Turkey's financial sector was impeded in the past by instability and fiscal deficits. As a result, the sector is smaller than it could be and performing below its potential. Furthermore, its development has until now been uneven. The share of non-bank financial institutions remains small compared to the banking sector. Finally, mobilized funds whether by banks or non-bank institutions have historically not been invested broadly in the private sector and have instead been largely invested in a few large firms and in government securities.

As Turkey's economic environment improves, Turkish financial markets become increasingly likely to develop according to their potential. Such development will be supported, not only by banks, but also by the already-vast variety of non-bank institutions, such as mutual funds, pension funds and real estate investment funds, and will bring with it a diversification of the assets to which their investments are allocated. With their substantial assets, non-bank institutions now have the potential to become sophisticated investors in the equity market, in the potentially-vibrant corporate bond market, and in the growing real estate market.

All kinds of funds are likely to increase their exposure to Turkish markets investing in diversified classes of assets, but signs of future changes are already visible. Mutual funds have become an increasingly important savings vehicle and their assets now account for 4.6% of GDP. As far as pension funds are concerned, the indicators of the Turkish Treasury reveal that there is a very important growth potential for the private pension system to be supported by new vesting and tax regulations, as well as the transfers from the non-profit foundation based pension funds. Fund accumulation of 5% to 10% of GDP is anticipated in the coming 10 years. With respect to Turkish real estate investments companies, their recent dynamism shows the potential of the underlying real estate market and related investments. Interestingly, the Initial Public Offering of Akmerkez REIC (Turkey's premier shopping and business complex) completed on April 2005 was the largest of the kind since 2000.

The Turkish legal framework for mutual fund management and other investment vehicles is well established. The Capital Market Law no 2499 was enacted in 1981, distinguishing between non corporate and corporate entities. The latter are closed-end portfolios incorporated as joint-stock companies whose shareholders may only sell their shares to other investors, the former are open-ended funds with the capacity to constantly issue and redeem new certificates. Both may be publicly traded. The sector is supervised by the Capital Markets Board (CMB) which was created by the Capital Market Law.

Mutual funds

It has been almost 20 years since the first mutual fund was set up in Turkey, in 1987. The sector has seen constant growth with a 25% increase since 2004 in terms of net asset value, to reach $22.8 billion today. Yet its potential is still unachieved compared to the $70 billion of domestic savings existing in the country.

The first piece of delegated legislation regulating mutual funds was adopted by the CMB in 1986. Ten years later, in 1996, a new comprehensive text that brought many innovations to the regulation of mutual funds came into force. This Communiqué is still in use and has been modified no fewer than 14 times since, reflecting the attention focussed on the sector by the Turkish authorities. The last amendment is dated April 2006.

Mutual funds are "a property established to manage a portfolio of capital market instruments, real estate, gold, or other precious metals by funds collected from the public in return for participation certificates, under the principle of distribution of risk and fiduciary ownership". They have no legal personality. However, their assets are separate from those of their founder.

They are operated in accordance with the rules provided in their internal statute, which includes general terms about management of the fund, custody of the assets, valuation principles and conditions of investing in the fund.

Turkish Mutual Funds are then often referred to as a four party contractual relationship tainted with fiduciary relationships. Yet the main advantage for not having legal personality is the safety investors can enjoy should the founder or the manager be subject to liquidation proceedings. Additionally, the assets of the funds may neither be pledged nor provided as guarantee or seized by third parties.

There are two different types of Turkish mutual funds: Type A and Type B. Funds permanently investing at least 25% of monthly average weighted portfolio value in stocks of corporations established in Turkey, including the ones that shall be privatized, are called Type A, and all others Type B. Type B funds, which are considered as less risky, may not engage in certain operations. As of today, 152 Type B funds represent 95% of the total value of assets held through the 277 Turkish mutual funds. Two years ago, the share of Type B funds was slightly more than 98%.

Mutual funds are classified in 12 categories depending on their asset allocation, and their portfolio may only be composed of: (i) shares of Turkish corporations, (ii) public and corporate sector debt instruments, (iii) foreign public and private sector debt instruments, (iv) gold and other precious metals traded on national and international exchanges and capital market instruments traded on exchanges that are based on these metals, and (v) other capital markets instruments approved by the CMB.

As in many other jurisdictions, the four actors of mutual funds are the founder, the investor, the fund manager and the custodian. The CMB should not be forgotten though: the regulatory body in charge of the compliance with mandatory disclosure requirements is also responsible for granting approvals prior to operating on the Turkish capital markets.

Founders

The initial fund amount must not be less than NTL100,000 ($75,500). Founders can be banks, intermediary institutions (that is, institutions approved by the CMB that operate in the business of buying and selling capital market instruments for commercial purposes), insurance companies and retirement and pension funds. The founder must appoint a board, consisting of at least three individuals in charge of operations of the fund and at least one auditor. Board members are subject to certain restrictions and must be university graduates having at least five years of experience in capital markets.

Founders must comply with certain requirements set out by the Communiqué. Such requirements, together with certain documents including the fund's internal statute are checked by the CMB. In addition, the opinion of the Turkish Undersecretariat of Treasury has to be sought when founders are banks or insurance companies.

Meanwhile, a fund service unit has to be formed for providing operational services to all the funds created by a founder. The service unit must be composed of full-time fund managers having the same qualifications as the founder's board members, must have efficient technical equipment and accounting systems and an adequate number of personnel to ensure the operations of the fund are duly performed.

Investors

Investors invest in the fund by buying and selling participation certificates. Participation certificates represent the rights and the amount of units the investors have in the fund.

An application is to be submitted to the CMB for the issuance and registration of the certificates for public offerings or private placements. In this respect, the founder shall complete along with their request a circular and a prospectus containing enough details to disclose clearly the substantial information on the fund. Once approved by the CMB, the prospectus is registered with the Trade Registry and the participation certificates can be offered to investors.

Certificates are negotiable instruments. They have no nominal value. The price of a certificate is calculated at the end of every trading day, by dividing the net asset value of the fund by the outstanding number of certificates. In the event of emergency or extraordinary situations, the CMB may suspend the calculation of the certificates' value and forbid their purchase and sale.

Portfolio management

Either intermediary institutions that have been authorized to manage portfolios or portfolio management companies manage the portfolio of the mutual funds.

Management companies too have to obtain a licence from the CMB. They must be joint-stock companies with a minimum share capital of NTL750,000 and can be owned by foreign investors. In such case, the CMB will liaise with the competent authority in the shareholders' home country.

A written contract between the fund and the portfolio manager governs their relationship. The manager is responsible for managing the portfolio consistent with objectives stated in the Capital Market Law, the Communiqué and the internal statute of the fund.

Managers must have an adequate number of expert personnel in fund management with at least five years of experience in capital markets on assets to be invested by the fund, and technical hardware suitable to the management and investment purpose of the fund.

To ensure that mutual funds' portfolios are sufficiently liquid and well diversified, the Communiqué enforces limitations on their portfolios. These limitations have to be complied with by the manager, including the following:

• To sustain the fair price in the transactions of the fund, which is the lowest price when buying and the highest price when selling an asset;

• Not to invest in unlisted securities, with a limited exception for securities the founder or the portfolio manager of the fund underwrites;

• Not to invest in the securities of a single issuer more than 10% of the fund's net asset value;

• Not to purchase more than 9% of one issuer's shares;

• Not to invest in the securities of the founder or the portfolio manager;

• Not to be represented in the management of the companies whose shares the fund has purchased.

Custodian

Turkish mutual funds are required to protect securities in their portfolio by depositing them in a depository institution: the Istanbul Stock Exchange Settlement and Custodian Bank, or the Istanbul Gold Exchange for precious metals. Other custodians may nonetheless be accepted by the CMB. The CMB requires the depositor to segregate mutual fund portfolio securities from other assets. A custody contract sets out the terms and conditions of the relationships between the founder and the custodian.

Like in many other European jurisdictions, the Turkish mutual fund system relies on the notion of contractual relationship. This is illustrated by the fact that the relationships between the founder and the investors are, in the absence of any contrary provision of the Law, the Communiqué or the fund's internal statute, governed by the rules of the Turkish Code of Obligations regulating agency. Still the underlying principle of fiduciary ownership set out by the Capital Market Law and the Communiqué, drawn from the German-Swiss origins of Turkish commercial law, ensures that investors' rights and interests are respected.

The future of Pension funds

The Private Pension Law no 4632 published in the Official Gazette on April 4 2001 laid down the features of a fully funded system, of the defined contribution type, voluntary, and based on individual retirement accounts.

Only the licensed pension companies are entitled to sell personal private pension products and collect personal pension contributions in Turkey. The collected funds in this system should be invested through the investment vehicles called Pension Mutual Funds (PMF), which are mutual funds founded by the pension companies exclusively for the investment of pension monies. Also, the investment of these PMF can only be managed by the portfolio management companies and not by the pension company itself. The pension company pays a commission to the portfolio management company for the fund management service.

Employers can make contributions to the private pension accounts of their employees and deduct these contributions from their corporate tax base as business expense. Such arrangements are called Group Personal Pension Plans.

Investors are able to retire from the system, once they are over 56 and have been in the system for 10 years. They are also able to track their investments, change their investment plans up to four times a year, and change companies up to once a year. Thus, the system has great transparency, and security. The system also guarantees people's funds, even if the company providing the pension plan becomes weak financially. Private auditing, in addition to inspections by the CMB, is conducted regularly. Furthermore, private pension law provides significant tax reductions on earnings.

Private companies, domestic and foreign alike, have already been capitalizing on this law. Considering that average life expectancy has increased to 70 in Turkey, and that the top 5% to 10% of the population controls almost half of the total income in the country, it is clear that the current inadequacy of the Turkish social security system leaves room for strong demand for private pension plans.

It is estimated that in 10 years an accumulated $15 billion to $25 billion will be created with these investments. Furthermore, participation in the personal private pension system in the form of groups constitutes a crucial potential for the development of the system. The share of group contracts among the total pension contracts in the personal private pension system is now about 24%. However, with the new proposed legislation specifying the type and limits of vesting schedules that may be imposed by employers within the group personal pension plans, this ratio is expected to rise to a level of 60% to 70% in a couple of years. A considerable number of companies have budgeted their contributions to the private pension system for their employees for 2006, as a result of the expectation of such legislation.

Real estate investment

The number of building permits granted in Turkey expanded by 50% in 2004 and 2005. Sometimes improperly referred to as real estate investment trusts (Gayrimenkul Yatirim Ortakligi), Real Estate Investment Companies (Reics) are often considered to be the most efficient investment vehicle in the real estate sector. Reics are totally exempt from corporate income tax, and dividends distributed to their shareholders are, provided those shareholders are legal entities being Turkish residents, exempted from any withholding tax. The applicability of withholding tax exemption for foreigners is a controversial issue that could not be settled yet by the contradictory rulings issued by the Tax Administration from time to time.

Foreign appetite for Reics has been growing and has been shown by recent landmark transactions such as the €148 million subscription by Dutch Corio NV, one of the largest quoted property companies in Europe, to the IPO of Akmerkez REIC, a highly regarded shopping mall located in the most prestigious and affluent neighbourhoods on the European side of Istanbul.

Author biographies

Guillaume Rougier-Brierre Gide Loyrette Nouel Guillaume Rougier-Brierre, a partner at Gide Loyrette Nouel since 2001, is admitted to the Paris Bar. He graduated with honours from the Paris Political Studies Institute (Institut d'Etudes Politiques de Paris) and holds an honours degree in European and international law from the University of Paris II and a dual postgraduate degree in company law from the Universities of Paris II and Paris V. He began his career at GLN in early 1993, working in the Real Estate Transactions and Financing Department until 1997. He spent the following three years at the Warsaw Office advising the Polish government and foreign investors on cross-border acquisitions, privatizations and major international contracts (BOT). Guillaume has been managing the Istanbul Office since June 2000 and specializes in M&A, arbitration and international finance. He is the president of France's Foreign Trade Advisers to Turkey. Pierre Briguet-Lamarre Gide Loyrette Nouel Pierre Briguet-Lamarre, an associate admitted to the Paris Bar, has been working at the Istanbul office of Gide Loyrette Nouel since 2004 where he has been advising foreign clients on M&A transactions and cross-boarder financing operations. He holds a master's degree in business law from the University of Paris V, a postgraduate degree in business and tax law (DJCE) and a postgraduate degree (DEA) in private law from the University of Poitiers, as well as a European law degree from Gonville & Caius College, Cambridge, UK. Pierre recently joined the Paris office Finance Department where he is working on fund structuring and asset management.