Indonesia eyes netting changes to enable derivatives CCP

Central bank says legal amendments will pave way for locally cleared NDFs and interest rate swaps

indonesia-rupiah-2016

Indonesia’s central bank is pushing for a legal change that would allow banks to apply close-out netting on derivatives trades.

Bank Indonesia says it would also spur the development of a new derivatives clearing house in the country within the next few years that would focus initially on clearing local currency non-deliverable forwards (NDFs) and interest rate swaps. Foreign banks say this should help the onshore market, and would help them trade more with local counterparties.

“During this time of crisis, banks such as ourselves are reluctant to use lines to the weaker banks, but with a CCP [central counterparty] up and running, our exposures are only to the CCP and it is almost covered by the initial margin,” says the country head of a Chinese bank’s Indonesian subsidiary.

“Our exposure to the CCP would be almost risk free and liquidity in the derivatives markets should increase significantly.”

Close-out netting allows positive and negative mark-to-market amounts to be collapsed into a single amount that would be paid out on the event of a default. However, there are concerns that the application of close-out netting on derivatives trades in Indonesia may conflict with the Bankruptcy Act and Suspension of Payment legislation.

This law states that, in the event of a bankruptcy, management of assets passes from the transacting party to an appointed curator. This means the decision about how to net off trades may rest with the curator, rather than the two parties concerned.

Guidelines from the central bank say that when trading derivatives, Indonesian counterparties should use a local version of the International Swaps and Derivatives Association master agreement known as ‘Perjanjian Induk Derivatif Indonesia’. But this does not refer to the enforcement of close-out netting provisions.

Addressing regulatory impediments to netting was identified as a priority in Indonesia’s National Strategy for Financial Development 2018–2024, a policy strategy document published back in 2010. The document also lists the establishment of a clearing house for derivatives as an objective, which would help the country to meet one of the recommendations for the reform of over-the-counter derivatives agreed by G20 heads of state in 2009.

Our exposure to the CCP would be almost risk free and liquidity in the derivatives markets should increase significantly
Country head of a Chinese bank’s Indonesian subsidiary

An amendment to the Bankruptcy Act could finally provide derivatives users with legal certainty on the enforceability of close-out netting in the jurisdiction, says Priyanto Nugroho, director of financial market deepening at Bank Indonesia in Jakarta.

The central bank participated in a cross-agency working group to consider how the country’s bankruptcy framework needs to change to provide clarity on close-out netting. The working group sent a letter to the National Law Education Agency urging it to prepare an amendment to the country’s bankruptcy law.

“We want this to be one of the priorities for the parliament but that is not under our control, so we escalated it to a higher level,” says Nugroho. “The NLEA is trying formulate the specific clause for the amendment [to address close-out netting], but it is not a part of the public discussion yet – it is still with a small working group.”

The working group was set up by a task force created to prepare the legal ground for the establishment of a derivatives CCP. The task force, which concluded in 2019, was comprised of members from Bank Indonesia, the Financial Services Agency and the country’s finance ministry, and was headed by Nugroho. 

Another non-netting jurisdiction in Asia – India – has also sought to address legal uncertainty around close-out netting through a package of legislation, rather than a standalone regulation.

Referring to India’s lengthy legislative path to achieving clarity around close-out netting, Nugroho says the process, which began two years ago, could take up to five years in total. In Isda’s 2019 Asia-Pacific Derivatives Survey, fewer than 3% of respondents said they felt that legal certainty on close-out netting would be achievable in Indonesia within three years.

“Our approach, considering the legislative structure in Indonesia, is not to come with a specific netting law but to accommodate that in an amendment to the bankruptcy law,” he says.

Cleared for takeoff

Policy discussion on close-out netting comes after new rules that were drafted by the central bank to allow for the establishment of a clearing house for interest rate and foreign exchange derivatives became effective in June.

The establishment of the CCP is regulated through Bank Indonesia Regulation Number 21/11/PBI/2019, which sets out certain requirements that must be met covering capital, governance and risk management. A provision stating that the CCP has the authority to apply close-out netting, early termination and auction transactions of a defaulting member is also included in the text.

Despite the netting provision included in the CCP regulation, Nugroho says Bank Indonesia recognised the need for more legislative clarity on the application of netting at the clearing house in a bankruptcy scenario.

According to the central bank’s 2019 Financial Report, further regulations will be drafted later that will identify which products will be subject to mandatory clearing at the CCP, in line with the G20’s requirements from 2009.

Nugroho adds that the new regulatory framework enabling the establishment of a CCP is aimed at supporting the growth of the local OTC derivatives market.

A markets head at a US bank in Hong Kong says that “in theory” a CCP in Indonesia would deliver great benefits for the market. But this very much depends on the size of the country’s OTC derivatives trading, something the US bank executive says isn’t known at the moment since domestic banks are still not required to report their OTC derivatives transactions to trade repositories, despite this being another requirement of the G20 reforms.

Some clues about the size of the market can be gleaned from data in the market for non-deliverable FX derivatives. As of August 12, LCH had cleared $931 billion of non-deliverable US dollar/Indonesian rupiah NDFs in the year to date. In the onshore market, domestic NDFs – the rupiah-settled and onshore fixed FX instruments introduced in 2018 – saw an average of $56 million a day in transactions, according to Bank Indonesia, but numbers are not available for other OTC instruments.

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