Why Turkey's stock market is under scrutiny after last week's selloff

By Mirac Dereli and Ezgi Erkoyun

Sept 22 (Reuters) - Turkey's equity market is under scrutiny after a week of turmoil, as regulators grapple with investment funds concentrated in illiquid, low-free-float stocks, and index providers raise concerns about market structure.

Below are key questions and answers on the selloff, the authorities' response and broader concerns about the structure of Turkey's equity market.

WHAT HAPPENED LAST WEEK IN MARKETS?

Turkey's main share index .XU100 dropped more than 8% last week - its worst performance since March 2025 when the jailing of Istanbul Mayor Ekrem Imamoglu triggered a sharp selloff.

Last Monday, losses had accelerated as concerns grew over investment funds heavily exposed to thinly traded stocks. Analysts said some funds were forced to sell liquid holdings to meet redemptions, driving broader declines and triggering further investor withdrawals.

Pusula Portfoy became the first asset manager to say it could not meet redemptions in some funds last Tuesday. The benchmark index fell around 5.5% the following day. Tera Portfoy, which had agreed to acquire Pusula the previous Sunday, disclosed similar problems in some of its own funds after markets closed on Wednesday.

WHAT ACTIONS WERE TAKEN IN RESPONSE?

Turkish authorities moved to contain the fallout, with the Financial Stability Committee holding an emergency meeting and the central bank increasing repo funding from a few billion lira to 603 billion lira ($12.35 billion) while raising banks' interbank borrowing limits tenfold.

The Capital Markets Board (SPK) eased margin trading requirements until October 2, filed criminal complaints over alleged market manipulation, including against executives at Pusula and Tera, and ordered the liquidation of 131 funds managed by seven asset managers.

The affected funds had more than $18 billion in assets and around 353,000 investors, according to a source.

On Tuesday this week, Turkey's stock exchange, Borsa Istanbul, announced it will replace more than a quarter of the constituents of its benchmark BIST-100 index.

HOW DID THE PRESSURE BUILD?

In late August, Turkey's Capital Markets Board introduced new limits on holdings of illiquid stocks and stricter requirements for portfolio management companies.

The limits cap exposure to thinly traded stocks at between 2% and 8% and are being phased in through October, November and December.

Analysts said the changes forced some funds to reassess positions and liquidity needs, prompting selling in thinly traded stocks and helping drive last week's broader market selloff.

WHAT STRUCTURAL ISSUES DOES TURKEY'S STOCK MARKET FACE?

Turkey has hundreds of listed companies, but relatively few are large and liquid enough to absorb significant institutional investment. Many of the country's biggest businesses remain unlisted, tightly controlled by founding families, or have relatively small free floats.

As a result, investors are often concentrated in a relatively small pool of stocks. Critics say this can amplify volatility, complicate price discovery and distort markets when large funds build substantial positions in illiquid shares.

WHAT DO INDEX PROVIDERS SAY?

International index providers have raised concerns about Turkey's equity market.

MSCI abandoned plans to add real estate-focused group Kiler Holding KLRHO.IS to its Global Standard Index in February after investor complaints over free-float calculations. In June, MSCI said international investors had raised concerns about shareholder transparency and coordinated trading in the Turkish equity market, and warned that failure to make credible progress could lead to a review of the country's market classification.

Relegation from emerging market status could curb investor interest and force some index-tracking funds to cut exposure to Turkish stocks.

S&P Dow Jones Indices has also flagged market accessibility and ownership transparency issues. FTSE Russell said it could not reconcile Turkish free-float data with its methodology and postponed some index changes in September.

MSCI, S&P Dow Jones and FTSE Russell said they were monitoring developments. Analysts said the Capital Markets Board's recent measures could help address concerns raised by international index providers.

DOES THIS POSE A SYSTEMIC RISK?

Turkey is sensitive to market turmoil because it relies on external financing and remains vulnerable to shifts in investor sentiment.

Financial stress can pressure the lira and raise borrowing costs, helping explain why authorities often respond swiftly to episodes of market turbulence.

However, analysts do not see the latest episode as a systemic threat.

"It's a mini crisis. This can be contained. It's going to hurt some retail investors, but it's not a system-wide issue," said Emre Akcakmak, senior advisor with East Capital.

"This is not a country crisis, or a macro crisis."

($1 = 48.8164 liras)