Improving the Business Environment in Iraq Through Secured Transactions

Improving the Business Environment in Iraq Through Secured Transactions Murat Sultanov Beirut, October 17, 2011

CONTENTS What is Secured Transactions? Economic Importance 1 Why these systems are underdeveloped in MENA? 2 What are the best practices? Situation in Iraq? 3 IFC s Global Experiences and Proposal for Reform 4 Collateral Registry: Best Practices and Demo 5

WHAT DO WE MEAN BY SECURED TRANSACTIONS SYSTEMS? SECURED TRANSACTIONS SYSTEMS: LEGAL AND INSTITUTIONAL FRAMEWORK TO FACILITATE THE USE OF MOVABLE PROPERTY AS COLLATERAL FOR BOTH BUSINESS AND CONSUMER LOANS MOVABLE PROPERTY: ALL TYPES OF MOVABLE ASSETS, TANGIBLE AND INTANGIBLE, PRESENT AND FUTURE, INCLUDING: Vehicles, industrial/agricultural machinery and equipment Inventory Accounts receivable Agricultural products (crops, livestock, fishfarm) Consumer goods (computers, furniture, household appliances) Commodities Intellectual Property Rights Negotiable instruments Bank accounts, insurance policies Minerals and timber to be severed, etc. 3

BENEFITS OF A SOLID SECURED TRANSACTIONS SYSTEM INCREASES ACCESS TO CREDIT REDUCES THE COST OF CREDIT - Underserved SMEs - Women entrepreneurs - Better interest rates - Longer repayment periods - Development of industries (factoring and leasing) - NBFIs - Credit risk diversification: immovable and movable - Sector diversification in the portfolio INCREASES MARKET COMPETITION PROMOTES CREDIT DIVERSIFICATION

WHY ARE FINANCIAL INSTITUTIONS NOT WILLING TO LEND TAKING MOVABLE PROPERTY AS COLLATERAL? LACK OF ADEQUATE LEGAL FRAMEWORK - Restrictions on types of assets - Priority of creditors unclear - Enforcement issues LACK OF REGISTRY OF SECURITY INTERESTS IN MOVABLES - Dysfunctional registry - No registry, lack of publicity, no transparency LACK OF KNOW HOW ON MOVABLE ASSET LENDING - Have never done that type of financing - Do not have the staff with skills NOT INTERESTED - Not their type of business - No competition in the lending market - Revenues from other sources (TB) - Other reasons

Capital Stock of Firms Collateral Taken by FIs SME FINANCE GAP AND COLLATERAL ANCE GAP AND COLLATERAL GAP SME FINANCE GAP IN MENA, BETWEEN US$ 165-200 BILLION MISMATCH BETWEEN ASSETS OWNED BY COMPANIES AND COLLATERAL REQUIRED 22% 44% 27% 34% 73% Vehicles/machinery/equipment Accounts Receivable Land / Real Estate Source: World Bank Enterprise Surveys Land / Real Estate Movable property

WEAK BORROWERS AND CREDITORS RIGHTS WEAK CREDITORS RIGHTS DESPITE 1. G22, 1998 2. BASEL II, 2004 3. G20, 2010 BORROWERS AND CREDITORS RIGHTS INDEX (0-10) High income: OECD Europe & Central Asia East Asia & Pacific Latin America & Caribbean South Asia Sub-Saharan Africa Middle East & North Africa 6.9 6.6 6.1 5.5 5.4 4.6 3.0 Source: World Bank Doing Business 2011

WORLD BANK DOING BUSINESS STUDY 2011 Region/Country Getting Credit Ranking Strength of Legal Rights (0-10) Legal Rights Ranking OECD N/A 6.8 1 Eastern Europe and Central Asia N/A 6.6 2 East Asia and Pacific N/A 5.7 3 Latin America and Caribbean N/A 5.5 4 South Asia N/A 5.3 5 Sub-Saharan Africa N/A 4.3 6 Middle East and North Africa N/A 3.0 7 MENA countries Algeria 135 3 128 Bahrain 87 4 106 Egypt 71 3 128 Iraq 168 3 128 Jordan 127 4 106 Kuwait 87 4 106 Lebanon 89 3 128 Morocco 87 3 128 Oman 127 4 106 Qatar 135 3 128 Saudi Arabia 61 4 106 Syria 181 1 178 Tunisia 87 3 128 UAE 71 4 106 West Bank/Gaza 167 0 182 Yemen 150 2 168 Source: Doing Business 2010 9

SNAPSHOT OF SECURED TRANSACTIONS AND ACCESS TO CREDIT IN MENA World Bank Enterprise Surveys 34% of Firms Consider Access to Credit a Major Constraint 60 50 40 30 Access to a Line of Credit or Loans from Financial Institutions (% of Firms) 56.92 54.97 45.02 37.54 25.07 60 50 40 30 20 49.85 Use of Bank Loans to Finance Investments (% of Firms) 34.18 28.77 27.20 26.21 16.45 20 10 10 0 Eastern Europe & Central Asia Latin America & Caribbean South Asia Sub-Saharan Africa Middle East & North Africa 0 Eastern Europe & Central Asia OECD Latin America & Caribbean South Asia Sub-Saharan Africa Middle East & North Africa Country Loans to Firms requiring collateral (%) Algeria 79 Egypt 84.4 Jordan 97.6 Lebanon 67.5 Morocco 90 Oman 73.8 Palestine 84.5 None of the MENA Countries have a modern secured transactions law. Very fragmented legal frameworks with provisions in many laws None of the MENA countries have modernized their collateral registries Secured Transactions and Islamic Finance can co-exist

WORLD BANK SME LENDING SURVEY IN MENA (2010) ACCEPTANCE OF MOVABLE ASSETS AS COLLATERAL: 50% of banks accept movable property REGISTRATION OF SECURITY INTERESTS IN MOVABLE PROPERTY: 49% of banks claim problems registering rights on movables ENFORCEMENT OF SECURITY INTERESTS IN MOVABLE COLLATERAL: 58% of FIs in MENA consider enforcement of movable collateral upon default a major hurdle SALE OR DISPOSITION OF MOVABLE COLLATERAL BY FINANCIAL INSTITUTIONS: 70% of FIs in MENA consider the sale of the asset a major constraint

SECURED TRANSACTIONS GENERAL PRINCIPLES PRINCIPLE 1: BROAD SCOPE OF RIGHTS THAT CAN BE CREATED ON ALL TYPES OF MOVABLE ASSETS Security rights (possessory and non-possessory) in all types of movable assets, tangible or intangible, present or future, including their products and proceeds All legal and natural persons should be able to create security rights. All property rights created contractually to secure the payment of an obligation, including: assignments of receivables, retentionof-title sales and financial leases (Functional Approach). 13

SECURED TRANSACTIONS GENERAL PRINCIPLES PRINCIPLE 2: PUBLICITY OF SECURITY INTEREST IN MOVABLE COLLATERAL All kinds of claims against movable property must be publicized to make them transparent to third parties. Publicity is commonly provided by registration in a public registry, but may be provided by other means such as possession by the creditor or control by the creditor or an agent of the creditor. 14

SECURED TRANSACTIONS GENERAL PRINCIPLES PRINCIPLE 3: PRIORITY OF SECURITY INTERESTS IN MOVABLE COLLATERAL Determines the sequence in which competing claims to the same collateral will be satisfied when the debtor defaults on one or more of the claims. Clear policies and no conflict of laws are key. Clear policies based on two main principles: 1. The order in which competing interests were made transparent to third parties determines the order of priority 2. Exceptions to this rule require clear policies explaining the rationale for that exception (Purchase Money Security Interest) 15

SECURED TRANSACTIONS GENERAL PRINCIPLES PRINCIPLE 4: ENFORCEMENT OF SECURITY INTERESTS IN MOVABLE COLLATERAL Process for enforcing a claim against movable property when the debtor defaults on the secured obligation. Key principles: 1. Immediate right to possession by creditor upon default by debtor 2. Disposition (private or public sale) of the collateral by the creditor 3. Distribution of proceeds in priority sequence 4. Rights of the debtor during enforcement proceedings (appeal after seizure, notification of disposition) 16

Key Constraints to Effective Secured Lending Practices in Iraq Legal framework for secured lending is outdated which restricts ability of SMEs to borrow against movable assets & for creditors to protect their rights effectively. Enforcement mechanisms are weak which delays and increases the cost of repossession. Self-help procedures not possible, even if parties agree. Priority scheme for creditors is unclear which increases uncertainty and raises risks to creditors, thus reducing their willingness to lend against movable property. No uniform, centralized collateral registry limits transparency and increases uncertainty related to rights of creditors and their priorities when lending against movable collateral.

CHINA CASE: REFORM PROCESS LEGAL REFORM 1. Property Law, 2007 2. Registry Regulations 3. Leasing regulations COLLATERAL REGISTRY 1. Centralized in Shanghai 2. Web Based 3. Public Access AWARENESS AND TRAINING 1. General Awareness 2. Training of Public sector Stakeholders 3. Training of FIs 19

CHINA: OPENING UP $1 TRILLION IN CREDIT FOR BUSINESSES THROUGH SECURED TRANSACTIONS REFORM US$ 340 BILLION IN NEW FINANCING TO SMEs 50,000 SMEs WITH INCREASED ACCESS TO CREDIT US$ 900 BILLION FINANCING FACILITATED 1.PROPERTY LAW 2. REGISTRY 3. TRAINING MORE THAN 5,000 PEOPLE TRAINED US$ 9.6 TRILLION VALUE OF TOTAL MOVABLE ASSETS 20

CURRENT PROJECT PORTFOLIO AFRICA Ghana Malawi Rwanda OHADA Regional Initiative South Sudan MENA Afghanistan Jordan West Bank & Gaza Yemen AMF EAST ASIA & PACIFIC Cambodia China Lao PDR Philippines Vietnam SOUTH ASIA India Nepal Sri Lanka ECA Azerbaijan Belarus Moldova Tajikistan Kyrgyzstan LAC Colombia Dominican Republic PIPELINE MENA (Lebanon, Egypt, UAE) 21

BUSINESS AND DELIVERY MODEL LEGAL AND REGULATORY FRAMEWORK 1. Create Committee 2. Draft new Secured Transactions Law 3. Awareness 4. Submit Law to Parliament 5. Draft registry regulations 1. Determine Government Agency to Host Registry 2. Develop Technical Specifications 3. Hardware and Software Procurement 4. Training/awareness 5. Launching of registry CREATION OF ELECTRONIC REGISTRY 1. Develop monitoring and evaluation plan including baseline information 2. Conduct periodic monitoring of impact through registry indicators and surveys 1. Training and awareness to main stakeholders (both public and private sector) on the new system, including law and registry 2. Training on movable asset financing for Financial Institutions MONITORING IMPACT BUILDING THE CAPACITY OF STAKEHOLDERS

Part 3 Registration and Registry REGISTRY BEST PRACTICES Accuracy capture exactly information presented Speed speed of registration and searching Accessibility any time, from any place Cost effectiveness fees cover costs of operation; not general revenue source for government Simplicity reduce risk of error and encourage use Limited to purposes of registration give notice and establish priority Rule-based decision-making no bureaucratic discretion in registration and searching

FORM OF REGISTRY Electronic registry uses best practices Accessible to all via internet Automated acceptance or rejection Reliable, fully automated search process No unnecessary formalities for registration Uniform treatment of notices of all types Automated fee payment system Secure from tampering and corruption

NOTICE REGISTRY GLOBAL EXAMPLES Electronic notice registries are in successful operation in countries ranging in size: from very small - such as Vanuatu and Micronesia, to mid-size such as New Zealand, Bosnia and Cambodia, to very large such as China, the US and Canada.

DEMONSTRATION OF REGISTRY SYSTEM Test copy of a live system in Cambodia Has been in successful operation for over four years

CONTACT INFORMATION Bassim Sharafeldin bsharafeldin@ifc.org Cherine El Sayed Celsayed@ifc.org Murat Sultanov msultanov@ifc.org Thank you for your participation