Turkey: Over-The-Counter ("OTC") Derivatives

In contrast to exchange-traded derivatives, OTC derivatives are privately negotiated derivative contracts, provided directly by dealers to end-users or to other dealers, transacted off exchanges. Although the OTC global market is large with the total outstanding nominal amount of USD 298 trillion as of 2005 according to the Bank for International Settlements, OTC derivatives remain unregulated in Turkey.

The general principles of Turkish law are applied to these derivative contracts because there is no specific legislation regulating OTC derivatives traded in Turkey. In this respect, the general principle regarding the formation of contracts, and the relevant provisions applicable to a specific type of contract that has the most common characteristic of such derivative contract determined in the Code of Obligations, will be applicable.

Accordingly, under the general principles of Turkish contract law, the validity of derivative contracts is not limited to those in written form. As long as there is mutual agreement between the parties, provided that no further objection is raised as to the validity or conditions of the contract, a verbally agreed contract will be valid. However, for private procedural law purposes, in the event of any dispute, exceeding 400 YTL can only be proved by way of showing or submitting evidence in written form. Furthermore, the governing law of OTC derivative contracts may be determined as foreign law as long as there is a foreign element to such contract.

On a different note, some CMB experts insist that an application be made to the CMB, prior to execution of an OTC derivative contract without any regulatory basis, although other experts deem these transactions within the freedom of contract principle without the necessity of filing an application.

Regulation of the OTC derivative market is a long debated issue. Some are opposed to the idea, since regulating OTC transactions would place new burdens and higher costs on the participating parties. It is argued, for example, by the Bond Market Association, that "[B]ecause of the cost and complexity in structuring individual OTC derivatives, the market is only used by sophisticated institutions whose management is familiar with the risks and rewards of these financial tools. Individual investors, who would require regulatory protection, do not use OTC derivatives".

Others believe that changes must be made in the current capital markets legislation not merely to remove any uncertainty in relation to enforceability of these derivative contracts, but mainly to facilitate the growth of the OTC derivatives market without the introduction of legal impediments to the development of such market. Changes should be introduced that are necessary to promote innovation, efficiency, competition and transparency in the OTC derivatives markets as well as to reduce systematic risk and to protect the small investor without placing burdens and higher costs on the participating parties.

In line with such global discussions, at the beginning of August 2006, the CMB made a public disclosure stating its aim to amend the relevant CMB legislation, namely the Communiqué on Principles Relating to Brokerage Activities and Brokerage Firms, Serial V No. 46; Communiqué on the Share Capital of Brokerage Firms, Serial V No. 34; and Communiqué on the Internal Auditing Systems of Brokerage Firms, Serial V No. 68, to create the legal structure to facilitate trading of OTC derivatives. The CMB stated that, in view of the developments in the financial sector and the need for legal regulation of sophisticated financial instruments such as OTC derivatives, it proposed certain amendments to the foregoing Communiqués.

The proposed amendments are still in draft form and not incorporated into the Communiqués. The proposed amendments seek to provide that (i) necessary structures for risk modeling, scaling, auditing, control and management are established in intermediary companies, which either trade or provide intermediary services for trading; (ii) stress tests for risk management are established; (iii) Over the Counter Derivatives Risk Acknowledgement Forms are read and signed by customers prior to commencement of any transactions; (iv) trading of over the counter derivatives is evaluated vis-à-vis share capital requirements; (v) the calculation for positions, the counter party risks and provisions due to trading OTC derivatives are established; and, (vi) the process for internal auditing procedures regarding trading OTC derivatives is followed, among others.

In summary, the proposed amendments are designed to ensure that brokerage firms are able to trade OTC derivatives and on a cross-border basis, provided that the risk assessment will be made in detail. The CMB also does not favor setting forth more structured rules in relation to the contracts to be provided, which may prove to be the right approach, obliterating the legal uncertainty, whilst providing enough space for this sector to grow in a less regulated environment.


1. The specifications of gold future transactions were recently announced as per the Communiqué on Gold Future Contracts, which entered into force on 1 March 2006.

2. Some of these future contracts became tradable on TurkDEX only after 2005.

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.

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