* Political, economic factors behind policy shift
* Bank, corporate issuers gain pricing benchmark
* Islamic banks can strengthen funding structures
* First non-financial issuer possible next year
* Tax treatment will be important
ISTANBUL/DUBAI, Sept 19 (Reuters) - Turkey's issue of its
first sovereign sukuk this week paves the way for Turkish
companies to raise money through Islamic bonds, and may help the
country become a major market for Islamic investors from the
Gulf and southeast Asia.
After coming to power a decade ago, Prime Minister Tayyip
Erdogan's government, which espouses Islamic values, largely
shied away from Islamic finance for fear of opening itself to
charges that it was trying to roll back state secularism.
This prevented the world's eighth most populous Muslim
nation from participating fully in rapid growth of the industry.
Islamic financial assets globally hit $1.3 trillion in 2011, a
150 percent increase over five years, according to an estimate
by lobby group TheCityUK's UK Islamic Finance Secretariat.
The Turkish government's issue of a $1.5 billion Islamic
bond this week, which drew heavy bids totalling about $7.5
billion from global investors, is a step towards bringing Turkey
into the mainstream of Islamic finance, potentially giving it
more access to tens of billions of dollars of Islamic investment
funds from other Muslim nations.
The sukuk is expected to serve as a benchmark for the
pricing of future Islamic bond issues in the Turkish private
sector. Other Islamic financial practices, such as takaful or
Islamic insurance, may also attract more demand in Turkey after
the government's shift.
"This is a landmark for Islamic finance in Turkey. Sukuk
would help to deepen capital markets in Turkey," said Ibrahim
Oguducu, head of the financial institutions business at Bank
Asya, the country's largest Islamic bank.
Islamic finance, which operates according to religious
principles such as bans on interest and pure monetary
speculation, has been growing during the global financial crisis
partly because it can draw on a huge pool of religiously-
oriented investment funds from the oil-rich Gulf.
But Turkey has only four Islamic banks, which held a
combined 61 billion lira ($33.9 billion) of assets in June, only
4.8 percent of the country's banking assets, according to
Turkish brokerage IS Investment. In the Gulf Arab states,
Islamic institutions hold roughly a quarter of the market,
according to an estimate by consultants Ernst & Young.
Because of political sensitivities in Turkey, and to adhere
to local law, Islamic banks in the country do not describe
themselves as such but use the label "participation banks".
Sukuk are described as "participation certificates", a reference
to the fact that instead of paying investors interest, they pay
returns on a pool of assets.
This week's sukuk issue suggests Turkey is moving away from
such squeamishness about Islamic finance. Another sign of this
is the government's 2007-2013 economic development plan, which
refers in general terms to "asset-based" and "interest-free"
financial instruments as part of efforts to develop the country
as a regional financial centre.
"We have strong expectation for the Turkish treasury to
continue sukuk issuances in the following years," said Yavuz
Yeter, group manager for investment banking, treasury product
development and marketing at Kuveyt Turk, one of the Islamic
One reason for the policy shift appears to be the growing
confidence in power of Turkey's ruling AK Party, which in the
last several years has succeeded in reducing the political power
of the secularist military.
A bigger reason may be economic trends. The Middle East and
North Africa are becoming increasingly important to Turkish
companies as growth in Europe and the United States stagnates.
"In this year, 34 percent of Turkish exports went to the
MENA, so we need a similar kind of story for financials, foreign
direct investment and any kind of debt issuance," Melis Metiner,
senior economist at HSBC Turkey, said at the bank's MENA-Turkey
forum, held in Dubai this week.
"In terms of debt issuance I think that would be a very
Turkey's Islamic banks have so far issued only two sukuk.
Both were issued by Kuveyt Turk, 62 percent owned by Kuwait
Finance House, which raised a total of $450 million in
2010 and 2011.
The sovereign sukuk is expected to stimulate more issuance
by the banks, by giving investors a benchmark off which to
calculate yields they will accept. Kuveyt Turk has said it
plans to sell a lira-denominated sukuk this year.
Last November Bank Asya shelved a plan for a $300 million,
five-year sukuk issue, citing "adverse developments in
international markets", but it may eventually revive the plan.
Al Baraka Turk, a unit of Bahraini lender Al Baraka,
has been talking about a possible $200 million sukuk issue.
Current market conditions for Turkish sukuk issuance appear
excellent. Because of a big overhang of unsatisfied investor
demand for sukuk in the Gulf and elsewhere - Ernst & Young
estimates outstanding demand globally is over twice this year's
expected supply of sukuk - many borrowers have been able to
issue Islamic bonds more cheaply than conventional bonds.
"In the current context, where Turkish banks have been able
to obtain international financing via Eurobonds at relatively
cheap rates, there is room for advantageous pricing," said
Ugursel Onder, senior associate at IS Investment.
Turkey's Islamic banks have so far been depending largely on
retail deposits and short-term syndicated loans for funding, and
have had limited access to international markets. So borrowing
longer-term money via sukuk could improve their funding
structures, Yeter said.
Onder said sukuk might help Turkey's Islamic banks meet
minimum capital adequacy ratios as regulators tighten standards
around the world. Since sukuk are asset-based instruments, they
may in some cases be treated as a form of capital on banks'
balance sheets, unlike conventional bonds which are pure debt,
"Participation banks can issue sukuk as capital-like loans.
In that way, these can be considered as Tier 2 capital and be
treated like equity, which will in return boost their capital
Once Islamic banks issue their own sukuk, they may shift
their attention to underwriting sukuk for Turkish companies
seeking to raise money.
"The first non-financial sukuk could come as early as 2013.
I think corporates will closely watch the sovereign issuance
first," Onder said.
"As the know-how improves in the market, big corporates,
holding companies and commercial firms would be much more
interested," said Oguducu. "A number of corporates are
interested in issuing sukuk, especially in the domestic market."
Since many international investors would require companies
to have investment-grade credit ratings before buying their
sukuk, some companies will focus on attracting domestic
investors with lira-denominated sukuk, analysts said.
Turkey's sovereign sukuk uses an ijara structure, a leasing
contract in which investors acquire partial ownership of an
underlying asset and share in returns on renting it out.
Broadening the types of sukuk in the market to include
structures such as musharaka and mudaraba, which resemble
partnerships or asset management contracts, would encourage
corporate issuance, Yeter said - though the necessary expertise
would take time to develop in Turkey.
Another important issue is tax policy. Because sukuk can
involve two or more transfers of their underlying assets - one
at the time of issue, and a second when the sukuk matures - they
can be taxed more than once, making them less attractive. The
Turkish government currently exempts ijara sukuk from multiple
taxation but not other structures, Yeter said.
In addition to demand for Turkish sukuk from international
investors, significant interest is expected from Turkish pension
funds, some of which offer Islamic products, and from other
investment funds keen to diversify their fixed-income holdings,
Sukuk could eventually hold a share of the lira corporate
bond market that exceeds the roughly 5 percent share which
Islamic lenders have in the banking sector, Ibrahim Turhan,
chairman and chief executive of the Istanbul Stock Exchange,
told Reuters. "In sukuk, I expect a better performance."