Turkey did not have an easy 2013, economically or politically. But the country took important steps in introducing Islamic finance — even as prime minister Recep Tayyip Erdoğan sparked fierce protests because of his perceived Islamist agenda.
These bold strides illustrate the country’s growing confidence in the asset class and the importance of this young but fast growing sector to its economy.
Turkey built upon its international and domestic Islamic debt curve in 2013 with dollar and lira sukuk. It also saw all four of its participation banks bring deals — three of which were debuts. Meanwhile, the government introduced legislation to enable wider sukuk issuance — helping open up the possibility of corporate deals in 2014.
Turkey is seen by many Islamic finance practitioners as a key prospect if the market is to consolidate and build upon its gains of the last few years. In this regard, Turkey has both strategic and geographical value as a gateway between the Gulf, Europe and Malaysia.
“As one of the G20s, Turkey’s adoption of Islamic finance would further cement the growing importance of Islamic finance globally,” says Mohamad Safri Shahul Hamid, deputy chief executive officer at CIMB Islamic in Kuala Lumpur. “For the industry to grow, it needs to be embraced by new players beyond the Middle East and Malaysia. Turkey is one of the premier emerging economies and, given its strategic position and location, could potentially become one of the most important hubs for Islamic finance in the near-to-medium term.”
Turkey’s deep, diversified market, decent growth projections and majority Muslim population of nearly 80m all lend themselves to this view. Its leading industries also fit well with Islamic finance — in particular construction, financial services, insurance and manufacturing.
“It is a tremendously exciting market for Islamic finance because it has a large Muslim population and a developed economy which provides huge scope for growth,” says Farmida Bi, partner at law firm Norton Rose Fulbright in London.
Government leads way
In October, the Turkish Treasury issued its second, $1.25bn dollar-denominated sovereign sukuk. The five year note built upon the $1.5bn 5.5 year debut it brought in September 2012. Turkey also brought TL1.9bn ($973m) of two year supply for domestic investors in August, again adding to the TL1.6bn of two year paper it sold in October 2012.
By coming with a slightly smaller size than the aggressively priced 2.803% first issue, Turkey avoided the criticism it got from some of the debut’s investors at the time for being too large. At 300bp over mid-swaps, the new dollar deal was priced inside the 305bp over mid-swaps trading level of its March 2018-dated sukuk, but was outside the 275bp level of Turkey’s March 2019 conventional bond.
Leads noted that Turkey’s ascent to investment grade in 2013 helped it achieve a bigger and higher quality book than for its debut sukuk. The notes drew $7.7bn of orders and also performed better in secondary markets than the March 2018 debut, rising 0.5 points above par on the break and to 102.5 in its first week — compared to a two point fall for the original.
The October 2018 second sukuk was quoted at 101.50 in December, while the debut March 2018 was at 95.25.
Mentor to Europe
Having established itself as a practiced sukuk market borrower, Turkey is likely to influence the issuance strategies of European countries — in particular the UK, which plans to bring a £200m debut in its next financial year.
Turkey itself came to market having spent 10 years deciding whether or not to issue a sukuk. In doing so, it conducted research, took advice from pioneers like Malaysia and traversed many of the ideological obstacles that European countries might face in bringing a first sovereign issue.
Recently, market sources told EuroWeek that the UK Treasury had asked its Turkish counterpart to help it navigate the practicalities of issuing sukuk — such as finding suitable assets, requesting proposals from advisers and ensuring a close price with conventional Gilts.
Turkey has already played a role in guiding Egypt to put together its sukuk issuance plans. Those have so far fallen flat, however, after Egypt’s military ousted Islamist president Mohamed Morsi in early July.
A framework to participate
According to Jaseem Ahmed, secretary general of the Kuala Lumpur headquartered Islamic Financial Services Board, Turkey is putting in place the building blocks to support a broad-based Islamic finance industry that is both stable and resilient. This includes its focus on strengthening the legal underpinnings of its national industry, its integration of Islamic finance into the public expenditure framework and its commitment to a sovereign sukuk programme.
“In terms of stability and resilience, which is the principal mandate of the IFSB, Turkey is noteworthy for its clear public policy stance in support of the industry as well as co-ordinated action between policymakers and the relevant regulators focusing on resilience,” says Ahmed. “This is both desirable and necessary in today’s global environment of heightened vulnerability to external shocks and rapidly shifting risk perceptions.”
As well as deepening its Islamic debt curve in 2013, Turkey developed its regulatory framework for issuance. Before June, Turkey’s regulations only supported the issuance of ijara (leasing) sukuk, but that month the Capital Markets Board introduced new rules to open up the use of five other structures — istisna, mudaraba, murabaha, musharaka and wakala.
This will allow borrowers much more flexibility in coming to market. It is of great potential benefit to Turkey’s participation banks — a sector that some believe will grow faster than conventional counterparts. The Participation Banks Association of Turkey (TKBB) predicts that participation bank market share will rise from 5% in 2013 to 15% by 2023.
April saw Albaraka Türk issue the first ever murabaha subordinated sukuk — a 10 year non-call five — and become the last of Turkey’s four participation banks to bring a dollar Islamic deal. That came closely after Türkiye Finans was the country’s first bank to issue a benchmark size $500m.
In November, Kuveyt Türk — which opened Turkey to sukuk in 2010 and 2011 — brought TL150m of one year domestic notes, a door-opening first for a participation bank.
“Participation banks expect to be more active players, especially in the Turkish lira sukuk market, in the very near future,” says Cenk Karacaoglu, vice-president in fixed income at Bank Asya, which itself issued $250m of 10 year non-call five subordinated notes in March.
Prospects are high that Turkish state banks will look to open Islamic business units in the coming year. For example, Ziraat and Halkbank are looking at breaking into the sukuk and covered bond markets as part of an effort to diversify away from deposit funding.
“2014 will be a great year because it is expected that some parts of state owned banks will act as Islamic banks in Turkey,” says Karacaoglu. “This will be helpful for introducing Islamic banking instruments to a wider group of people.”
Participation banks need more foreign investment to continue growing, however, according to Standard & Poor’s. The rating agency said in November that over the next 12-18 months the sector will likely consume the additional capital cushion stemming from tier two issuances. Therefore, further market gains would hinge on fresh capital.
The Turkish Islamic market will really come of age when a wider array of borrowers issue sukuk — something that could happen in 2014.
“The Turkish market is familiar with structured capital markets transactions and I would hope to see Shariah compliant equivalents of these in the next year,” says Bi. “Sukuk issues from corporates would also be a welcome development.”
For example, sukuk has been earmarked as a major part of the $350bn infrastructure financing plans for Turkey’s redevelopment and construction company Ağaoğlu has said it may issue up to $2bn of sukuk to help build the new Istanbul Finance Centre.
A deepening primary market should in turn give more scope for investors in Turkey to set up dedicated funds.
“The country’s plan to adopt Islamic finance in a more aggressive manner would not only benefit participation banks but also the people in a predominantly Muslim nation,” says Hamid at CIMB Islamic. “I’m confident that segments such as asset management, treasury and capital markets will find their way into the system sooner rather than later.”
Turkey is an untapped market for Islamic investment funds, but could establish itself as a popular marketplace for businesses to raise money.
“Turkey’s Islamic funds sector is at a very nascent stage, but with opportunities aplenty,” says Omar Selim, chief executive officer of Arabesque Asset Management in London. “It is expected that Turkey will in 2014 introduce a new regulation enabling the establishment of funds with no interest bearing securities.”
Turkey’s private pension scheme includes a state-contributed 25% of the pension to participants each month, adds Selim. Interest-free pension funds have gained momentum quickly since 2008, when Turkey lifted the requirement to hold at least 30% of Treasury bills in investment portfolios.
As such, Turkey looks good for sukuk issuance in 2014, but investors will hope that its economy has a smoother ride than in 2013. The protracted emerging markets bond sell-off that began in May was compounded in Turkey by the country’s own political upheaval in June and July.
Turkey is, however, positioning itself for increasing trade. It hopes its new financial district — scheduled to be completed by 2023 and part paid for through sukuk — could help establish Turkey as one of the world’s lead trading hubs. Islamic finance is sure to be a beneficiary of this long term strategy.
Borsa Istanbul head İbrahim Turhan has said that the stock exchange wants to become one of the leading centres for non-interest finance and participation banking. He says Istanbul seeks a comparable prominence for this in EMEA as Malaysia enjoys in East Asia.
“Turkish players can help bridge the gap between Asia, Europe and Middle East given its strategic location,” says Hamid. “Its economy has been thriving in the last few years and, despite a slight setback last year, I’m optimistic the country will get its act right where Islamic finance is concerned.” s