Securitization & Financial Development in MENA Dr. Nasser Saidi* 1 Keynote speech at Securitisation World: MENA 2007 Conference Dubai, 18 March 2007

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1 Securitization & Financial Development in MENA Dr. Nasser Saidi* 1 Keynote speech at Securitisation World: MENA 2007 Conference Dubai, 18 March 2007 Ladies and Gentlemen: 1. Thank you for inviting me to be with you at this Securitisation World MENA 2007 conference and allow me to commend your action in raising public awareness on the importance of securitisation as an integral component of financial market development. My comments are directed at stressing the importance of instituting a well-functioning securitisation framework for economic development, as a major building block of financial markets and as an instrument to manage and share risk. Asset securitisation, financial markets & economic development 2. Capital markets in the MENA region are at their nascent stages of development. They remain fragmented, lack breadth, depth, liquidity and integration with the global markets. MENA financial markets must invest in infrastructure; ensure transparency and disclosure and good corporate governance, and develop the enabling legal and regulatory framework for risk diversification and management. The lack of development of the financial markets is now acting as a barrier to sustaining economic growth in the MENA region. The recent boom in GCC stock markets and sharp correction in 2006 highlights the need for policy reforms to ensure sound, efficient and internationally integrated markets. The time to act is now. 3. Securitization and its associated financial instruments, mortgage backed securities (MBS) and asset-backed securities (ABS), was a major driving force and engine of reform and modernization of international financial systems and markets. For the GCC and other MNEA countries, securitisation should be a major building block for developing our financial markets, introducing new financial technologies, widening participation, allowing market participants to transform non-traded financial assets into tradable securities, resulting in risk reduction as a result of diversification, as well as enhanced return streams. Asset securitisation should underlie the emergence of a housing mortgage market to spearhead the development of domestic financial markets, and provide access to the international financial markets. By enlarging the financial opportunity set available, asset securitisation improves welfare, allowing higher levels of wellbeing and real income. Asset securitisation, as an institution, is an integral component of economic development. 1 Chief Economist, DIFC and Executive Director, Hawkamah Institute for Corporate Governance. N Saidi Securitisation MENA

2 Securitisation market: the world s largest financial market 4. The market for securitised assets is the largest in the world and is one of the fastest growing. The securitisation market is dominated by US financial markets, which had pioneered securitisation. While the total size of the US debt market stood at $27.4 trillion by the fourth quarter of 2006, securitised debt at $8.6 trillion (divided between $6.5 trillion in mortgage backed and $2.1 trillion in asset backed securities) was the largest single component, larger than US Treasury market ($4.3 trillion) or municipal securities ($2.4 trillion) 2. Europe, Asia and the MENA region have lagged in developing securitisation. Over the past few years, however, with the introduction of the enabling legislation the European securitisation market is rapidly growing and by end-2006 alone issuance reached about Euro 459 billion, marking an increase of 40 percent, with the UK taking the lead, and accounting for more than half of the issuance volume The data on securitisation for the MENA region is not reliable or complete. However an example on the size of securitization in the MENA region, a USD1.5 billion oil future revenue flow securitization was originated from Egypt in 2005 (Petroleum Export Limited). The total volume of securitisation is in the region of USD2.3 to USD2.5 billion; small compared to the potential. With US1.4 trillion in investment projects in the Gulf region and vast property and housing finance needs, the volume of securitisation could potentially reach US$100 billion. Benefits to Financial Institutions 6. During the current boom, MENA banks and financial institutions have accumulated a large exposure to real estate, commercial property loans and mortgages, in addition to personal loans that are used to finance real estate transactions and portfolio investments. Each loan in isolation may look like a good return for minimal risk (in fact, the economy is booming, rents are rising, and it remains a seller s market.) However, the accumulation of many of these types of loans creates correlation and concentration risk. The problem is that lending institutions are unable to diversify their risk across several real estate markets, due to legal or institutional restrictions, remaining exposed to local market risk. If real estate and commercial property prospects weaken and the sector becomes distressed, these large correlated concentrations place the entire financial institution at risk, leading to banking systemic risk. International experience shows that movements and volatility in commercial property prices have a major impact on a wide range of bank performance variables, ranging from risk indicators to profitability and lending activity and that real estate can have an impact on monetary and financial stability 4. Enabling securitization is an economic, and monetary and bank regulatory policy priority. 2 See The Bond Market Association, 3 See the reports from the European securitization Forum, 4 See BIS Paper No. 21, April 2005 on real estate indicators and financial stability, N Saidi Securitisation MENA

3 7. Securitization generates many benefits for banking and financial institutions. First, the sale of mortgages and removal from the financial institution s balance sheet hedges the credit risk and eliminates the direct exposure to the housing and real estate market. Second, the ability to sell the loans improves the liquidity of the bank s loan portfolio. The cash generated from the sale of the mortgages would be available for immediate spending or investment, such as issuing more mortgages. Third, given regulatory capital requirements under Basel II, loans carry a substantial risk weight in calculating capital requirements. If the loans are sold without recourse, the amount of capital that the financial institution must hold can be reduced and additional growth in total assets may be possible for a given level of capital. Fourth, once the financial institution sells the pool of mortgages, the level of profits has now been locked-in and can be realized immediately (instead of remaining uncertain and accruing over time). Fifth, by tapping into the financial market, banks can achieve more efficient funding terms than through traditional direct borrowing. This is especially true when the gap between the rating of the bank and its receivable is wide. Finally, in most instances, securitizing mortgages continues to generate fee income for the financial institution; it usually retains the servicing contract for which it receives a fee from the mortgage holder. In addition of the above mentioned benefits, securitization of mortgages should be looked at as a risk management tool for hedging real estate exposure at financial institutions. In the absence of a credit derivatives market, the only technique to reduce or eliminate mortgages credit risk or the real estate risk, is to resort to sale or securitization of the mortgage portfolio. Developing MENA Mortgage Markets 8. The US MBS experience has been successful, and relied on the use of tax incentives, governmental guarantees and federally chartered private sector companies to develop vibrant primary and secondary mortgage markets. As a result, in part, of government policies that encouraged home-ownership, more than 80% of US families own their dwellings, one of the highest proportions in the world. Housing represents the main tradable asset held by families and individuals. The ability to rely on marketable housing wealth has enhanced labour mobility in the US as well as increased resilience to economic shocks and business cycles by smoothing household consumption. 9. It is not clear that US mortgage market and institutional framework is easily exported to the MENA countries. Nonetheless, instituting mortgage finance and MBS should be a major building block of MENA financial markets and a major contributor to economic development. Further, given the current building boom in the GCC countries and the MENA region and the potential risks of a cyclical downturn, instituting an MBS market is a critical component of risk mitigation and diversification for the banking sector as well as for real estate development and contracting companies. However, the development of mortgage markets and MBS markets hinges on instituting and protecting property rights. N Saidi Securitisation MENA

4 10. MENA countries have young and rapidly growing populations putting pressure on physical and social infrastructure. Housing finance facilities are inadequate and in most countries, of limited access to low and middle income groups. Housing shortages have become a serious economic and social problem. Housing market distortions, the absence of legal procedures for enforcing claims, dealing with defaults and eviction have also hindered housing mortgage market growth. To institute a securitisation framework, MENA governments should start by developing effective land property rights regimes. This includes: the constitutional protection of property, the laws and regulations defining rights and obligations to property, the means of assigning of rights to property, and the institutional arrangements which register and enforce such rights. 11. Effective creation and protection of land and real estate property rights will free the locked wealth and dead assets of MENA economies, leading to the creation of collateral for credit and financial markets where those assets can be traded. The creation of collateral will lead to the emergence and growth of SMEs and increased factor mobility, increasing productivity growth and per capita income growth. Building blocks for Securitisation in MENA 12. For a securitization market to grow and develop in the MENA region a sound and comprehensive securitization framework encompassing the legal, regulatory, accounting and tax issues will need be designed and implemented. The inadequacy or incompleteness of existing legal structures requires the enactment of special laws. The toolbox of laws includes a modern Securities Law, a modern Insolvency Law, Securitisation Law, a law on Mutual Funds allowing for the creation of Special Purpose Vehicles (SPVs) and asset securitization, allowing the process of pooling rights to assets and issuing securities that are collateralised by these assets. Existing laws and regulations in particular, those relating to property rights, to the ownership of assets and their transfer- are not capable of accommodating the complex set of legal relationships supporting securitisation. Such a framework will ensure clarity and transparency and reduce legal risks and uncertainty. Such a regulatory framework is still absent in the MENA market with the exception of securitisation laws enacted in Egypt, Lebanon, Tunisia. Role of DIFC in developing the MENA Securitization Market 13. Sound, efficient and stable financial markets are based on market integrity, modern trading platforms with performing payment systems and an enabling legal and regulatory infrastructure and credible regulators, all conforming to international best practices. DIFC s mission is to develop a sound, efficient and stable regional market for MENA and beyond. N Saidi Securitisation MENA

5 14. The DIFC has been active in creating the instruments and conditions to support the development of funding for the real estate and property market and the emergence of a mortgage market. The DIFC has issued a Collective Investment Law (CIL) - DIFC Law No. 1 of 2006, which permits both the domicile of funds in DIFC and or distribution of existing foreign funds (both public and private funds). The flexible legislation permits a variety of recognised investment vehicles. Importantly, the CIL permits the operation of various types of funds including, but not limited to: property funds, Islamic funds, hedge funds, private equity funds, and fund of funds. In turn the DFSA issued legislation to regulate the managed funds industry within the DIFC that is compliant with the IOSCO Principles for Collective Investment Schemes. The regulation of fund operators rather than funds leaves room for product innovation and minimizes regulatory burden, and permits appropriate delegation and outsourcing. DIFC has innovated by providing a sound and transparent framework for the operation and supervision of the hedge fund industry. 15. Similarly, the DIFC Investment Trust Law- DIFC Law no. 5 of 2006, introduced legislation permitting the setting up of Collective Investment Funds in the form of an Investment Trust. In particular, for the first time in the UAE and the MENA region, rules to permit the operation of real estate investment trusts (REITS) have been introduced. REITS have become the most favoured method for attracting public ownership in property investments. They provide a convenient form for listed and tradable property ownership with transparent pricing and liquidity. Under these rules it will be possible to issue and trade REITS for the first time in our region, utilizing the facilities of the DIFX. It will add a significant new dimension to the UAE s property market. 16. Importantly the DIFC Collective Investment and Investment Trust legislation also support the development of Shari a compliant finance. DIFC has set clear procedures for authorising Shari a compliant institutions and aims to be the global market for Shari a compliant finance. The DIFC Authority (DIFCA) has set-up an Islamic Finance Advisory Council (IFAC), which can act as a centralized Shari a Compliance Board for DIFC markets and financial instruments. DIFCA, DFSA and DIFX have streamlined the listing of Shari a compliant financial instruments; the aim is to provide the main regional platform for a secondary market in Sukuk and Shari a compliant funds. Already the DIFC has become the largest global Sukuk market. We will be supporting the build-up of a government Sukuk market to finance infrastructure and to mainstream Sukuk as a public finance instrument, as well as the set-up of a Shari a compliant securitization and mortgage market to support property and housing finance in the UAE and the region. N Saidi Securitisation MENA