In today’s financial markets, derivative instruments comprises an essential part of capital market activities, both for banks and intermediary institutions, as well as the companies aiming to manage their portfolio risk. Furthermore, almost 90% of such derivative transactions are being carried out over the counter (OTC), meaning that the derivative instruments are traded in a context other than through a formal exchange (e.g. Borsa İstanbul). The new Capital Markets Law numbered 6362 (“CML”) and the regulations issued thereunder, while setting out the framework in which derivative transactions can be carried out over the counter without any intermediation, also introduce new rules so as to allow intermediary institutions to take part as dealers in this market.
New Communiqué on Principles Regarding Investment Services and Activities and Ancillary Services
Derivative Transactions
Derivative transactions are sub-categorized essentially under two different headings based on the market where such transactions are affected. In this respect, (i) transactions that are effected under organized markets with the standardized agreements are deemed as exchange transactions; whereas (ii) transactions that are effected between the parties based on their mutual agreement, and specifications of which are determined based on the needs and understanding of the parties, are deemed as over the counter (OTC) transactions. Even though such derivative transactions pose disadvantages when compared to exchange transactions in respect of liquidity and risk, they also provide much more flexibility due to lack of requirement, such as membership, collateral and centralized exchange. In this respect, it should further be noted that as per Article 36 of the new Communiqué on Principles Regarding Investment Services and Activities and Ancillary Services numbered (III-37.1) issued on 11 July 2013, which came into effect on 1 July 2014 (“Communiqué”) of the Capital Markets Board (“CMB”), CMB is authorized to determine the derivative instruments that are to be transacted in an exchange, and the specific rules and principles regarding the execution of such transactions pursuant to the proposal of the centralized execution institute, and also based on the limits to be set for these transactions, and within the framework of the principle of reducing the systemic risk. The CMB can also require that the over the counter transactions of investment institutions are executed in an institution that is to be authorized as the centralized counter party.
Requirement for Intermediation under New Communiqué
The CML defines the capital market instruments as securities, derivatives, and other capital market instruments (including investment agreements) that are to be determined as such by the Capital Markets Board (“CMB”). Further, as per Article 37 of the CML (i) receipt and transfer of orders in relation to capital markets instruments; (ii) execution of orders of capital market instruments in the name and on behalf of the client, or in its own name and on behalf of the client; (iii) sale and purchase of capital market instruments on behalf of itself are deemed as investment services. As such, since these activities are deemed as investment services, they can solely be carried out by authorized investment companies under the CML in accordance with the Article 39 of the CML. In this respect, as the derivatives are also deemed as capital market instruments, the intermediation of an investment company will be required regardless of whether the transaction is executed in an exchange or over the counter.
Exemption under the Communiqué
Article 25 of the Communiqué stipulates that the activities of transfer of order, intermediation of transaction, or portfolio, in relation to derivative instruments other than leveraged transactions shall be carried out in exchanges, institutionalized market places, or over the counter depending on the type of the transaction contemplated to be engaged in. Article 26 of the Communiqué, on the other hand, sets out that (i) the physical sale and purchase of the exchange, precious metals, precious stones, goods and other assets; and (ii) the derivative transactions effected between real and/or legal persons without the intermediation of an investment company that cannot be deemed as the commercial or professional activity, are not deemed as derivative instruments. Within such legal framework, it can clearly be set out that there is no obligation to use intermediary institutions imposed upon the parties engaging in any kind of derivative transaction, provided that such transaction (i) is not executed in an exchange platform (i.e. Borsa Istanbul); (ii) is engaged in by the parties in their own name and behalf; (iii) cannot be deemed as a commercial or professional activity of the parties (e.g. parties aim to hedge their own risks). In cases where such exemption does not apply, the parties have to use an authorized investment institution as the intermediary, although no specific reporting requirement arising solely from such transaction is imposed upon the parties.
Intermediary Institutions as Dealers
Until the issuance of the Communiqué, the intermediary institutions were not allowed to act as the counterparty to the derivative transactions, with the main concern that such prohibition would also prevent the counterparty risk that may have to be assumed by the intermediary institutions. The new Communiqué, on the other hand, allows for the intermediary institutions to engage in such transactions by defining a new activity as “intermediation for portfolio.” In this respect, Article 21 of the Communiqué defines “intermediation for portfolio” as the activity that allows intermediary institutions to effect the orders of purchase and sale in relation to capital market instruments as the counterparty to such transactions. As such, the intermediary institutions granted with the specific authority “portfolio intermediation” can act as dealers under the new Communiqué.
Conclusion
Within the scope of such regulatory framework, the new CML and the Communiqué, while requiring the intermediation of investment companies for derivative transactions also aims not to set limits on the commercial activities of the parties by paving the way for engaging in such transactions so long as the conditions set out under the CML and the Communiqué are satisfied.
