The Saudi Arabian Legislative Spring has seen the issuance of the long-awaited Mortgage Law and other significant new legislation. The legislative environment in the Kingdom is being prepared for the emergence of mortgage-backed securities and the consequential development of the insurance sector.
The Saudi Arabian Legislative Spring – towards an insured securitisation
The long-awaited Saudi Mortgage Law has been passed by the Saudi Arabian Council of Ministers and is accompanied by four new laws relating to the real estate finance sector. Inevitably this has led to the publication of numerous articles commenting on the anticipated increase in demand for property insurance. However, such commentary reflects an intuitive reaction to the shock of the issuance of a law that was not expected to be released so soon. It is clear from this legislative activity that it is misleading to consider the Mortgage Law on its own. A more measured assessment of all of the new laws would suggest that the Kingdom is seeking to develop a securitisation model for the Saudi market; albeit, accompanied by a revolutionary growth in the insurance market.
While several Arab countries were busy in an Arab spring of governmental and political restructuring, the Saudi Council of Ministers has been busy issuing regulations aimed at serving the needs of the Saudi population. In one meeting on 01 July 2012 the Mortgage Law, the Financing Lease Law, the Enforcement Law, the Real Estate Financing Law and the Law on Supervision of Real Estate Financing Companies were issued. In addition, the Council issued an amendment to article 5 of the Capital Market Law allowing Authorised Persons (APs) (i.e. licensed financial institutions) to establish special purpose vehicles (SPVs).
Observers have portrayed the Mortgage Law as a solution for the social, economic and legal obstacles experienced by the Saudi real estate sector. The Mortgage Law will also boost the insurance industry (life insurance typically being a prerequisite for real estate financing) and it is expected to resolve the housing difficulties of around 2.3 million Saudi nationals by resolving the current housing problem in KSA within a period of 10 years. However, the total package of the laws is perhaps even more promising for the insurance sector than initially expected. Put simply, by creating the potential for the securisation of mortgage portfolios the laws result in a massive new area of insurable risks.
The New Laws
As the Implementing Rules of the new laws have not been issued / published yet, many of the details of the laws remain outstanding. However, based on the publically available material, the significant characteristics of each of the laws are as follows:
The Mortgage Law
- establishes the regulations for the financing of real estate or movables by setting criteria that are intended to protect the creditor, the debtor and any guarantor in a transaction;
- includes a description of the assets that may be mortgaged and the procedures and conditions for placing and cancelling a mortgage; and
- specifies the rights and obligations of the parties to a mortgage agreement, including and not limited to the handling of the mortgaged property during the term of the mortgage and third party rights existing prior to the mortgage.
The Financing Lease Law
- provides for a financing structure that may be provided by joint stock companies that are specialised in financing leases to enable the beneficiary to benefit from all the real estate and movable assets and the moral rights in a lease structure;
- allows a beneficiary an opportunity to own the asset / right;
- regulates the practice of activities of financing lease in order to limit the risks on the parties participating in a financing lease transaction, and prohibits certain practices that are perceived as having a negative effect on the financial sector; and
- the supervision and monitoring of the financing lease sector is to be undertaken by the Saudi Arabian Monetary Agency (SAMA).
The Real Estate Financing Law
- establishes a market for the real estate financing to be provided by specialised joint stock companies in association with real estate developers (and provides for the possibility of refinancing);
- allows beneficiaries to own properties pursuant to financing by companies under the supervision of SAMA (who is mandated to regulate the fairness of the transactions and safeguard the financial system;
- ensures a high degree of transparency through required disclosures; and
- supports the development of the real estate financing by dedicating a portion of the budget of the Saudi Real Estate Development Fund (SREDF).
The Law on Supervision of Real Estate Financing Companies
- regulates setting up and licensing of real estate financing companies and their products and sets the standards for such activities including and not limited to the capital adequacy requirements, the limit of credit concentration and the amount of reserves;
- allows the practice of financing activities for real estate, small- and medium-size investments, credit cards, consumer finance and microfinancing;
- prohibits real estate financing companies from engaging in activities other than their licensed activities, including trading in real estate and movables or accepting deposits, whether directly or indirectly; and
- assigns the monitoring and supervision of such companies to the SAMA.
The Enforcement Law
- Ends the delays in enforcement of judicial decisions;
- Governs the settlement of enforcement disputes, the issuance of enforcement related orders and decisions and the evidencing of illiquidity;
- Fortifies the role of the enforcement judge by binding the relevant authorities to cooperate with his requests;
- Specifies the enforceable documents, the assets that may be subject to enforcement and the rules of attachments and seizures;
- Sets the procedures for provisional seizures, execution attachments and attachments in matters of personal status;
- Provides for imprisonment in case of noncompliance with the enforcement; and
- Establishes a specialised body for enforcement at the Ministry of Justice to monitor some of the enforcement activities that are assigned to the private sector.
The Insurance Opportunity and Securitisation
Property insurance and protection & saving insurance (the Shari'a compliant life insurance product) will inevitably be prerequisites required to be purchased by the borrower in order for the bank to approve any lending. We therefore expect growth in these classes of insurance. However, the laws also create an additional opportunity: securitisation. In this regard, it is unlikely that Saudi banks and real estate financiers (influenced by western practices) will be prepared to bear the liquidity risk associated with such loans (whereby they would be required to await the repayment of the loan over the life of the mortgage financing, or in appropriate cases, to seek to recover the costs of the financing from the local insurance companies). Instead, the financier will seek to package up their mortgages utilising securitisation models to generate income.
The securitisation model is well recognised in the West and, indeed, has been highlighted as a cause of the global financial crisis in 2008. In essence, they involve a financier contracting with an AP to establish an SPV. The SPV acquires a mortgage portfolio from the financier and issue to investors securities backed by the receivables of the mortgages. If all the underlying loans and dealings are Shari'a compliant, the issued securities will likely be in the form of sukuk. If not, they will be conventional mortgage-backed securities. The purchase price paid by investors in return for the mortgage-backed securities is used to finance the SPV to purchase the securitised assets.
In addition to the mortgage financing, the SREDF will also be extending a tranche of the real estate financing. Any loan made by the Fund will be subordinate to the mortgage financing, but will also be secured by the financed real estate asset. We anticipate that the SREDF will also seek to avail itself of the benefits of securitisation. In this regard, the SPV becomes a pool of senior as well as subordinated loans that will be converting into cash within their respective terms.
Financial Guaranty Insurance
The growth in securitisation resulting from the development of the Saudi mortgage market will also require financial guaranty insurance for many purposes, including the enhancement of the credit rating of the SPV and their securities. However, such insurance products are usually provided by specialised insurance companies, known as "monoline" financial guaranty insurance companies which do not currently exist in KSA. Further consideration of this sector of the industry is needed by the insurance regulator, SAMA, and it remains to be seen how it will regulate and license such financial guaranty insurance products.
In addition, insurance companies will have a greater opportunity to market professional indemnity and, potentially, directors & officers' liability insurance for all entities playing a role in the mortgage market, including the banks and financiers, advisors and the APs involved in the securisation process. SAMA will also need to be careful to monitor the role of brokers and other intermediaries involved in the marketing the insurance products related to the real estate sector.
Does the judicial environment assist the insurance evolution?
The package of laws relating to the mortgage market does provide for judicial initiatives to facilitate the resolution of disputes. For example, the Law on Supervision of Real Estate Financing Companies provides for the establishment of the Committee for the Resolution of Financing Disputes and Violations with jurisdiction over all disputes arising out of the application of the provisions of the Law on Supervision of Real Estate Financing Companies and the Financing Lease Law and the relevant implementing rules and circulars. This is accompanied by an amendment to the Banking Disputes Committee (previously known as the Committee for Resolution of Banking Disputes) which has jurisdiction over all disputes relating to banking and financial instruments that include asset-backed securities.
However, notwithstanding these developments it remains likely that the disputes arising out of the insured mortgage-related dealings will be subject to dispute of jurisdiction of a range of judicial authorities in KSA, especially where insurance companies elect to exercise their rights of subrogation. There are also concerns in some quarters that the decisions rendered by the Committee for Resolution of Insurance Disputes and Violations are unreasonably pro insured.
In light of the above concerns, there are still many grey areas in the Saudi mortgage industry which increase the risk of insurance companies. How will the regulators and judicial authorities detect fraud in the mortgages and the resulting financial instruments? What effective measures will be taken to prevent such fraud? How will the judicial system be managed to prevent holding the insurance companies liable to pay the mortgages on behalf of the Saudi population?
No doubt many more questions and issues will arise following the application of the new laws. That there is great opportunity for the insurance industry is undeniable. But only when the new laws are implemented will the true results show.
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