Turkey is attempting to unlock Sukuk's potential in its market, writes international law firm White & Case

As a fast growing emerging market and a major economy with its unique geostrategic position as the bridge between Europe, the Middle East and Asia, Turkey has a mature Islamic finance industry that aims to win a bigger slice of the global Sukuk market. As Turkey seeks to overcome a year fanned by a series of political events, its Government is determined to triple the share of participation banks—banks that operate in accordance with Islamic law—in the country by 2025. The vision, if successful, will make Istanbul a financial hub for Islamic finance, regionally and globally.

While steps to establish participation banking were undertaken as early as 1985—through the incorporation of Kuveyt Türk and Albaraka Türk—the success of interest-free banking model was limited due to the lack of regulatory framework. However, as Sukuk gained popularity both within and outside of the Islamic world, the 2010-2015 period saw Islamic finance in Turkey growing significantly, underscored by new regulations in participation banking. The first Turkish Sukuk was issued in 2010 in the form of asset-based instruments known as certificates.

A further critical catalyst to the success of Islamic finance in the country was the introduction of public finance law and amendments to tax legislation in the years that followed. As a result, it issued eight sovereign Sukuk with an approximate total value of $7.71 billion, and numerous private issuances with an approximate total value of $4.07 billion—all between 2011 and September 2015.

The most common Sukuk structure in Turkey is Ijarah. Under the practice, the entity seeking to raise funds establishes a special-purpose vehicle (SPV) for the sole purpose of issuing lease certificates, and then transfers the underlying assets to the SPV. The SPV then leases these assets back to the entity and issues lease certificates based on the proceeds of the lease. In addition to the Ijarah structure, the Capital Markets Board (CMB) in 2013 introduced new permitted Sukuk structures, including Mudharaba, Murabahah, Musharakah and Istisnah.

Commenting on the development if Islamic finance in Turkey, Derin Altan, Partner at White & Case’s Istanbul office said, “Turkey has gone from strength to strength in the past few years and has become a model for the world in interest-free banking. This is supported by the Government’s strategy of increasing the market share of participant banking from around five to 15 per cent by 2025, which would make Turkey an important player in global Sukuk market.”

On a larger scale, Turkish corporations and the Government are likely to step up its use of Islamic finance structure to fund public and public-private partnership (PPP) infrastructure projects, mainly airports, ports, bridges, highways, energy facilities and other transportation-related infrastructures. As of December 2015, Turkish corporations required additional financing of $350 billion in order to complete a backlog of projects planned through to 2023—some or all of which could be provided by Islamic financing.

Altan added, “Despite the viability and prominence of the Turkish Sukuk market, there have been only a handful of domestic corporate Sukuk issuances other than participation bank issuances. As of June 2016, no international corporate Sukuk have originated from Turkish issuers other than banks. However, certain participating banks appear to be laying the groundwork for such issuances by incorporating a separate asset leasing company (ALC) for third-party issuers.”

Globally, corporate Sukuk issuances constituted 36 per cent of the total volume of international Sukuk issuances in 2014, and 39 per cent of the volume in 2015. Participation by new players—especially the governments of the UK and Luxembourg, both rated AAA by Standard & Poor’s—has been warmly welcomed by other market participants as sovereign participation in Sukuk issuances pave the way for corporates to follow through.

Looking ahead, the first Turkish corporate to successfully issue an international Sukuk will inevitably need to overcome certain hurdles. However accommodating as regulators may be, these speed bumps create uncertainty that must be reflected in transaction timetables and cost estimates—a challenge in current global capital markets where favourable issuance windows appear and then disappear in the blink of an eye.

Encouraged by the broadened stamp tax, VAT and duty exemptions encompassing all types of Sukuk transactions, market players would likely be more willing to diversify their issuance structures, paving the way for a deeper Turkish Sukuk market.

The CMB, Borsa İstanbul and other governmental authorities in the Turkish financial markets appear to be extremely willing to encourage growth in the Sukuk and Islamic finance markets in Turkey. To achieve this, regulators should welcome and accommodate any commercially and legally reasonable Sukuk structures, even if doing so requires further
legislative amendments.

As the relevant regulators have made clear, any amendment to regulations to accommodate a specific type of Sukuk would first require a proposed transaction that can be presented to regulators for their review and consideration. Feedback and participation from all market players—including but not limited to banks, corporates, arrangers, law firms, other advisors and investors—will be key to shaping the future of the Sukuk market in Turkey.

© Islamic Business and Finance 2016