Jonathan Roberts provides an overview of the regulation of Islamic financial products in Turkey following his talk on this subject at City Week 2014.
City Week is organised under a partnership between the UK Government, TheCityUK and City & Financial. The City Week Management Committee, which oversees the project, includes representatives from UK Trade & Investment, HM Treasury, TheCityUK and City & Financial.
In 2000 and 2001, Turkey suffered a domestic banking crisis which meant that a number of banks had to be bailed out. It caused a great deal of damage to the economy. Turkey emerged relatively unscathed from the worldwide recession beginning in 2008, but it nevertheless triggered reform in the state regulation of financial markets.
The Turkish government has sought to become pro-active in seeking to avoid future such crises, whilst also looking to become a larger regional player in the field of financial services. The recent reform to Islamic financial products typifies this trend.
Conventional finance facilitates the flow of capital to investments which provide the highest monetary return, regardless of the implications to society. By contrast, Islamic finance is based on an underlying altruistic rationale intended to produce positive socio-economic outcomes. Extraordinarily, in 2009 the Vatican newspaper (L'Osservatore Romano) praised the ethical principles of Islamic finance.
The most striking characteristics of Islamic finance are the avoidance of interest (riba) and the avoidance of speculation or uncertainty (gharar). Bonds issued on Islamic principles are known as sukuk. These provide the investor with the ownership of a share in an asset which provides security and cash flow (sukuk al ijara). In this way there is no contravention of the prohibition on interest. The lender is rewarded by providing a share in the asset.
Islamic finance is no longer regarded worldwide as merely a faith based financial system. It is now seen as a real alternative to the conventional finance, interest based model. Further, it is perceived that investment in Islamic lending involves less risk and less speculation than the conventional model. If returns on investment can be comparable, that is clearly a useful selling point.
Islamic finance in Turkey
Turkey’s need for inward investment remains considerable in the face of its rapid population growth. The population of Turkey is currently 80 million and predominantly Muslim. Turkey is keen to attract capital from the highly liquid Gulf region.
Turkey has historic links with many Islamic countries in the Balkans, Africa and the Middle East; its proximity to Europe also provides access to the EU. Its geographical position and time zone give Turkey many advantages in achieving its aim of becoming a centre for Islamic finance in the region. To that end, the World Bank has located its Global Islamic Finance Research Centre in Istanbul; the Islamic Financial Centre has been set up with the intention to making Istanbul the hub of Islamic finance.
Although the Islamic friendly AKP (Justice and Development Party) has been in power since 2002 little was done initially to promote Islamic finance apart from the passing of Banking Law 5411 in 20061. In 2010 the government created a framework for corporate sukuk. This was announced by the Capital Markets Board and enabled the creation of sukuk al ijara (otherwise known as lease certificates, or a share in ownership of an asset). Sukuk al ijara could be traded on the exchange and issued by banks and are equivalent to corporate bonds.
In August of the same year Kuveyt Türk (one of the Participation Banks) issued Turkey’s first sukuk (a public loan of US$100 million). Hitherto the Participation Banks had been relatively small banks with a very limited business providing services to a predominantly religious customer base. In 2011 the Istanbul Stock Exchange issued the first Participation Index. This index included all equities in Turkey which adhered to the principles of Islamic Funding. Later that year the Turkish Parliament passed legislation promoting Islamic Finance. The Bill on 29 June 2012 authorised the Treasury to issue sukuk al ajara (in this case Government Bonds).
This had constitutional ramifications, as the government action potentially breached of Article 2 of the Turkish Constitution which guaranteed secularity. A supposedly secular government was issuing financial bonds which embodied religious precepts. However this action by the government was not challenged in the courts.
The key difference between Bonds and Sukuk
Conventional bonds are contractual debt obligations but the holders of sukuk own a specific asset which is leased or rented to the borrower. The investor gets rent rather than interest. Sukuk bonds fit in with traditional Turkish industry such as construction, finance, insurance and infrastructur. It all these cases there is an identifiable asset a share of which the sukuk holder can own.
New forms of sukuk established
Progress has continued apace. In September 2012, the first dollar denominated sovereign sukuk was issued in the amount of US$ 1.5 billion. There was a second issue in 2013 in the amount of US$ 1.25 billion. In October 2012 the first lira denominated sovereign sukuk was issued for US$ 9.04 million.
In March 2013 the Deputy Prime Minister Ali Babacan set in motion the establishment of two new state-owned Participation Banks: one a subsidiary of Ziraat Bank, the other a subsidiary of Halk Bank. In the same month another Participation Bank, Bank Asya issued the first Turkish lira sukuk out of Turkey. In July 2014 a Mutual Fund Regulation will come into force enabling the issue of collective investments consisting of securities which do not pay interest. Tax law in Turkey now favours Islamic compliant instruments with corporate tax, income tax and VAT exemptions.
On 7 June 2013, a change in the law took effect enabling the issue of alternative forms of sukuk in addition to the existing sukuk al ijara. The new types of sukuk made available are as follows:
- Sukuk Al Istisna (Islamic Project Bond) - This is based on a contract between a buyer and a developer wherein the developer agrees to complete the development by a certain date.
- Sukuk A Musharaka (Joint Venture sukuk) - In this case the sukuk holder becomes the owner of a joint venture asset and therefore is entitled to share the profit it generates. A committee of investors participates in the decision making process.
- Sukuk Al Murabaha (Cost plus or deferred payment sukuk) – Here an asset belonging to the investors is sold to a third party on a cost plus profit basis.
- Sukuk Al Mudaraba (a sukuk based on equity partnership) – In this case the sukuk holder is silent partner in a partnership venture.
- iesSukuk Wakala – whereby the investor takes ownership of a share of a pool of assets which are managed by an attorney.
These new types of Sukuk allow borrowers much more flexibility in coming to market and thus provide a myriad of potential benefits to Participation Banks. The Participation Banks Association of Turkey forecasts an increase in market share for Participation Banks from the present 5% to 15% on the centenary of the Republic in 2023.
It is anticipated that the liberalisation resulting from these recent reforms will foster increased inward investment into the Turkish economy and bolster Turkey’s nascent status as a regional player.
1This replaced “Special Finance” institutions with for “Participation Banks” and created a savings deposit insurance fund for banks operating on Islamic principles.