The legislative boost

Mustafa Ünal of Eryurekli Law Office provides guidance on the regulatory framework that applies to alternative business set-ups engaging in portfolio management and investment advisory businesses

Turkey's economy has experienced strong growth following the recession that took hold at the beginning of the century. An increasing amount of foreign investment flow and the notable growth in the real estate sector have been the main driving forces behind the economic development. Growth in the GDP has increased the number of persons falling under the definition of high-net-worth individuals. These individuals are in search of investment product yields that are relatively higher than traditional products such as bank deposits, government bonds and even stocks. Although important steps have been taken to diversify the number of local investment products, the local financial markets have not been successful in presenting a satisfactory pallet of investment options. Capital markets service providers identified this need and helped high-net-worth individuals to turn their attention to foreign investment products. Since these individuals are mostly alien to foreign markets and foreign products, portfolio management and investment advisory service providers have been gradually becoming key players in satisfying the needs of high-net-worth individuals.

Further to the above, although the GDP growth observed since the beginning of the century has had a positive impact on almost all households across the country, the ever-increasing value of real estate, especially in İstanbul, Ankara and İzmir, has made direct real estate investments difficult for high-net-worth individuals. As a result, real estate portfolio management companies specialising in real estate investment funds have emerged to help those individuals benefit from the rising value of real estate.

Moreover, the new legal infrastructure which was put into force in mid-2014 also triggered a growing interest in portfolio management and investment advisory business. New legal rules provide a relatively flexible infrastructure to existing portfolio management companies, set legal standards for new portfolio management companies intending to specialise in specific segments of portfolio management and investment advisory business, and have even created a specific segment for investment firms that could deal solely with investment advisory business.

The above developments in the portfolio management and investment advisory business drew the attention of foreign financial service providers. A number of foreign financial service providers, such as Azimut and Taaleri, have already entered the market, whereas a considerable number of other service providers from Europe, the US and the Gulf region are all in the line-up to have a seat among local service providers. It is expected that the entrance of foreign players into the market will be a game changing move for local portfolio management and investment advisory business and will upgrade service quality and boost diversification in local capital markets.

Definition of the business

Under the New Capital Markets Law, Portfolio Management Communique and Investment Services Communique (collectively referred to as the New Legislation), portfolio management business is classified under two categories, namely (i) discretionary management of collective investment schemes and, (ii) discretionary management of individual portfolios.

Under the New Legislation, discretionary management of individual portfolios is defined as the management of portfolios that belong to individuals and which are composed of financial assets, in the name of and on behalf of the individuals, in return for direct or indirect benefit. The New Legislation, unlike former rules, does not specifically set out the nature of the monetary benefits that can be gained and provides that the service provider can receive any type of benefits in return for portfolio management services. Unlike discretionary portfolio management services addressing individuals, the New Legislation does not recognise any difference with regard to the definition of discretionary management of collective investment schemes.

The New Legislation defines investment advisory services as the provision of influential advice regarding securities and issuers of securities to an investor or a group of investors with similar financial status and risk and return preferences, either at or without the specific request of the investor. New principles cut the compulsory link between investment advisory services and monetary benefit. Accordingly, obtaining monetary benefit will no longer be a required criterion for the characterisation of investment advisory services.

Service providers

A foreign institution intending to engage in portfolio management and/or investment advisory business has a number of options.

A wide-scope option for engaging in this type of businesses is the portfolio management company. The New Legislation allows portfolio management companies to establish investment funds and to engage in (i) discretionary management of collective investment schemes, (ii) discretionary management of individual portfolios and, (iii) investment advisory business.

Unlike portfolio management companies, brokerage firms and investment banks are not authorised to establish investment funds and to provide discretionary portfolio management services to collective investment schemes. Portfolio management companies, as the sole financial service providers authorised to establish investment funds, reserve the right to provide collective portfolio management services.

The regulatory framework employs a liberal approach regarding service providers that can engage in the discretionary management of individual portfolios and investment advisory business. Portfolio management companies, brokerage firms and investment banks are all authorised to engage in those businesses provided that they meet the requirements arising from the applicable legal framework.

Alternative options for different business needs

The investment bank is treated as an unfeasible option to deal specifically with portfolio management and/or investment advisory businesses. These businesses are, in practice, considered as ancillary for investment banks, which largely deal with financing activities. Furthermore, organisational costs and minimum equity requirements are onerous in nature and, thus, these obligations automatically exclude the investment bank option during the course of structuring work.

Brokerage firm set-up

The brokerage firm structure is a prominent alternative for engaging in portfolio management and/or investment advisory businesses. However, as mentioned above, brokerage firms cannot provide collective portfolio management services. Therefore, if there is an intention to focus on the management of collective investment schemes, the brokerage firm structure would not be the appropriate solution. However, if the local set-up will be centred on discretionary portfolio management services addressing individuals and/or investment advisory services, the brokerage firm structure may be an efficient solution.

The regulatory infrastructure governing brokerage firms provides alternative vehicles for foreign institutions intending to engage in referred business.

The New Legislation created a specific brokerage firm segment which can solely deal with investment advisory services and/or the receipt and transmission of orders. This type of brokerage firm is treated as the entry-level brokerage firm and is subject to relatively favourable equity and organisational requirements. The regulations provide that a minimum equity amount of TL 2,022,320 ($717,000) is sufficient for the entry-level brokerage firm set-up. Moreover, head-count requirements are limited to the CEO, trading department head, research analyst and sufficient number of traders, compliance staff and back-office personnel. It is not compulsory for these brokerage firms to hire internal control, risk management or any other personnel. Moreover, traders can at the same time act as investment advisors and there is no requirement to hire separate advisors.

The receipt and transmission of orders is a service by means of which the brokerage firm, having received a purchase or sale order from the client, instead of carrying it out personally, sends it to another intermediary for execution. If a foreign institution intends to concentrate on investment advisory services rather than the discretionary management of individual portfolios and also intends to provide execution services, it may prefer to benefit from this relatively low-cost entry-level brokerage set-up. We believe that this set-up is a feasible solution for foreign institutions that wish to provide investment advisory services with regard to foreign products, receive client orders for these products locally and transmit the same to a foreign financial institution. However, this structure, in itself, would raise solicitation concerns. In order to overcome those concerns, a full-fledged fine-tuning session must be conducted in line with legal and regulatory sensitivities. This fine-tuning session will focus on the marketing activities of the brokerage set-up and must provide a clear plan for the implementation of the business model.

Alternative brokerage firm set-ups can also be considered if there is an intention to provide individual portfolio management services in addition to investment advisory and execution services. The costs of these alternative brokerage set-ups depends on the level of the execution services to be provided to the clients.

A brokerage firm must have at least TL10,111,600 ($3,585,000) of equity if, under the brokerage set-up, it will execute orders in various trading venues in the name of and on the account of the clients or in the name of the brokerage firm but on the account of the clients. The head count requirement for this mid-level brokerage set-up is parallel to that of the entry-level brokerage set-up.

Regulatory obligations become onerous if, under the brokerage set-up, the brokerage firm sells certain financial instruments to the client or purchases them directly from the said client as the counterparty. The minimum equity amount for this top-level type of brokerage firm is TL 25,279,000 ($8,964,000). Internal control, risk management and pricing personnel must be hired in addition to the personnel envisaged for entry-level and mid-level brokerage firms.

In mid-level and top-level brokerage firms it is possible for traders to also act as portfolio managers and investment advisors.

Portfolio management company set-up

If the provision of execution services is not an important issue and/or if there is an intention to establish investment funds and engage in collective portfolio management business in addition to individual portfolio management and investment advisory businesses, it would be feasible to proceed with the portfolio management company set-up.

The New Legislation categorises portfolio management companies in terms of the amount of assets under management (AuM) and imposes equity obligations and organisational requirements accordingly.

Under the legislation:

• if the total value of the AuM of a portfolio management company is up to TL 100,000,000, the minimum equity amount of the company must be TL 2,000,000 ($709,000) (base-size portfolio management company),
• If the total value of the AuM of a portfolio management company is between TL 100,000,001 and 500,000,000, the minimum equity amount of the company must be TL 3,000,000 ($1,063,500) (mid-size portfolio management company),
• if the total value of the AuM of a portfolio management company is between TL 500,000,001 and 5,000,000,000, the minimum equity amount of the company must be TL 5,000,000 ($1,773,000) (large-size portfolio management company) ,
• if the total value of the AuM of a portfolio management company exceeds TL 5,000,000,000, the minimum equity amount of the company must be TL 10,000,000 ($3,546,000) (top-size portfolio management company) .
• if the total value of the AuM exceeds TL 10,000,000,000, the portfolio management company must add 0.02 percent of the portion of the value of the AuM exceeding the referred threshold to its equity amount. However, the additional equity requirement is not applicable if the equity amount of the company exceeds TL 20,000,000 ($7,092,000).

It is worth noting that, unlike the minimum equity requirement, the minimum share capital requirement is standard for all portfolio management companies. Accordingly, at the outset, it is possible to establish a portfolio management company by injecting a cash amount of TL 2,000,000.

The regulation imposes organisational requirements by taking into account the above categorisation. Under the legal principles:

• base-size portfolio management companies are required to hire a CEO, at least two portfolio managers and a sufficient number of back-office personnel and are authorised to outsource internal audit, internal control, risk management, fund administration, research, IT, HR and legal services;
• mid-size portfolio management companies are required to hire internal audit and internal control personnel in addition to the staffing requirements envisaged for base-size portfolio management companies; these companies' outsourcing is limited to risk management, fund administration, research, IT, HR and legal services; and,
• large-size and top-size portfolio management companies are subject to more onerous staffing obligations and are required to establish risk management and research departments and employ sufficient risk management and research personnel in addition to those envisaged for mid-size portfolio management companies; these companies' outsourcing opportunities are limited to fund administration, research, IT, HR and legal services.

The New Legislation paves the way for CEOs of all types of portfolio management companies to also act as portfolio managers. This means that all types of portfolio management companies may proceed with at least one portfolio manager in cases where the CEO has portfolio management capabilities.

New breed of portfolio management companies

Steps taken under the New Legislation are not limited to ordinary portfolio management companies. The new regulatory framework introduces new breeds of portfolio management companies, namely:

• portfolio management companies exclusively dealing with (i) incorporation and management of foreign collective investment schemes which will be marketed to non-residents and, (ii) the provision of portfolio management and investment advisory services to non-residents (portfolio management companies for non-residents);
• portfolio management companies exclusively dealing with the incorporation, management and marketing of real estate investment funds (portfolio management companies for REIFs); and,
• portfolio management companies exclusively dealing with the incorporation, management and marketing of venture capital investment funds (portfolio management companies for VCIFs).

The new regulatory framework imposes quite a number of exemptions for these new types of portfolio management companies. For instance, unlike the TL 2,000,000 minimum share capital requirement envisaged for ordinary portfolio management companies, it is possible to incorporate these new-breed companies with a share capital amount of TL 1,000,000. Moreover, the minimum equity requirements that apply to ordinary portfolio management companies will apply to these companies with a 50% discount. In other words, the minimum equity requirement ranges from TL 1,000,000 to TL 5,000,000 in parallel to the value of the AuM ranging from TL 100,000,000 to TL 10,000,000,000.

Regional financial centre

The portfolio management company for non-residents is a business model for institutions that wish to use Turkey as an international/regional hub for their portfolio management and investment advisory business. The company is prohibited from providing any kind of portfolio management and investment advisory services to persons resident in Turkey, and is not permitted to establish and manage local collective investment schemes nor to market shares of foreign collective schemes within Turkey. This new structure is an outcome of the recent efforts to position İstanbul as a regional /global financial centre. There has been considerable interest from foreign financial institutions to benefit from this specific structure and some of these institutions are taking concrete steps to obtain the necessary licence. The regulations impose a low-cost model in terms of staffing obligations and there are quite a number of outsourcing opportunities for this type of portfolio management company. In this respect, the company must hire a CEO, at least one portfolio manager and back-office personnel, and is entitled to outsource internal audit, internal control, research, risk management, accountancy, fund administration, IT, HR and legal services. It would even be possible to run the office with two personnel, if the CEO and portfolio manager functions could be carried out by the same person.

Portfolio management companies for REIFs have been presented as a response to the recent boom in the real estate sector. The continuing rise in real estate prices and the emergence of large-scale real estate projects have made the real estate sector an attractive investment option. The new regulatory structure which brings a new set of rules for real estate investment funds also triggered a need for portfolio management companies specialising in real estate investments. In response, the regulatory authority presented portfolio management companies for REIFs as a specialised portfolio management vehicle. This type of company is solely authorised to establish, manage and market real estate investment funds. It is not entitled to establish or market other types of collective portfolio management schemes or provide other types of collective portfolio management services; nor is it authorised to provide individual portfolio management services or investment advisory services. In line with the approach envisaged for portfolio management companies for non-residents, the regulations impose minimum staffing obligations and provide quite a lot of room for outsourcing opportunities. In parallel to the growing interest in the real estate sector, quite a number of portfolio management companies for REIFs have already been licensed by the regulatory authority.

Portfolio management companies for VCIFs have been presented as another specific breed of portfolio management company. This type of company is only authorised to establish, manage and market venture capital investment funds and it is not permitted to establish, manage or market any other type of collective investment scheme. Moreover, the company is not permitted to engage in individual portfolio management or investment advisory business. The staffing obligations are minimal and outsourcing opportunities are flexible in parallel to the approach adopted for other specific breeds of portfolio management company. Venture capital business is still in its infancy and there is no interest for portfolio management companies specialised in VCIFs.

The new regulatory framework has a flexible infrastructure and provides quite a number of alternative options for foreign financial institutions intending to engage in portfolio management and investment advisory business in Turkey.

For those, who would prefer to provide execution services in addition to portfolio management and investment advisory services, a brokerage firm set-up may be appropriate. This set-up may also help foreign institutions to meet foreign product demand coming from high-net-worth investors.

For those who would prefer to establish, manage and market local collective schemes or who are not interested in execution services, the portfolio management set-up can be a feasible solution. Moreover, foreign financial institutions interested in local and/or regional products, but not interested in local investors, may position Turkey as a regional hub for the management of foreign collective and individual portfolios. Foreign financial institutions may also benefit from the rising trend in real estate investments by incorporating a portfolio management company for REIFs which can establish, manage and market real estate investment funds.

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Mustafa Ünal
Eryurekli Law Office
Istanbul

About the author
Mustafa Ünal graduated from the Ankara University Faculty of Law in 1996 and started his career at the Capital Markets Board (CMB) in 1997. He worked as an expert in the corporate finance department. There he conducted supervision and surveillance activities with respect to publicly traded corporations and provided technical expertise in establishing new rules and regulations.

Ünal joined Eryürekli Law Office at the beginning of 2008. He provides legal consultancy services to foreign and local companies with respect to capital markets, foreign investment and corporate matters.

He studied business administration, accountancy and finance at the Ankara University, Faculty of Political Sciences, and also received an LLM degree in International Trade Law from the University of Durham. Mustafa Ünal is the author of various articles.