Modern times: Legal changes and product introductions herald a new era

In line with the country’s rising profile as a destination for emerging market investment, Turkey’s capital markets are undergoing a major modernisation. A combination of legal reforms, an expansion of local exchange offerings into more complex instruments, and technological and procedural improvements to facilitate electronic and algorithmic trading are laying the groundwork for future growth.

Legal Reforms

Two major legal reforms with a direct impact on capital markets have been adopted in recent years: a new commercial code, which went into effect in June 2012, and a new capital markets law, which has been enforced since December 2012.

The new commercial code modernised corporate governance requirements for Turkish companies, bringing them largely into line with EU and Swiss law. Turkish accounting standards were made equal with International Financial Reporting Standards, and use of independent external auditors was made obligatory for all joint stock companies. The code enshrined general principles of transparency and introduced new rules for share issues aimed at preventing majority shareholders from unfairly diluting minorities.

The most unusual change brought by the commercial code was a requirement that all publicly traded firms allow electronic voting at shareholder meetings, while still holding physical meetings. Turkey’s electronic voting system, called e-GEM, allows shareholders to remotely observe and listen to meetings, communicate with each other and securely transmit their votes. E-voting is especially important for portfolio investors who employ activist strategies.

The new capital markets law was aimed largely at implementing the commercial code’s standards within the realm of public companies and at reforming the Capital Markets Board (CMB) and the country’s main exchanges. Although the law came into effect in December 2012, much of its implementation was set to follow later and as of April 2013 government agencies were still in the process of drafting regulations.

Among the law’s more notable innovations is a requirement that the CMB approve appointments of independent directors to ensure that they are truly independent. Also, if a company fails to appoint independent board members, the CMB is empowered to appoint them itself. The law also made it mandatory for all listed companies to have at least two independent directors. In addition, the capital markets law set in motion plans to move the CMB from its current location in Ankara to Istanbul, where it will be located within the planned Istanbul International Financial Centre, in the Ataşehir district on the Asian side.

Exchange Consolidation

The capital markets law also included a reform and consolidation of the country’s three top exchanges: the Istanbul Stock Exchange, the Istanbul Gold Exchange and the specialty derivatives exchange TurkDex, based in Izmir. Under the law, the stock exchange and gold exchange were merged in early 2013 into a single national exchange company, named Borsa Istanbul, which was set to absorb TurkDex later in the year.

The government wants Borsa Istanbul to also move from its current home in the Sarıyer neighbourhood to the planned Istanbul International Financial Centre. During the ceremonial first session of Borsa Istanbul in April 2013, the prime minister, Recep Tayyip Erdoğan, said he wanted all central government institutions dealing with the financial markets to move to Istanbul, including the central bank.

The law set Borsa Istanbul’s initial shareholder structure as follows: a 49% stake for the government, a 9.4% stake divvied up among the former owners and members of the three exchanges and the Association of Capital Market Intermediary Institutions of Turkey, and a 41.6% position that “will be at the disposal of Borsa Istanbul for use in entering into strategic partnerships with global exchanges and technology and liquidity providers”, according to the exchange. The government and Borsa Istanbul officials have already begun courting interest from international exchanges, particularly NYSE Euronext. The London-based derivatives exchange of NYSE Euronex, NYSE Liffe, has been trading options and futures on Borsa Istanbul’s XU30 index stocks since January 2013.

Exchange Expansion

The joint listing with NYSE Liffe followed the introduction of derivatives and equity repo markets on the Istanbul exchange in December 2012. Although the market got off to a modest start – by March 2013, traded volumes for were TL30m (€13m) of options and TL80m (€34.5m) of futures for the month – the development of an active derivatives market was seen as an important step in raising Borsa Istanbul’s international profile.

By comparison, the more established TurkDex derivatives exchange had total traded volumes of TL30bn (€13bn) in March 2013. TurkDex is a futures exchange, with contracts linked to local equity indexes, interest rates, commodities and dollar and euro exchange rates. By far its most popular contracts are futures linked to Borsa Istanbul’s XU30 index, which account for about 95% of TurkDex’s trade volumes.

Technical Advances

While expanding offerings and seeking greater integration with global exchanges, Borsa Istanbul has been modernising its trading systems technology to enable access to its exchange by modern electronic trading and algorithmic trading systems. A first crucial step was taken in October 2010 when the Istanbul exchange first allowed orders to be cancelled during the same session they were placed. That allowed the French broker Crédit Agricole Cheuvreux to launch the first algorithmic trading services on the Turkish market later that same month.

Since that time, an increasing number of brokers and trading systems providers have launched similar services, including Société Générale, Citi Group, Liquidnet and Neonet. Bringing high-frequency trading (HFT) to Turkey is still in the early planning stages, but some HFT players are already familiar with the country as traders of lira on international exchanges.

As of April 2013, no international brokers were yet offering electronic trading on the Turkish market to retail investors. Turkish banks offer electronic order-placement to their retail clients, but client funds are typically locked for two business days between trade execution and settlement, which limits the usefulness of such services for active trading.

Controversies

The new capital markets law also had three controversial aspects. One was that it preserved, with changes, a clause that makes market manipulation punishable by up to five years in prison. Such a clause had existed for decades and had not been actively enforced. Although the new law clarified that only intentional manipulation was criminal, the financial industry felt the law’s wording was overly broad and subject to arbitrary interpretation.

In January 2013, after the new law came into effect, Société Générale briefly suspended market commentary by its analysts in Turkey, while others spoke out in the media against the law, saying they were afraid they or other commentators could be charged for voicing honest opinions. The controversy calmed after the CMB responded with a statement insisting there was “no reasonable ground to conclude that the scope of the actions that constitute the criminal offence has been widened”. However, several analysts told OBG they and their companies were being more careful about making potentially market-moving commentary.

The capital markets law’s requirement that the CMB approves appointments of independent board members initially raised concerns that the rule could be used by the regulator to effectively choose board members for companies. The CMB later clarified that it would only screen appointments to ensure independence, and would only appoint independent members in cases where owners persistently failed to do so.

Another controversial part of the capital markets law was that it removed the CMB chairman and all board members, appointing replacements who were regarded as more loyal to the government. The move followed a long period of conflict between the government and CMB board members, which revolved largely around a shareholder dispute at telco Turkcell.