The Pragma Corporation Financial Sector Initiative Fourteenth Quarterly Report for the Period November 22, 2003 – February 21, 2004

USAID FSI Project: Fourteenth Quarterly Report The Pragma Corporation Financial Sector Initiative Fourteenth Quarterly Report For the Period November 22, 2003 – February 21, 2004 For the U.S. AGENCY FOR INTERNATIONAL DEVELOPMENT GENERAL INFORMATION CTO USAID/CAR Lewis Tatem PROJECT MANAGER Mohammad Fatoorechie CHIEF OF PARTY David Lucterhand ALMATY, KAZAKHSTAN 0 USAID FSI Project: Fourteenth Quarterly Report Table of Contents A. PROJECT OVERVIEW 2 I. PROJECT DESCRIPTION 2 II. SIGNIFICANT EVENTS AND ACHEIVEMENTS 2 III. PROJECT EXECUTIVE SUMMARY 3 IV.PROJECT STAFFING 6 B. FINANCIAL INSTRUMENTS 8 C. PENSION AND INSURANCE 14 D. MORTGAGE 22 E. CREDIT BUREAU / CREDIT RATING AGENCY 30 1 USAID FSI Project: Fourteenth Quarterly Report A. PROJECT OVERVIEW I. PROJECT DESCRIPTION The Pragma Team works with the Kazakhstan Stock Exchange (KASE), the National Bank of Kazakhstan (NBK), the Pension Regulatory Body/State Accumulation Pension Fund (SAPF), the Ministry of Labor and Social Protection, Ministry of Finance, pension fund asset managers, banks, and broker/dealers to implement the Financial Sector Initiative Project. In September 2001, Mr. Rick Gurley, the CTO for the USAID/CAR Mission, approved the Work Plan that set forth the priorities of the Project through its completion date. In August, 2002 Dr. Lewis Tatem became the new CTO of FSI. During the eighth quarterly review, Dr. Tatum approved FSI’s work plan though the remainder of the first option exercise, August 2003. In July, 2003 FSI reviewed its activities and received notification that USAID would exercise its option to have FSI continue. In late August, FSI and USAID mutually agreed on revised expected results. The updated work plan that reflects these revised expected results (for completion during the remaining six quarters) was presented to FSI’s CTO for approval during FSI’s quarterly review (12th & 13th) in December 2003 (See Attachment 1). The priorities of the Project for this period are noted by component in the boxes below. The project update for this quarterly report will correspond to the activities set forth in the action plan described below and reported by component. I. SIGNIFICANT EVENTS AND ACHIEVEMENTS NBK REGULATORY FUNCTIONS TRANSFERRED TO NEWLY FORMED AGENCY FOR REGULATION OF FINANCIAL INSTITUTIONS AND MARKETS (AS OF JANUARY 1, 2004) SUPERVISORY AGENCY GIVES PRELIMINARY APPROVAL TO HEDGING OF FOREIGN CURRENCY RISK BANK TUREN ALEM MORTGAGE COMPANY ISSUES ITS FIRST MBS ASSESSMENT OF INSURANCE SUPERVISION DEPARTMENT FOR NEWLY FORMED REGULATORY AGENCY BEGINS AGENCY FOR REGULATION ADVISED ON SYSTEMIC RISK RE: AFFILITED INSURANCE COMPANIES ACTUARIAL ADVANCED COURSE IV DELIVERED KAZAKHSTAN MORTGAGE GUARANTEE FUND RECEIVES FSI/USAID EQUIPMENT 2 USAID FSI Project: Fourteenth Quarterly Report PRAGMA/FSI COMPLETES VALUATION OF STATE ACCUMULATION PENSION FUND FSI MEETS WITH PRIME MINISTER’S REPRESENTATIVE ON REGIONAL HOUSING FINANCE INITIATIVE FANNIE MAE COMPLETES ASSESSMENT OF KAZAKHSTAN MORTGAGE COMPANY DRAFT CREDIT BUREAU LAW SUBMITTED TO MAZHILIS IN DECEMBER 2003, FSI INVITED TO MAKE MAJOR PRESENTATION TO MEMBERS OF PARLIAMENT NBK SIGNS LETTER SUPPORTING CREDIT BUREAU SHAREHOLDERS MEETING CHAIRMAN OF AGENCY FOR REGULATORY AGREES TO ESTABLISH PRIVATE CREDIT BUREAU FOR CONSUMERS AND SMALL BUSINESS; UPHOLDS CONSUMERS’ CONSENT. FSI HOSTS AMBASSADOR OF ISRAEL, EDP AND USAID REPRESENTATIVES FOR PROGRAMATIC DISCUSSIONS FSI MEETS OPIC REPRESENTATIVE FSI MEETS MBIA REPRESENTATIVES III. PROJECT EXECUTIVE SUMMARY This Report provides details on the events and activities summarized below, as well as other events and activities regarding the USAID Financial Sector Initiative, as implemented by consultants for The Pragma Corporation (the Project), for the period from November 22, 2003 through February 21, 2004. The report is comprised of four components: Financial Instruments, Pension/Insurance, Mortgage, and Credit Bureau/Credit Rating Agency. Each component section of the report will have a summary with specific activity tasks identified and the status of each task with appropriate commentary, relevant attachments, and reference to administrative issues, if any. Financial Instruments In February, Azamat Djoldesbekov, President of KASE, and Pragma/FSI representatives met with the Deputy Director of the Financial Supervisory Agency to discuss the issue of hedging currency risks in the pension fund system. At that meeting, FSA gave tentative agreement to allowing pension funds to use the KASE futures contract, provided (1) pension funds themselves expressed some interest in using the dollar futures contract and (2) Pragma/FSI would develop the methodology for determining and reporting the amount of currency risk in pension fund portfolios. 3 USAID FSI Project: Fourteenth Quarterly Report BTA Mortgage, the mortgage lending subsidiary of Bank Turen Alem, issued its $3.0 million pilot mortgage-backed security during February 2004. The issue is a tenge-denominated un- indexed three-year maturity with an embedded put-call feature that allows semiannual re-pricing. This is the second issue of a MBS by a financial institution other than the Kazakhstan Mortgage Company. By the end of the quarter under review, cumulative corporate bond issuance in Kazakhstan stood at $1.24 billion of cumulative issuance this year with $716 outstanding excluding MBS. KMC issuance now stands at $108 million. The KMC has conducted bi-monthly auctions for the purpose of ensuring predictability to investors and maintaining sufficient liquidity for the purchase of new mortgages. Currently, the weighted average maturity of outstanding corporate bonds is 5.7 years and the weighted average yield to maturity (YTM) 7.4 percent per annum. Insurance/Pension The Association of Insurance Industry Participants was registered in January 2004. Insurance companies that are affiliated to banks are offering mortgage insurance or down payment insurance. While this is legal under current Kazakh law, using a non-credit insurance (“civilian responsibility”) to insure a credit product (mortgage) represents a serious deviation from prudential fiduciary norms of both insurance and banking. If allowed to continue, this could jeopardize the soundness of both the banking and the insurance industries in Kazakhstan. The practice is outlawed in virtually all developed economies worldwide. In September, the Government of Kazakhstan reiterated its interest in privatizing the State Accumulation Pension Fund. In response to the statement, the National Bank of Kazakhstan changed the prudential norms, which had governed the SAPF’s investment policies since its inception, to those which now govern the investment policies of private pension funds. At the direction of the National Bank, the management of SAPF also approached Pragma/FSI with a request to value the fund for sale. In the first quarter of 2004, the GOK publicly announced its decision to privatize the SAPF. Pragma/FSI’s completed valuation will provide the Government with an independent, third party assessment of SAPF’s value as an ongoing concern. Potential buyers, whether domestic or international, will in the course of their due diligence undertake their own valuations. Concurrent with its completion of the valuation, Pragma/FSI received its semiannual visit from Jonathan Woollet, EBRD’s Director of Non-Bank Financial Institutions Operations in London. The EBRD has long expressed an interest in investing in SAPF when the decision was finally taken to privatize it. Pragma/FSI assisted EBRD in arranging a meeting with the Governor of the National Bank of Kazakhstan to discuss EBRD’s possible participation. SAPF is currently a wholly owned subsidiary of NBK. 4 USAID FSI Project: Fourteenth Quarterly Report Mortgage The Kazakhstan Mortgage Guarantee Fund (KMGF) continued preparing its legal guidelines in cooperation with Pragma/FSI’s legal staff and refining insurance products for ultimate sale. Additionally, and related to KMGF and the varying kinds of mortgage guarantees the fund would offer, FSI prepared a paper for the Agency for Regulation that directs attention to systemic risk banks present to when having affiliated insurance companies offering mortgage insurance. In the event of a real estate market meltdown, bank exposure through affiliates can result in massive losses i.e. consolidated balance sheets. Please see the related insurance component executive summary. Pragma/FSI’s consultants from the Institute for Urban Economics continued technical assistance to local and regional banks that cooperate with the Kazakhstan Mortgage Company (KMC). Their emphasis included a review of compliance with KMC underwriting standards and efforts for improvement. One structural weakness identified in a KMC roundtable with originating banks was the lack of confidence in independent appraisals. This condition, in turn, has led to banks using their own appraisers. This lack of confidence derives from different appraisers using non-standard methodologies. FSI plans to remedy this deficiency by undertaking a series of roundtables with independent and bank appraisers participating together in order to agree on a standardized approach all appraisers can use to ensure acceptability. Other roundtable findings include unprofessional sales practices. FSI is considering the introduction of licensing requirements for all real estate sales persons. An assessment by FSI staff of real estate selling practices is currently underway. FSI/USAID received a request from the First Deputy

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