OJK Issues New Rules for Assessing Financial Soundness of Venture Capital Companies in Indonesia
The Financial Services Authority (“OJK”) has issued new rules (the “Rules”) to give effect to the provisions of Chapter V of OJK Regulation No. 35/POJK.05/2015 (the “Regulation”), which governs the management of venture capital (“VC”) providers. The Rules are set out in OJK Circular No. 7/SEOJK.05/2018 on the Financial Soundness of Venture Capital Companies (the “Circular”), which entered into effect on 7 March 2018.
The provisions of Chapter IV of the Regulation essentially require all venture capital companies (“VCC”) to have a minimum financial soundness rating of “healthy.” However, the Regulation does not define “healthy,” or set out a mechanism for assessing it, instead leaving this to be subsequently provided for by way of an OJK Circular.
As the Rules are highly technical in nature, for purposes of brevity we have confined the scope of this legal update to a general description of their key features.
The term “VCC,” as used herein, includes conventional VCCs, shariah-compliant units of conventional VCCs and dedicated shariah-compliant VCCs, save where otherwise expressly stated.
Further, the term “investee” should be construed as also meaning “borrower,” should this be required by the context.
2. Key Criteria for Assessment of Financial Soundness
In line with the Regulation, the Rules set out two key criteria that are to be used for the assessment of a VCC’s financial soundness: (a) the quality of its productive assets; and (b) its level of profitability.
(a) Productive Asset Quality
A “productive asset” is defined by the Rules as any asset that is held by a VCC for the purpose of generating income. A VCC’s productive assets may consist of:
- Equity Investments (i.e., shares);
- Quasi-equity investments (i.e., convertible bonds);
- Bonds (including shariah-compliant bonds) issued by an investee company during its start-up and/or growth stages; and/or
- Business financings, including shariah-compliant financings.
A VCC is required to assess, monitor, and take all necessary measures to ensure the quality of its investments and financing receivables.
In order to facilitate this process, the Rules set out a list of indicators for assessing the quality of each class of productive asset. These indicators are as follows:
1. Equity Investment
a. Investee’s prospects
b. Investee’s financial performance
2. Quasi-equity / bond investment
a. Repayment capacity of investee
b. Financial performance of investee
c. Investee’s business prospects
3. Business Financing
A. For financings amounting to less than Rp 1 billion at the time the agreement was signed:
- Timeliness of principal and/or interest payments in the case of a conventional VCC, or timeliness of payment of principal, profit shares and/or margins in the case of a shariah-compliant unit of a conventional VCC or a shariah-compliant VCC.
In addition, the following criteria may be had regard to:
a. Investee’s capacity to repay;
b. Investee’s financial performance; and
c. Investee’s business prospects.
B. For financings amounting to Rp 1 billion or more at the time the agreement was signed:
a. Investee’s repayment capacity
b. Investee’s financial performance; and
c. Investee’s business prospects.
Each of the above indicators is accompanied by a list of components that are to be employed in their application. However, it is beyond the scope of this ABNR Legal Update to describe these components in detail.
With the exception of financings amounting to less than Rp 1 billion at the time the agreement was signed, the assessment of productive-asset quality should have regard in all cases to the following considerations:
- the significance or materiality of each indicator and its accompanying components;
- the relevance of each indicator and its accompanying components to the investee’s business.
Under Part E of the Rules, a VCC is required to set aside provisions for productive asset write-downs in the case of quasi-equity investments, bond purchases at the start-up or growth stages, and business financings, while a shariah-compliant unit of a conventional VCC or a shariah-compliant VCC is required to set aside provisions for write-downs of investments in convertible sukuk or other shariah-compliant bonds, sukuk issued by an investee at the start-up and/or growth stages; and/or profit sharing-based financings. Such provisions are set as a percentage of the outstanding value of each asset, less the value of security/collateral.
Lower levels of provisioning are permitted in the case of a number of priority economic sectors, including the creative economy, food, low-cost housing, new and renewable energy, eco-friendly tourism, water treatment, power, transportation infrastructure, and the marine sector.
The Rules contain detailed provisions for the treatment of security. Due to their technical nature, however, a full discussion of these is beyond the scope of this update.
Profitability is defined in the Rules as a benchmark that is used to identify the capacity of a VCC to generate profit over the course of a defined period and to assess the effectiveness of management in running the business.
In assessing the profitability of a VCC, the following ratios are used:
- Return on Assets (ROA)
- Return on Equity (ROE)
- Operating Profit Margin (OPM)
As described in the Rules, these ratios are as generally applied in business and by the accounting profession.
3. Procedures for Assessment of Financial Soundness
The Rules describe detailed, step-by-step procedures for the assessment of a VCC’s financial health. These procedures may be summarized as follows:
a. Calculating the value of each productive asset quality and profitability ratio;
b. Assigning a weighting to each asset quality and profitability ratio;
c. Determining composite scores for (i) productive-asset quality, and (ii) profitability; and
d. Determining a composite financial soundness ranking.
4. Verification and Validation by OJK
The OJK is authorized to conduct verification and validation as regards the accuracy and reasonableness of the asset-quality and profitability conclusions arrived at by a VCC. Should the conclusions reached by the OJK based on such verification and validation differ from those drawn by the VCC, the OJK’s conclusions shall prevail.
5. ABNR Commentary
After a slow start, the venture capital industry is now playing an increasingly important role in Indonesia, where a particularly conservative banking system makes it even more difficult than usual for start-ups and early-stage businesses to access financing. For investors, the Indonesian market remains attractive given the country’s relatively high economic growth, rapidly expanding middle class, and burgeoning population of tech-smart young people. However, the VC industry also has the potential to cause losses if not properly regulated, as happened during the internet bubble crash at the end of the last century. In addition, many VC providers raise funds from the public to finance their investments. Consequently, it is essential that a comprehensive legal framework be put in place to ensure that the industry is properly regulated and all involved receive adequate legal protection. The Rules are therefore to be welcomed as they provide the OJK with clear parameters by which the overall financial health of the VC industry and its individual players can be assessed.