Recent development 

On February 1, 2016, a Turkish issuer of corporate bonds announced that it had defaulted on its bond obligations, marking only the second time in a decade that a Turkish corporate issuer defaulted in the debt securities market. This followed another default less than a year earlier in March 2015. As a result of these defaults, the Turkish Capital Markets Board (the "CMB") imposed sanctions on the first issuer, credit rating agency, and the auditor as well as the issuer's directors. These events are likely to trigger the adoption of tighter domestic bond regulations, reshaping the future of Turkey's domestic corporate bond market.

What the CMB faces

Practically non-existent between 1999 and 2006, since 2006 the Turkish corporate bond market has grown rapidly, with easy access to credit supported by a regulatory overhaul that replaced piecemeal regulations with a prescriptive, unified approach. These reforms included reorganization of Turkish capital markets law, incentives to banks and other non-bank financial institutions, and the same tax treatment for corporate bonds as for government bonds.

Currently, the volume of corporate debt securities is TRY 45 billion (~USD 15.4 billion) -- led by banks with TRY 25 billion (~USD 8.5 billion), non-bank financial institutions with TRY 12 billion (~USD 4.1 billion), and corporates with TRY 8 billion (~USD 2.7 billion). Turkish corporate debt securities are offered in Turkish lira with high yields and are colloquially referred to as "baklava bonds" due to the sweet margins with which they are associated.

Following the March 2015 default, Borsa Istanbul delisted the issuer's securities. The CMB had already initiated criminal proceedings against the issuer's directors for misrepresentation of the issuer's financial condition prior to the default. Further, in September 2015, the CMB disqualified the credit rating agency and its responsible credit rating expert from operating in Turkish capital markets for two years. On February 4, 2016, the CMB also imposed a monetary fine of TRY 280,091 (~USD 96,000) on the audit company, cancelled the audit firm's license and indefinitely disqualified the audit firm's responsible partner from providing audit services in Turkish capital markets.

The CMB has yet to take action in connection with the second default in the market but Borsa Istanbul has already delisted the issuer's debt securities.

While it is still unclear whether the CMB will impose tighter rules for domestic corporate debt securities issuances or opt in for a more laissez-faire approach, we believe that the CMB's approach will be conservative in order to protect investors, especially given that domestic investors hold 98% of issued corporate debt securities. The CMB's current domestic corporate debt amendment proposal (see an overview of the amendments here) requires a credit rating for domestic debt securities issuances, mandatory provision of bank guarantees, and prohibition of corporate guarantees for some issuances.

Conclusion

Companies in Turkey have historically relied on bank loans for funding but an increasing number of Turkish companies are accessing capital markets to diversify their funding portfolio. Furthermore, direct funding through "baklava bonds" helps reduce the need for financing from abroad. The CMB's reaction to the defaults is understandable from an investor-protection perspective, which the CMB has been pursuing since 2012. Along with plans for stricter rules for domestic corporate debt securities, enhanced regulatory supervision is on the agenda; the CMB wants to increase the protection of corporate debt securities investors, a market characterized by its domestic nature. The effect of a stricter corporate debt securities regime for "baklava bonds," however, remains to be seen as that will depend on the CMB's policy decisions when adopting new safeguards.