2010 has been a remarkable, if somewhat demanding, year for all those involved in the derivatives market. In the aftermath of the recent financial crisis, there have been heated debates on issues ranging from transparency, to standardisation and the proposed implementation of Central Counterparties (CCPs). And these debates have not been limited to the American and European markets. Asian regulators have spent a great deal of time and effort to prevent the problems that were seen in the US and Europe from happening on their turf - and Indonesia is no exception to this. Here, as the end of the year approaches, we take a look at a couple of the important developments we have witnessed in Indonesia this year.
REGULATION: PRUDENTIAL REGULATION
In July 2010, in a response to the increasing complexity of financial instruments and the consequential need for greater transparency and quality of information, as well as the financial market crisis that affected many developed countries, Bank Indonesia implemented a regulation No. 12/9/PBI/2010 entitled Prudential Principles in Conducting Offshore Financial Product Agency Activity by Commercial Banks (Prinsip Kehati-hatian Dalam Melaksanakan Aktivitas Keagenan Produk Keuangan Luar Negeri oleh Bank Umum.) (the "Prudential Principles Regulation").
The Prudential Principles Regulation was one of a number of regulations issued by Bank Indonesia this summer as part of its monetary policy package. It applies to a wider range of financial instruments (including some that are also regulated by other institutions) but omits commodities-based financial instruments which remain subject to separate legislation. It requires that Indonesian commercial banks (including Indonesian branches and subsidiaries of foreign banks) cannot be involved in any activity regarding offshore financial products without obtaining the prior approval of Bank Indonesia and also puts in place detailed requirements, including categorizing customers as 'retail' or 'non-retail' (indicating the sophistication of their understanding of the products and associated risks) and features including risk management, risk assessment and customer protection (including procedures for the application of the 'KYC' ('know your customer') principles and product suitability). These features introduce the application of more stringent measures that were not present previously, such as requirements for the banks to conduct an annual internal audit on their offshore financial product agency activities which must be reported to Bank Indonesia, and provision of 'transparent' information to customers in relation to these financial products and their associated risks. Banks are subject to sanctions for violations of these requirements, including a decrease of a violating bank's rating, revocation of its banking business license as well as possible sanctions for its managers/offices.
How Much Will the Prudential Principles Regulation Help?
When any counterparty looks to challenge the enforcement of a derivative contract, several arguments that are frequently heard: the transaction was neither suitable for nor properly understood by the counterparty (perhaps because of the complexity of the product and/or because of language difficulties); the product was mis-sold by 'unscrupulous' bankers; the product itself is speculative - and perhaps too speculative to be enforceable as a matter of public policy. The list goes on. These arguments are certainly not unique to Indonesia but, as many readers are all too aware, have been raised there in the past. Similar arguments, in a variety of guises, were heard in a line of cases from the late 1990s to present day.
In light of this, the Prudential Principles Regulation is to be welcomed in that it clearly contemplates that derivatives are an important tool for companies that wish to manage their exposure to risk and that derivatives have a useful role to play in financial management in Indonesia.
It would, of course, be astonishingly naïve to assert that the new regulation will cure all that ails a counterparty looking to enforce a derivative contract in Indonesia but strict compliance will, we believe, go someway towards mitigating some of the more commonly-heard arguments.
What Else Can Be Done? Best Practice
In addition to strict compliance with the Prudential Principles Regulation, we would also advise that as part of its 'best practice', any party looking to enter into a derivative transaction with an Indonesian counterparty provide that counterparty with a full 'scenario analysis' in Bahasa Indonesian. As a minimum, this analysis should:
- identify the counterparty's exposure and hedging needs (for whilst hedging is a question of fact and not something that any third party can confirm, any information that can be included to identify a hedging need and demonstrate that the transaction was entered into for hedging purposes and is not speculative in nature will be of benefit);
- identify the risks (including potential risks) to the counterparty of entering into the proposed transaction; and
- identify and quantify all amounts payable by parties under the proposed transaction in a variety of possible scenarios (both realistic and extreme).
Ideally it should also show how any increase in amounts payable under the derivative is offset by a decrease in other expenses of the counterparty and should demonstrate how and why the proposed transaction is commercially reasonable, even if it ultimately proves to be significantly 'out of the money' for the counterparty.
This isn't a magic bullet and enforcement of derivative contracts in Indonesia may remain a challenge but a detailed, local-language scenario analysis is gold dust in any enforcement situation. And Indonesia is certainly no exception.
BAHASA INDONESIAN ISDA DOCUMENTATION: TRADE TEMPLATES
As we reported to our clients last year, on July 9, 2009 the Government of Indonesia enacted Law Number 24 Year 2009 on the National Flag, Language, Emblem and Anthem (Bendera, Bahasa, dan Lambang Negara, serta Lagu Kebangsaan) (the "Indonesian Language Law"). This covers the use, treatment and application of certain Indonesian identity symbols and imposed new requirements regarding use of the Indonesian language in written agreements. One of the main provisions of the law, Article 31, provides that parties must use the Indonesian language in memoranda of understanding or other written agreements with Indonesian counterparties. The Indonesian Language Law further provides that if any such agreements involve non-Indonesian parties, the agreements may also be written in the national language of the non-Indonesian party and/or in the English language, and that "all of such texts are equally genuine" (click here and here to view the O'Melveny & Myers Client Alerts on the Indonesian Language Law (No 24/2009)).
To facilitate its members' compliance with the requirements of the Indonesian Language Law, ISDA commissioned and released the Bahasa Indonesian language version of the 2002 ISDA Master Agreement last year. Building on this, ISDA have now prepared confirmations for the most common trade templates in Bahasa Indonesian (being Deliverable USD/IDR FX spots, FX forwards and FX swaps, put and call currency options and binary options and Deliverable and Non-Deliverable USD or IDR interest rate swaps and USD/IDR cross currency swaps). These templates, together with an FX Glossary of the relevant provisions from the 1998 FX and Currency Option Definitions, as amended by the 2005 Barrier Option Supplement and a Rates Glossary of the relevant provisions from the 2006 ISDA Definitions, are due to be published today, Monday 20th December 2010. We will keep you posted on this.
O'Melveny & Myers LLP routinely provides advice to clients on complex transactions in which these issues may arise, including finance, mergers and acquisitions, and licensing arrangements. If you have any questions about the operation of the applicable statutory provisions or the case law interpreting these provisions, please contact any of the attorneys listed on this alert.
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