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 (“Non-Bank 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 Corporations from 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

  1. The Regulation requires Non-Bank Corporations which have offshore debt in foreign currency to adopt prudential principles which include the following:
    1. 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:

  1. 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 
  2. 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.

  1. 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.

  1. 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

  1. 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.
  2. 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 purpose refinancing 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

  1. 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 
  2. 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.
  3. 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

  1. 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

  1. 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

  1. 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:

  1. The minimum hedging ratio, as set out in paragraph 4(a) above, shall be at least 20% of:
    1. 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
    2. 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.
  2. The minimum liquidity ratio, as set out paragraph 4 (b) above, shall be at least 50%.
  1. 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. 
  2. 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 

  1. Whilst it currently remains unclear how Bank Indonesia will apply this new regulation in practice, our initial observations are  as follows: 
    1. 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).
    2. 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.
    3. 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.
    4. 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.

Tjahjadi Bunjamin and Cornellius Adrian Pranata