Regulatory changes by Turkey in 2011 have created a favorable environment for the issuance of Islamic asset backed debt, writes Paul Wouters.
Ibrahim Turhan, the new chief executive and chairman of Istanbul's stock exchange (now Istanbul Borsasi), says he has a special interest in Shariah-compliant securities, the implication being that there should be an Islamic niche at the planned Istanbul International Financial Center, or IFC. It also means that plans for the first Turkish sovereign sukuk will develop with full speed.
The planned third bridge over the Bosporus will trigger the long awaited maiden Sukuk Ijara to be issued in 2012, as has been repeatedly confirmed at high governmental levels. It will be the first European sovereign sukuk.
Here is an excerpt from a Reuters report:
Turkey's government plans its first-ever issue of Islamic bonds this year, overcoming sensitivities about Islamic finance in the secular republic as it seeks to tap a rich pool of investors flush with oil money.
A sovereign sukuk issue from an economy regarded as one of the most progressive and successful in the Muslim world would signal intent on Turkey's part to play a bigger role in Islamic finance. The size of the global sukuk market is estimated at more than USD 100 billion.
"It will be like ringing a bell and attracting all the attention," said Murat Cetinkaya, deputy chief executive for treasury at Kuveyt Turk, an Islamic bank that has been a trend-setter for corporate sukuk issues in Turkey.
"Other issuances will follow the sovereign and Turkey will be on the agenda in this market constantly...as a frequent issuer...
"Turkey could very easily issue a couple of billion US dollars worth of sukuk. It will probably issue USD 500 million or USD 1 billion at first and see how it goes," said Osman Akyuz, secretary general of the Participation Banks' Association of Turkey.
Banks and Other Players
Whilst Kuveyt Turk took the honor of issuing the first two Turkish sukuk (one in October 2010, a three-year USD 100 million Cayman asset based Ijara/Murabaha, and the other in October 2011, a five-year USD 350 million full Turkish partly assed backed Ijara/Murabaha), it continued the momentum and announced the first retail Turkish lira sukuk for 2012.
Previous attempts in November 2011 by Bank Asya (five-year USD 300 million Cayman asset based Ijara/Murabaha) and by Albaraka Turk (five-year USD 200 million full Turkish partly assed backed Ijara/Murabaha) failed due to market conditions.
Though the market was interested in both offers and expected revenues were higher than 6%, both participation banks decide to wait for better times. Both had indicated that they would use the sukuk to raise funds for general purposes, to finance balance sheet activities and to diversify their sources of funding. A recent excellent market report from Is Investment revised the status of the Albaraka Turk shares to 'Outperform with upside potential of 31%'. Both banks have announced that they are up for a second run in the coming months.
So far, neither Turkiye Finans (for the moment loaded with syndicated facilities) nor other financial market participants have entered the sukuk market, but it is not impossible that 2012 might hold a surprise from that side.
Enhanced Regulatory Framework
Regulatory changes by Turkey in 2011 have created a favorable environment for the issuance of Islamic asset backed debt. Tax neutrality measures for the Sukuk Ijara were adopted by the Turkish parliament that reduced the withholding tax on such sukuk to 10% and exempted sales from value-added, stamp and corporate taxes.
This allowed, for instance, the sale and transfer of tangible real estate to an onshore special purpose vehicle combined with some asset-based Murabaha / Ijara elements. Both the successful Kuveyt Turk USD 350 million sukuk and the postponed Albaraka Turk USD 200 million bonds consisted partly of the transfer of their respective head offices with a lease back, combined with other real estate and a mix of receivables.
The available assets increased the safety and attractiveness of the sukuk, whereas in the GCC, various regulatory factors such as high land transfer fees make asset backed deals more expensive and difficult.
Additional legislation exempted sukuk certificates with a minimum tenure of five years from taxes on revenue. Notes with shorter maturities would still be subject to a tax rate ranging from 3% to 10%, putting them on par with non-Islamic Turkish bonds. But since most corporate bond issuance today fits the short term profile, additional efforts would be needed to open the market further.
Turkish Corporates
Abundant opportunities for project finance and non-financial corporate sukuk will likely only be realized after tax regulations become more favorable for short term sukuk (one to three years) and stretch beyond the Sukuk Ijara. These changes would create exciting possibilities for fast and real innovative asset backed structuring.
International ratings might hinder competitive pricing for most corporate SME issuers, while the local market has sufficient liquidity to absorb the demand, larger infrastructure works or specific desire to diversify funding excluded. An expanding Turkish economy or an upgrade of the sovereign to investment grade might offer some additional openings for the bigger, better regulated and subject to enhanced corporate governance 'blue chip' market players.
One should also not forget that some conventional players such as HSBC and Garanti Bank have been offshoring Islamic structuring for their corporate clients for some years now. They might be tempted to confirm their presence with a surprise arrangement.
Evaluation and Prognosis
A volatile Turkish lira, global rising interest rates accompanied by rising Turkish inflation (up into double-digits since 2011, after nearly a decade), and mostly floating interest rates in the market, combined with a historic inclination by domestic and international investors towards Turkish sovereign paper (nearly 98% of the existing market), will probably slightly dampen the relatively nascent corporate bond market and might restrict any corporate sukuk attempt by the large Turkish holdings or extraordinary infrastructure works. Syndicated Murabaha facilities therefore will stay in demand.
Where the upcoming sovereign sukuk is concerned, ratings and present cost of default swaps, next to the usual 'sukuk premium', might result in an expected yield in the range of 5.5%, which could become the benchmark for future Turkish corporate sukuk.
The Turkish Islamic finance market is hungry to prove itself after years of constraint and one or two attempts from Turkish non-financials (most likely industrials or consumer goods) are not to be excluded, provided long term projects are in the pipeline and/or tax regulations are eased.
The entrepreneurial spirit, assisted by a liquid international sukuk market, will certainly trigger some attempts, predictably eyeing GCC investors given the increasing trade volumes.
Turkey's improved ties with the Arab world are encouraging more GCC-based investors and entrepreneurs to seek a foothold in the country with an expanding economy (international predictions project a growth rate of 5% per annum over the next seven to nine years) and with a population of about 76 million people, almost all of whom are Muslim. The sukuk issuances could profit from that enhanced appetite.
In line with the present deployment of the 1991 OIC Trade Preferential System efforts, Turkey's trade with the Middle East and North Africa is said to have surged six-fold since Prime Minister Recep Tayyip Erdogan's party came to power in 2002, reaching USD 30 billion last year.
Although subject to developments on the international markets, the prospects for the Turkish Islamic banks, Islamic financial markets and the underlying real economy are excellent.
With this respect and without diminishing the capabilities of the market competitors, the reputation in corporate finance and investment banking from Kuveyt Turk in the local market is a formidable asset that is likely to pay off. With their specific market position combined with the invaluable, personal experience as present market leader and flawless track record in the local market, Kuveyt Turk repeatedly positioned itself as consultant to Turkish corporates for sukuk. Their properly licensed Dubai DIFC branch only enhances the possibilities.
After nearly a decade in Istanbul, Paul Wouters is now based in Southeast Asia. With focus on Islamic wealth management and deal structuring, he keeps close contact with Turkey and the GCC.
© Zawya 2012
