The Committee on Increasing Competitiveness Main Recommendations February 2012

1. The Committee on Increasing Competitiveness Main Recommendations February 2012 1

2. The Committee’s Mandate The Committee was appointed in October 2010 by the prime minister, the finance minister and the governor of the Bank of Israel The Committee’s Mandate: To examine the effect of the present structure of the economy on the level of competitiveness in the various sectors of the economy, on its financial stability and on its economic efficiency, and to recommend advisable policy measures, with emphasis on the following topics: • Necessary steps for reinforcing corporate governance at public companies • The issue of control of real companies over financial companies • Applicability of the antitrust policy • The issue of control at public companies by means of a pyramid holding structure • To examine stepping up the conditions for business groups in acquiring government assets and obtaining licenses and concessions

3. Committee Members • Haim Shani , Committee Chairman • Prof. Eugene Kendall, Prime Minister’s Office, Head of the National Economic Council • Prof. Shmuel Hauser, Chairman of the Israel Securities Authority • Prof. David Gilo, Antitrust Commissioner • Gal Hershkovitz, Budget Supervisor, Finance Ministry • Dr. Karnit Flug, Deputy Governor, Bank of Israel • Dudu Zaken, Supervisor of Banks, Bank of Israel • Prof. Oded Sarig, the Finance Ministry, Supervisor of Capital Markets, Insurance and Savings • Attorney Avi Licht, Ministry of Justice, Deputy Attorney General • Dr. Gitit Gur Gershgoren, Chief Economist, the Israel Securities Authority

4. The Work of the Committee • Inviting the public to express its position before a draft was formulated • Examining staff work and research on the Israeli and global economy • Holding dozens of plenary sessions and many meetings of small teams • Receiving approximately 100 position papers from private individuals and organizations • Holding two rounds of hearings in which it heard approximately 60 people, including experts and academics, representatives of the third sector and organizations and bodies representing interested parties • Obtaining an expert opinion from Prof. Arye Bebchuk of Harvard University

5. Method for allocating State Assets and Rights

6. Recommendations The functions that are in charge of the procedures for the allocation of State rights and assets (sale of assets to private entities, granting of concessions, licensing, BOT), will be obligated to consider as part of the allocation process considerations of competition in the sector and the decentralization of control in essential infrastructures Preventing the transfer of control of State assets to the hands of few

7. Assimilation of Considerations of Competitiveness in the Various Sectors • A prerequisite for the allotment of rights by the State will be consulting the Antitrust Commissioner whenever the value of the right or the asset is in excess of NIS 150 million, or in lower values wherever the economic value of the asset does not reflect its significance to the public (Section 1.1)

8. Assimilation of Considerations of Centralizationin the Control of Essential Infrastructures • A prerequisite for the allotment of rights in essential infrastructures (as shall be defined by law) will be consulting an Advisory Committee whenever at least one of the following rules is met (Section 1.2): A. The purchasing group controls at least 50% of the essential infrastructures that are relevant to the allotment Or B. The sales turnover of the purchasing group in Israel is over NIS 6 billion • Members of the Advisory Committee: Director General of the Ministry of Finance (Chairman), the Antitrust Commissioner, the Economic and Fiscal Deputy Attorney General and the Chairman of the National Economic Council • Examples of Essential Infrastructures: water, energy, communications, transportation, healthcare and natural resources

9. Examination of the Real Financial Holding Structure

10. Real Financial Holding? Controlling shareholder Controlling shareholder Public monies Pension fund Bank Real estate Infrastructures Bank Provident fund Food Energy Pension fund Bank Commerce Communication Financial sector Business sector

11. Potential Problems with the Real Financial Connection Ineffective allocation of resources Conflict of interests – use of inside information Competitiveness barriers – preventing credit for competitors Business connections between affiliates System-wide risk Advantage – controlling shareholder with significant capital (stability) In the small Israeli economy, separation between big borrowers and big lenders is desirable

12. Recommendations • Prohibiting control or holding in a significant financial entity by a significant real entity or by the controlling shareholder in a significant real entity (Section 2.1) Controlling shareholder Or • Significant real activity: • Sales in Israel- • *NIS 6 billion for a new entity • * NIS 7.5 billion for an existing entity • Or • *Credit in Israel- • NIS 6 billion for a new entity • * NIS 7.5 billion for an existing entity Significant financial activity: Assets - NIS 40 billion

13. Recommendations • Restrictions on the concurrent office of directors in a significant financial entity and a significant real entity (Section 2.2.1) • *Joint rules will be formulated for all the supervisory agencies that will determine restrictions on the scope of employment of the chairman of a significant financial entity in real corporate entities (Section 2.2.2) • The controlling shareholder in a significant financial entity that is a banking corporation will not be able to control a significant financial entity that is not a banking corporation (insurance – supplement to the Bachar Committee,Section 2.8) • Promoting the necessary supplementary legislation as a prerequisite for implementing the recommendations (Section 2.7) Significant Financial Entity Significant Real Entity Or

14. Implementation Mechanisms and Exceptions Interim Provision: • The entities will be given another four years to implement the separation • Separation at boards of directors within two years • *Entities that are obligated to undergo a change in ownership due to the Committee’s recommendations will be given an additional two years to implement the separation of boards of directors • *Tax incentives for companies that are required to separate

15. Pyramid Holding Structure

16. International Comparison: The 10 largest groups as a percentage of the value of the public companies market Percentage of the market value of the public companies 41% Countries that belong to the OECD Countries that do not belong to the OECD Belgium Israel Thailand Japan * Sweden Britain Spain Ireland Taiwan Austria Italy Finland Norway Malaysia Singapore Switzerland France Hong Kong Portugal Indonesia South Korea Germany The Philippines Data sources: Processed by the Economics Department of the Israel Securities Authority * According to Claessens et al, the rate in Sweden is approximately 10%, according to Hogfeldt, in the year 2000 this rate was higher than 50% Source: The Economics Department of the Israel Securities Authority

17. Source: The Economics Department of the Israel Securities Authority Most Companies in Israel have a Controlling Shareholder With a controllingshareholder Without a controlling shareholder

18. The common denominator of major groups in Israel is that they are incorporated in a pyramid structure with a controlling shareholder

19. Potential advantages of business groups • Inter-company backup where necessary • sharing of know-how, business relations • penetration of new areas of business • Substitute for absent institutions • Survivability The pyramid structure is very common in emerging markets

20. Potential problems of the pyramid structure • Tunneling of resources • Ineffective allocation of resources • Excessive assumption of risks • Internal (inefficient) capital market • Double leveraging • Entrenchment Public 51% Public 51% Public 51% The controlling shareholder’s interest is liable to be different from the interest of the public companies that he controls

21. Potential Problems at the Economy Level • Impairment of stability • Meeting in a number of markets • Deterring foreign investors

22. The Gap between Investment and Control in Business Groups NIS Billions Value of capital holdings of all the controlling shareholders Share market value Debenture market value 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 * The value of the debenture market includes corporate debentures, convertible debentures, debentures of private companies in a group and institutional sequence. In addition, this refers to a direct and indirect holding of capital. The value of issued and paid-up share capital was used as an estimate of the value of the market of debentures traded in an institutional sequence. * The figures are as at June 30, 2010 The Economics Department of the Israel Securities Authority

23. International ComparisonAverage Control Premium Average Depth of Pyramid Source: Dyck and Zingales (2004)- Private Benefits Of Control: An International Comparison

24. International Comparison – Number of Layers Source: Masulis et al. 2011- Family Business Groups around the World: Financing Advantages, Control Motivations and Organizational Choices

25. Guiding Principles for the Final Recommendations • Preventing the formation of structures that are too leveraged, complex and big • Protecting the shareholder and debenture holder public • Simplifying regulation • Proportionate intervention in the companies’ ongoing management and functioning • Long-term solution without a major shock to the economy in the short term

26. Change in the handling strategy Clear structural step + easily implemented regulatory tool

27. Main Recommendations • Imposing structural limitations on the number of liabilities in the pyramid structure • Distinguishing between the handling of existing companies and structures and limitations on future incorporation • Restrictions on the scope of credit in major groups • Reinforcing the powers of the antitrust commissioner

28. Breakdown of the Recommendations

29. The Present Structure of the Economy – there is No Limitation on the Number of Layers in a Pyramid Structure Controlling shareholder Control Public Holding Public Company A Control Public Holding Public Company B Control Public Holding Public Company C Control Public Holding Public Company D

30. The Structure of the Economy in the Future Two layers of public companies and debenture companies Special board of directors structure for a wedge company in the second layer Controlling shareholder Public Company A Additional company regulation Public in the second layer And when the controlling shareholder holds less than From - 33% of the capital Public Company B It will not be possible to acquire a controlling interest in a public company in the third layer

31. 1. Control of a public wedge company in a second layer New definition of a wedge company: Special handling in cases where the controlling shareholder in the chain holds less than 33% of the capital Regulation to begin approximately one year after approval of the Committee’s recommendations (Section 3.8): 1.1 One third of the members of the Board of Directors will be outside directors 1.2 The approval of the outside directors by the general meeting will require a majority that does not represent the controlling shareholder or of anyone who has a personal interest

32. 2. Additional recommendations to be completed within 90 days 2.1 At the end of 90 days, the Finance Ministry will present the government with a system of tax incentives for companies that sell assets in the wake of the Committee’s recommendations (Section 3.6) 2.2 At the end of 90 days, the Committee will submit its comments with regard to public companies that are listed for trade abroad (Section 3.4.3)

33. Interim Provisions with regard to Existing Pyramid Structures

34. 3. Control of public companies in the fourth layer and above 3.1 Prohibition of control of a public company in the fourth layer and above (Section 3.5.1) 3.2 Four year transitional period 3.3 Regulation that will commence approximately one year after the Committee’s recommendations about companies in the fourth layer have been approved: • The number of external directors will constitute a majority, less one, of the total members of the board of directors • The approval of the outside directors by the general meeting will require a majority that does not represent the controlling shareholder or of anyone who has a personal interest - Independent directors will constitute a majority on the board of directors 3.4 At the end of the transition period, the shares of the controlling shareholder at the companies that remain in the fourth layer and above, will be transferred to a trustee

35. Control of a public company in the third layer The Committee has recommended that there be no public companies in the third layer in the Israeli economy in the future. In order not to “shock” the economy, the Committee decided to distinguish between existing companies at the third level and new companies (Section 3.4) 4.1 Regulation that will apply to existing public companies in the third layer approximately one year after the Committee’s recommendations have been approved: • The number of external directors will constitute a majority, less one, of the total members of the board of directors • The approval of the outside directors by the general meeting will require a majority that does not represent the controlling shareholder or of anyone who has a personal interest - Independent directors will constitute a majority on the board of directors

36. Corporate governance of all the public companies in Israel

37. 5. Transactions with Interested Parties 5.1 Adopt or disclose the execution of a competitive process prior to the approval of a transaction with an interested party for the sale of an asset, the receipt of operating services, the purchase of a shelf product or of the receipt of a loan (Section 3.9.1.1) 5.2 Authorization and supervision by the Audit Committee of transactions which, although not “extraordinary”, are also not financially negligible (Section 3.9.1.2)

38. 6. Strengthening the position of the minority shareholders 6.1 The Israel Securities Authority and Ministry of Justice will work to set up a platform that will enable investors to vote at general meetings and at meetings of debenture holders by means of the internet (Section 3.9.2)

39. 7. Encouragement of individual enforcement by the shareholders 7.1 The Israel Securities Authority will expand the financing of class actions and derivative claims (Section 3.9.3)

40. 8. Encouragement of Activism of Institutional Investors 8.1 The Committee has proposed examining a requirement whereby an institutional investor will be required to take into consideration the quality of the corporate governance, inter alia, (insofar as no commitment as stated has been regulated by law), in the framework of its investment policy. Institutional investors will also be required to take the granting of loans intended for the acquisition of leveraged control (LBO) into consideration (Section 3.9.4.1) 8.2 It is proposed to require institutional investors to determine “warning signs” that will require taking action vis-à-vis the Committee (insofar as there is no administrative commitment as stipulated by law) (Section 3.9.4.2) 8.3 It is proposed to introduce supervision and regulation of entities that advise institutional investors with regard to voting in general meetings (including from the aspects of eligibility and conflicts of interest) (Section 3.9.4.3)

41. Encouraging Competition

42. Multi-sector Interface

43. 9. Broadening the authority of the Antitrust Commissioner The Antitrust Law should be amended in order to address the problems of competition stemming from a multi-sector interface that is liable to cause the creation of a cartel-like balance in a number of sectors (Section 3.10.1) 9.1 The Antitrust Court will be authorized to enforce changes (structural remedies) in concentration groups 9.2 The imposition of sanctions in administrative enforcement

44. Reducing the Leverage and the Risk in the Economy

45. 10. Restrictions on credit from public institutions 10.1 The Committee supports the limitations on new investments in the capital market sector stipulating that a single issuer, a group of borrowers, the five largest issuers and the five largest groups of borrowers will not constitute a segment larger than 5%, 10%, 20% and 40% of the managed assets of each fund, respectively (Section 3.11.1) 10.2 These restrictions will be reexamined at the end of the transition period and presented to the KnessetFinance Committee (Section 3.11.2)

46. Principal Recommendations • Separation between holdings in significant realand significant financial activity • Separation between the tenure of directors at real companies and financial companies (significantly) • Imposition of structural limitations on incorporation in a pyramid structure • Strengthening the powers of the Antitrust Commissioner in handling concentration groups • Examining the considerations of competition and centralization in the allocation of rights by the State Note: All the Committee’s recommendations were made by a majority vote. There is a minority opinion with regard to a number of sections.

47. The Significance of all the Committee’s Recommendations • More efficient allocation of capital in the economy • Further development of the Israeli capital market • Allocation of national resources from an economy-centric perspective • Increasing competitiveness in the economy • Reducing the system-wide risk Complete implementation of the recommendations will be carried out gradually and will affect the economy in the medium and long range 48

48. Timetable for Implementation • Submittal of final report to the government for approval • Within a few weeks • The complete recommendations chapter that will be included in the final report is attached to the press release • Completion of Legislation • Transfer to the Knesset for legislation immediately after approval by the government

49. Thank you