4 January, 2016
Changes to Indonesia’s regulatory environment are putting traditional project financing arrangements to the test.
Notwithstanding the subdued nature of commodity prices globally, Indonesia continues to host a healthy pipeline of development projects in the natural resource sector. However, a number of recent regulatory changes that affect international project financing mean that market players are keen to see how international lenders and investors choose to structure their credit arrangements.
There is good reason to believe a number of refinements to financing structures will develop in the market – the inevitable responseto thoseregulatorychanges.Just how far financiers will go to secure their projects’ revenue though remains a matter for speculation.
“The risk of money being caught in Indonesia is temporary only.”
Enduring trust
Historically, international lenders have relied on trustee borrowing scheme (TBS) structures in Indonesia to offshore the income of projects that involve commodity exports and state controlled entities or assets. This is in large part due to latent concerns about cash revenues onshore being available to leave Indonesia
to service onshore debt and also the World Bank Negative Pledge (WBNP) which prevents lenders from securing the assets of state controlled projects.
The TBS structure typically provides for an offshore entrustment of a project’s export revenue. In effect, this means international lenders lend to an offshore trustee borrower who applies the loan proceeds to onshore project costs and then retains all of the project’s revenue offshore and applies it in a manner prescribed by a dedicated order of application.
This structure not only minimises lenders’ concerns about a limited or non-recourse loan, it also reduces some of the political risk implications of money being applied outside of lenders’ control onshore. “Lenders have historically depended on TBS structures as a way of creating a framework for a bankable export-based project,” explains Matthias Schemuth, partner at Ashurst.“Many big Indonesian resources projects have relied on it for decades.”
Responding to change
However, recent developments in Indonesia’s regulatory environment have largely undermined this approach. In particular, three new pieces of legislation have cast doubt over financiers’ ability to effectively control a projects’ revenue in the manner of a TBS structure. “There is a question mark over existing projects and how they will react to the new changes – and how a new structure will develop as a result,” says Schemuth.
Staying onshore
The first of these regulations (PBI 14/25/ PBI/2012 as replaced by PBI 16/10/PBI/2014 concerning Receipt Of Export Proceeds And Withdrawal Of Foreign Exchange From Offshore Debt) pertains to the treatment of export income. Hard currency export receipts in industries such as oil and gas and other commodities are now required to be repatriated back into Indonesia as a matter of law.
This has clear implications for international project financiers.“If you have a mandatory requirement to move the revenue of projects onshore some of the historical benefits of the TBS structure are defeated,” says Schemuth, noting,“Financiers have long sought to
avoid money being exposed to exchange controls and restrictions on transferability of cashflows from Indonesia.”
One response has been to substantially reduce the window of time that the project revenue stays onshore. “These are models that try to modify the TBS structure to make it compliant with regulatory requirements while still protecting the international financiers’ interests,” says Schemuth.
Export revenues are repatriated to Indonesia within the current mandated 90 days, it goes into an entrusted account to ensure it is ‘ring-fenced’ and thereby secured. Then, within a short space of time (perhaps the same day, which most participants agree is permitted by the regulations), the money is sent offshore again before being applied in the normal prescribed manners. Says Schemuth:“The risk of money being caught in Indonesia is temporary only.”
In any event
Even given the short space of time, a project’s revenue is not entirely protected:“What if the money passes onshore and the law subsequently changes, meaning it is no longer able to be converted into US dollars and transferred back offshore?”
This concern has given rise to another risk mitigant. In the event the project cashflow is retained in Indonesia and cannot be freely transferred – whether because of a political event or a problem with the local account bank (an insolvency event for example)
– the financiers will seek to suspend the project’s revenue from moving onshore. This period of suspension is intended to last until a solution is agreed upon by the relevant parties, including the relevant sector regulator. “In such events, obtaining the blessing of the regulator responsible for the project’s industry is critical,” confirms Schemuth.
All about rupiah
Another, more recent regulation (PBI 17/3/ PBI/2015 concerning Mandatory Use of Rupiah within the Territory of the Republic of Indonesia) is further cause for concern.
It requires mandatory use of the Indonesian rupiah (IDR) in most domestic sales transactions, including offtake agreements.
This is particularly problematic for internationally funded projects which are largely financed in US dollars. The result is a currency mismatch, exposing lenders to the risk of fluctuations in foreign exchange rates. “One of the golden rules of project finance is to avoid mismatching the currency in which you are to earn income with the currency in which your debt is to be serviced.”
In fact certain projects have already successfully obtained exemptions to this regulation, notably a number of oil and gas projects. There are also certain existing projects that have been able to claim grandfathering of their contractual relationships.
Yet not all lenders are home free. “It remains to be seen what happens,” says Schemuth. “Rupiah denominated tariffs in power projects, for example, might still prove to be an issue for offshore lenders. Certainly, we need to find solutions for those projects that can’t claim exemptions.”
Home duties
A third regulatory issue faced by international financiers on resources based projects is Indonesia’s domestic market obligation (DMO) – a requirement that a certain proportion of a project’s resources or reserves should be dedicated and made available to meet domestic demand. This will of course impact on the economics of resources based projects and their ability to generate export sales in international currencies.
As recently as the 1990s, Indonesia did not have a DMO. The practice of the government of Indonesia requiring that a substantial portion of production is diverted to meet onshore demand is on the rise. The 2001 oil and gas law, for instance, introduced an express obligation in production sharing contracts (PSCs) to dedicate up to 25 percent of a project’s offtake to the home market. Some drafts of a proposed new oil & gas law suggest 25% will be the minimum DMO in future. In the case of recent LNG expansion projects, there has been a DMO allocation of up to 40% on the expansion volumes.
A good price
What concerns international financiers with this trend is their increased exposure to Indonesia’s domestic market as well as the credit strength of counterparties.
“You are potentially facing companies that might not be as creditworthy as international buyers. However, this may be balanced by a trend towards better domestic market prices being achieved. The economics are changing such that the price domestic buyers are paying may create a healthy mix of cashflows (both export and domestic) used to generate funds for debt service.” says Schemuth.
Such domestically generated cashflows, however, further exacerbates the issue of ensuring that no mismatch arises between the currency of cashflows and debt service. This might create opportunity for involvement of domestic banks in local currency tranches.
Where to from here?
The TBS structure is by no means sacrosanct. Recently, the Donggi Senoro LNG project, which involved limited recourse loans by Korea Eximbank and JBIC and NEXI covered lending, reached financial close without the benefit of a TBS structure. Nevertheless, Indonesia’s largest projects have relied on its protection for many decades now and the question remains: how will project financed deals respond to the new regulatory environment?
The LNG Tangguh Train 3 Expansion project is currently addressing these challenges. There are also many more projects in waiting, including a number of government- sponsored regasification and refinery deals. And these issues do not merely affect natural resource projects. “Similar issues can impact contracts in many sectors,” points out Schemuth.
Doubtless a number of innovative techniques will be employed to navigate the new regulatory environment. Ultimately, however, “it will be a matter of getting the balance right,” says Schemuth – a balance between Indonesia’s national interests and financiers’ need for repayment security.
For further information, please contact:
Matthias Schemuth, Partner, Ashurst
matthias.schemuth@ashurst.com
