Israel awaits developed market status
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Emerging Markets

Israel awaits developed market status

The CEO of the Tel Aviv Stock Exchange tells EM she hopes inclusion in the FTSE advanced market list will draw in more foreign investors by offering them the best of both worlds

The Tel Aviv Stock Exchange (TASE) will have a decision by the end of August 2007 on whether it will be added to the list of advanced markets in the FTSE global family of indices, raised from “advanced emerging market” status at present. TASE head Ester Levanon tells Emerging Markets that, if FTSE does upgrade Israel, she believes Morgan Stanley – whose MSCI is the benchmark for many global equity funds – may follow within two years.

“Personally, I believe we are not an emerging market exchange, if you look at measures of GDP per capita or market sophistication. On the sell-side, some banks have already moved Israel out of their emerging market equities desk, but most fund managers still include it in their emerging market portfolio,” says Levanon.

However, she is happy for foreign investors to play the market both ways: the transparency and depth of an advanced market, but with GDP and profitability growth rates higher than most developed economies. Israel’s GDP grew by 5.1% in 2006, and Levanon points out that it has consistently outstripped Bank of Israel (BoI) forecasts in recent quarters. Moreover, the TASE has seen 46 new listings so far in 2007, compared with just 36 IPOs for the whole of 2006.

Increasingly entrenched stability in economic policymaking is a key factor behind this success, and Levanon argues that a return to the double-digit inflation and exchange rate volatility of the 1980s and 1990s is no longer on the cards.

“In any case, many Israeli companies are now hedged against volatility in the Israeli economy through export activities or the relocation of some production outside Israel,” she adds.

The overseas diversification of Israeli companies brings a new challenge, however, faced by other small emerging markets. Israeli firms are beginning to look at listing on major international exchanges such as London and New York, to maximize the pool of potential investors. Levanon is keen to persuade companies to consider dual listings, and says she is having some success, as IPOs on the TASE are not undervalued.

“Smaller companies, especially in the high-tech and biomedical sectors, find it better to list in Tel Aviv first, as it is difficult to get attention on the Nasdaq. Many of the firms listing in London are subsidiaries with parent companies already listed on the TASE; in particular, it is the real estate companies looking to make investments in Eastern Europe and Russia, so they want to raise capital in European currencies rather than shekels,” Levanon explains.

Nevertheless, after 10 years working on the IT side of TASE operations before her appointment as CEO in 2006, she is keen to fulfil a longstanding ambition of marketing the exchange more effectively on the international stage. Levanon’s background puts her in good company: John Thain of the New York Stock Exchange is one of a number of exchange heads drawn from an IT background to take on what is an increasingly technical role.

Trackers prove attractive

Indeed, Levanon attributes the recent success of the TASE partly to its product development. Of the exchange’s $200 billion market capitalization, $18 billion is now accounted for by tracker funds, for both Israeli and international indices. The availability of international trackers has allowed TASE to retain the activity of Israeli institutional investors, even after the BoI lifted a 20% limit on overseas investment in 2003. The Israeli-focused trackers include a mid-cap index that was recently expanded to 50 from 30 stocks, and a Tel-Bond 20 corporate bond index that has been particularly important in drawing foreign investors who are seeking passive exposure to Israeli credit markets. Levanon has plans to expand the Tel-Bond 20 to reflect the booming corporate bond issuance that has stemmed from low and stable interest rates.

Moreover, in contrast with some of the smaller Asian emerging markets, the head of TASE is not concerned about possible volatility caused by any increased foreign investor activity in the market. Historically, data on foreign investment has not been comprehensive - there were originally only two major banks acting as brokers to most foreign players, who were therefore reluctant to reveal the information to each other.

Today, the BoI estimates foreign participation in Israeli equities at 20%-25%, but Levanon believes the real figure might be higher: the TASE operates Sunday to Thursday, and trading volumes on the Sunday are often only a quarter that of the working days shared with international markets. For corporate and government bonds, some transparency is provided by the TASE’s role in settlement on the EuroMTS system, which accounts for around half of all trades in the shekel-denominated fixed income segment.

In any event, Levanon is confident that the local market is deep enough to ride out changes in foreign investor sentiment, especially since the Bachar reforms of 2005 that obliged retail banks to sell their mutual and pension fund businesses.

“The Bachar measures reduced concentration and allowed brokerage firms to grow their role in the market through purchasing the banks’ mutual and pension funds,” she tells Emerging Markets.

Although she acknowledges the TASE staff is stretched by the level of new issuance, with around 150 applications pending, Levanon is confident in the strength of the regulatory environment. The BoI recently published a paper broaching the possibility of merging its own bank supervisory role with the Israeli Securities Authority (ISA) to create a single, UK-style financial services regulator, but Levanon is neutral on whether this is necessary.

“The head of the ISA now has regular meetings with the bank and pension fund supervisors, and that cooperation is very effective,” she says.

The macroeconomic and regulatory environment may be looking attractive, but according to a recent Merrill Lynch survey, global portfolios are still a net 40% underweight Israeli equities (see “Emerging equities: the only way is down?”). This is despite the fact that they are 50% overweight emerging market industrials, which constitute around 76 billion shekels (38%) of the TASE capitalization.

Consequently, direct cooperation with foreign exchanges is potentially a final piece of the puzzle to draw in greater investment from overseas. Levanon is playing her cards close to her chest, and will say only that the TASE is in discussions with a number of other bourses.

“Israeli investors are active in many markets, so our priority is to seek the kind of cooperation that is not exclusive, that will not tie us to only one other exchange,” she concludes.

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