LONDON – It is all about timing and the Turkish Treasury get it spot on. No sooner had the Turkish Treasury mandated Citigroup, HSBC and Liquidity Management House (LMH), the investment bank subsidiary of Kuwait Finance House, in early September “to explore opportunities for a possible Lease Certificate (Sukuk Al-Ijara) issuance in the international capital markets”, the roadshows to the GCC, Southeast Asia, Europe and the US were already in motion. The mark-to-market process including the price discovery for a debut international issuance was unusually short – hardly a fortnight. The pricing, confirmed one banker, was tight from the start, always within the 300 basis points range. The intention was to raise $1 billion from the market. But because of the huge demand, it was upsized to $1.5 billion with the order book reaching $8 billion and the offering over-subscribed five times. By the third week in September the deal was dusted and done and priced at a coupon rate of 2.803 percent per annum with semi-annual distribution of payments. Because of its Reg S and Rule 144 A Format, investors according to the regulations especially pertaining to US onshore investors, were accorded a mandatory one week cooling off period. Despite the fact that the issuance was technically a notch below investment grade – BB by Standard & Poor's and Ba1 by Moody's Investors' Service, to match the country's sovereign ratings - investors, both in the Muslim world, the West and East Asia, and starved of quality conventional commercial papers due to the impact of the Eurozone sovereign debt crisis, lapped up a debut sovereign sukuk issuance by a major OECD/MENA issuer by effectively treating it as an Investment Grade offering. Not surprisingly, the issuance has already precipitated a momentum with Albaraka Turk Participation Bank and Asya Bank both reviving plans a week ago to raise funds from the international market through their respective debut sukuk issuances. Both had plans to issue sukuk last year but these were put on the back burner because market conditions were not deemed to be conducive and Asya Bank underwent a restructuring. Albaraka Turk, part of the Saudi-owned Albaraka Banking Group, which is incorporated in Bahrain, recently confirmed its intention to raise US$250 million from the international markets this year through a sukuk issuance. But the biggest potential will come from utilities, state-owned enterprises and corporates. “The recent sukuk issue by the Treasury,” explained Dr. Vedat Akgiray, Chairman of the Capital Markets Board of Turkey (CMB), “is certainly the needed first step to start an active sukuk market, both primary and also secondary market. So, it is a welcome step, and now we can expect this market to grow faster. Diversity is always good for overall market efficiency and liquidity. Istanbul Stock Exchange has also recently announced the start of trading in sukuk instruments on the exchange.” These sentiments, albeit with an important caveat, were echoed by Islamic bankers in Istanbul such as Albaraka Turk's Meliksah Utku. “In Turkey, the first sukuk issuance was executed by Kuveyt Türk Participation bank with an amount of $150 million. So a private bank took the lead. But with the Turkish Treasury's entrance to the sukuk market, banks, companies and utilities will have a trustable benchmark that will help boost private issuance. On the other hand, this progress may not be too rapid, unless local primary and secondary sukuk markets operate effectively with increasing volumes,” he said. An interesting aspect of the issuance in the latter respect is that it is listed not on the London Stock Exchange, or Bursa Malaysia, or the Luxembourg Stock Exchange, or the Istanbul Stock Exchange or Nasdaq Dubai, but on the Irish Stock Exchange. Stock exchanges have in recent times competed to establish themselves as sukuk and Islamic equity and ETF funds listing domiciles. The sukuk issuance, which has a tenor of 5.5 years and is guaranteed by the Republic of Turkey, was issued through a special purpose vehicle, Hazine Müstearl Varlk Kiralama Anonim irketi, The quick turnaround, the tight pricing and huge demand for the issuance took the market and some of the center right political elites in Turkey and those in Europe by surprise. Middle East investors accounted for 58 percent of the subscription, followed by European investors with 18 percent, Asian investors with 14 percent and US and other investors the remaining 10 percent. Sukuk structuring expert, Muhammed Safri Shahul Hamid, Deputy CEO of CIMB Islamic Bank in Malaysia, believes that the success of the inaugural sukuk by Turkey has raised the awareness (and a lot of eyebrows) especially amongst those in Europe and Turkey. “The sukuk was priced within the country's conventional bond offerings, which proves that the investors do not differentiate between the two. The perception about the extra ‘premium' attached to sukuk is now just a myth,” he said. The strong order book has further amplified the primary benefit of doing sukuk which is to diversify the investor base to include Islamic and non-Islamic accounts, hence a wider net is cast. Safri believes the success of the trade will likely pave the way for more sukuk issuances not only by the government but also by the Turkish corporates, which augurs well for Islamic finance as a whole. With more issuances, the supply will improve to meet the ever increasing demand for high grade issuers. However, there are other important implications for the Turkish banking market of Turkey's debut sovereign sukuk. There are currently four participation banks in Turkey – Albaraka Turk, Kuveyt Turk, Turkiye Finans and Asya Bank. Participation Banking assets in the last year or so have expanded faster than those of conventional banks. The four Turkish participation banks now account for 5.6 percent of the total banking sector assets in Turkey and have some 762 branches throughout the country, employing 14,600 people. Participation bank assets grew year-on-year five times in 2011. According to Turkish Deputy Prime Minister Ali Babacan, the participation banking sector is now an indispensable and complementary element of the Turkish banking sector. “Until recently,” said Meliksah Utku, Deputy General manager at Albaraka Turk Participation Bank, “we as participation banks suffered in utilizing Shariah based financial instruments for liquidity and investments purposes. With the recent developments in sovereign sukuk, Turkish participation banks will be able to place their excess funds in these instruments and then also use it for liquidity raising by means of these sukuk being accepted as collateral in the exchange of cash by the Central Bank of Turkey. Beside that facility, insurance companies, investment funds and other financial institutions will produce Shariah-based investment products based on those sovereign sukuk for interest-rate sensitive customers ignored by the current interest based system.” From a government external borrowing requirement point of view, there was no need for Sovereign Turkey to go to the international financial markets to raise funding. The Turkish Treasury's own figures show that the government earmarked external borrowing from the Eurobond market totaling EUR4.5 billion in fiscal year 2012. But the Treasury actually raised EUR4.6 billion through the Eurobond market. As such, the Treasury did not need to raise funds through a sukuk issuance this side of 2012. Not surprisingly, the proceeds from the US$1.5 billion debut sukuk will be allocated in the expenditure for fiscal year 2013. The above issuance would not have been possible had it not been for the game-changing changes in Turkish legislation over the last few years which has facilitated tax neutrality measures for sukuk on par with conventional bonds and the introduction of Sukuk Al-Ijara structures. “Until 2010,” explained Serra Ba?o?lu Gürkaynak, Partner, and Ali?ya Bengi Dan??man, Associate, in the local law firm, Mehmet Gun & Partners in a recent briefing, “Turkish legislation gave very few incentives for the issuance and sale of sukuk. Moreover, the financial institutions, the originators (as asset owners) and investors (as sukuk holders) in a Sukuk Al-Ijara transaction were subject to various tax implications applicable to a regular sale and leaseback transaction. One such setback was the value added tax (“VAT”) incurred on each separate transaction (Article 28 of the VAT Code numbered 3065 and dated October 25, 1984). With the recent regulation forming the backbone of Sukuk Al-Ijara offerings and private placements in Turkey and the amendment to the tax regulations that took place through the Omnibus Bill passed on 13 February 2011, the Turkish Sukuk Al-Ijara market can now be deemed to be functioning. A very recent development that will push forward the progress is the omnibus bill, which entered into force on June 29, 2012, that enables the issuance of Treasury Sukuk Al-Ijara. These regulations as a package, aim to encourage the use of Islamic finance tools and to strengthen the sukuk market in Turkey.” The above laws was preceded by an important Capital Markets Board's (CMB) Communiqué on the Principles Regarding Lease Certificates and Asset Lease Companies issued in April 2010. By way of this Communiqué, lease certificates were introduced to the Turkish market for the first time. While the term lease certificate is used in the Communiqué, it also uses the term lease-backed sukuk, in other words Sukuk Al-Ijara. But according to Messrs Gürkaynak and Dan??man, The Code (Law) 6327 of 29 June 2012 added a new article to the Turkish Public Finance and Debt Management Law regarding the issuance of lease certificates, in the section setting forth domestic and foreign debts. With this addition, they explain, “Treasury sukuk certificates can be issued onshore or offshore where the underlying assets will be state-owned movable and/or immovable properties. Only assets owned by state-owned, publicly-traded companies are excluded from this scope. Another form of assets which can be the basis of a Treasury Sukuk Al-Ijara is the intangible assets of such institutions, such as their usufruct rights or operational privileges. For instance, the Treasury will be able to issue sukuk certificates whereupon the income is generated from the operation of state-owned bridges, dams, railways, highways, airports and so on.” Not surprisingly, there have been some reports that the funds may be used by the government to part finance the building of a third bridge over the Bosphorus to ease Istanbul's dire traffic congestion. As the Turkish Islamic finance market becomes more sophisticated, the legislation, according to Messrs Gürkaynak and Danman, will too develop to accommodate more sophisticated mechanisms and structures. Turkey is the 17th largest economy in the world and it has a population of 70 million of which the average age is 29, which is the youngest in Europe. The country is the 16th largest steel producer in the world and averaged a GDP growth rate of 10.3 percent for the first half of 2011.
