Jurisdiction - Indonesia
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Indonesia – Central Bank Issues New Regulations Regarding Foreign Currency Off-Shore Indebtedness By Non-Bank Entities.

7 November, 2014

 

 

Background


1. On 28 October 2014, Bank Indonesia issued Regulation No. 16/20/PBI/2014 on the Application of Prudential Principles in Management of Offshore Debt of Non-Bank Corporations (the “Regulation”). The Regulation as a whole will take effect on 1 January 2015, although certain specific aspects will take effect after this date and different requirements will apply throughout the implementation period – see section headed “Implementation Period” below.


2. The primary driver for the issuance of the Regulation is Bank Indonesia’s growing concern over the sharp increase in recent years of offshore debt in foreign currency incurred by the Indonesian non-bank private sector. The concern appears to be that adverse future global economic conditions (including a continuing depressed state of commodity prices) may once again lead to a repeat of the severe financial crisis of 1997/1998 due to the weakening of the Rupiah, particularly where such debt is un-hedged and borrowers or, as the case may be, issuers are susceptible to (among other risks) currency, liquidity and over-leverage risks. Although at present the rate of default by Indonesian non-bank corporate borrowers remains relatively low, we understand that the concern is that any sudden adverse economic conditions could increase the default risk of such corporate borrowers which could eventually lead to a disruption of the stability of Indonesia’s financial system and its macroeconomic outlook. The Regulation is designed to mitigate the above risks arising in the context of corporate offshore debt in foreign currency.


3. The Regulation is applicable to all non-bank corporations in Indonesia (“NonBank Corporations”) which incur offshore debt in foreign currency. This includes group corporate and shareholder loans to subsidiaries, not just external bank financings or bonds. ‘Offshore debt’ is defined under the Regulation as debt incurred by residents (being individuals, legal entities or other bodies which are domiciled in Indonesia, or plan to be domiciled in Indonesia for at least 1 year) with respect to non-residents in foreign currency and/or Rupiah1, including syariah financing. The definition of ‘offshore debt’ is broad enough to capture both loans and bonds. The Regulation is not directly aimed at restricting Non-Bank Corporationsfrom incurring offshore debt in foreign currency as such, but rather is designed to strengthen the risk management of Non Bank Corporations when incurring offshore debt in foreign currency, by ensuring that such entities adopt prescribed prudential principles to mitigate the risks related to such offshore debt (with respect to both loans and bonds).


Requirements


4. The Regulation requires Non-Bank Corporations which have offshore debt in foreign currency to adopt prudential principles which include the following:


(a) Hedging Ratio2


Non-Bank Corporations which have offshore debt in foreign currency must comply with the minimum currency hedging ratio as set out in the Regulation. The hedging is to be implemented in the form of derivative transactions of the relevant foreign currency against Rupiah by way of forward, swap and/or option transactions.

 

The minimum hedging ratio is set at 25% (though see the initial lower ratio in paragraph 12(a) below) of:


(i) the negative difference between the foreign exchange assets3 and the foreign exchange liabilities4, which will become due within the 3 months to occur after the end of the relevant quarter; and 


(ii) the negative difference between the foreign exchange assets and the foreign exchange liabilities, which will become due in the period between the commencement of the 4th and the ending of the 6th month after the end of the relevant quarter.


Note that foreign exchange assets include receivables originating from forward, swap and/or option transactions which will be realized within the 3 months to occur after the end of the relevant quarter and/or the period between the commencement of the 4th and the ending of the 6th month after the end of the relevant quarter.


(b) Liquidity Ratio5


Non-Bank Corporations which have offshore debt in foreign currency must also satisfy the minimum liquidity ratio (of at least 70%), by maintaining sufficient foreign exchange assets against foreign exchange liabilities which will become due within the 3 months to occur after the end of the relevant quarter. Note that foreign exchange assets include receivables originating from forward, swap and/or option transactions which will be realized within the 3 months to occur after the end of the relevant quarter.


(c) Credit Rating6


Non-Bank Corporations which obtain offshore debt in foreign currency must have a minimum credit rating of Standard & Poor’s (S&P) BB7 (or equivalent) issued by a rating agency recognized by the relevant authorities. Such credit rating will be in the form of rating over the relevant corporation and/or bonds issued by that corporation. 


The validity period of credit rating in relation to a corporation (issuer rating) and/or bonds issued by that corporation (issue rating) shall be a maximum of 1 year since such rating is issued. If a corporation will be issuing long term offshore bonds, then the rating to be submitted must be a long term debt rating. The Regulation is unclear whether the BB (or equivalent) rating needs to be maintained at all times whilst the debt remains outstanding – we will monitor development on this issue in the months ahead.


Please refer to the section headed “Implementation Period” below with respect to the requirements applicable during the implementation stages of the regulation.


Exemptions


5. The requirements as set out in paragraph 4 above do not apply to offshore debt in foreign currency which is in the form of trade credit. Trade credit refers to debt arising from credit which is granted by offshore suppliers under goods and/or services transactions.


6. There are certain exemptions from the requirement to satisfy the minimum credit rating criteria and on and from 1 January 2016 that requirement will not apply to (i) the refinancing of offshore debt in foreign currency (where for this purposerefinancing means offshore debt which are used to replace previous debt with better terms and conditions and which does not increase the outstanding offshore debt), and (ii) offshore debt in foreign currency from international bilateral or multilateral institutions (e.g. International Finance Corporation (IFC), Japan Bank for International Cooperation (JBIC), Japan International Cooperation Agency (JICA), Asian Development Bank (ADB) and Islamic Development Bank (IDB)) in relation to financing for infrastructure projects. This exemption for infrastructure projects is included in order to support the development of national infrastructure (which is a stated objective of Indonesia’s new government).


Reporting Obligations


7. Non-Bank Corporations must report to Bank Indonesia (along with the provision of the relevant supporting documents8) on the implementation of the prudential principles set out in paragraph 4 above and the applicable exemption (if any) as set out in paragraphs 5 and 6 above.

 

8. The procedure for submitting the report and supporting documents as mentioned above will be conducted in line with the Bank Indonesia regulation on the reporting of foreign exchange activities and on the reporting of the implementation of prudential principles in the management of off shore borrowings by Non-Bank Corporations.


9. While the reporting procedure under Bank Indonesia regulation on foreign exchange traffic has been established since 2012, the implementing regulation which governs the reporting mechanism on the implementation of prudential principles in the management of offshore debt by Non-Bank Corporations has not yet been issued. It may be the case that Bank Indonesia will soon issue the relevant implementing regulation on the reporting obligations of Non-Bank Corporations in relation to the requirement under the Regulation.


Monitoring


10. Bank Indonesia will monitor the compliance of Non Bank Corporations by examining the reports and supporting documents submitted by the relevant Non Bank Corporations. In conducting its examination, Bank Indonesia may (i) request explanation, evidence, records and /or supporting documents with or without involving the relevant institutions, (ii) conduct direct examination of the relevant corporation, and/or (iii) appoint another party to conduct any such examination on Bank Indonesia’s behalf.


Sanctions


11. Non-Bank Corporations which violate the prudential principles as set out in paragraph 4 above, will be subject to administrative sanctions in the form of warning letters from Bank Indonesia. Bank Indonesia will also inform the following parties, among others, regarding the application of the administrative sanction to the relevant Non-Bank Corporation (i) the relevant offshore creditor(s), (ii) the Minister of State Owned Enterprise (for stated owned enterprise borrowers), (iii) the Minister of Finance, c.q. Directorate General of Taxation, (iv) the Financial Services Authority (Otoritas Jasa Keuangan – OJK) and (v) the Indonesian Stock Exchange (where the Non-Bank Corporation is listed on the Indonesian Stock Exchange).


Implementation Period


12. The implementation of the prudential principles as set out in paragraph 4 above will be staggered as follows: 

 

From 1 January 2015 until 31 December 2015:


(a) The minimum hedging ratio, as set out in paragraph 4(a) above, shall be at least 20% of:

 

(i) the negative difference between the foreign exchange assets and the foreign exchange liabilities, which will become due within the 3 months to occur after the end of the relevant quarter; and

 

(ii) the negative difference between the foreign exchange assets and the foreign exchange liabilities, which will become due in the period between the commencement of the 4th and the ending of the 6th month after the end of the relevant quarter.

 

(b) The minimum liquidity ratio, as set out paragraph 4 (b) above, shall be at least 50%.


13. The new requirement to satisfy the minimum credit rating requirement, as set out paragraph 4(c) above, applies to new offshore debt in foreign currency which are signed or issued since 1 January 2016. 


14. The provision regarding sanctions as referred to in paragraph 11 above will be effective from the third quarter report of 2015 (i.e. the report for the period covering July to September 2015).


Observations 


15. Whilst it currently remains unclear how Bank Indonesia will apply this new regulation in practice, our initial observations are as follows: 


(a) The Regulation does not overturn Indonesia’s longstanding policy of having a free foreign exchange regime. It simply introduces the application of prudential principles in risk management to Non-Bank Corporations which have offshore debt in foreign currency. It remains to be seen how effective these measures will be in practice, particularly as the sanctions do not appear to be particularly onerous (see below).


(b) The Regulation does not directly prohibit (i) an Indonesian borrower from incurring offshore debt in foreign currency with respect to an offshore lender; or (ii) an offshore lender from lending in foreign currency to an Indonesian borrower, in circumstances where such Indonesian borrower does not comply with the prudential requirements as set out in the Regulation.

 

(c) The nature of the sanctions prescribed in the Regulation (i.e. the issuing of warning letters by Bank Indonesia and Bank Indonesia disclosing the non-compliance by the Indonesian borrower to their offshore creditors and relevant regulators) suggests that they are aimed at affecting the credibility of the Indonesian borrower in the event of non-compliance, rather than imposing more severe regulatory penalties.


(d) It remains at the discretion of the relevant offshore lender as to whether it is willing to grant credit to a Non-Bank Corporation if such corporation does not comply with the prudential requirements under the Regulation. In our view, considering the fact that the prescribed sanctions for non-compliance are expressly only administrative in nature, any failure by an Indonesian borrower to comply with the requirements under the Regulation should not in principle affect the validity and enforceability of the relevant offshore debt documents. In addition, the sanctions are targeted at the borrower and not the offshore lender, and accordingly the lender will not be penalized if they fail to include terms and conditions that require compliance with the relevant requirements under the Regulation.

 

End Notes:

 

1 Although the definition of ‘Offshore debt’ is defined to include Rupiah debt, the minimum hedging ratio, liquidity ratio and credit rating requirements are only applicable to offshore debt in foreign currency.


2 Hedging ratio is defined as the ratio between the hedged amount and the negative difference between foreign exchange assets and foreign exchange liabilities.

 

3 Foreign exchange assets is defined as the current assets in foreign currency which consist of cash, giro, savings, deposits, marketable securities, and receivables originating from forward, swap and/or option transactions. 


4 Foreign exchange liabilities is defined as current liabilities in foreign currency which must be settled or paid and liabilities originating from forward, swap and/or option transactions.
5 Liquidity ratio is defined as the ratio between total foreign exchange assets and foreign exchange liabilities.


6 Credit rating is defined as the evaluation by a rating agency to convey the financial condition of a company or the ability of a company to fulfill its obligation in a timely manner (i.e. credit worthiness).


7 For example, the debt rating which is equivalent to Standard & Poor’s (S&P) BB rating is Ba for Moody’s Investor Service or idBB for Pefindo. BB debt rating covers BB-, BB, and BB+ (S&P) or equivalent to Ba1, Ba2, and Ba3 (Moody’s) or equivalent to idBB-, idBB, and idBB+ (Pefindo).


8 Example of supporting documents include, among others, quarterly (management) or annual (audited) financial statements.

 

herbert smith Freehills

 

For further information, please contact:

 

David Dawborn, Partner, Herbert Smith Freehills

david.dawborn@hbtlaw.com

 

Adrian Cheng, Partner, Herbert Smith Freehills
adrian.cheng@hsf.com

 

Tjahjadi Bunjamin, Partner, Hiswara Bunjamin & Tandjung

tjahjadi.bunjamin@hbtlaw.com

 

Cornellius Adrian Pranata, Partner, Hiswara Bunjamin & Tandjung

cornellius.adrian@hbtlaw.com

 

Andrew Bennet, Herbert Smith Freehills
andrew.bennett@hsf.com

 

Vik TangHiswara, Bunjamin & Tandjung

vik.tang@hbtlaw.com

 

Banking & Finance Law Firms in Indonesia 

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