Turkey, short of investment, increases sukuk issuance

Turkey is seeking to ramp up the issuance of Islamic sukuk bonds to help compensate for a decline in foreign investment in the country.

But the economic effects of the COVID-19 pandemic, combined with concerns about economic policy in Turkey, have reduced demand for the sharia-compliant investment tool.

“Volatility is part and parcel of doing business in Turkey,” said Guillaume Petitgas, head of emerging markets, debt capital markets for the Middle East and Africa at HSBC, according to a January report published by the Bonds & Loans website.

Many foreign investors have been spooked by accelerating inflation in Turkey, economic and monetary policy, and the decline of the lira, which traded near a record low of 10.07 to the euro on Monday.

In 2019, Turkey accounted for 8.7 percent of global sukuk sales, which totalled $135 billion. The government doubled issuance in 2020.

Official Treasury data compiled by Mushtak Parker, editor at Islamic Banking Magazine, showed that Turkey raised the equivalent of $7.82 billion in the first seven months of 2020. That included 35.8 billion liras ($4.31 billion) through Turkish Treasury Lease Certificates (Sukuk Al-Ijarah); $2.42 billion through Turkish Treasury U.S. Dollar-denominated Lease Certificates; and €488.5 million ($591.1 million) through Turkish Treasury Euro-denominated Lease Certificates.

In addition, the Ministry also issued Turkish Treasury Gold-backed Lease Certificates totalling 36,894,600 certificates, after collecting 36,894,600.000 1000/1000 grams of gold from investors.

But competition will be tough in attracting investors in 2021. Global sukuk supply is expected to accelerate in 2021, as issuers seek to refinance maturing debt and fund large budget needs, Fitch Ratings said in January.

The easing of Gulf Cooperation Council (GCC) investment restrictions following the normalisation of relations between Qatar and its neighbours will also contribute to higher volumes.

In September 2020, credit ratings agency Moody's downgraded the entity with which Turkey issues some sukuk. Moody’s cut the senior unsecured backed debt rating of the Hazine Müsteşarlığı Varlık Kiralama A.Ş., a special purpose vehicle owned by the Turkish government, to B2 from B1. It maintained its negative outlook on the issuer.

The three key drivers for the downgrade were:

1. Turkey's external vulnerabilities are increasingly likely to crystallise in a balance of payments crisis.

2. As the risks to Turkey's credit profile increase, the country's institutions appear to be unwilling or unable to effectively address these challenges.

3. Turkey's fiscal buffers, which have been a source of credit strength for many years, are eroding.

Moody’s also cited “downside risks associated with the authorities’ inadequate reaction function, which makes Turkey more likely to suffer a full-blown balance of payments crisis in the coming years”.

Sukuk is an Arabic word that means certificates. These are usually compared with bonds, but the structure of sukuk is quite different.

“Unlike a conventional bond (secured or unsecured), which represents the debt obligation of the issuer, a sukuk technically represents an interest in an underlying funding arrangement structured according to sharia, entitling the holder to a proportionate share of the returns generated by such arrangement and, at a defined future date, the return of the capital.

“Broadly speaking, compliance with sharia means that:

  1. Any profits derived from these funding arrangements must be derived from commercial risk-taking and trading only.
  2. All forms of conventional interest income are prohibited.
  3. The assets that are subject to the funding arrangement must, themselves, be permissible (halal).

“The overall risk profile and economic return for the investor is akin to a conventional bond where the bondholder is a debtor of the issuer,” said Debashis Dey, a partner in the global capital market practice at the White & Case law firm in the United Arab Emirates.

Sukuks come in various structures such as Ijara, Murabaha, Modarabah, and many other forms. For al-ijara, or lease-based sukuk preferred by Turkey, the entity seeking to raise funds establishes a special-purpose vehicle (SPV) for the sole purpose of issuing lease certificates, Dey and White & Case said in a report in August 2016.

The underlying assets are then transferred to the SPV, which in turn leases them back to the entity and issues lease certificates based on the proceeds, White & Case said.

Lease certificates representing the ownership share in the underlying asset entitle their holders to a pro rata share of the proceeds generated by the asset.

The SPV is established as a joint stock company upon approval by the Capital Markets Board (SPK), which does not require a prospectus for a private placement sale, according to White & Case. Lease certificates may be sold through either public offering or private placement.

Turkey joined with other sukuk issuers last year in offering what is called green sukuk.

According to the Industrial Development Bank of Turkey (TSKB), the first Turkish Sustainable Sukuk issuance took place in June 2020 with Zorlu Energy as seller. The company has released a sustainable sukuk framework under its sukuk programme of 450 million liras. The first issuance within the program amounted to 50 million liras and took place on June 3, 2020.

Innovative and diverse issuances like green, sustainable, transition and hybrid sukuk are likely to continue to attract wider investor demand.