II. LEGAL GROUNDS / APPLICABLE LAWS AND REGULATIONS
1. Turkish Code of Obligations
2. Council of Ministers Decree Regarding Protection of Value of Turkish Currency
3. Compliance With ISDA Regulations
III.TYPES OF DERIVATIVES
1. Forward Contracts
1.2. Relevant Provisions of Council of Ministers Decree No. 32
1.3. Communiqué of Undersecretariat of Treasury Regarding Council of Ministers Decree No. 32
1.4. Provisions of Circular of Turkish Central Bank
1.5. Contents of Forward Currency Contracts
1.6. Summary of Laws and Regulations
2. Swap Contracts
3. Futures Contracts
3.1. Currency Futures Contracts
3.2. Futures and Options Exchanges in Turkey
3.2.1. A New Exchange
3.2.2. Cooperation With Foreign Exchanges
3.2.3. Brokerage Fee
3.2.4. Contracts To Be Traded
3.2.5. Contents of Exchange Regulations
3.2.6. Types of Positions
126.96.36.199. Long Position
188.8.131.52. Short Position
184.108.40.206. Reverse Transaction (= Position Closing)
3.2.7. Market Makers
3.2.8. Clearing House Members
3.2.9. Security Deposit
3.2.10. Supervision and Audit
3.3. Option Contracts
The institutions and instruments necessitated by a liberal economy, paralleled with Turkey’s economic growth and development, positive approach to globalization and the process of harmonization with the European Union’s political and economic approaches in line with the prospects for eventual membership therein, have given a boost to the national Turkish economy, opening Turkey’s economic doors to international trade. In this respect, the Turkish financial system has become as flexible as necessitated by foreign capital and investments, which in turn extends and broadens the scope of derivate instruments on a daily basis.
II. LEGAL GROUNDS / APPLICABLE LAWS AND REGULATIONS:
1. Turkish Code of Obligations:
The Turkish Code of Obligations (Law No. 818), adopted in 1926 as an assimilation of the translation of the Swiss Civil Code and Code of Obligations, regulates the contractual rights and obligations of the parties to contracts, is based on the principle of freedom of will in contractual relations between parties which do not include the State, and accordingly, provides in Article 1 that a contract is entered into upon the mutual declarations of real or legal persons of sound mind and body. The validity of contracts is not subject to any form or format, unless otherwise clearly specified under the Code (Article 11).
Contracts relating to derivatives are also subject to and governed by these rules of contract established under the Code of Obligations.
2. Council of Ministers Decree Regarding Protection of Value of Turkish Currency:
The Council of Ministers Decree No. 32 for the Protection of the Value of Turkish Currency is applicable to transactions containing a foreign currency element. As a result of this Council of Ministers Decree, adopted in 1989, Turkey has become one of the most liberal countries in the world with respect to transactions involving foreign currencies, such that:
- Foreign currencies may be freely imported into Turkey.
- Persons resident in Turkey may freely possess and carry foreign currencies, and freely purchase, use or otherwise dispose of foreign currencies or cash in Turkey and abroad.
- Persons resident in Turkey may freely accept and receive payments in foreign currency from persons resident abroad for transactions to be performed in Turkey.
- Persons resident abroad may freely purchase foreign currencies from banks.
- Persons resident in Turkey or abroad may freely transfer foreign currencies abroad through banks.
- Foreign persons and entities making direct investments may freely and at any time in their discretion transfer their principal, interests, dividends and other income abroad.
- Persons resident abroad may freely purchase and sell all kinds of securities through banks and intermediary institutions, and transfer the sale proceeds and amounts obtained from such sales of securities abroad through banks.
It is unequivocal that payments relating to derivatives will also take advantage of such a free and liberal market.
3. Compliance With ISDA Regulations:
Turkish derivates practices and regulations are in compliance with ISDA rules and regulations. PEKİN & PEKİN Law Office, seated in Istanbul, Turkey is a member of ISDA and is, therefore, entitled to present to ISDA its opinions and comments about derivatives practices in Turkey.
Close-out and netting, which are consequences of set-off, are significant concepts under ISDA practices and are accepted and permitted under Turkish law. The following legal provisions are especially relevant to this end:
- According to Article 950 of the Turkish Civil Code: "Creditors may withhold personal properties and securities owned by debtors and in the possession of creditors with the consent of debtors until the repayment of secured debt, provided that the underlying debt has become due and payable, and the withheld properties or securities are by nature associated and related to the underlying debt. If the possession and debt have arisen out of a commercial relationship, this association is deemed to exist between merchants. The creditor will have a right of lien also on the personal properties not owned by the debtor, to the extent of protection of possession acquired in good faith."
- Articles 118 to 124 of the Turkish Code of Obligations deal with "set-off". Accordingly, where two persons are mutually indebted to each other for payment of a certain amount of money or for delivery of similar other properties, and if both of the debts become due and payable, either party may settle and their respective debts with their respective receivables. Set-off may be demanded even if one of the debts is disputed.
Article 121 of the same Code provides that: "in the event of bankruptcy of the debtor, the creditors may set-off and swap their receivables, even if not yet overdue, with and for their debts owed to the bankrupt debtor."
- Article 88 pertaining to current accounts of the Turkish Commercial Code also permits set-off and netting of debts by referring to "the balance recognized or legally required as a result of setting off of the receivables and debts at the end of each accounting period".
- Article 200 of the Turkish Debt Execution and Bankruptcy Law (Law No. 2004) is entitled "Set-off", and states in summary that a creditor may set-off its receivables against debts owed by such creditor to a bankrupt debtor.
As apparent from the above-listed provisions, set-off is recognized under Turkish laws as a statutory right before, on or after bankruptcy and insolvency and, in this light, ISDA 1992 and 2002 Master Agreements are valid and applicable on the liabilities of real or legal persons in Turkey.
III. TYPES OF DERIVATIVES:
As a function of free trade and liberal economic understanding, the functions of international derivatives have been recognized and put into effect in Turkey for certain economic and financial relationships.
Some derivatives are traded in banking and financial transactions, while others, by nature, are traded on exchanges.
Among all sectors in Turkey, the banking sector is the one that should face the least difficulty in harmonizing itself with the European Union norms and legal principles. The entire Turkish banking system, which also includes foreign banks active on a small-scale in Turkey through local branches, is already participating in international derivatives transactions. The banking system is authorized to trade on exchanges by obtaining a license for all transactions other than stock purchase and sale.
Article 21 of the Regulation Regarding the Foundation and Operations of Banks (published in the Official Gazette dated June 26, 2001) determines the extent to which futures, options and other similar contracts are required to be taken into consideration in calculation of credit limits.
1. Forward Contracts:
Forward contracts are contracts whereby foreign currencies, securities, metallurgic or agricultural commodities are agreed and undertaken to be delivered at a future date at a pre-determined maturity, quantity and price. The term "forward transaction" refers to purchase or sale of foreign currencies, securities, metallurgic or agricultural commodities at a certain future date at a price agreed upon in the underlying forward contract.
In forward transactions, which are the subject of forward contracts, the obligation to buy and sell the goods at a certain predetermined price is fulfilled and performed at the predetermined maturity by physical delivery and payment of the predetermined price.
In a forward exchange contract, if the spot exchange rate is higher than the contract exchange rate at the due date, the party who purchases currency on forward basis by this contract takes the advantage of this positive difference.
Forward exchange contracts are based on estimated exchange rates.
Forward exchange contracts are first to be discussed below.
1.2. Relevant Provisions of Council of Ministers Decree No. 32
The last sentence of the first paragraph of Article 6 of the Council of Ministers Decree No. 32 is as quoted below:
"The Central Bank is authorized to issue regulations regarding forward currency purchases and sales."
1.3. Communiqué of Undersecretariat of Treasury Regarding Council of Ministers Decree No. (32):
Article 4 of the Communiqué No. 91-32/5 relating to the Council of Ministers Decree No. 32 repeats the provisions of the Council of Ministers Decree No. 32 quoted above. Article 4 reads: "Principles of forward currency purchases and sales shall be determined by the Central Bank."
1.4. Provisions of Circular of Turkish Central Bank:
Pursuant to Circular No. (I-M) of the Turkish Central Bank relating to the Council of Ministers Decree No. 32:
- Exchange rates applicable to foreign currency and cash purchases and sales related to commercial and non-commercial transactions shall be freely determined by the banks, etc. within the framework of market rules.
- TL exchange rates for differing foreign currencies applicable to transactions shall be reported by the relevant financial institutions to the Central Bank on daily basis.
- Banks, etc. are obligated to comply, in managing foreign exchange positions, with the (liquidity) and (foreign exchange position) ratios specified in the Circular.
- Banks with activities in Turkey shall each be responsible for the printing of currency buying and selling certificates, in accordance with their needs and the forms provided as annexes to the Circular, for use in all cash and foreign currency purchases and sales. (Article 46).
- The only provision of the Circular directly related to this subject matter is its Article 7/B, effectuated as of 01.01.1998, which reads: "Banks and precious metal intermediary institutions may conduct forward exchange transactions."
1.5. Contents of Forward Currency Contracts:
In our opinion, it is appropriate for forward exchange contracts to contain at least the following provisions:
- Statement verifying compliance with all regulations for Protection of the Value of Turkish Currency and all directives of the Turkish Central Bank;
- Undertaking to perform and fulfill the obligations at the maturity dates agreed upon in the contract (with reference to both quantity and price);
- Statement that disposable funds are to be made available on the maturity date;
- Place of payment, maturity date and time;
- Delay penalty (+ legal expenses) payable by the party defaulting on the maturity date;
- Determination of the applicable parity (as currency, date and time);
- Provision indicating that a statement is to be sent after completion of the transaction;
- Authorization of relevant bank is authorized for clearance/settlement and set off;
- Term of the relevant contract;
- Provisions that accounts, records and documents of the bank will be considered and accepted as evidence; and
- Copy of the statement.
1.6. Summary of Laws and Regulations:
As apparent, a review of the pertinent laws and regulations reveals that the only existing legal provision regarding forward exchange contracts is the following: "Principles of forward exchange purchases and sales shall be determined by the Central Bank." The Central Bank has yet to establish or determine the "principles" in connection therewith. Subsequently, it may be assumed that such contracts may be freely drafted according to general legal principles, providing that they do not contain any clause in conflict with the laws and regulations.
2. Swap Contracts:
Turkish banks conduct (swap) transactions with their customers as banking transactions. Transactions under swap contracts are conducted by using various different financial instruments with a view to minimizing (hedging) the exchange risks created by the exchange rate fluctuations in foreign exchange markets1 and include the following transactions: conversion of a fixed interest rate debt to a variable interest rate debt; exchange of one currency for another currency and re-conversion to the initial currency; and conversion of money with a variable interest rate to other money with a variable interest rate. To put it in other words, it might be said that a swap is executed by a contract containing the mutual promises of both parties for payment of money in certain intervals.
The essential elements of swap contracts include the definition of the currency or currencies to be exchanged, the fixed or variable interest rates to be applied to each currency, and the respective payment dates. Swap contracts are not methods of borrowing or investment, but are only financial instruments used for changing or readjusting the cash flow of existing debts or investments.2
Swap transactions in the Turkish market, are executed through banks. The most common type of swap transaction is the interest swap contract where variable (forward) interest rate is exchanged for fixed (spot) interest rate in the same currency. Accordingly, through interest swap contracts, firms may swap their interest payment obligations from variable (forward) interest rates to fixed (spot) interest rates, thereby protecting themselves from the risks caused by the uncertainty of variable (forward) interest rates.3 However, an investor intending to hedge its risks by a swap transaction must find an appropriate financial instrument and calculate the sensitivity of that financial instrument to swap transaction (hedge ratio), and therefore, although performed, such transactions are not very common in the market.
On the other hand, although firms which do not have access to some markets due to their low credit rating may thus create another financial source and have access to such markets and provide a cash flow in another currency, it is not a common practice in the Turkish financial markets.
3. Futures Contracts:
3.1. Currency Futures Contracts:
Currency futures contract is a type of contract wherein two parties agree and undertake to purchase or sell a certain amount of currency against a certain amount of another currency (to put it in other words, a certain exchange rate) at an agreed upon price (exchange rate) at a predetermined future date.
Characteristics of the currency futures contracts are also determined generally by exchanges. However, as there is not yet an exchange active specifically on such matters in Turkey, banks are able to enter such contracts over the counter (off-exchange).
3.2. Futures and Options Exchanges in Turkey:
3.2.1. A New Exchange:
Pursuant to Article 40 of the Capital Markets Law, futures and options exchanges may be established in Turkey in the form of joint-stock corporations authorized to ensure that capital market instruments, comprised of futures and options contracts and all types of derivatives, are freely and easily purchased and sold under stable, free market conditions and authorized to determine and announce market prices of such capital market instruments.
The Capital Markets Board paved the way for establishment of such an exchange by issuing the Regulation Regarding the Establishment and Operation of Futures and Options Exchanges, published in the Official Gazette dated April 14, 2003.
Members of such exchanges are required to be firms which hold a certificate of authorization (= license) obtained from the Capital Markets Board for financial intermediation for the purchase and sale of derivatives and are required to be accepted to the membership of the exchange in accordance with the relevant exchange laws and regulations.
In accordance with the Regulation of the Capital Markets Board, the initiative for establishment of a futures and options exchange in İzmir, Turkey is in the final stages as of April 2004.
Such a futures and options exchange is established in the form of a joint-stock corporation authorized to ensure that the "capital market instruments", comprised of futures and options contracts and all types of derivatives, are freely and easily purchased and under stable, free market conditions and authorized to determine and announce market prices.
The following may be traded on such futures and options exchanges:
- Futures contracts establishing undertakings for the purchase and sale of certain economical or financial indicators, capital market instruments, commodities, precious metals and foreign currencies at a predetermined price, quantity and quality at a certain maturity date; and
- Options contracts which "entitle" the option buyer and "oblige" the option seller to respectively purchase and sell certain economic or financial indicators, capital market instruments, commodities, precious metals and foreign currencies at a predetermined price, quantity and quality at or until a certain maturity date.
3.2.2. Cooperation With Foreign Exchanges:
Exchanges may validly enter into agreements with foreign exchanges for unilateral or mutual trading in transaction systems and/or for trading of their contracts mutually in predetermined markets, however such agreements are subject to approval by the Capital Markets Board.
3.2.3. Brokerage Fee:
Tariff of brokerage fees/commissions to be paid to exchange members by their customers for each transaction executed by the members in an exchange as a broker are to be determined by the board of directors of such exchange and approved by the Capital Markets Board.
3.2.4. Contracts To Be Traded:
Futures and options contracts are to be traded on such exchanges, and the other derivatives to be traded on such exchanges shall be determined by the Capital Markets Board.
3.2.5. Contents of Exchange Regulations:
A Regulation establishing the rules of operation of futures and options exchanges has been prepared by the Izmir Exchange in consultation with the Capital Markets Board and such Regulation has been approved by the relevant State Ministry. The Regulation establishes the following: (i) the minimum components, (ii) types and (iii) validity terms of customer orders, (iv) delivery of customer orders to the Exchange, (v) submission, (vi) matching, and (vii) recording of put and call offers/bids, (viii) updating of accounts, (ix) collection of security deposits, (x) determination of price of reconciliation, (xi) announcement of prices, (xii) daily price movement limits, (xiii) modus operandi of market, (xiv) method of submission of price quotations, (xv) liabilities of the Exchange members and customers, (xvi) temporary suspension of transactions and (xvii) cancellation of transactions containing mistakes of fact or executed as a result of acts disrupting market competition.
3.2.6. Types of Positions:
The provisions under the relevant laws and regulations pertaining to types of positions may be summarized as follows:
220.127.116.11. Long Position:
(i) In Futures Contracts:
In futures contracts, the party with a long position is obliged and liable to PURCHASE, or reconcile in cash for, the assets subject to the contract at the quantity and price agreed upon in the contract at the end of maturity established thereunder.
(ii) In Options Contracts:
- In call options, the long party with a position is entitled and has the right to PURCHASE, or reconcile in cash for, the assets subject to the contract at the agreed upon quantity and price at or until the end of maturity established thereunder.
In put options, the party with a long position is entitled and has the right to SELL, or reconcile in cash for, the assets subject to the contract at the agreed upon quantity and price at or until the end of maturity established thereunder.
18.104.22.168. Short Position:
(i) In Futures Contracts:
In futures contracts, the party with a short position is obliged and liable to SELL, or reconcile in cash for, the assets subject to the contract at the quantity and price agreed upon in the contract at the end of maturity established thereunder.
(ii) In Options Contracts:
- In call options, the party with a short position is obliged and liable to SELL, or reconcile in cash for, the assets subject to the contract at the agreed upon quantity and price at or until the end of maturity established thereunder.
In put options, the short position party is obliged and liable to PURCHASE, or reconcile in cash for, the assets subject to the contract at the agreed upon quantity and price at or until the end of maturity established thereunder.
22.214.171.124. Reverse Transaction (= Position Coverage):
(i) In Futures Contracts:
Reverse transactions in futures contracts refers to settlement and coverage of a position by buying short position against long position or buying long position against short position for futures contracts which have entirely the same characteristics, until the last transaction day in the market where the contracts are traded.
(ii) In Options Contracts:
Reverse transactions in options contracts refers to settlement and coverage of a position through a reverse transaction.
3.2.7. Market Makers:
Market makers are required to give double-sided purchase and sale quotations and to execute transactions on the basis of such quotations for each of futures and options contracts within the scope of their responsibility and within the framework of powers vested by the board of directors.
The Board of Directors of theExchange is authorized to determine and appoint the market makers.
3.2.8. Clearing House Members:
Members of the clearing house undertake to perform, confirm and close the transactions under the subject contracts.
3.2.9. Security Deposit:
In order to ensure the performance of provisions of futures and options contracts, Exchange members are obliged to deposit a security deposit through the relevant clearing house member for transactions executed on the basis of each position opened on their own behalf and on behalf of their customers.
The initial security deposit is the security deposit required to be deposited at the time of opening a position.
The maintenance security deposit refers to the lowest level of security deposits updated according to the daily price changes and movements.
The Capital Markets Board may impose a minimum limit for these security deposits.
3.2.10. Supervision and Audit:
All kinds of transactions, accounts, records and books of the Exchange, Clearing Center and Exchange members are subject to supervision and audit by the Capital Markets Board.
3.3. Option Contracts:
Call options granting a right of purchase to the option buyer and put options granting a right of sale to the option seller are currently being used as a banking transaction between banks and their customers in Turkey, and contracts generally containing minimal differences are used for such options. In our opinion, most of the option contracts in the market will be tradable on the Izmir Futures and Options Exchange once the exchange becomes operative.
At present, both European type and American type options are traded in the banking market depending on the contract type used therein. At present, most of the options traded on the market are currency and interest options.
International banking and financial transactions are indispensable also in Turkey which is a part of the global market and is obliged to use the same instruments and methods as a requirement of its commercial relations.
Futures, options and other derivatives are being enforced in Turkey, thereby depicting a trend toward expansion, as Turkey is a member of the international community. A futures and options exchange is about to become operative. Turkey’s approach to forward, futures and options contracts and transactions parallels international practices. Transactions aimed at taking advantage of price increases or decreases in a derivative are considered and treated as "trading", while a derivative used for covering a company from risk is considered and treated as "hedging". The market players are conscious of the important difference between "trading" which requires assumption of risks, and "hedging" which enables reduction or an attempt to cover risks. However, there is no officially accepted Turkish accounting standard for hedging. "Hedging" transactions in Turkey therefore require accounting of the hedging in the same manner as the accounting for the asset which is hedged. The line-items in the balance sheet for hedging and the derivative instrument used for hedging are accounted by using rediscount accounting methods* .
In Turkey, like in much of the world, the price risks and variability of financial markets have led players to find third parties willing to assume the risks against a certain charge. It is obvious that as the financial markets develop in the country, forward contracts, futures interest contracts, currency futures contracts, short and long-term interest futures contracts, exchange index futures contracts, option contracts related to futures contracts and similar other options shall become more widespread. An exchange for the organized trading of futures contracts is about to become operative. It is perceived that the market will benefit and take advantage of risk transfers, financial leverage effect, liquidity, flexibility, profitability and transparency resulting from an increase use of option contracts as a financial derivative instrument. The legal framework is adequate and appropriate to foster such forward, futures and options trading in Turkey.
1. “Problems of Harmonization in Banking in EU and Turkey”, TÜSİAD, Istanbul, 1988 (Publication No. 88/12), page 27
2. "Finansal ve Vadeli Islem Piyasasina Giris" (translation: "Entry into the Financial Futures Market"), Istanbul Stock Exchange VIP Directorate, Istanbul, November 2002, page 156.
3. i.b.i.d., page 165
* Ç.A. Dönmez, "Futures & Forwards", ISE, Page 11.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.