basel II standards for internal rating systems. - CPs 10, 11, 23, 24 (intra-group transactions and related parties): - Supervisor empowered to regulate such transactions. - Current regulation and supervision "covers these issues adequately," considering other limitations on banking groups' structure and ownership. - Authorities "will consider strengthening the regulation in this area including relevant ring-fencing arrangements." - CP 14 (liquidity risk): - Updating regulation "will soon be issued" and will refer to the assessment issues; most issues already covered by BSD supervisory practices. - BSD examines quality of data used by banks for internal models through on-site process and checks logic through off-site process. - BSD "will devote more resources to the validation of reported data in the liquidity as well as in other areas." - CP 15 (operational risk): - Shortly after the mission a new regulation concerning operational risk management was issued, implementing recommendation to streamline regulatory framework. - Other regulations continue to include elements of operational risk; Basel papers refer to other documents. - BSD covers operational risk through off-site and on-site processes. - Staff from designated operational risk on-site unit "will strengthen its participation in other on-site units' examinations" to cover operational risk aspects. - CP 23 (corrective and remedial powers of the Supervisor): - Authorities share assessors' recommendations and comments. - Supervisor operates under "very old legislation" that needs updating. - BSD preparing proposals to amend legal framework for bank resolution, giving the BOI flexible resolution tools for banks with significant deterioration but still solvent. - CP 24 (consolidated supervision): - Authorities accept comments related to securities activities performed by asset management and underwriting subsidiaries. - BSD "will map the existing gaps and will act to close them in cooperation with the Israeli Security Authority." ### Insurance Core Principles (ICPs) — Summary and institutional context - General assessment: - "Insurance sector regulation and supervision is generally in line with international standards and stringent." - Authorities take a "pro-active approach" and regulations are "generally up to date"; in some areas regulation and practice "goes well beyond the standard." - Regulation and supervision of insurance, pension fund, and provident funds "is generally of a high standard," but cross-border supervisory cooperation and information-sharing "needs to be strengthened." - MOUs and regular communication with supervisors of jurisdictions with significant investment in the Israeli insurance sector "should be in place" and communication channels established where Israeli insurers operate. - Policies on group capital adequacy, reinsurance and risk concentration, internal control mechanisms, and risk management systems "are not fully articulated"; no specific requirements for group-wide reporting; holding companies "escape adequate supervision." - Assessment methodology: - Assessment carried out in November 2011 within the FSAP Update for Israel. - IAIS Methodology (approved October 2003) and an IMF/World Bank Template used. - Assessment based solely on laws, regulations, supervisory requirements and practices in place at time of assessment; ongoing regulatory initiatives noted as additional comments. - Institutional structure: - Regulation and supervision responsibility: Capital Markets, Insurance and Savings Division (CMISD) of the MOF. - Political responsibility: Minister of Finance. - Insurance supervisor: Commissioner of the CMISD of the MOF. - Principal legislation: The Control of Financial Services (Insurance) Laws 5741-1981. - Market structure as of June 30, 2011: - CMISD oversees "23 insurance companies, 11 “new” pension funds, 18 “old” pension funds, 65 management fund companies, altogether having total assets of almost NIS 1 trillion as at June 30, 2011." - "Five large insurance companies account for 90 percent of the insurance premium in the country." - Most insurers are composite companies transacting both life and non-life business; one major insurer is foreign-owned. - Bachar reform (mid-2005) led banks to divest most non-commercial banking activities; non-bank financial sector has grown rapidly with managed assets in long term savings growing "at an annual rate of more than 20 percent per annum over the past several years." - Life insurance market: most sales are unit linked products where purchaser bears investment risk; traditional life products are not a large part of the market. - Non-life insurance: "accounts for about 50 percent of total premiums," motor premium makes up "about 50 percent of that total." - Financial crisis impact: Israeli stock market fell by "51 percent" in 2008; by end of 2009 had reached pre-crisis levels. Performance-based fee arrangements caused a drag on life insurers' future earnings. ### Preconditions and supervisory infrastructure - Macroeconomic and public infrastructure: - Monetary policy based on inflation targeting; BOI independence strengthened by 2010 BOI Law. - Fiscal policy strengthened with establishment of a fiscal rule supporting fiscal consolidation. - Legal framework comprehensive and regularly updated; judicial system, bankruptcy and enforcement of property rights "well-developed." - Auditing and accounting: "generally comply with international standards"; listed companies and most nonbank financial institutions applied IFRS since 2008; legislative framework assures auditor independence. - Payment and settlement: BOI operates Zahav (real time gross settlement system) linked to BCH, Masav, and TASE clearing house. - Market discipline and governance: - Competition encouraged; market open to foreign participation; "no significant non-prudential barriers to entry." - Corporate governance governed by Companies Law and Securities Law; sectoral legislation supplements governance. - Securities Law sets financial reporting principles, addresses prospectus contest, insider information prohibitions, and penalties. ### Main findings, supervisory strengths and weaknesses - Overall compliance: - "High degree of compliance with the IAIS Core Principles." - CMISD strengths and best practices: - ICP 14 (Preventive and Corrective Measures): Commissioner can issue instructions on virtually any topic. - ICP 26 (Information Disclosure and Transparency Toward the Market): public information requirements are "extremely comprehensive." - Modern supervisory framework and formal insurer risk assessment process advanced. - Staff motivated with high knowledge levels; Commissioner powers comprehensive and frequently utilized. - Areas needing strengthening: - Cross-border supervisory cooperation and information sharing: - On domestic front cooperation reasonable; cross-border information sharing "needs to developed" to capture overseas risks. - MOUs and regular communication with foreign supervisors "should be in place"; communication channels where Israeli insurers operate should be established to receive early warnings. - Group supervision deficiencies: - CMISD lacks formal policies on group capital adequacy, reinsurance and risk concentration, internal control mechanisms, risk management systems, and requirements for group-wide reporting. - Work underway to strengthen group supervision, recommended as high priority. - Law should be amended to give CMISD greater authority to access holding companies and adhere to international standards on group-wide supervision. - Pace and burden of reforms: - Rapid and numerous reforms, including preparation for Solvency II, may generate operational risk for industry. - Recommendation to supplement supervisory staff with seasoned professionals with operational risk backgrounds. - Recommendation to conduct cost benefit assessment before introducing substantial new regulation. - Additional desirable improvements: - Composite insurers: - Most insurers are composite (life and non-life); law requires separation of businesses but liquidation of composite firms can create legal problems. - Recommendation: change law to prohibit composite structure and plan for existing situations, or prohibit new composites and strengthen law for separation certainty in liquidation. - Insurance agents and intermediaries: - Most agents are employees of agencies owned by insurance companies, creating potential public confusion about loyalties. - CMISD could increase transparency by requiring changes to ownership structure or labeling protocols for intermediaries. - Fraud: - CMISD has effectively addressed internal company fraud but consumer insurance claim fraud is common. - Suggestion: amend laws to require more and more effective actions by insurers to limit cost of insurance claim fraud. *Source: _cr1272 - 29. Furthermore there are a number of recommendations and comments where the* ### 5. Supervisory ### 5. Supervisory ### Supervisory cooperation and information sharing - Finding: There are no established working relations with relevant international supervisors. This is deemed to be a limitation in the supervision. - Recommendation: CMISD should include in its various early warning procedures an internal requirement that when an insurer that is a subsidiary of a foreign insurer reaches a certain level of risk (commonly measured by the company‘s position with regard to the capital adequacy requirement), the home supervisor will be contacted: - (1) to advise the home supervisor of the situation; and - (2) to ascertain the financial condition and soundness of the parent insurer. - Recommendation: CMISD should require foreign owned insurers to submit on an annual basis a copy of the supervisory filing that is submitted to the home supervisor. ### Licensing - Finding: Composite insurers are currently licensed under the law. - Recommendation: The law should be changed so that at least for the future, composite insurers will not be licensed. - Recommendation: CMISD may require future business plans to be reviewed by an experienced professional (e.g., actuary or independent auditor) to attest to the reasonableness of underlying assumptions and the attainability of the business plan. ### Suitability of persons - Recommendation: For the future, amend the law to include the independent auditor in the list of entities to which the fit and proper provisions apply. ### Changes in control and portfolio transfers - Finding: In the limited number of situations with changes in control and transfers of business the CMISD has appropriately applied the regulation to protect consumer interests effectively. ### Corporate governance - Finding: Corporate governance requirements are very detailed (covered by a series of circulars), but exhaustive lists can be disadvantageous. - Recommendation: Where possible, amend the law to supplement detailed listings with additional, more general principles for board compliance. ### Internal controls - Finding: Recent regulation strengthens internal controls and allocates accountability to the board. - Recommendation: As companies become more familiar with new rules, supervision should focus more on the board‘s role. This will become more relevant with the introduction of Solvency II in 2013. ### Market analysis - Finding: The CMISD conducts sophisticated and thorough market analysis. ### Reporting to supervisors - Finding: Outsourced activities are currently not subject to CMISD monitoring. - Recommendation: Specifically monitor outsourced activities for core functions more closely. ### On-site inspection - Finding: On-site inspection fully complies with international standards. - Best-practice recommendations: - Increase emphasis on comprehensive company-wide inspections and reduce emphasis on highly targeted inspections. - Enhance cooperation and information sharing with the independent auditor. - Hold an exit meeting with insurance company management after the inspection to ensure no miscommunications prior to commencing the Division‘s report. - Improve efficiency by reducing frequency of inspections that use relatively few person days spread over months; apply most person days to a single, more extended visit. ### Preventive and corrective measures - Finding: The law empowers the Commissioner to issue instructions to safeguard policyholders; preventive and corrective powers have been utilized in recent examples. - Recommendation: Amend law to allow CMISD to demand additional capital at any time the Commissioner believes such action is necessary to protect policyholders (rather than limited cases). - Finding: CMISD is working to develop a formal ladder of intervention with control levels triggering types of intervention. - Limitation: At present, no general ability to require capital increases and lack of formally stipulated intervention measures related to overall financial viability limit market-wide strategies. - Recommendation: Introduce a ladder of intervention to ensure greater consistency and transparency. ### Enforcement or sanction - Finding: Extensive powers are granted to the Commissioner; requirement to report annually to the Ministry of Justice is an important control instrument. - Practice: - Minor breaches: companies normally required to correct procedures rather than fined. - Serious offences: significant fines can be levied, possibly including personal fines to officers and directors. ### Winding-up or exit from the market - Finding: Law accounts for special nature of insurance contracts; policyholders rank ahead of other creditors and varying preferences among policyholders can be established. - Historical example: The last insurance company wind-up was in 1991; the failed insurer had a market share of over 30 percent, policyholders did not lose money and policies continued without interruption with other insurers. - Recommendation: Consider introducing amendments explicitly allowing the ring fencing of insurance companies belonging to a conglomerate that is being resolved. ### Group-wide supervision - Finding: Group-wide supervision may be of less significance in Israel but cannot be assumed unimportant; several Essential Criteria are not satisfied for this ICP. - Expectation: Situation likely to be rectified as new laws and regulations facilitate the Solvency II regime. - Recommendation: Provide some level of supervisory authority regarding holding companies, at least to obtain detailed financial and ownership information. - Recommendation: Require each supervised institution to file a complete organizational chart for the group annually, showing every entity controlled by the institution‘s controlling shareholder, including direct and indirect interests; include this in the affidavit sworn by company signing officers. ### Risk assessment and management - Finding: Focus on the role of the board will need further intensity with Solvency II introduction. - Observation: Some circulars allow reduced scope for small companies, but the circular on CRO functions does not appear to differentiate; this could be remedied in future. ### Insurance activity (reinsurance) - Finding: Quality of reinsurance is monitored using rating and other sources; concentration and counterparty risks call for risk capital charges. - Practice: Exposure to reinsurers and total exposure of each reinsurer to the market is followed and recommendations can be issued to address excesses. ### Liabilities - Finding: Use of Liability Adequacy Testing (LAT) is a positive initiative. - Recommendation: Define parameters and methodology for LAT; do not leave methodology solely to company discretion. - Observation: LTS products with variable commissions example where a liability provision for adverse investment performance was missing. - Finding: No legal requirement for companies to stress test balance sheets under different economic scenarios. - Recommendation: Introduce a legal requirement for companies to perform stress testing. ### Investments - Finding: Introduction of a prudent person supervisory approach, clear board accountability, and requirements for a professional investment committee is positive. ### Derivatives and similar commitments - Recommendation: Given current market development, a conservative supervisory approach is recommended; keep current tight limitation of derivatives for hedging under review as market develops. ### Capital adequacy and solvency - Finding: Current solvency regime is an enhanced Solvency I with some risk-sensitive elements (market consistent valuation of assets, market risk, reinsurance credit risk and concentration risk charges). - Observation: Calibration of risks needs attention. - Recommendation: Further develop stress testing and introduce standardized stress testing as well as technical provision stress testing. - Expectation: With Solvency II planned for 2013, full observance of this principle will be achieved. - Reiteration: CMISD is working to develop a formal ladder of intervention; current lack of general ability to require capital increases and formal intervention measures limits market-wide strategies. ### Intermediaries - Finding: For agents owned by insurance groups, transparency of interests should be enhanced. - Recommendation: Require consumers give "informed consent" when dealing with agents owned by an insurer recommending that insurer’s product; consider changes to ownership structure or labeling protocols for intermediaries to increase transparency. - Recommendation: Implement standards regarding service levels to clients vigorously. ### Consumer protection - Finding: Consumer protection provisions are generally strong. - Recommendation: Introduce a cooling off period for products sold under pressure, such as direct sales and credit card or loan linked products. - Best-practice complaint handling refinements recommended: - Board to appoint internal ombudsman who is a senior officer. - All claimants notified of internal ombudsman contact details when claim information is received, plus clearly shown on company web site. - Complainants first approach insurer; insurer has fixed period to resolve (suggestion: up to 30 days). - If unresolved, insurer provides a "final position letter" explaining why and includes CMISD contact details. - CMISD investigates and offers mediation along with other services; final resolution can be to the court system. ### Information, disclosure and transparency towards markets - Finding: The amount of information required to be made public is very comprehensive. ### Fraud - Recommendation: Amend law to label insurance consumer fraud as a criminal offence and require boards to implement policies to detect and reduce claim fraud. - Recommendation: Consider more extensive use of industry databases to detect insurance fraud (similar to Motor Bodily Injury system), with due regard for confidentiality. ### Anti-money-laundering, combating the financing of terrorism (AML/CFT) - Finding: AML/CFT provisions and practice are generally of a high standard. - Status: A new regulation to complete and harmonize the regulatory framework was in the process of being issued at the time of the assessment. - Recommendation: The new regulation should be adopted and implemented. ### Recommended Action Plan (selected items from Table 4) - ICP 2 – Supervisory objectives: Reduce the time lag to publication of the Annual Report. - ICP 3 – The supervisory authority: Consider an independent budget for the CMISD or audited financial statements to enhance transparency. - ICP 4 – Supervisory Process: - Conduct a cost/benefit analysis prior to recommending significant new regulations. - Increase reliance on industry input; consider industry/supervisory working groups coordinated through the industry association. - ICP 5 – Supervisory collaboration and info sharing: - Establish a stronger working relationship with relevant international supervisors. - Include internal requirement to communicate with international supervisors under certain conditions. - Require annual submission by foreign-owned insurers of the supervisory filing submitted to their home supervisor. - ICP 6 – Licensing: - Do not license composite insurers in the future. - Require formal segregation of assets for unit linked funds by holding assets ―in trust‖ for investors as a licensing condition. - ICP 7 – Suitability of persons: Amend law to include independent auditor under fit and proper provisions. - ICP 9 – Corporate governance: Implement an over-arching requirement of duty, skill and care. - ICP 12 – Reporting to the supervisor and off-site monitoring: Introduce regulation to more closely monitor outsourced providers. - ICP 13 – On-site inspection: - Increase frequency of comprehensive inspections. - Enhance cooperation with independent auditor and hold exit meetings; consolidate person days into extended visits. - ICP 14 – Preventive and Corrective Measures: - Introduce regulation for a formal ladder of intervention. - Amend law to allow additional capital requirements at any time the supervisor deems necessary, not only during initial five years of operation. - ICP 16 – Winding-up or exit from the market: Consider amendments allowing ring fencing of insurance companies belonging to a conglomerate being resolved. - ICP 17 – Group-Wide Supervision: - Include regulation for basic supervision of holding companies. - Require annual filing of complete organizational chart showing every entity controlled by the controlling shareholder. - ICP 18 – Risk assessment and management: - Intensify focus on the board’s role with Solvency II. - Apply proportionality to CRO requirements. - ICP 20 – Liabilities: Develop and introduce standards on the use of LAT. - ICP 22 – Derivatives and similar commitments: Keep tight limitations for hedging under review as the market develops. - ICP 23 – Capital adequacy and solvency: - Introduce Solvency II adapted to Israel. - Further develop stress testing and introduce standardized and technical provision stress testing. - ICP 24 – Intermediaries: - Require "informed consent" when agents owned by an insurer recommend that insurer‘s products. - Consider ownership or labeling protocol changes for greater transparency. - Implement service level standards vigorously. - ICP 25 – Consumer Protection: - Introduce a cooling off period for products sold under pressure (e.g., health insurance, credit card or loan linked products). - Make insurers initially responsible for dealing with complaints; CMISD handles unresolved complaints. - ICP 27 – Insurance fraud: - Require boards to adopt policies to detect and reduce claim fraud. - Consider greater use of industry databases to detect fraud, respecting confidentiality. - ICP 28 – AML, CFT: Adopt and implement the new regulation. *Source: _cr1272 - 5. Supervisory* ### 54. We would like to express our most sincere thanks for your efforts as the entire CMISD ### _cr1272 - 54. We would like to express our most sincere thanks for your efforts as the entire CMISD ### CMISD reaction to the FSAP and planned actions - CMISD expresses thanks for the FSAP process, noting it was "highly beneficial" and expects the review to expedite ongoing development efforts and help design future regulation and supervision processes. - CMISD found IMF staff comments "comprehensive and knowledgeable" and thanks them for an "intensive" effort and a "detailed and thoughtful report". - CMISD generally agrees with the assessment and offers clarifications and additions on specific points: - ICP 5 – Supervisory collaboration and information sharing: - CMISD is in the process of signing MOU's and joining the MMOU with foreign counterparties. - The work plan calls for completion of the process within 2012. - ICP 6 – Licensing: - CMISD is examining ring-fencing existing life insurance assets to enhance their protection according to the IMF-FSAP recommendations. - CMISD is considering necessary changes to the law to allow full separation of life and non-life business in new insurance companies. - ICP 12 - Reporting to the supervisor and off-site monitoring: - CMISD will release later this year outsourcing guidelines that, inter alia, will reflect the IMF-FSAP recommendations. - ICP 17 - Group-Wide Supervision: - CMISD acknowledges the necessity to improve its group supervision regulation. - This will be addressed as part of adoption of the Solvency II regulatory paradigm; CMISD is waiting for a publication of global supervisory standards in this matter. - ICP 23 - Capital adequacy and solvency: - CMISD is finalizing regulatory procedures based on international standard and principles of Solvency II. - ICP 24 – Intermediaries: - CMISD intends to improve transparency in pension and insurance distribution through strengthening the Advice Law and improving information provided to pension savers. ### IOSCO assessment — overall summary - Overall level of compliance with the IOSCO principles is high. - The regulatory regime is well developed and, in most respects, comparable to that in major jurisdictions. - Regulation and oversight by the Israel Securities Authority (ISA) is described as robust and effective. - Significant gap noted in regulation of broker-dealers: - Broker-dealer activity can be undertaken without falling within the regulatory framework if the activity neither involves membership of the stock exchange nor the provision of advice services to retail clients, nor a licensed bank. - Certain over-the-counter (OTC) derivatives activity, including the sale of products to retail investors, can take place outside the regulatory regime. ### Information and methodology used for the IOSCO assessment - The assessment was conducted in November 2011 within the framework of Financial Sector Assessment Program Update for Israel. - A previous assessment was undertaken in 2001; since then, regulatory and market developments have significantly changed the framework. - Assessors relied on: a review of relevant legislation, a self-assessment and other material prepared by ISA staff, detailed discussions with ISA staff and other regulatory authorities, market participants and representative bodies, and other experts. - The assessment used the IOSCO Objectives and Principles of Securities Regulation and the associated methodology adopted in 2003, as updated in 2008. - An assessment of Principle 30 (securities settlement systems) was not carried out; a review (but not formal assessment) of Israel's clearing and settlement system was carried out as part of the overall FSAP. - New IOSCO principles adopted in June 2010 were discussed informally and are reflected in the report. ### Institutional structure and market structure — key points - ISA: independent agency responsible for regulation of the securities sector, including exchange markets, capital markets, mutual funds, portfolio managers and advisers and marketers of securities. - Supervisor of Banks (within BOI): responsible for regulation of banks and banking groups. - Capital Markets, Investment and Savings Division (CMISD) within MOF: responsible for regulation of insurance, and the retirement savings sector (pension and provident funds). - Competition authority: broad responsibility for anti-trust issues, including in the financial sector. - Tel Aviv Stock Exchange (TASE) acts as a significant self-regulatory organization (SRO) with responsibility for authorization (licensing) of stock exchange members and supervision of their obligations under TASE rules; ISA retains direct responsibility for detecting and responding to insider trading and other market abuse. - Banks active in securities markets are subject to regulation by three different authorities: - Prudential (stability) and consumer protection regulation by the Supervisor of Banks (group-wide, extending to subsidiaries). - Direct regulation by the ISA in respect of insider trading and other market abuse; banks issuing equities or debt or engaging in underwriting, takeovers or mergers are regulated by ISA in these activities. - Regulation by TASE (under ISA supervision) concerning compliance with TASE rules and regulations. - TASE market structure and participant statistics: - TASE is the only exchange market in Israel. - Over 600 issuers in the equities market. - Over 250 issuers in the corporate bond market. - TASE has a government debt market, a derivatives market (dominated by trading in 2 option products, the TA-25 and the NIS/USD foreign exchange), and an institutional trading platform for debt securities that have not been publicly offered. - TASE has 29 members: 15 banks (including 3 foreign banks) and 14 nonbanks. - Banks account for two thirds of all equity trading, 74 percent of bond trading and over 80 percent of derivatives trading. ### Recent developments and market dynamics - Two broad headings for recent changes and reforms: - Changes from development of new products and activities: e.g., corporate bond market expanded about ten-fold as a share of GDP between 2004 and 2007 and was the sector most significantly impacted by the global financial crisis. - Changes from major policy shifts: additional reforms and regulations enacted in response to the financial crisis, particularly impacting portfolio management and the bankruptcy process. - Mutual fund and long-term savings industry: - Underwent extensive structural change over the past decade. - Bachar reform forced banks to divest holdings in mutual fund management firms; most divestment took place within the first year following ratification of the Bachar Law. - Rapid growth in specific product areas: - Exchange traded notes (ETNs): at the end of 2010, there were 437 ETN series (up from 133 in 2006). - Portfolio management activities: at the end of 2010, NIS 242 billion was managed on a discretionary basis, up from NIS 103 billion in 2005. ### Preconditions for effective securities regulation - General preconditions are in place: - Legal, accounting and audit systems support implementation and effective regulation. - Commercial law is modern; corporate governance standards are modern. - Regulator has legally enforceable powers. - Macro-economic environment has been positive over the last several years. - Israeli legal framework for the financial sector is comprehensive and regularly updated. ### Main findings mapped to IOSCO principle groups - Principles for the regulator (Principles 1–5): - ISA works under a clear mandate with responsibilities and powers established by legislation. - ISA has a high degree of operational independence, though some regulatory powers are reserved for the minister of finance. - Notable gap: lack of coverage of broker-dealer activity not involving TASE membership or provision of advice services to retail clients; some OTC derivatives activity can take place outside the regulatory regime. - Supervision of conduct of business obligations of members of the stock exchange is split between TASE (nonbank members) and Supervisor of Banks (bank members); ISA has no direct role except for advice giving and marketing activities. - Principles for self-regulation (Principles 6–7): - TASE as SRO authorizes and supervises its members (not required to be licensed by ISA) and supervises market conduct and clearing/settlement activities. - Bank members of TASE are also regulated by Supervisor of Banks for prudential supervision and conduct of business obligations. - ISA regulates insider trading and other market abuse directly. - ISA has broad powers to supervise TASE's compliance, but limited powers to act against exchange members unless they hold an ISA license or market abuse is involved. - Principles for enforcement (Principles 8–10): - ISA has extensive powers to obtain information and records and can exercise these on a routine basis. - Regulated entities are subject to detailed record keeping and retention requirements, including client identity and tracing of funds and securities. - ISA administers anti-money laundering and combating financing of terrorism legislation for portfolio managers and nonbank members of TASE. - ISA has comprehensive powers to investigate administrative and criminal violations of securities laws. - Principles for cooperation (Principles 11–13): - Major improvements since the 2001 assessment. - ISA has power to share information domestically and internationally on regulatory matters, including investigative and enforcement activities. - Enhanced exchange of information and analysis is needed in developing a macroprudential framework. - Precondition for international information sharing is existence of an MOU with the relevant regulator; government approval is required but readily given for signing MOUs. - Principles for issuers (Principles 14–16): - Public issues of equity and debt require a prospectus approved by ISA. - Prospectus disclosure requirements are in line with IOSCO principles. - Issuers submit annual and quarterly reports and immediate reports about material developments. - Financial statements must be prepared in accordance with IFRS (other than banks, which must comply with BOI standards). - Auditors conducting statutory audits are subject to oversight by a registration authority and the relevant professional body; auditors must be independent. - Changes in control transactions must comply with disclosure requirements and obligations to treat shareholders equally. - Note: the 2006 "shelf prospectus" provision allows rapid issuance of a prospectus, which in practice may reduce the ability of underwriters to conduct a thorough analysis. - Principles for collective investment schemes (Principles 17–20): - CIS are subject to licensing by ISA with eligibility and integrity standards. - ISA currently lacks power to examine adequacy of internal management procedures at time of licensing. - Managers face minimum capital and insurance requirements. - All CIS must have a trustee who holds fund assets and supervises the manager. - Clear rules govern legal form and structure of CIS. - ISA performs systematic on-site and off-site inspections. - CIS must have a prospectus that complies with IOSCO Principles. - Detailed rules govern valuation of assets and pricing of units, with full transparency. - Principles for intermediaries (Principles 21–24): - ISA licenses portfolio managers, advisers and marketers of securities; TASE authorizes its members. - Potentially significant unregulated activity remains (including certain broker-dealer and OTC derivatives activities). - For licensed entities, ISA ensures minimum criteria are met; licensees face comprehensive ongoing requirements and active monitoring. - TASE supervision focuses on nonbank members’ compliance with capital standards and systems interacting with exchange systems. - Supervisor of Banks is responsible for supervising bank members' dealings with clients. - Minimum capital and insurance standards apply to ISA licensees (though they do not address risks from outside the regulated firm). - Risk based capital standards apply to nonbank members of TASE. - Capital standards for TASE members allow long term unsubordinated debt to count as capital; this is out of line with common international practice. - Principles for secondary markets (Principles 25–30): - TASE is the sole secondary market in Israel and operates securities and derivatives markets and, through two subsidiaries, clearing and settlement facilities for each market type. - TASE holds a license issued by the minister of finance and is supervised by ISA, which has extensive powers to ensure compliance. - Market participants are supervised by TASE and (for banks) by BOI. *Financial Sector Assessment Program Update for Israel — assessment conducted in November 2011.* ### 78. The following table summarizes the assessment: ### _cr1272 - 78. The following table summarizes the assessment ### Summary implementation of the IOSCO Principles (Table 5) — Key findings - Principle 1. The responsibilities of the regulator should be clearly and objectively stated. - The responsibilities of the ISA and TASE are clearly established by law. The mandate is also well understood by market participants. - Arrangements for cooperation and information sharing between the financial sector regulators exist, but there may be a need for further effort to ensure they work fully effectively in practice. - A notable gap in the regulatory framework is the lack of coverage of broker-dealer activity that does not involve TASE membership or the provision of advice services to retail clients; and some over-the-counter (OTC) derivatives activity (the issue is relevant to a lesser extent with regards to TASE members banks, which are supervised by the BOI). - Principle 2. The regulator should be operationally independent and accountable in the exercise of its functions and powers. - The ISA has a high degree of operational independence, although some powers of a regulatory character are reserved for the minister of finance, and the minister has control over staffing levels. - The level of accountability to the government, parliament, and the public is high. Decisions of the regulator are required to be transparent and are amenable to judicial review, and the ISA is subject to comprehensive rules relating to procedural fairness. - Principle 3. The regulator should have adequate powers, proper resources, and the capacity to perform its functions and exercise its powers. - The ISA has adequate powers and resources to carry out its regulatory functions, and has rulemaking authority, although this is time limited in one area. - Principle 4. The regulator should adopt clear and consistent regulatory processes. - The ISA has clear and consistent regulatory processes, and operates in a transparent way. - Principle 5. The staff of the regulator should observe the highest professional standards. - ISA members and staff are subject to integrity policies that ensure high standards of professional conduct and compliance with these standards is monitored effectively. - Principle 6. The regulatory regime should make appropriate use of SROs that exercise some direct oversight responsibility for their respective areas of competence and to the extent appropriate to the size and complexity of the markets. - The TASE plays a significant role as an SRO, and members of the TASE do not require to be licensed by the ISA unless they engage in advisory or marketing activities. - Principle 7. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities. - TASE is subject to regulatory oversight by the ISA. Its rulemaking requires approval and the ISA has an active oversight presence. - TASE has the attributes required of an SRO and is bound by standards appropriate for a professional regulatory body. Its regulatory decisions are subject to judicial review. - Principle 8. The regulator should have comprehensive inspection, investigation and surveillance powers. - The ISA has comprehensive information gathering, inspection and surveillance powers. Regulated entities are subject to extensive record keeping and retention requirements. - Principle 9. The regulator should have comprehensive enforcement powers. - The ISA has extensive evidence gathering and other investigative and enforcement powers. Criminal sanctions are available for serious violations. - Until recently, the ISA had only limited ability to impose sanctions for non-criminal violations, but it now has new powers (not yet fully operative), through an Administrative Enforcement Committee, to impose a broad range of sanctions. - Principle 10. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance, and enforcement powers and implementation of an effective compliance program. - The ISA has a credible and effective supervisory and enforcement program. It is an active regulator and carries out well planned programs of supervision that include on-site and off-site reviews of regulated entities. It is also active in investigating and taking enforcement action for breaches of the legislation it administers. - Principle 11. The regulator should have the authority to share both public and non-public information with domestic and foreign counterparts. - The ISA has power to share information both domestically and internationally on matters relating to its regulatory functions, including its investigative and enforcement activities. It can share both public and non-public information with a minimum of procedural restrictions. - Principle 12. Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts. - The ISA has domestic information sharing arrangements with other financial sector regulators. - It is also a full signatory to the IOSCO multilateral MOU and has signed multiple MOUs with foreign counterparts. - There is good evidence that these arrangements are working in practice. - Principle 13. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers. - The ISA can provide effective and timely assistance to foreign regulators to assist them in their regulatory and enforcement activities. - With one exception, the ISA does not have to have an independent interest in a matter on which a foreign regulator seeks assistance, or for the conduct being investigated to be a breach of law in Israel. - Principle 14. There should be full, timely, and accurate disclosure of financial results and other information that is material to investors' decisions. - Public issuers are subject to comprehensive disclosure requirements, including prospectus disclosure and annual, quarterly and immediate reporting requirements. Financial statements are prepared in accordance with IFRS. Strict rules apply to the timing of disclosures and reports. Preparers of disclosure documents and reports are required to take responsibility for them. - Principle 15. Holders of securities in a company should be treated in a fair and equitable manner. - There is a strong regulatory framework that requires fair treatment of securities holders. The Companies Law and the Securities Law facilitate shareholder decision making and protect the rights of minority shareholders, especially in groups with controlling shareholders. Takeovers and other change of control transactions are regulated to ensure equal treatment and full disclosure. - Principle 16. Accounting and auditing standards should be of a high and internationally acceptable quality. - Israel has adopted IFRS in full and financial statements are of international quality. Audit standards appear to comply with international standards though they are not yet fully aligned with them. Auditors are subject to tight independence rules. - Principle 17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme. - CIS are subject to authorization standards and ISA licensing. The ISA does not currently have the power to examine the adequacy of internal management procedures at the time of licensing. - Managers are subject to minimum capital requirements, and insurance requirements. The ISA carries out a systematic program of on-site and off-site inspections. - Principle 18. The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets. - All CIS must have a trustee who holds fund assets and supervises the actions of the manager. There are clear rules governing the legal form and structure of CIS. Client assets are protected through their being held by a trustee. - Principle 19. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor‘s interest in the scheme. - CIS must have a prospectus that complies with IOSCO Principles. The ISA approves prospectuses and has power to hold back or intervene if there is inadequate disclosure. CIS are also subject to regular reporting requirements, and their accounts must be prepared in accordance with Israeli GAAP. - Principle 20. Regulation should ensure that there is a proper and disclosed basis for assets valuation and the pricing and the redemption of units in a collective investment scheme. - Detailed rules apply to valuation of assets (including assets for which a market price is not readily available), and the pricing of units, and there is full transparency about these issues. - Principle 21. Regulation should provide for minimum entry standards for market intermediaries. - Not all intermediaries are subject to an authorization process (see under Principle 1). Entities that are licensed are subject a minimum entry standards and subject to ongoing obligations. For entities it licenses, the ISA has comprehensive powers. TASE has similar powers with respect to its members. Advisers are fully regulated. - The ISA has a systematic and active monitoring and compliance program for licensed entities. - Principle 22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake. - Licensed entities are subject to limited initial capital requirements. Nonbank members of TASE are subject to a full risk weighted capital regimes. ISA licensees must hold insurance designed to enable them to compensate investors. - The capital requirements set for ISA licensees do not address risks from outside the regulated entity, though this is unlikely to give rise to serious problems given the nature of these licensees‘ activities. - Unusually, long-term non-subordinated debt can count towards capital for TASE members (although in practice use of secondary capital is very limited). - Principle 23. Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters. - Standards for internal organization and operational conduct apply to both ISA licensees and TASE members. - For ISA licensees the requirement for an independent periodic evaluation of large portfolio managers‘ internal controls and risk management processes, while recently legislated for, is not yet implemented. - Principle 24. There should be a procedure for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk. - Adequate procedures exist for dealing with the failure of a licensed intermediary or a TASE member. Insurance is available in the case of ISA licensees. - Principle 25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight. - TASE is the only secondary market in Israel, and operates both securities and derivatives markets, and (through two subsidiaries) clearing and settlement facilities for each type of market. It holds a license issued by the minister of finance and is subject to the supervision of the ISA, which has extensive powers to ensure TASE acts in accordance with regulatory requirements. Market participants are supervised by TASE and (for banks) the BOI. - Principle 26. There should be ongoing regulatory supervision of exchanges and trading systems, which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants. - The ISA is closely involved in TASE decision making processes and maintains an effective supervision program. - Principle 27. Regulation should promote transparency of trading. - Trading on TASE‘s markets is appropriately transparent. - Principle 28. Regulation should be designed to detect and deter manipulation and other unfair trading practices. - All forms of market abuse are prohibited by the Securities Law. The ISA has direct responsibility for detecting insider trading and other forms of market abuse. It uses an impressive technological system to assist it to detect all forms of market abuse. - Principle 29. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption. - The management of large exposures, default risk and market disruption is achieved through the rules of TASE and its clearing houses. - Principle 30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective and efficient and that they reduce systemic risk. - Not assessed. See CPSS assessment. ### Recommended Action Plan (Table 6) — Priority recommendations - Principle 1. The responsibilities of the regulator should be clearly and objectively stated. - The authorities should work fast to close the gap in the regulatory framework that permits broker-dealer activity and OTC derivatives activity to take place outside the regulatory regime. - Principle 17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme. - The ISA should receive the power to examine the adequacy of internal management procedures at the time of licensing. - Principle 21. Regulation should provide for minimum entry standards for market intermediaries. - The authorities should make sure that all intermediaries are subject to an authorization process (see under Principle 1). - Principle 22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake. - Consideration should be given to excluding long-term non-subordinated debt count from capital of TASE members. ### Authorities’ response — ISA actions and views - Paragraph 80: The ISA thanks the IMF's staff and found the reports and comments comprehensive and helpful; exchange of views was useful and efficient. - Paragraph 81: The regulation of broker-dealer activity received high priority at the ISA. The ISA has established an internal working group dedicated to examine and propose a legislative framework to regulate the broker-dealer activity in Israel. This process will be closely coordinated with the BOI. - Paragraph 82: Notwithstanding differentiation between TASE member categories, all TASE members are currently subject to TASE rules pertaining to conduct towards customers, disciplinary violations, and compliance with TASE enforcement and general provisions pertaining to member obligations towards TASE. - Paragraph 83: According to the data the ISA has, most of the OTC derivatives activity is performed in trading platforms within the banks. The exposure of retail clients to OTC derivatives is limited by law, and their indirect exposure is also low (mutual funds are prohibited from investing in OTC derivatives, however ETNs are not). - Paragraph 84: The ISA currently acts to extend liability of underwriters. The amendment proposed by the ISA, if approved, will impose a mandatory duty to have an underwriter in every public offering, for the purpose of external due diligence. - Paragraph 85: Regarding the comment that capital requirements for ISA licensees do not address risks from outside the regulated entity (Principle 22), the ISA believes that due to the specific regulation of these licensees, there is no need in changing the capital requirements and impose unnecessary burden on the industry. ### New IOSCO Principles — readiness and developments (Table 7) — Key findings - Context: - In June 2010, IOSCO reviewed its Principles; 9 new Principles were added and one Principle removed (Principle 6). - Assessment of Israel‘s compliance with IOSCO Principles was against the old Principles and used the old methodology. Brief discussions were held on the 'state of readiness' to implement the new Principles, using an analysis prepared by the Israeli authorities. - New Principle 6 (Systemic risk monitoring): The Regulator should have or contribute to a process to monitor, mitigate, and manage systemic risk, appropriate to its mandate. - A forum for cooperation on systemic risk issues has been set up. The forum was established at the instigation of the BOI and includes the Governor of the BOI, the ISA Chairman, and the Chairman of and Commission of Capital Markets. - The forum's mandate includes formulation of methods, measures and indicators for the timely identification of systemic risks related to the activity of the various financial entities, markets, instruments and the financial system; articulation of measures to manage and minimize systemic risks, and to analyze their impact; definition of the required data and indicators; consideration of alternative courses of action to address crisis situations, and analysis and assessment of the consequences of these alternatives. - The forum has begun to meet and will continue to meet regularly. - New Principle 7 (Perimeter of regulation): The Regulator should have or contribute to a process to review the perimeter of regulation, appropriate to regularly. - See New Principle 6 findings (forum arrangements). - New Principle 8 (Conflicts of interest): The Regulator should seek to ensure that conflicts of interest and misalignment of incentives are avoided, eliminated, disclosed or otherwise managed. - A significant portion of ISA regulatory action is focused on the prevention (if possible), disclosure and management of conflicts of interest and misalignment of incentives. - Regarding securitization, since, to date, securitization has not played any significant role in the Israeli market, particular problems associated with the securitization process have not arisen. - New Principles 19–21 (Auditor oversight, independence, and standards): - The new Principles expand on Principle 16, accounting and auditing standards. The assessment of Principle 16 implies that the elements of the new Principles are largely in place. - The ISA proposes to establish an appropriate institutional framework for the development and implementation of auditing standards, auditor independence, ethical conduct, quality assurance, and enforcement. - New Principle 22 (Credit rating agencies — CRAs): - A company applying to receive approval as a rating agency must file a written application to the Commissioner of Capital Markets (CMISD) and if approved must: - a. engage only in the rating of corporate debt, unless it receives the Commissioner‘s advance written approval to engage in another activity. In deciding whether to give such approval, the Commissioner considers whether the additional activity is liable to create conflicts of interest with the credit rating activities of the company; - b. operate under know-how, guidance and support agreement with a recognized foreign credit rating agency for a period of at least five years. - Other rules set out in circulars issued by the CMISD apply, including rules about ownership, liquid asset requirements, confidentiality, publication of ratings, governance, and the methodology used for rating (including use of a ratings committee). - A new legislative proposal is being developed that would bring regulation and enforcement of rating agency activity under the authority of the ISA. The proposal covers transparency, independence, conflicts of interest and accountability issues and be similar in intent, scope and implementation to regulation in Europe and the US. - New Principle 23 (Analysts and analytical services): - The current regulation of analytical research services is based on the concept that an analytical report expresses a position and often a recommendation regarding a certain investment, and taken to be investment advice under the definition of the Investment Advice Law. Therefore, and subject to the exceptions stipulated in the Law, analysts are required to be licensed and are subject to most of the legal obligations set out in the Law. - New Principle 28 (Hedge funds): - There is no specific regime for hedge funds in Israel but the Mutual Funds Law recognizes them as a possible investment category for mutual funds. However, in practice, Israeli mutual funds do not invest in hedge funds, and overall institutional investment in hedge funds is very small. *Source: _cr1272 - 78. The following table summarizes the assessment* ### 87. The introduction in 2007 of a real time gross settlement high-value payment ### The introduction in 2007 of a real time gross settlement high-value payment system, Zahav, and the enactment of a Payment Systems Law in 2008 and the BOI Law in 2010 were crucial steps in establishing a modern, robust payments system ### Overview and Background - Zahav (RTGS) implemented in 2007; Payment Systems Law enacted in 2008; BOI Law came into effect in 2010. - Key remaining challenges: complete development of payment system oversight, aspects of risk management and collateral arrangements, business continuity arrangements, and the pricing of services. - Need to ensure multilateral net settlement systems that settle in Zahav benefit from full protection of the law and have suitable loss sharing agreements. - BOI needs to better define conditions for provision of emergency liquidity assistance (ELA), including to elements of the payments system. ### Information and Methodology Used for Assessment - Assessment of the CPSIPS conducted in November 2011 within the framework of Financial Sector Assessment Program Update for Israel. - Zahav was assessed against the CPSS Core Principles based on a review of documents provided by the BOI, including a self-assessment, Zahav rules, participation agreements, pledge and other agreements, business continuity plans and risk assessments. - Cooperation with the assessment was complete and open; discussions held with Zahav participants including CLS. - Main laws reviewed in conjunction with IMF Legal Department; presentations received from market participants and bodies such as the ISA. - External technical expert: Christopher Mann. ### Institutional and Market Structure - Main financial institutions: banks and insurance companies; active markets in shares, corporate bonds, and government bonds; variety of pension, provident, and mutual funds. - BOI supervises banks and is responsible for payments system oversight. ISA oversees securities sector. Commissioner of Capital Markets, Insurance, and Savings (CCMIS) at MOF deals mainly with insurance and pension sector. TASE has some supervisory responsibilities for its members. - Zahav is the only RTGS system in Israel. Four payment systems participate in Zahav: the Stock Exchange Clearing Houses (Maof Clearinghouse and Securities Clearinghouse), the Bank Settlement Center (Masav) (an ACH), the BCH, and the CLS system. - Direct participants include the BOI, the Postal Company, CLS Banks, and the 15 commercial banks. - Payment Systems Law 2008 established oversight function and finality/irrevocability rules; BOI Law 2010 requires BOI to “regulate the payment and settlement systems in the economy, with the goal of ensuring their efficiency and stability, including in accordance with the Payment Systems Law.” - Payment Systems Law excludes the multilateral net payment system embedded in TASE-CH; ISA has responsibility for oversight of TASE-CH per amended Securities Law. A MOU exists between BOI and ISA. ### Main Findings (by Core Principle / Central Bank Responsibility) - CP I – Legal foundation - Legal framework encompasses almost all building blocks necessary but some steps recommended to widen scope. - Recommendation: enact specific imperative rules for foreign participant participation to capture foreign law risk. - Recommendation: make explicit equivalent protection for TASE-CH multilateral net settlement by changing paragraph 2 (a) of the Payment Systems Law. - Recommendation: consider a general legal framework to capture all collateral arrangements in the form of a pledge or a repo. - CP II – Rules and procedures / Understanding and management of risks - Zahav Rules cover wide variety of legal, business and operational issues; updated at least annually; clear, complete and up-to-date; information clear and accessible to participants. - CP III – Management of credit and liquidity risks - Settlement in Zahav is RTGS, with finality at point of debit and credit (locked together) across payer‘s and receiver‘s settlement account in Zahav. - In all circumstances, participants incur no credit (or liquidity) risk in the system; settlement is final and subject to legal protection against insolvency laws. - System is currently awash with liquidity; limited need for interbank liquidity management; development of secured interbank market may take time. - Suggested actions: model minimum amount of liquidity needed for daily settlement to identify possible requirement for ‘start up’ liquidity; BOI might review basis for providing ELA to TASE-CH against outright purchase of pledged assets; Banking Supervisor may consider size and management of intraday credit limits offered by direct participants to their customers. - CP IV – Prompt final settlement - Zahav is an RTGS system, with finality protected by Law. Operating hours are long. Unsettled payment orders at close are cancelled and must be resubmitted the following day. - CP V – Multilateral netting - Does not apply. - CP VI – Use of central bank money - Settlement in Zahav takes place across participants‘ accounts in the books of BOI (Zahav accounts are liabilities of the central bank). - CP VII – Operational reliability and contingency - BOI has detailed and comprehensive business continuity plans for Zahav and related systems, regularly tested. - Further work required to integrate plans and tests into an overall business continuity vision. - Priority actions: establish overall definition of optimal contingency arrangements, ladder of increasingly demanding tests, timetable, and allocation of resources. - BOI is vulnerable to use of a third party supplier of Zahav application software; need to consider depth and distribution of supplier expertise. - Recommendation: draw up Internal Control Objectives and assess to international standards for systems and controls. - CP VIII – Practicality and efficiency - Zahav is reliable and efficient; provides means for high-value payments, final settlement of multilateral net settlement systems, shekel leg of FX deals settled in CLS, and central bank and government business. - BOI encouraged to identify dedicated and shared costs of Zahav to review policy of not recovering costs from some participants and to inform investment decisions. - CP IX – Access - Any financial sector institution is eligible for Zahav membership, not just payers/receivers; used to enable TASE-CH to open an account for emergency procedures. - Certain exemptions provided to CLS to accommodate special requirements. - Consideration: extract high level membership and eligibility requirements in general statement for public availability. - Membership of Zahav by nonbanks raises question of conditions under which they may receive BOI ELA (addressed in accompanying Financial System Stability Assessment). - CP X – Governance - Governance would be more effective, accountable and transparent if fully allocated costs were available to stakeholders. - Sharing breakdown of costs would provide transparency for users if asked to meet a share of costs. - Central Bank Responsibilities A–D - Responsibility A: Specific payment system oversight function being created; project scheduled to be completed in 2013. “Responsibilities of the Central Bank in Applying the Core Principles for SIPS” have not been formally assessed. - Responsibility B: BOI is creating oversight function; project due to finish in 2013; review premature. - Responsibility C: Payment Systems Act 2008 permits Governor to exempt a system from Central Bank oversight (exercised for CLS); oversight of TASE-CH made responsibility of ISA; MOU between BOI and ISA exists. - Responsibility D: Not assessed. ### Recommended Action Plan (selected recommendations and sequencing) - Legal foundation (CP I) - Cover foreign law risk—24 months - Unify legal framework for the full range of eligible collateral—24 months - Complete declarations for Masav and BCH—6 months - Explore strengthening of finality in General Ledger settlement—36 months - Make explicit equivalent protection available to TASE-CH in respect of its multilateral net settlement by changing — 24 months - Understanding and management of risks (CPs II–III) - Encourage readiness of interbank market—12 months - Model start-up liquidity in Zahav—12 months - Consider “throughput” limits—6 months - Review provision of BOI ELA to elements of the payment system—12 months - Review support arrangements for TASE-CH—12 months - Redesign Masav/BCH Loss sharing Agreement and modalities for its mobilization—12 months - Review prudential liquidity requirements in light of liquidity use in Zahav—12 months - Settlement (CP IV–VI) - None - Security and operational reliability (CP VII) - Define optimal arrangements, test their working—24 months - Integrate risk management—12–24 months - Draw up internal control objectives and prove them—36 months - Efficiency and practicality (CP VIII) - Review strategy on pricing and make costs transparent—24 months - Criteria for participation (CP IX) - Make eligibility criteria publicly available—12 months - Governance (CP X) - Build and integrate Zahav business model and ensure minimum central bank subsidy—36 months - Central Bank Responsibilities (A–D) - Apply Payment Systems Law to systems for which a declaration has yet to be made; get oversight fully operational, with highest priority, and suitably organized; make approach, principles and objectives publicly available—12–24 months ### Authorities’ Response (BOI) - General - BOI welcomes recommendations, is establishing an oversight function expected to be completed in 2013, and will undertake detailed reviews of Zahav, Paper-based Clearing House, Masav, and TASE clearing houses. - CP1 - BOI will thoroughly study recommendations for amending Payment Systems Law and other legal topics and act toward implementation where necessary; notes changes require long periods. - Notes General Ledger system is last resort; works in batches at end of day; not near real time; does not include all RTGS settlement mechanisms and therefore does not ensure final settlement at end of batch process. - CP3 - BOI will examine issues raised and implement changes as needed. - Notes Zahav has tools enabling participants to manage liquidity and BOI tools to regulate transactions, such as variable pricing over the course of the day. - Will ensure participants are familiar with liquidity management tools and how to use them. - Will consider size and management of intraday credit limits offered by direct participants to their customers and study international practice to avoid increasing liquidity risk. - CP7 - BOI has already begun implementing main recommendations under this Principle. - Internal Audit periodically reviews and evaluates all controls in accordance with up-to-date standards and methodologies. - CP8 - BOI prepared a pricing module that includes all activities of the Bank, specifically RTGS operations; pricing module will be used as basis for justified pricing tariff when current pricing policy changes. - CP9 - BOI accepts recommendation and will work to implement it. - CP10 - BOI accepts recommendation in principle; if decision made to collect hardware replacement costs from participants, BOI will proceed to implement it. *Source: IMF assessment of Zahav and Israeli payment systems (FSAP update, assessment conducted November 2011).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1272.pdf_