Thanks to forward-thinking regulation, the Turkish capital market is one of the most innovative in the world but, in terms of volume, it is still relatively undeveloped. Can a government initiative to make Istanbul a leading international finance centre marry this world-class innovation with volumes that will see it compete with the likes of London and Dubai?

Turkey’s financial market is a market with vision and innovation. While the government is pressing ahead with plans to create an international financial centre in Istanbul, Turkish issuers have broken new ground in the international arena – and favourable legislation could bring even more innovation.

Şekerbank, the country’s 16th largest lender by Tier 1 capital, was the first bank in the world to issue a covered bond backed by a pool of small and medium-sized enterprise loans. The deal was sold in an international private placement in 2011. It was followed by similar deals by Turkish banks Denizbank and Yapı Kredi, but it was 18 months before this type of deal was replicated outside of Turkey, in a transaction by Germany’s Commerzbank.

Such a global first was possible thanks to Turkey's sophisticated national legislation, which is supportive of new instruments, says Müge Ekşi, head of capital markets advisory at Yapı Kredi Yatırım, the investment banking arm Yapı Kredi. She says that there could be more innovation to come, as not everything allowed by legislation has been issued in the market yet.

“The capital markets board has done a lot of work on covered bonds, on equity linked, unsecured and asset-backed securities [ABS], and equity-linked legislation looks good, too,” she says.

Domino effect

For years, the Turkish market has issued future flow ABS – structured products for banks that securitise cash flows that they know they will receive in the future. The market for future flow ABS collapsed after the global financial crisis, but this year some large transactions have been done with long maturities of 18 to 20 years.

“These deals are another sign of the innovation that is possible in Turkey and, in terms of the product diversification, compared with a lot of other markets, we are advanced,” says Ms Ekşi.

Yapı Kredi Yatırım, which is part-owned by Italian bank UniCredit, is uniquely placed to offer both domestic and international products to investors and issuers and is working across both markets, which, according to Ms Ekşi, are growing in parallel for Turkish borrowers.

“Turkey was upgraded [by Fitch in 2012 and Moody’s in 2013] and currently enjoys two investment-grade ratings, which gave blue-chip companies more confidence that they could obtain sufficiently high ratings to access the international markets,” she says. “And they saw that they could achieve, on a senior unsecured basis, large-sized bullet maturities at very attractive costs.”

Beverage company Anadolu Efes was the first investment grade-rated Turkish borrower to access the international bond market with its $500m 10-year bond in April 2013. Since then, the international Eurobond market has grown more popular among Turkish issuers, including household appliances manufacturer Arçelik, which issued the country’s first euro-denominated Eurobond in September 2014.

Banks, meanwhile, have issued Basel II-compliant bonds in the past, and are awaiting regulatory approval to start raising Basel III-compliant subordinated deals, according to Ms Ekşi. Some are also looking to sell Turkey’s first mortgage-backed covered bonds.

Transformation phase

While sophisticated, the local market is still in its infancy. With maturities of two to three years, the Turkish market offers significantly shorter duration than the international market’s five, seven or 10 years. But even this marks a significant advance from the six- and 12-month maturities that it was limited to in the past.

Local deals are denominated in Turkish lira and usually come in floating rate form. Sizes are smaller than in the international bond markets, where the minimum size is Tl1.12bn ($500m), but the Turkish banks have started to use the market very actively and are issuing benchmark transactions of Tl500m to Tl1bn.

The government launched its ‘Istanbul as a Financial Centre' initiative in 2009 and with it aims to boost the city’s profile as an international trading hub. Since then, a lot of changes have been made.

“We are passing a transformation stage in terms of capital markets,” says Çağlan Mursaloğlu, deputy CEO of IŞ Investment. “The capital markets law has been changed, and Borsa Istanbul has partnered with Nasdaq OMX and is adapting its technological infrastructure to comply with world exchanges’ technical specifications.”

Borsa Istanbul, which is the new name of the merged Istanbul stock exchange and derivatives exchange, will offer its own shares to the public within the next two years.

“Istanbul is the trade, manufacturing and financial centre of Turkey, and is the centre for the economy at the crossroads between Asia and Europe,” says Simin Oz, CEO at Erste Securities Istanbul. “However, becoming the financial centre that the government is targeting, that is a massive undertaking. In the global financial centre indices Turkey now ranks 47th out of 77 cities. The initial aim is to become a regional hub and to eventually develop it further into a financial centre similar to London, New York or Dubai.”

Setting a global benchmark

In an effort to boost the project’s development, new legislation to improve the rights of minority shareholders and increase transparency and accuracy in corporate governance has been passed, as well as new regulatory requirements for brokers.

“Changes have been made to align Turkish capital markets with EU laws and international norms,” says Ms Oz. “Separately, the capital markets board has introduced capital adequacy requirements for brokerage houses, which means that they will now be tiered in terms of their capital structure and in terms of their operational focus.”

To be issued a full licence, which allows firms to undertake the full spectrum of brokerage activities, including initial public offering (IPO) underwriting, corporate bond issuance, trading and custody services, firms now need to have at least Tl25m of equity. A partial licence – which allows for the execution of orders of some investors, only best-effort IPOs, and limited custody services and portfolio management – is only granted to firms with a minimum of Tl10m equity. A limited licence requires Tl2m and allows for the reception and transmission of orders as well as investment advisory. The requirements came into effect in July this year, with a transitional period of one year.

Consolidation calls

Erste Securities Istanbul is a fully authorised broker, which started its operations in Turkey in 2010, after acquiring the licence of Lehman Brothers Menkul Değerler as well as its offices. Erste works with institutional investors, both local and international, and covers about 85% of the Turkish equity market with its research.

“We are comfortably in the threshold to continue with the operations and services we are providing at the moment, and we will continue to do so,” says Ms Oz. “However, for the sector it has had some consequences, as there are nearly 90 brokers in the market and, eventually, some of them will fall if they don’t go for a capital increase, which could lead to some consolidation in the sector.”

The country’s brokerage firms do the bulk of their trading with private individual clients (60%), while domestic institutional investors only take up about 8% of the trading volume, according to IŞ Investment data. Foreign individuals, corporations and investors make up about 21% of the volume, while foreign investors actually hold the majority of Borsa Istanbul’s market capitalisation.

“The average investor holds shares for about three hours – so it is intra-day buying and selling, mainly by domestic individuals,” says Ms Mursaloğlu. IŞ Investment is the market leader in trading volumes in Turkey, she adds, but due to the fragmentation in the brokerage market, it only has a market share of 8% to 9%.

Most actively traded are foreign currencies, according to IŞ Investment, which have seen trading volumes more than double from 2012 to 2013 to Tl5000bn, while all other markets saw their volumes increase at a slower rate. The equity market saw Tl1600bn move hands in 2013, compared to Tl775bn in 2007.

Investor interest

At the end of 2013, 405 companies were listed on the stock exchange in Istanbul – 18 of which had done an IPO that year. Meanwhile, bond issues were the product that most investment banking clients were interested in. From a volume of Tl1.9bn issued in 2010 to Tl17.8bn the following year, corporate borrowers, including banks, have raised Tl55.6bn in 2013 – 85% of which was sold by banks, according to IŞ Investment data.

While the bond market is booming and the stock market expanding, the main disadvantage in Turkey’s local market is the lack of institutional investors to support the market’s growth.

“Turkey only has a savings rate of 14% of gross domestic product [GDP],” says Ms Mursaloğlu. “The equity investor base is not increasing well enough and we don’t have international asset managers in the country. To work a functioning international financial centre you need more investors.” Institutional investors only make up about 7% of domestic savings, she adds, while traditional bank deposits take up 55% of Turkish residents’ savings.

“In Turkey, companies don’t have to have pension schemes,” says Ms Mursaloğlu. “Pensions are not mandatory and at 9.5%, interest rates are quite high – as long as the rates are so high for deposits, people often don’t want to take their chances and invest in equities.”

Yet, there is hope that the government’s initiative to give individuals saving in a private pension a 25% state contribution, will see the market increase. The pension market now makes up about $16bn of all assets under management, according to Ms Oz, and she expects to see the number rise to $125bn by 2023, which corresponds to 5.5% to 6% of GDP.

“Some additional reforms on the legal front and the tax front are necessary to become a competitive international financial centre, and we need more product diversification,” she says. “The corporate bond market is there but not yet large enough to make it into what we want to become.”

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