Turkey's financial sector
After a flat 2006, in 2007 the Istanbul Stock Exchange saw an increase of 72% in US$ terms. That said, the current market cap for the Turkish equities market is about 45% of GDP. The corresponding figure for the EU is 150%, for the Mediterranean market it is 65-70%, and BRIC countries and emerging markets likewise have much higher figures. This, in Eczacıbası Securities' opinion, makes it safe to assume the ratio will eventually get to 65%: representing a 50% increase. In the meantime, if GDP continues to increases by 5-6% per annum, then the equity market's development will be significant indeed.
These figures are indicative of a continuing aversion to the stock market on the part of both Turkish corporates and investors. Foreigners, however, are much less sceptical, holding fully 73% of all the shares listed on the ISE and buying on average 70% of every IPO. Interestingly, whereas in the past much of this money could be fairly described as speculative ‘hot money' there is increasing evidence that this capital is now here for the long term and thus more resistant to the intermittent hiccups to which all emerging markets are prey. Whereas it would be over stating the case to argue that volatility is a thing of the past, the evidence is that investors' reactions tend to be more nuanced and circumspect: they know that in some ways it's par for the course.
Views on what the next 12 months will bring are split between those who think that Turkey's economy and financial markets will continue to grow and those taking a more cautious approach. In truth, it is too soon to tell if or how Turkey will be affected by the big losses emerging form the sub-prime mortgage debacle. There is a chance that some foreign investors - having done well out of their Turkish investments - may feel that it is time to ‘cash in', leading to capital flight. The depth of the market is such, however, that it would be able to sustain such a sudden outflow without it becoming a full blown crisis.
It is into this relatively benign environment that the ISE announced the appointment of its new chairman, Hüseyin Erkan. With a background that includes setting up the ISE's international relations department and acting as its executive vice chairman until 2006, he is well positioned to take on a role that requires a firm grasp of what is needed to keep international investors interested in Turkey while improving the extremely low involvement of domestic investors. His appointment came quick on the heel of the announcement of the government's ninth development plan, which puts development of the ISE at its very centre. Erkan sees his resultant priorities as being to increase the number of companies listed on the ISE and increase domestic participation.
To date, the bulk of foreign investment on the ISE has come from the US and the UK, with a much smaller amount from continental Europe and east Asian interest just beginning. While this remains important, Turkey's geographical and cultural proximity to the booming Middle East presents a peculiar opportunity that both banks and the ISE are set to grab at. Until recently, Middle Eastern capital had entered Turkey primarily in the form of FDI, and primarily into real estate. But in the future it is hoped that the introduction of instruments complementary to Islamic investment proscriptions on interest will lead to a burgeoning involvement of Middle Eastern investors.
More staidly perhaps, Hüseyin Erkan hopes to oversee and increase the share of free float, startingly low at present. While increasing the number of IPOs is important, Erkan is firm that this must be balanced against the need to ensure there is enough free float out there to keep investors satisfied, something he refers to as a "delicate balance". A lift in the average percentage of free float among listed companies is, according to Erkan, not going to come from a legal requirement to do so. A few years ago, the percentage of free float required for listing was increased from 15% to 25% and no further such moves are expected. Instead, Erkan believes it is the Turkish real estate sector that must realise the benefits of increased percentages of free float, and he expects the financial sector to bring this realisation about.
The financial sector as a whole is entirely comfortable with this view. From the perspective of some working for the biggest players in the sector, their efforts to entice companies onto the exchange would benefit from further central support - both moral in terms of a government campaign and material in terms of sanctioning instruments that would make the capital markets more attractive. Currently, many houses embark on regular ‘road shows' around Turkey, making presentations about the benefits of the capital markets to local chambers of commerce and industry forums. These are not done for entirely altruistic purposes as they bring firms into contact with a multitude of potential investment opportunities for the future. As the Oyak Securities' Meltem Agci candidly states: "The road shows expose us to so much opportunity that we have begun categorising Turkey into areas of varying potential. They also unfailingly serve to increase our client base, as those we speak to may not be ready to list, but are most certainly ready to invest and to make use of our corporate finance services."
That said, some in the industry are open in expressing frustration at not being able to do more. One of the most common criticisms is of the Capital Markets Board's perceived conservatism in response to suggestions for change and temerity in floating the prospect of new instruments and then gradually shrinking from their introduction. To take just one example, single stock futures have been promised for a while, but are yet to be introduced and some brokers are beginning to lose hope they will ever arrive. Even when they do arrive they will be traded on Izmir's Turkdex, a derivatives exchange and itself the product of private sector initiative. Sources of frustration are not only consigned to the domestic sphere: the lack of give-up contracts is pointed to as a particular fault, important for foreign investors who do not use Turkish firms as custodians. In the view of Meltem Agci, it is regulation that will play the crucial role: "If the regulation becomes more supportive then I think that the sky is the limit. We can only do so much to educate people about the markets without the appropriate regulation. Without it, most of the business around foreign money active in relation to listed Turkish companies will continue to be done in London, as it is now. We are losing commissions, the government is losing tax revenues, but nothing happens."
The ISE has seen very few IPOs in recent years and practically all of those that occurred in 2007 were from the financial sector. Erkan intends to target the top 500 Turkish companies, of which only about 110 are currently listed. The reasons for their hesitation are many, but a key factor appears to be cultural rather than rational. The size of Turkey's 'grey economy' is such that some companies feel that the transparency requirements attendant to being listed will put them at competitive disadvantage vis-à-vis rivals who are not. Fortunately, structural changes to the economy are assisting in making this ever less true in fact, although the perception persists. New company rules already adopted will eventually mean that all companies have the same reporting requirements, regardless of whether they are listed or not. Similarly, the adoption of international accounting standards and the reduction of corporate tax rates have likewise reduced the penalty of being listed.
Increasing the number of domestic investors active on the market is another priority for Erkan and the industry as a whole. It is striking that the flourishing of the domestic economy is not reflected in domestic participation in capital market products and securities. Much of the potential for an upturn in domestic institutional investment is tied up in the prospects of the private pensions market where domestic institutional investment hinges - and this is indeed growing rapidly (see asset management article). But capital accumulation has yet to reach critical mass and is unlikely to do in the near future.
One of the most signal trends of the last few years has been the increasing arrival of big international financial houses in Turkey. There are currently about 10 international firms present either through having bought the licences or entering into joint ventures with existing brokerage firms. Turkey is not new to international firms as most were already running Turkish services out of an EMEA team that would also be covering countries such as Russia and Hungary, usually employing one country analyst and one economist. Increased involvement in the market, mostly in M&A, now necessitates an actual presence in-country. This presence commonly involves a dedicated sales force and three to four analysts. Being based in Turkey has meant that their scope of activities has expanded beyond their past focus on big IPOs and big M&A deals to encompass other, smaller deals. Additionally, whereas before they would regularly partner up with local brokerage houses to carry out their Turkish trading activities, these are increasingly carried out in-house. This has been great news for Turkey in general as it has only served to increase the already frenetic pace of activity in the markets, but it also serves to make the environment a more competitive one.
This change to the market is taking place at a time of important structural transition for the Turkish economy that is likewise exerting a transformational pressure on how business is done. Among the transitional factors are the steadily lowering interest rates. In the past, making money was relatively easy: capital was kept in deposit accounts and loans were made to the government. In the words of Is Investment's Serhat Gürleyen: "Borrow short term and lend long term; if you can manage liquidity, you make money." But this period is now firmly in the past. The financing needs of the public sector are much diminished, the government is now a net debt payer and inflation is down and going lower. Though real interest rates remain high at 10%, in two or three years' time they should drop to below 7%. This represents a new world for financial firms in Turkey used to rates approaching three figures - one in which there is volume growth, but declining margins. The expectation is that volume growth will be enough to sustain profits, but it is in many ways a question of scale.
In short, the financial sector is experiencing a significant shake-up. Firms whose profits in the past depended to a significant extent on servicing the brokerage needs of international houses are now being forced to take steps to recalibrate their activities accordingly. The same goes for houses that concentrated in the past on lending primarily to government. Companies are addressing these pressures in several ways, one of which is to work more directly with ‘end users' such as mutual, hedge and pension funds. As Yapı Kredi Yatırım's Ahmet Yıldırım says: "We know we can't compete with the big international banks on trading, but international funds are aware of the benefits of working with locals and we aim to leverage that knowledge to replace lost business on the brokerage side."
The transition to working with end-users is not straightforward. Despite foreign interest in Turkey, securing the business on offer is pushing Turkish firms to become increasingly proactive in their marketing. Those firms with international partners have of course been able to leverage that partnership, while others take the step of making regular road shows. Several send sales teams to London and other developed markets to meet with fund managers based there on a monthly basis, occasionally taking representatives of Turkish firms with them to present to potential investors. Producing reports is another core activity though there is the wry acknowledgement that "brevity is the way forward in reaching fund managers who, let's face it, are interested in a lot of markets. We just keep shoveling the advice on and trust that its quality will take".
On the domestic side, the fall in fees that comes from the arrival of international firms is creating similar shake-ups. As Salih Reisoglu explains, Turkish domestic business can be roughly split into two categories: smaller investors who really need and really take advice and volume investors - small in number but huge in size - who know what they want do and, as they trade in huge volumes, are very sensitive to prices. The category of customer that they focused on in the past will determine to a large extent the precariousness of the future. Those catering to the former - of whom Eczacıbası and Global Securities are two pre-eminent examples - are confident of retaining that business, as long as they continue to prioritise and invest in the quality of their research and customer service. Those catering to the latter will, over time, find their margins increasingly squeezed to the point where remaining in business will not be guaranteed.
However, it should not be understood from the above that the sector is going through a time of stress and consolidation. Far from it. While consolidation and increased competition is one part of the story that has defined the banking scene in recent years, there is a parallel trend slowly picking up pace: that of diversification and expansion. A number of firms have taken the step in recent years of expanding abroad: Is Yatirim recently opened an FSA-licensed subsidiary house in London called Maxi Securities, while others, such as the corporate finance house Daruma, are looking more regionally, expanding into Bulgaria, Romania and India. Global Securities, an early mover in the past, is refocusing on its own international offices that it had originally opened before the 2001 crisis. Although these activities have yet to return big profits, there are high hopes for the future.
As above, so below: on the retail side, some brokerage firms that have previously been content to work through their retail parents' branch offices are now opening their own branches. This is in part due to the often referenced need to educate the domestic investor about capital markets, but importantly is also a rational investment that should see a return before long. A few firms have taken the step of establishing sister companies to address different sides of the market. Deniz Bank - bought by Dexia last year - has both EkspresInvest and Deniz Yatirim and a specialty derivatives firm to cater to different aspects of the brokerage market. EkspresInvest focuses on an international client base, primarily international fund managers, while Deniz Yatirim has a wider purview and will become the principle domestic firm in time. Similarly, Global Holdings has the large and long-established Global Securities as well as the boutique Hedef Securities that focuses on high net worth individuals and a few large institutions, but is planning to expand into asset management and international capital markets in 2008-9.
One of the more prominent shifts has been the expansion in the number of firms now offering corporate finance and investment banking services. In material terms, some of the rationale for this is the already referenced encroachment of international firms into Turkey that has removed some of the profitability from ‘straight' brokerage. A far bigger incentive, however, is the sheer number of opportunities stemming form this area, one that will only grow in tune with the economy. Foreign companies are increasingly looking to make acquisitions in Turkey, foreign funds are looking to make investments in Turkish firms as yet unlisted and Turkish companies are increasingly willing to engage in acquisitions and partnerships of their own, both in Turkey and abroad.
The reasons for this are explained in greater depth elsewhere in the report but in nutshell the government's privatisation programme, the increasing stability of macroeconomic conditions, growing regional wealth, a positive demographic situation and growing consumer spending power are all factors working to spur the growth in demand for corporate financing. Of the 96 brokerage companies in Turkey, only a few have the requisite five licences to carry out broader corporate finance and investment banking activities, but they are expanding these activities and are being joined by a number of new companies that focus exclusively on this area.
Most are subsidiaries of the big Turkish banks or big international names, but there are a few independents as well. It should be noted that investment banking ‘proper' does not currently exist in Turkey, as even those firms referring to themselves as such lack a proper loan facility and can grant loans for equity trading alone. For project finance purposes or commercial loans, one must resort to the banks themselves, who have their own, different limitations. The only firm that can arguably be called an investment bank is TSKB, established in the 1950s as a development bank. Though now privatised, it continues to work closely with international development institutions and its charter contains restrictions that prevent it from being considered a standard investment bank.
While the move into corporate finance activities by large brokerage houses is a relatively new trend, there are Turkish firms have been active in corporate finance for some time. As Daruma's Okan Altug points out: "It is a misperception that debt and equity financing are new practices for Turkish companies. Turkey is a capital negative county and has always been in need of financing." Though he admits that, historically, to suggest an equity partner to a Turkish businessman was akin "accusing them of prostitution", he stresses that this now no longer the case.
However you look at it, it is clear that there is a huge amount of confidence and that corporate finance is set to grow and grow in the coming years. Much of this confidence is grounded in the government's programme of privatisations for the next few years. Although arguably some of the bigger privatisations have now taken place, including some of the larger corporations, telecoms, petrochemicals, 2008 will see the privatisation of two big banks - Halk Bank and either Ziraat Bank or Vakif Bank- as well as in the sugar industry, Turkish Airlines, management of the roads and railways and perhaps most excitingly in electricity distribution and generation. As well as these big projects, Meltem Agci of Oyak Securities points out that the entry of big capital tends to activate a smaller capital.
This is attested to by others who say they are seeing increasing numbers of domestic companies that wish to be more active. Of course, the relatively low starting point of many Turkish corporates in areas such as transparency and corporate governance means that it is not quite as straightforward as it might be in other markets. For this reasons, there are an increasing number of companies specialising in pre-IPO and pre-M&A transactions. They aim to foster links between Turkish companies with great potential and international funds with the management ability and funds to cut the often huge debts that these companies have built up during the previous period of high interest rates. They then assist in the restructuring of these debts and the introduction of proper corporate governance rules and more professionalised and stream-lined management in advance of listing the company, usually within two years of the initial deal having been struck.
Indeed, despite the added pressure many voices in the industry are quietly upbeat about their ability to prosper in a more competitive market place, even at the expense of foreign rivals. Some suggest that some international firms may have rushed into the market a bit quickly and will find the going tough in terms of outright profitability over the coming years. Ahmet Yıldırım reckons: "As the domestic market grows, it's difficult to see how they will manage to compete with people such as ourselves who have 650 branches compared to the one or two that a Merrill will have. Out of this network comes - and will come - increasing amounts of locally-based businesses…Practically, their business will be restricted to the big-ticket deals, and these will not always be around. I see them keeping a presence and filling most of their time with brokerage activities as we - and other local firms - take an increasing piece of the domestic corporate finance business and partner with them on the big international deals."