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Current Updates on Structured Products Regulation

By : AYMP

01-Jun-2016

The Financial Service Authority (Otoritas Jasa Keuangan – “OJK”) has recently enacted Regulation No. 7/POJK.03/2016 concerning Prudential Principles in Implementing Structured Product Activities for Conventional Banks (“POJK 7/2016”). This POJK 7/2016 has come into effect on 27 January 2016 and revokes the previous regulation i.e. Bank Indonesia Regulation No. 11/26/PBI/2009 concerning Prudential Principles in Implementing Structured Product Activities for Conventional Banks. In comparison between POJK 7/2016 and the previous regulation, there are no material changes made under POJK 7/2016, save for the reporting obligation which currently submitted to OJK and through online system.

Below are some key points in POJK 7/2016 which may be useful to demonstrate the implementation of structured products offering activities in the jurisdiction.

 I. Definition

Pursuant to POJK 7/2016, “Structured Products’ are defined as combinations of 2 (two) or more financial instruments both in form of non-derivative and derivative financial instruments OR derivative and derivative financial instruments (including embedded derivatives product), and shall have at least these following characteristics:

1. value or cash value arising from the products linked to one or a combination of basic variable, such as interest rate, exchange rate, commodity prices and/or equity prices; and
2. changes in patterns of value or cash flow of the product are irregular in nature if it is compared with the change pattern of basic variables as mentioned in point (a) above, which cause the change of such value or cash flow, not reflective of the whole change pattern from the basic variable linearity (asymmetric payoff), among others, indicated by the existence of:

• optionality, like caps, floors, collars, step up/step down and/or call/put features;
• leverage;
• barriers, like knock in/knock out; and/or
• binary or digital ranges.

 II.Customer Classifications

There are certain customer classifications who can engage into structured products transactions, as follows:

• a. professional customer, which shall mean customer who has sufficient understanding on characteristic, feature and risk of structured products, including (i) bank, (ii) securities company, (iii) financing company, (iv) future contract dealer, (v) company having equity for more than IDR 20,000,000,000 (twenty billion Rupiah) or its equivalent and involving in its business for at least 36 (thirty six) consecutive months, (vi) Indonesian or other countries’ government, (vii) Bank Indonesia or other countries’ central bank, and (viii) multilateral bank or development institution; 

• b. eligible customer, which shall mean customer who has sufficient understanding on characteristic, feature and risk of structured products, including (i) pension fund, (ii) insurance company, (iii) company having equity at least IDR 5,000,000,000 (five billion Rupiah) or its equivalent and involving in its business for at least 12 (twelve) consecutive months, and (iv) individual customer having asset portfolio (i.e. cash, giro, saving and/or deposit) at least IDR 5,000,000,000 (five billion Rupiah) or its equivalent; and

• c. retail customer, which shall mean customer who does not fulfill criteria as professional customer and eligible customer.

III. Restrictions

Bank is prohibited to (i) offer structured products to retail customer, unless the offered structured product is issued with full protection toward the principal amount invested by the customer (in original currency) at maturity date and (ii) offer structured products to the eligible customer, in case the structured product can cause potential loss exceeding principal amount invested by the customer and/or the structured product is a combination between derivative and derivative financial instruments.

Bank is also prohibited from offering any structured products using the words “deposit”, “giro”, protected”, “savings” and/or similar words which may give a view that bank will provide full-principal-refund protection on any structured products, whereby in fact no such protection is given.

 IV. Mandatory Collateral

For bank which conducts structured product transaction in the form of combination of derivative and derivative financial instruments is obliged to request its customer, cash collateral in the amount of 10% (ten percent) from the notional amount of the transaction at the time of transaction. The implementation of this mandatory collateral requirement must be stipulated in the written agreement between the bank and its customer.

The exemption on the above mandatory collateral requirement will apply for customer in the form of: (i) bank; (ii) government of Indonesia; (iii) Bank Indonesia or other countries’ central bank; and (viii) multilateral bank or development institution.

 V. License Requirement and Risk Management

In order to conduct the structured products activities, a bank shall fulfil 2 (two) stages of license obtainment from OJK:
(1) principal approval and (2) effective statement for issuance of structure products.

In support of implementation of structured products activities, a bank must implement an effective risk management system which shall at least comprise of: 

No.	Risk Management	Description
1.	active supervision by the Board of Directors, which shall include these following activities:	(i)     determine a bank plan for structured products activities, which further will be set out in bank’s business plan and submitted by the directors to Bank Indonesia in accordance with prevailing regulations; (ii)    determine policy and procedure for structured products activities; (iii)   supervise and evaluate structured products activities.
2.	active supervision by the board of commissioners, which shall include these following activities:	(i)     approval of board of commissioners upon a bank plan for structured products activities; (ii)    evaluation of implementation of bank plan for structured products activities.
3.	adequate structured products’ policy and procedure, which at least shall comprise of:	(i)     policy of structured products risk level assessment; (ii)    policy of customer risk profile assessment; (iii)   policy of suitability of structured products risk level assessment with customer risk profile; (iv)   policy of human resources; (v)    policy of employee incentive structure; (vi)   procedure of implementation of structured products activities, including the development of structured products, marketing and offering of structured products, and implementation of structured products transaction; (vii)  dispute settlement procedure; and (viii) procedure of identification, measurement, supervision, risk control and information system for structured products activities.
4.	adequate process of identification, measurement, surveillance and risk control as well as risk management information system.
5.	internal compliance system, in the form of:	(i)     limitation of authority and responsibility for working unit for structured products activities; and (ii)    the assessment by internal audit working unit.

 

VI. Reporting Obligation

Bank is obliged to submit the report on structured products transactions monthly through online system. This is a new system appeared in POJK 7/2016, as previously the report was to be submitted manually to Directorate of Supervision of Bank Indonesia or to the relevant Bank Indonesia office. Under POJK 7/2016, bank may submit periodical report through the system of Report of Head Office of Conventional Bank (Laporan Kantor Pusat Bank Umum – LKPBU).

Pursuant to Bank Indonesia Regulation No. 14/12/PBI/2012 concerning LKBPU, structured products’ reports shall include data of (i) outstanding transactions of structured products and (ii) troubled structured products transactions. The report shall be submitted at the latest 5 (five) business days at the beginning of next reporting month. Bank will be deemed as late to submitting the report if the said period is exceeded and bank still have the obligation to submit the report. Any bank which is late to submit the report shall be sanctioned by administrative penalty of IDR 500,000 (five hundred thousand Rupiah) per 1 (one) day. The maximum penalty shall be IDR 7,500,000 (seven million five hundred thousand Rupiah). Other than this sanction, the bank can be imposed with written admonition in case bank has not submitted any report in the next reporting period.

VII. Sanctions

Bank who does not comply with the provisions under POJK 7/2016 shall be imposed with administrative sanction, ranging from:

1. written admonition;
2. downgrading of bank’s health level;
3. freezing and revocation of approval for certain business activity; whether for certain branch of the bank or for the bank itself;
4. the dismissal of bank’s management board and further appoint the temporary replacement until next commencement of shareholders’ meeting; and/or
5. inclusion of name of the shareholders, management board or executive boards into the blacklist in banking area. 

Bank which conducts structured products activities without required license can be imposed with additional administrative sanction in the form of fine in amount of 1% (one percent) from the structured products transaction OR minimum fine of IDR 27,000,000,000 (twenty seven billion Rupiah).

OJK may also revoke the existing principle license and/or effective statement, if, based on its assessment:

1. application of risk management principle for structured products activities conducted by the bank is not adequate; and/or
2. risk arising from structured products activities conducted by the bank may harm the continuity of the bank’s business.  

This summary only highlights particular issues under
POJK 7/2016 and may not reflect the entire issues and requirements in the implementation of prudential principles in relation to structured product activities in Indonesia.   

Please visit our website at www.aymp.law for more information about our firm.

For more specific inquiry about this matter or other emerging legal issues in Indonesia, please contact the following lawyers:

• Arie Armand (arie@aymp.law)
• Gunadarma (gunadarma@aymp.law)
• Agung Santoso (agung@aymp.law)

Hana Monica (hana@aymp.law) 

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