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14 February, 2017
Following Moody’s Investors Service affirmation of Indonesia’s sovereign credit rating at Baa3 with a stable outlook in January 2016, there has been renewed interest in the international bond market for Indonesian credits. This bulletin seeks to summarise the regulatory changes in Indonesia over the last 24 months as well as a couple of structuring considerations which affect all future debt capital market issues by Indonesian issuers. These regulatory changes were introduced by Regulation No. 16/21/PBI/2014 on the Application of Prudential Principles in Management of Offshore Debt of Non-Bank Corporations (the “New Regulation”) and Circular No. 16/24/DKEM on the Application of Prudential Principles in Management of Offshore Debt of Non-Bank Corporations by Bank Indonesia ("BI") (the “New Circular” together with the New Regulation, the “New Regulations”) which were introduced towards the end of the 2014.
The New Regulations introduce various measures designed to ensure only credits of a certain quality are able to tap the debt capital markets. These measures include requiring potential issuers to, among others, have certain minimum credit rating, minimum hedging and liquidity ratio.
Minimum credit rating requirement
Pursuant to the New Regulations, subject to certain limited exceptions discussed below, all non-bank Indonesian corporates wishing to issue foreign debt after 1 January 2016 must obtain a minimum credit rating equivalent to at least 'BB-' from a rating agency recognised by BI (note, this compares with the previous minimum credit rating requirement of BB). Such a credit rating may be obtained from any rating agency recognized by BI (whether domestic or international). The below table sets out the BB- equivalent rating of key domestic and international rating agencies as set out in Appendix 1 to the New Circular:
| Name of rating agency | BB- Equivalent Rating | |
| Domestic rating agencies | PT Pemeringkat Efek Indonesia (PEFINDO) |
BB-(idn) |
| Fitch Ratings Indonesia |
Ba3 | |
| International rating agencies | Moody's Investors Service |
BB- |
| Standard & Poor's |
BB- | |
| Fitch Ratings |
BB- | |
| Japan Credit Rating Agency |
BB- | |
| Rating and Investment Information Inc. |
BB- | |
It should be noted that domestic ratings will be treated equally with those of international rating agencies under the New Regulations. This being the case, Indonesian issuers tapping the unrated markets (such as the Singapore dollar market or the private placement market) are likely to only approach domestic agencies who have generally provided ratings that are more favourable than those of international rating agencies. For other markets where a rating is usually required such as the Eurobond and US markets (for both investment grade and high yield debt), investors will expect potential issuers to obtain a rating from an international rating agency. It remains to be seen how BI will handle a situation where an Issuer has a rating above BB- from a domestic agency and a rating below BB- by an international rating agency. Whilst BI has informally indicated that in practice, it considers the ratings received from a domestic agency to be sufficient for the purposes of the New Regulations, it remains to be tested whether they will adopt this approach in the case of a real conflict.
Exemptions
As noted above, there are certain exceptions to the minimum credit rating requirement. These include, among others, offshore bonds issued to refinance existing offshore debt or to finance infrastructure projects (considered a sector of current national importance), and intra-group bond issues, in each case, subject to certain restrictions.
Minimum hedging and liquidity ratio
Minimum hedging
The New Regulations require all non-exempt non-bank issuers to hedge at least 25% of the shortfall between their foreign currency assets and foreign currency liabilities falling due within the following two quarters (the "Minimum Hedging"). From 1 January 2017, all hedging must be conducted with Indonesian banks or Indonesian branches of foreign banks. There are, however, certain exemptions from the Minimum Hedging requirement including for smaller companies with a spread of foreign currency assets over liabilities of less than US$100,000, and companies with an export revenue to total revenues ratio for the current year which is greater than 50% of the prior year's ratio and who have obtained approval from the Ministry of Finance to record their financial statements in United States dollars.
Minimum liquidity
In addition to the Minimum Hedging requirement, issuers are also required to maintain under the New Regulations foreign currency assets of at least 70% of their foreign currency liabilities (the "Minimum Liquidity"). For the purposes of the Minimum Hedging and Minimum Liquidity requirements, foreign currency liabilities includes all current obligations due within the relevant period (excluding liabilities due to be rolled over or refinanced), and foreign currency assets include cash and cash equivalents (including marketable securities), receivables, inventory and hedging receivables. As to the latter, there is no guidance as to how hedging receivables from swaps, forwards and option transactions should be valued, leaving significant room for interpretation which in turn could yield very different results. For example, valuing a swap at its mark-to-market value may result in a value which is significantly different to its notional contract value. Until there is clarification, potential issuers are likely to adopt valuations that most favour their position in order to comply with the Minimum Liquidity requirement.
Consequences for non-compliance?
It should be noted that failure by an issuer to obtain the requisite rating or non-compliance with the Minimum Hedging or Minimum Liquidity requirements only results in a warning letter from BI and possibly public censure for the relevant issuer. Such action by BI is intended to warn creditors of the non-compliant debt and other interested parties that such issuer is a higher credit risk because it lacks the minimum credit rating set by BI and may not have adequate hedging and liquidity. It should be noted that a breach neither results in invalidity of the underlying documents nor in any civil or criminal liability. We note that underwriters/managers are, for now at least, not insisting that these requirements be conditions precedent to closing of deals. Underwriters/managers seem to be comfortable relying instead on the general compliance with law covenants/representations in underlying documentation. However, note the litigation risk highlighted below.
Reporting and monitoring
In order to monitor compliance with the New Regulations, BI requires Indonesian corporate issuers to file reports with BI on a quarterly basis. As with non-compliance with the other requirements introduced by the New Regulations referred to above, non-compliance with this filing requirement also does not carry any civil or criminal liability but may result in a warning letter from BI and public censure.
Litigation risk
Whilst, as noted above, non-compliance with the New Regulations does not result in any criminal or civil liability or invalidate the underlying documents, we have seen that even a minor taint to legality can be held sufficient by Indonesian courts to void the underlying transaction (see APP International Finance Company and Nine Am cases). Accordingly, the parties should not ignore the potential litigation risk of non-compliance, particularly if things go "pear shaped" and the debt burdened issuer looks for an excuse to avoid its debt obligations. The fact that the New Regulations do not provide for non-compliance to result in the underlying documents becoming void or voidable should help to reduce such risks. Nevertheless, Indonesian courts can be unpredictable and the potential litigation risk may cause arrangers/managers to take more seriously the requirements introduced by the New Regulations.
Withholding tax
Subject to certain limited exceptions, cross-border bond issues by Indonesian issuers attract withholding tax in Indonesia on interest payments at the rate of 20%. Whilst the terms and conditions of cross-border bonds typically require issuers to gross-up on account of such withholding tax so that investors are made whole, the imposition of such withholding tax does add a significant layer of cost to issuers. Although not a recent development, tax structuring to deal with withholding tax features on every deal post amendments to the tax regulations in 2009 which made it more difficult to structure an issue through an offshore special purpose vehicle ("SPV") in a lower tax jurisdiction with a double tax treaty with Indonesia to reduce the withholding tax rate.
Basically, post the 2009 changes, it is still possible to use offshore SPVs to take advantage of the double tax treaties between Indonesia and the jurisdiction of the SPV to reduce the withholding tax rate from 20% to, for example, 10% in the case of Singapore, or 0% in the case of the Netherlands (which will be increased to 5% once the June 2015 protocol amending the Indonesia-Netherlands tax treaty is ratified). However, in order for such a structure to be effective under the amended tax regulations introduced in 2009, the offshore SPV must be the beneficial owner of income derived from the onshore operating company. Essentially, the offshore SPV needs to be an operating entity in its own right. It should not have been incorporated solely for the purposes of minimising Indonesian tax liability otherwise the risk of such a structure being declared void resulting in the unenforceability of the underlying bond transaction significantly increases, particularly following the Indah Kiat International Finance Company B.V. and APP International Finance Company B.V. litigation cases.
Bahasa language law
In 2009 Indonesian legislators implemented Law 24/2009 which requires all contracts entered into with an Indonesian party (public or private) to be made in Bahasa Indonesia. Where a contract involves a foreign party, the parties may, in addition to Bahasa Indonesia, also use the national language of the foreign party and/or the English language. In 2013, the District Court of West Jakarta ruled that a loan agreement between an Indonesian limited liability company and a Texas-based lender was void on the grounds of illegality. The court held that the loan agreement, which was drafted in the English language only, violated Article 31 of Law 24/2009 and was therefore null and void. The Court ordered the parties to reinstate each other to the same position they would have been in as if the agreement had never been entered into. Although the Indonesian legal community were at the time and still are very critical of the Court's reasoning in this case, it was affirmed by the Jakarta High Court and again in August 2015 by the Supreme Court.
It should be noted that Indonesia is a civil law jurisdiction where the courts are not bound by previous case law. So whilst the above decisions may be used as a source of reference by future cases before the Indonesian courts, it is entirely possible that another Indonesian court may come to an entirely different decision when faced with the same facts. In any event given the recent decisions mentioned above, the practice now is to require all transaction documents to be entered into with an Indonesian party to be prepared and executed in both Bahasa Indonesia and in English. Indonesian issuers need to factor in the cost of translating transaction documents into Bahasa Indonesia in order to comply with Law 24/2009 on all future bond issues.
Going Forward
Whilst the changes to the Indonesian regulations appear to have tightened the foreign exchange regime, it remains to be seen how effective these measures will be, particularly as the sanctions for non-compliance are merely administrative. Furthermore, investment grade Indonesian issuers who would have tapped the international capital markets prior to the New Regulations are unlikely to be impacted by changes effected by the New Regulations as such issuers would most likely already be in compliance with the New Regulations. The New Regulations would appear to affect only those sub-investment grade or high yield issuers who are ordinarily not able to access the international capital markets and are limited to the Indonesian domestic markets for their financing needs.
For further information, please contact:
Philip Lee, Partner, Herbert Smith Freehills
philip.lee@hsf.com
