The debate over creating an Islamic security instrument for Turkish capital markets has finally reached the point where the Capital Markets Board (CMB) very recently introduced the lease certificate, a new capital market instrument that offers an alternative to non-interest-bearing bonds (sukuk).
Lease certificates are regulated under the Communiqué on Principles regarding Lease Certificates and Asset Leasing Companies, Serial III, No. 43 (Communiqué III/43). The CMB seems determined to encourage an Islamic method of financing in Turkish capital markets, and it is no coincidence that right after Communiqué III/43 entered into force in April 2010, the CMB signed a memorandum of understanding with the Securities Commission of Malaysia the motherland of sukuk with the aim of promoting mutual cooperation between the parties.
Charging interest on capital is generally illegal under Islamic law, and the CMBs primary motive in creating lease certificates is undoubtedly to take advantage of the increasing trend towards Islamic finance as a way of attracting foreign direct investments from the Persian Gulf region. The CMB is also attempting to promote the diversification of financial instruments, by creating a safer alternative to existing financial instruments, and to make Turkeys capital markets function more effectively.
Government efforts to adapt Islamic financing to Turkey go back several years. It was in 2003 that the government announced an interest in creating a legal framework for the issuance of Ijara Sukuk (a specific type of sukuk based on leased assets). To that end, the Undersecretariat of the Treasury prepared the Draft Law on the Provision of Financing to the Public through the Use of Public Assets (draft sukuk law), presented it to the Prime Ministrys office in 2003, and re-presented it in 2005.
The draft sukuk laws aim is to apply Ijara Sukuk to publicly-owned property including immovable property, privileges, and operating rights of public bodies and institutions thereby increasing the number of public-sector financing sources. Due to bureaucratic obstacles, the draft sukuk law has yet to be enacted. However, according to a CMB study on Islamic finance in Turkey (published in June 2009), the draft law is now being reviewed by the Prime Ministrys office. Once the Council of Ministers approves it, the Turkish Grand National Assembly (Parliament) will consider its enactment.
Although the sukuk is not yet a public financing method in Turkey, the CMB has managed to present lease certificates to the private sector as an alternative. Communiqué III/43 is based on Ijara Sukuk, one of the most common types of sukuk issuance especially in project finance transactions.
According to the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), Ijara sukuk differs from other types of sukuk in that it represents ownership of well-defined, existing and known assets tied to a lease contract. Ijara Sukuk requires the creation of a special purpose vehicle (SPV), whereby the obligor first sells certain assets to the SPV at a pre-determined price, and then signs a lease agreement with the SPV for a fixed term, leasing back the sold assets as lessee.
The SPV raises funds from investors by issuing sukuk certificates in an amount equal to the purchase price, and provides the obligor with such funds. In the meantime, due to the lease agreement, the SPV receives periodic rentals from the obligor which are then distributed to the sukuk holders as coupon payments. At maturity, or upon the occurrence of a dissolution event, the SPV sells the assets back to the obligor at a pre-determined value, which should be equal to any amounts still owed under the terms of the Ijara Sukuk.
Lease certificates under Communiqué III/43 function in almost the same way as Ijara Sukuk, the only differences being of a minor regulatory nature. To start with, because trusts are not recognised under Turkish law, an asset leasing company (Varlık Kiralama Şirketi or ALC) which functions as an SPV should be established as a joint stock corporation in Turkey. To protect the rights of the investors, as well as prevent ALCs from using income derived from the assets acquired on behalf of the investors beyond their scope, the CMB imposed certain minimum requirements on ALCs. Pursuant to Communiqué III/43, an ALC can be established only for the following activities, which should be explicitly indicated in its articles of association:
- issuing lease certificates;
- acquiring or renting assets on its own behalf, at the expense of lease certificate holders;
- making payments in relation to the funds derived from the assets to the lease certificate holders pro rata to their shares; and
- selling and transferring assets back to the obligor pursuant to the pre-determined conditions at the end of the lease term.
According to Communiqué III/43, ALCs cannot purchase the assets of different obligors simultaneously, and cannot establish rights in rem on the assets for the benefit of third parties. Communiqué III/43 also imposes many other restrictions on ALCs issuing and offering such certificates to the public. In that respect, one far-reaching obligation of ALCs is to inform the CMB quarterly of every asset subject to lease certificates that is sold through public offering, as well as payments to the certificate holders, prior to the cancellation of such certificates. Even with these limitations, the CMB retains its right to request additional and when necessary more detailed information from ALCs on their activities in the sector.
Most of Communiqué III/43s provisions are clearly designed to give investors wide-ranging protection. This is understandable, as we have all learned from the recent global financial turmoil that asset-backed securities may well be dangerous playthings in the hands of the uninformed investor. Determined to increase Turkish capital markets attractiveness to foreign investors, the CMB appears to be continuing in its own special way, strictly regulating the market instead of following the deregulation trend.
Gökhan Eraksoy and Tuğçe Uğurlu
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