We would like to begin by getting your insights on the global Sukuk market.
MD: The international Sukuk market has developed considerably since 2008, where longer tenors and a broader range of issuers are accommodated by the investor base. The average volume of annual issuances has been between US$15-20 billion over the last five years. 2016 has been a strong year with 18 issuances totaling US$15 billion to date and we expect this trend to continue and surpass last year’s volume due to increased borrowing requirements of GCC and Asian countries.
What type of issuers are traditionally looking to access the Sukuk market globally and more specifically in Turkey?
MD: Internationally, the main issuers are sovereigns and banks. There are certain corporates that have issued as well from the UAE, Qatar, Saudi Arabia and Malaysia.
HH: In Turkey, the main issuers are sovereign and participation banks too. We have yet to see a corporate Sukuk issuance in the international markets. Only a very select and small number of corporates have expressed interest for Sukuk to date, but this number is expected to increase in the coming years with the development of the Islamic finance market in Turkey.
We are proud to say that HSBC is the leading international Sukuk house in Turkey. HSBC arranged all four international Sukuk issuances of the Turkish Treasury to date and seven issuances of Turkish participation banks including the first Malaysian ringgit Sukuk issuance out of Turkey. The total financing volume arranged through these 11 transactions reached US$7.4 billion since 2011.
What is preventing the supply of international corporate Sukuk in Turkey?
HH: The corporates that expressed interest in the product have either never issued a conventional eurobond before and would prefer to do that first or they had structural issues. For others, the decision to choose Sukuk over any other alternative financing solution comes down to pricing, terms and execution. Our experience so far indicates that bank financing in Turkey can be relatively cheaper than a Sukuk issuance with longer tenors provided by local banks.
Additionally Turkish corporates don’t require a sizeable and bullet and benchmark financing in a single transaction unless there is a specific event-driven obligation to do so. There is, of course, a consideration for legal and regulatory angles of the execution process where corporates have to set up SPVs, apply for Capital Markets Board (CMB) approval and negotiate extensive legal agreements for Sukuk whereas they can borrow under straightforward general credit agreements from local banks.
MD: I would echo Hulusi’s comments and want to add that Malaysian or GCC corporates can borrow up to seven to 10 years with much more favorable pricing. In Turkey, the longest tenor we have seen is 10 years and this is for sovereign and a single participation bank’s Sukuk issuances. Also, GCC currencies are pegged to the US dollar unlike the Turkish lira and consequently, Turkish corporates take foreign currency risk which is certainly one of the challenges of the market.
How are CFOs positioning themselves in the short and long term under the current economic climate?
HH: Turkey, which went through two general elections in 2015 and 2016, has been volatile due to both foreign and domestic events, therefore we experienced a slowdown in new investments. Anticipating an interest rate increase by the Fed this year — although this may be postponed to 2017, CFOs are more concerned with managing their existing exposures and the impact of the Turkish lira’s depreciation against hard currencies.
We are seeing corporates that borrow in the US dollar either refinancing their bank loans before the Fed rate increase or switching to euro funding in order to benefit from low rates. Foreign currency hedging is also another important concern as the Turkish lira depreciated 40% against the US dollar since August 2014 which had a significant impact on bottom line profits.
It is important to also underline that the local banking sector continues to have significant FX liquidity and has a risk appetite for long-term financing transactions, especially for clients with strong credit profiles and for the right projects, which still makes bank market funding an alternative compared to the capital markets. In an environment where executives need to react quickly to market volatility, the availability and quick access to bank funds are proving to be an alternative to capital market solutions.
What is the investor appetite from the GCC like for Turkey?
MD: There is a greater level of scrutiny for Turkish issuers following the recent events that took place in Turkey but interest is still there. Investors make the distinction between good and bad credit and those corporates benefiting from a strong credit profile can always access the market. When the political and economic uncertainties settle in the near future, we expect GCC investors to start actively looking for Turkish issuers.
After the 15th July and following the positive outcome of the FOMC meeting on the 21st September, Turkish sovereign spreads widened by 75bps and normalized at 20-25bps levels respectively; similarly for financial institutions’ spreads, the initial widening was up to the 150bps level and stabilized to 40bps wider. These are positive indications that the market is returning to normal, but a sovereign/sub-sovereign conventional or Islamic issuance in a post-coup era will certainly provide more guidance to the private sector players on both the issuer and investor side.
Are mid-sized issuers, who are most in need of alternative sources of financing such as Sukuk, unable to access the market due to the required size of an issuance?
MD: The US$300 million level has traditionally been the minimum size sought by investors on any capital markets exercise for liquidity purposes so that the issue can be freely tradable in the secondary market. Anything below this threshold is achievable but with a select number of investors on a private placement basis. I would not categorize the size of an issuance as an obstacle for mid-sized issuers to access the market and there is definitely merit to consider Sukuk as a financing solution because of bullet repayment structures and the ability to tap a different investor base.
HH: There is a limited class of assets to be used for the structuring of Sukuk; only Ijarah and Murabahah-based structures have been used in Turkey so far. However, at HSBC, we held various workshops with regulators, corporates and financial institutions operating in different sectors to explore how we can implement alternative Sukuk structures in Turkey which are frequently used in Malaysia and GCC countries.
Unfortunately, we found out that the current tax and legal regime has to be revisited to enable the usage of non-real estate and intangible assets for Sukuk financing. Additionally, the requirement to have an external credit rating assigned by an internationally recognized credit agency will be another challenge that mid-sized issuers will face in the process.
What are Turkish authorities doing to develop the local Islamic finance market?
HH: The development of the Islamic finance market in Turkey is certainly a priority for the current administration. This is evident with the establishment of state-owned participation banks. The share of participation banks within the whole banking sector is expected to reach the 10-15% level by 2025 from the existing 5.5%. The participation banks will be at the forefront of this development and they will need to strengthen their capital structure to continue providing Shariah compliant liquidity to the market and to finance this expansion. Therefore, Basel III compliant Tier 2 capital Sukuk issues are expected to play an instrumental role in this space.
The CMB and Ministry of Finance (MOF) have spent considerable time to establish the Sukuk issuance framework and the relevant tax regime in the past. There are also ongoing initiatives to allow alternative Sukuk structuring tools in Turkey, such as Istisnah and forward Ijarah for construction projects under the ‘Build Operate’, ‘Build, Operate and Transfer’ and ‘Build Lease’ Frameworks; or Istisnah and Wakalah which are suitable for the ‘Transfer of Operation Rights’ Framework or other alternative structures such as menafae, etc.
Besides, as you may be aware, the Prime Ministry of the Republic of Turkey established an Islamic Finance Coordination Committee (Faizsiz Finans Koordinasyon Kurulu) back in December 2015 to accelerate the development of Turkey’s Islamic finance markets and to assist regulatory bodies such as the MOF, the central bank, BRSA, CMB, Borsa Istanbul and Islamic Banks Association of Turkey to transform Turkey as an international financial hub for Islamic finance. The committee envisages facilitating the discussion between the relevant legislative bodies to improve the necessary legal infrastructure.
The establishment of state-owned participation banks is expected to expand the overall banking sector’s client base through reaching out to the unbanked and/or underbanked population and consequently to grow the sector’s asset size. One key element for the growth of participation banking in Turkey is to enable these players to access competitive financing from a cost of funding perspective.
Therefore, the central bank’s recent action enabling participant banks to conduct open market operations is an important step in that direction. Moreover, Borsa Istanbul is working on enabling participation banks to do repo transactions using lease certificates, and this is expected to come into effect near the end of 2017, to create an alternative monetary policy instrument for these banks.
Turkey is also working to establish the Islamic Infrastructure Bank that will be located in Istanbul. So far, Saudi Arabia, Indonesia and the Jeddah-based IDB are prospective founding members of this institution.
MD: We are very excited with the steps taken by the Turkish government as explained by Hulusi. I would also like to highlight that JPMorgan recently decided to include Sukuk in its emerging market indices. We expect this decision to increase the liquidity of Sukuk instruments, including all four international Sukuk issued by the Undersecretariat of Treasury and the ones issued by Turkish participation banks.
Disclaimer: All kinds of transactions shall be subject to the business conduct of HSBC Bank and compliance to local legislation. No information in this document is provided by HSBC for the purpose of offering, cross-border marketing and sale by any means of any banking services outside of the Republic of Turkey. Therefore, this document may not be considered as an offer made or to be made outside of the Republic of Turkey.
Mohammed Dawood is the managing director and global head of Sukuk financing at HSBC Amanah and Hulusi Horozoglu is the assistant general manager, managing director and the head of wholesale banking and investment banking at HSBC Bank. They can be contacted at [email protected] and [email protected] respectively.