Israel: Regulatory policies threaten foreign investment in nearly perfect Israeli economy

The globalization process has not skipped over the investment field. Investors who in the past had focused their money at "home," are now diversifying their portfolios to include other nations' markets. Consequently, many American investors who would not consider investments abroad; today, however, boost their investment in foreign markets.
 
One of the most attractive targets for leading foreign investment houses in recent years, including those based in the US, is Israel.
 
The Israeli economy has experienced significant growth over the last two years. Growth rates are far beyond forecasts, indicating that tough times are a thing of the past for the Israeli economy. A series of structural reforms in the country’s financial market, pensions and banking have raised Israeli monetary markets to advanced levels, allowing them to integrate into global markets. In addition, Israel’s geopolitical situation has improved, as Israel is no longer alone in its fight against terrorism.
 
Recently, one of the world's most prestigious investment houses, Morgan Stanley, published a glowing review of Israel's economy, aptly titled "Israel: Almost Perfect." Other prestigious market players, including Deutsche Bank and Merrill Lynch, share Morgan Stanley’s view regarding the promising trends of Israel’s economy.
 
"The leading indicators point towards a strong growth momentum this year. Real GDP increased by 4.3% in 2004 and 5.2% last year well above the dismal performance in the previous years and the latest set of indicators confirms the continuation of above-trend expansion in domestic economic activity as well as in exports," Morgan Stanley's report stated.
 
Additionally, the International Monetary Fund published similar praise of Israel's economic achievements in its bi-annual global forecast earlier this year. IMF forecasts indicate that the rate of Israel's economic growth during 2006-2007 will be significantly greater than that of many developed countries in North America and Europe.
 
So too, statistics from the Bank of Israel indicate that foreign investments into Israel have strengthened the nation's economy significantly as foreign investor confidence in Israel rises; foreign investment grew by 67 percent in 2005 to US$9.7 billion, up from US$5.8 billion in 2004, the bank said.
 
Notably, foreign firms that had invested in Israel in the past focused primarily on the nation’s hi-tech sector, where Israelis continue to enjoy a reputation of innovation and pioneer spirit. In recent years, American mutual funds and institutional investors have expressed growing interest in Israeli assets. Last month, American millionaire Warren Buffet paid US$4 billion for an 80 percent stake in the Galilee-based metalworking firm "Iscar." This deal marked the first such major agreement for Israel’s manufacturing sector, rather than in technology. 
 
In the financial sector, the presence of foreign players however was disappointing. Citibank and HSBC opened branches in Israel, but their activities were limited and did not include the retail level. Many of those foreign players who open offices in Israel employ a small staff which deals chiefly with maintaining local contacts.
 
Expectations for the entry of foreigners into Israel’s financial system though, were strengthened following the approval of recommendations of the Bachar Committee. These recommendations for reforms forced the powerful Israeli banks to reduce their holdings in provident and mutual funds. The reforms were drawn up by the former and energetic general director of the Finance Ministry. Bachar was appointed to head the Committee by Benjamin Netanyahu, and enjoyed the full backing of former Premier, Ariel Sharon.
 
The Committee proposed reform was a dramatic move. Assets worth billion of dollars were put on sale and surprisingly, attracted serious buyers willing to pay hefty sums—much higher than predicted even by the most optimistic projections.
 
Contrary to expectations of some reform supporters, most buyers were from the domestic market, mainly insurance and investment firms which used the opportunity to gain platforms for significant activity in Israel’s financial market. 
 
Despite massive efforts by regulators and bankers to attract them, many foreign players in mutual funds and portfolio management preferred to "sit on the fence". Some of them attended presentations and briefings carried out by bankers regarding management firms up for sale, though when the moment of truth came, their positions remained unchanged.
 
An exceptional case arose when New York-based hedge fund, York Capital Management, a prestigious body that manages over US$7 billion in hedge funds, decided to purchase the most promising asset in Israel’s market—Bank Leumi's Psagot Ofek Investment House Ltd. Psagot manages assets worth some US$7 billion.
 
In November 2005, York Capital signed a memorandum of understandings to buy Psagot which was described by Globes financial daily as the "diamond in the crown" among all assets put up for sale.
 
However, last week, York understood that Israel has yet to free itself from obstacles that had previously deterred Western investors from its financial markets. York discovered that in relation to Israel's regulatory system, many unpleasant surprises can emerge, even for those who previously prepared for such instances. The major deal (in local terms), in which York Capital agreed to buy Psagot for US$300 million, suffered a last-minute setback as the two sides set out to finalize the deal. The problem stemmed from the Israel Securities Authority’s demand that two Psagot Ofek senior managers step down from their posts after completion of the sale.
 
Psagot Ofek general manager Gabriella Ravid and Psagot Ofek deputy CEO Daniel Silbiger are two of a large group of managers in Israeli banking firms involved in enquiries that led to the establishment of Bachar Committee. According to the Israel Securities Authority, investment consultants in the banks received illegal orders and on occasion incentives from managements so that bank clients would buy mutual funds of their bank and not those of competitors. The investigation into the issue has lasted three years though not one indictment has yet to be filed. Despite this fact, Israel Securities Authority chairman Moshe Tery, on the eve of the final signature of the York-Psagot deal, conveyed to York Capital that Ravid and Silbiger would not be allowed to manage Psagot in the future.
 
York, in response, told Bank Leumi that the deal was off. Without the two senior managers, there was doubt that the firm would be able to survive and cover the huge investment, as market competition is intensifying. The Israeli press has questioned how it was that the regulator decided to jeopardize such an important deal with a foreign investor while other managers involved in the marketing ordeal continue to work n firms owned by Israelis. Senior legal quarters have also claimed that Tery's move was completely "unreasonable,” and was oddly timed.
 
The fate of the deal is still unclear, but it seems more time will be needed before a prominent US firm will be ready to jump into the stormy waters of Israel’s finance market.