Turkey's capital markets to attract new listings through regulatory reforms and multi-tier trading platforms

Turkey’s stock exchange, the Borsa Istanbul (BIST), had a bumper year in 2014. It was ranked as the fifth most profitable exchange globally, with the BIST 100 index rising by 26% and closing at a record year-end high. While the early months of 2015 were more muted for the BIST, the appeal of the exchange and many of its listed stocks to investors is still strong.

Core Features

As of the end of 2014, there were 217 companies listed on the main National Market, with a total market capitalisation of $248bn, while the Second National Market, which focuses more on small and medium-sized enterprises (SMEs), had 94 companies with a $10bn market capitalisation, according to the 2015 handbook published by the Turkish Capital Markets Association (TCMA). Including the “collective products” market and the “watch list” of companies in specific situations, there were 401 companies listed on the equity market, with a total market capitalisation of $268.5bn.

A substantial share of foreign ownership is a characteristic of the Turkish system, with foreign investors accounting for “a large but steady” 61% to 73% since 2006, according to JP Morgan Cazenove, an investment bank. The growth of Turkey’s pensions sector, reinvigorated by reforms in 2013, has also boosted the market, with assets under management doubling to $15bn since then, though this remains low by international standards, indicating scope for considerable growth as the population starts to age.

Chief Regulator

The Turkish financial system is overseen by a range of organisations and has a number of different stakeholders, including industry associations which represent different groups.

The main regulator of the country’s capital markets is the Capital Markets Board of Turkey (CMB), a supervisory authority overseeing securities markets and institutions. It sets the operational principles of the market and is responsible for protecting the rights and interests of investors. The CMB regulates and supervises public and listed companies; investment companies; exchanges; mutual, closed-end and pension funds; and leveraged transactions on foreign exchange and precious metals – including gold, an important commodity in the Turkish market. It also oversees capital markets institutions including the Settlement and Custody Bank ( Takas-bank), the TCMA, the Investor Compensation Centre, the Central Registry Agency, and many other companies and bodies working in capital markets, including ratings agencies, independent audit companies, asset leasing companies, market operators, appraisal firms, and trade repositories.

Market Authorities

The TCMA is a self-regulatory institution to which all investment companies, banks authorised for capital market activities, portfolio management companies and investment trusts are obliged to belong. The association’s remit is to set rules for professional operation on the capital markets and monitor members to ensure “a fair and disciplined” market. It is thus responsible for enforcing regulations enshrined in the country’s legislation or in the decisions of the CMB.

The Banking Regulation and Supervision Agency (BRSA) is the top regulatory authority for the entire banking sector, and thus has significant overlap into capital markets, as well as an important impact on banks, which are among Turkey’s bigger listed companies. The BRSA regulates deposit banks, Islamic banks and development and investment banks (including Takasbank), as well as foreign branches operating in Turkey, audit firms, ratings agencies, financial holding companies, and firms involved in leasing, consumer finance and factoring.

The Central Bank of the Republic of Turkey is the regulator of money and foreign exchange markets, with a remit to promote both price and financial stability. Besides its core banking regulatory responsibilities, the central bank is also responsible for the secure operation of payment, settlement and security transfer systems. Other notable institutions include the Capital Markets Licensing and Training Agency, responsible for organising licensing exams and training market professionals; the Banks Association of Turkey, a self-regulatory body for all banks except the “participation banks” working in Islamic or sharia-compliant finance, which fall under the Participation Banks Association of Turkey; and the Association of Financial Institutions.

Legal Reforms

In December 2012, the government passed a Capital Markets Law that saw Turkey’s exchanges restructured. This law created the BIST by essentially renaming the Istanbul Stock Exchange, merging it with the Istanbul Gold Exchange and transforming it into a for-profit company. In 2013 another exchange was merged into the BIST – Izmir-based TurkDex, which was the second-biggest in Turkey, specialising in derivatives and one of dozens of commodities exchanges spread around the country, most of which are of very modest size.

The 2012 reforms were intended to broaden and deepen Turkey’s capital markets by encouraging more companies to list, offering a wider range of financial instruments, promoting international market integration, and increasing visibility, accessibility and transparency. The new law was also aimed at improving investor protection.

The longer-term aim is to prepare the BIST for privatisation. International counterparts have long expressed interest in potentially taking a stake in the company. For now, the BIST is 48.9% owned by the government, which has indicated an intent to sell its stake in an initial public offering (IPO) planned for early 2016. The 36% stake currently held by the BIST management company itself may go on the block first as the firm looks for financial institutions to act as “anchors” prior to the IPO. Other shareholders include OMX Technology (5%), the TCMA (1.3%), and various investment firms and banks.

The Capital Markets Law replaced the previous law, first enacted in 1981 and leading to the foundation of the Istanbul Stock Exchange in 1985. The new legislation follows EU standards – namely, the acquis communautaire, the body of EU law to which states theoretically must adhere prior to membership. Joint stock companies with more than 500 shareholders, or those which have public offerings, are subject to the law. Its disclosure requirements also apply to securities issued by state-owned enterprises (including those lined up for privatisation), municipalities and related institutions. Overall, the series of reforms to Turkey’s capital markets have greatly increased their value, marketability and visibility, while enhancing their operations.

Tiers & Markets

The BIST has several tiers and a number of separate markets, giving investors access to a broad range of companies and instruments. The first tier is the National Market for companies that fulfil listing and liquidity criteria, including all those on the BIST 100, the main capital markets index. Those not fulfilling criteria of the National Market are transferred to the Second National Market, temporarily or otherwise. The Second National Market, with 94 firms as of end-2014, is largely intended for SMEs. There is also a National Market index, a tracker for the main market that is broader than the BIST 100. A third tier is the Watch List Companies Market, into which companies are transferred while under investigation or special regulatory surveillance. This might include unusual trades; incomplete, inconsistent or delayed disclosure of information; or breach of rules and regulations. As of the end of 2014, there were 29 such watch-listed companies.

Other Platforms

In November 2009, the BIST launched the Collective Products Market, offering trading of certificates from a range of listed financial instruments, which as of end-2014 included nine investment trusts, 31 real estate investment trusts, six venture capital trusts and 15 exchange-traded funds. The market also allows trading of covered warrants and turbo certificates.

In May 2012, trading commenced on the BIST’s new Free Trade Platform, which offers trading of unlisted public companies. The idea behind this new market is to provide a platform for companies to raise capital and raise their profile vis-a-vis investors, with the hope that, over the longer term, many will move on to launch IPOs on one of the main markets.

The Emerging Companies Market (ECM) was launched in October 2010 following the passage of regulations the previous year. The first listing came in January 2011, and as of end-2014 there were 22 companies listed with a total market capitalisation of $403m. The ECM is for companies that have high growth potential but do not meet the criteria for listing on the National Market – strictly speaking, the companies are not listed, but rather are included in the ECM Directory. Companies are expected to meet some criteria, but do not have to meet quantitative criteria on market capitalisation, profitability, paid-in capital, company age or size of offering. As with the Free Trade Platform, the hope is that these firms will find new access to capital, grow and move towards full listing on the National Market.

Sentiment Moderates

In the early months of 2015, Turkey’s capital markets went through a difficult period, reflecting the reality of lower economic growth, uncertainty surrounding the June 2015 parliamentary elections, and rising inflation. In April 2015, the IMF cut Turkey's growth forecast from 3.4% to 3.1% for the full year. Headwinds came especially from the rising dollar, but also from political uncertainty, growing caution among both banks and consumers, and questions over monetary policy. Weakening sentiment towards Turkey pushed the lira down 13% against the dollar in the year to late April, while the BIST 30 fell more than 15%, against a benchmark emerging markets index of more than 10% growth, according to Bloomberg. Nonetheless, a return to the instability of the 1990s is unlikely – Turkey is on a much sounder footing now, even if it can be buffeted more than developed markets. Moreover, it is a large and youthful market with substantial long-term growth potential, both in terms of its broader economy and its capital markets.

Quantitative Easing

Short-term factors should also help buoy the market somewhat. As JP Morgan Cazenove noted in its CEEMEA Year Ahead 2015 report, Turkey stands out as one of the countries best-placed to benefit from the new quantitative easing programme of the European Central Bank (ECB), begun in March 2015. The ECB’s action is expected to boost bank lending, thus benefitting Turkey’s private sector, which borrows heavily from the euro-zone. Turkey is also well-placed to benefit from the expansionary effect on the eurozone economy, its major trading and investment partner. Earlier in the year, JP Morgan stated that it remained positive on Turkish equities, drawing attention in particular to conglomerates like Koç and Sabancı, which offer a well-diversified exposure to equities. It also commended Akbank’s market-beating return on equity.

Initial Public Offerings

In 2014, the BIST saw 13 IPOs that raised $306m, compared to 11 raising $727m in 2013. Much of the most significant activity was concentrated in the final quarter of the year. By far the biggest IPO was that of insurance company AvivaSA, which raised $146m, or 45% of the total proceeds. Ranking second was Ulusoy Elektrik, raising $75m. According to a report by PwC, “IPO Watch: Turkey Focus 2014”, out of the 13 IPOs, nine were on the main National Market and four on the ECM. As of February 2015, there were eight pending applications for listing on the BIST, two for the main market and six for the ECM, indicating the growing momentum behind the emerging-companies market. The more muted IPO market in Turkey to an extent reflected concerns about investor sentiment towards the country, and contrasted with what was the best global IPO haul since 2010, and an 80% increase in proceeds from European IPOs.

Forward Prospects

Turkey’s IPO market may be somewhat subdued again in 2015, as investors await the outcome of the June parliamentary elections and shy away from a country which has seen a degree of volatility over the past year and a half, following several years of admirable stability. But sound fundamentals that could underpin a bright future for Turkey’s capital markets should draw more IPOs in the longer term. Past years have seen strong growth from SMEs in particular; more of these can be brought to market, allowing investors to capitalise on that growth and the companies themselves to raise capital for further expansion.

As across the world, private equity funds are increasingly looking to exit their investments through IPOs. In January 2015, for example, Global Yatırım Holding AS, a Turkish investment and financial services company, announced that it had hired international and local advisors to manage the planned IPO of its port operator unit, Global Liman. This subsidiary runs ports in the Turkish cities of Antalya, Ku şadası and Bodrum, as well as in Lisbon and Barcelona in partnership with other players. Global Yatırım expects to raise capital of between $250m and $500m in the IPO of Global Liman, which it forecasts will earn total revenues of $85m in 2015 before interest, taxes, depreciation and amortisation.

Bond Market

Turkey has been one of the biggest issuers of sovereign emerging-market bonds in recent years. Its domestic corporate bond segment, however, did not take off until reforms introduced in 2010 slashed the red tape that had held back development. The government had good reason to ease regulations, as the effective non-existence of a domestic corporate bond market had pushed Turkish firms – including banks, which are major issuers – to borrow from abroad, thus increasing foreign exchange risk. The government’s own stance at the time had been to shy away from bond issues to an extent, which pushed investors towards corporate bonds as the perceived next-safest option.

The stock market’s volatility and high interest rates (which tend to draw investors towards time deposits rather than equities) have led to suggestions that the bond market may be a better bet than Turkish stocks. This is questionable: higher interest rates erode bond prices. But generous yields on Turkish bonds may yet draw in cash – as of May 2015, yields on 10-year lira-denominated sovereign bonds stood at just over 9%, compared to 2.3% for US Treasuries.

In May 2015 ratings agency Standard and Poor’s warned of a one-in-three chance of a ratings downgrade for Turkey within 6-12 months, largely due to the lira’s depreciation. The outlook for sovereign bonds is somewhat uncertain, hinging on regained economic momentum and, in the shorter term, the June election and the make-up of the government formed thereafter. But in an environment which has seen equities lose some of the ground gained in 2014, bonds may seem safer to some investors.

Corporate Bond Issues

A number of major corporates issued bonds in the early months of 2015, including $500m issues by Akbank, Halkbank and Vakifbank, a second $500m offer by Akbank, and $328m from Turkish Airlines, which it will use to purchase new aircraft. These issues – and upcoming floats by the likes of Türkiye İş Bankası and Ziraat Bankası – indicate that the bond market remains liquid despite macro concerns, but somewhat dominated by banks and a few large corporates.

Future Sale

In January 2015 the CEO of BIST, brahim Turhan, announced that the exchange’s management company was looking to sell its 36% stake to strategic foreign and domestic “anchor investors” in the run-up to a full IPO in early 2016. The IPO would reduce the government’s stake in the exchange. According to a Bloomberg report from early 2015, the offering would value the company at around $1bn; by decree of the Council of Ministers, it cannot exceed 42.75% of the company.

International Partnerships

Such an IPO would be the latest step in the restructuring and growth of Turkey’s capital markets, which has involved a growing range of international partnerships, some bringing capital and expertise to Turkey, and some allowing BIST to take its own capital and expertise to new markets. In January 2015, the BIST signed a partnership agreement with the London Stock Exchange, which enables the latter’s global clients to trade and clear Turkish futures and options on international markets. The LSE Derivatives Market offers trading in futures and options on the BIST 30 Index and on leading Turkish stocks. In 2013, the US-based exchange company Nasdaq bought a 5% stake in the BIST, a deal that led to BIST adopting Nasdaq systems – an upgrade on the technology it was previously using. Nasdaq also pledged to support the BIST’s efforts to establish itself as a regional financial centre. In January 2015, the BIST raised its stake in the Sarajevo Stock Exchange (SASE), the main bourse in Bosnia and Herzegovina, to 10%. The previous month, it had started trading index futures of the top 10 SASE-listed companies.

Financial Centre

The development of the BIST fits with the government’s vision of making Istanbul into a global financial centre. The main target markets that backers of the strategy hope it will serve are those with geographical, linguistic, cultural or historic links to Turkey: the MENA region, Central Asia, and Central and Eastern Europe. Naturally, it has strong competitors as a financial capital for such a varied range of countries, particularly Dubai, Moscow, Vienna and, most recently, Warsaw. Nonetheless, supporters assert that Turkey has a number of competitive advantages, not least its being a large, dynamic emerging market in its own right.

In this vein, a new financial district known as the Istanbul International Financial Centre (IFC) is taking shape on the Asian side of the city, drawing many financial institutions from the traditional business districts such as Levent and Maslak. The plan is also to relocate institutions like the central bank, the CMB, the BRSA and the headquarters of some state banks from Ankara to Istanbul.

The development of the IFC is very much a work in progress. Geographical issues are one challenge: many financial institutions are well-established on the city’s European side, and relocating to Asia has limited appeal, especially given issues with traffic across the Bosporus and around bottlenecks on each side. Another hurdle is human resources – Turkey has a budding group of young fund managers and traders, but many still move abroad to pursue their careers, and others who remain are still quite young and need to develop years of experience, particularly at international level. Other more experienced professionals may be reluctant to relocate from cities seen as the world leaders in finance (London, New York, Frankfurt) or those with more appealing tax and residency regimes (Dubai, Singapore, Hong Kong).

Realistically, the process will be an incremental one – speaking of Istanbul as a rival to London and New York or even Dubai would be somewhat premature. Nonetheless, the size and strength of the Turkish market and the expansion of Istanbul as a business centre serving a diverse range of regions, as well as the government’s vocal support of the project, are building momentum behind the IFC.

Outlook

Turkey’s equity and bond markets felt the impact of cooling investor sentiment and the related fall in the lira in the first few months of 2015. A degree of uncertainty over the fiscal and monetary policy outlook with an election looming – also not unrelated – had an effect as well. However, the reforms of the past few years have left the country’s capital markets larger, more liquid, more accessible to foreign capital and altogether better-off. One indication of this is the particularly strong performance of the BIST in 2014, a year of subdued economic growth. In sectors such as financial services, consumer goods and manufacturing, the country offers a number of large, high-quality companies, while lower tiers of the market are preparing smaller players for senior listing. Tough as some periods may be, the market’s future is founded on that of its economy, and in this regard Turkey’s large, young populace, diverse services and status as a major business centre all point to a bright long-term outlook.