Hedging your bets: Regulatory changes are set to support the growth of exchange-based derivatives trading

Despite the widespread use of hedging instruments offshore, Indonesia’s derivatives market has been slow to develop. Bank Indonesia (BI) regulations in late 2008 following significant losses linked to onshore structured products have restricted foreign-exchange (FX) and interest-rate derivatives to over-the-counter (OTC) trading between banks. A new exchange established in 2009, the Indonesia Commodity and Derivatives Exchange (ICDX) introduced commodity and limited FX futures that will benefit from new government regulations requiring the sale of key mineral commodities via onshore exchanges. While the Jakarta Futures Exchange (JFX) still struggles to introduce liquid contracts, the Indonesian Stock Exchange will reintroduce single-stock and index futures in late 2014, followed by interest-rate futures. The G20 Financial Stability Board (FSB) requirements to migrate OTC derivative trading on-exchange over the coming years will support growth in exchange-based derivatives trading.

OTC

In November 2008 BI issued new regulations barring banks’ use of structured products, which hedge FX movements, following losses by several banks. The biggest losses were recorded by Danamon, which saw a Rp800bn ($80m) loss, and Standard Chartered. “The new BI rules have ruled out structured derivative products, although it is still possible for clients to buy such tailor-made contracts through Singapore,” Poltak Hotradero, head of research at IDX, told OBG.

In particular, the use of FX non-deliverable forwards through Singapore-based banks has created a dynamic offshore forward market, with average daily volumes in the $500m-$700m range, according to HSBC estimates. By April 2013 Indonesia accounted for just 1% of total Asian OTC FX derivatives, according to management consultancy Oliver Wyman. “FX options trading volumes dropped significantly following 2009 rules from BI,” Ali Setiawan, HSBC’s senior vice-president of global markets, told OBG. “Banks like HSBC still quote dollar/rupiah rates, but these are only plain vanilla, so we are not seeing any development of this market.”

The majority of clients used such products to hedge against financial risks rather than to speculate, a 2010 survey by Gadjah Mada University found. Meanwhile, the regulator, Financial Services Board (OJK), requires equity and commodity futures to be traded on-exchange.

By September 2013 the ratio of OTC to on-exchange derivatives trading was 6:1, with only commodity and limited FX futures listed.

Oversight

The two are regulated by the Ministry of Trade’s Commodity Futures Trading Regulatory Agency, which is separate from OJK. While aggregate monthly turnover on JFX has grown from Rp152bn ($15.2m) in 2009 to Rp3.99trn ($399m) in the first three quarters of 2013, no published turnover figures are available for ICDX. Both commodity exchanges have developed fledgling storage capacity networks to standardise product quality and delivery times, although more investment will be needed as trading grows. “One of the key issues in developing a commodities futures market is the infrastructure, mainly warehousing capacity that insures standardised quality,” Purbaya Yudhi Sadewa, chief economist at local financial services firm Danareksa, told OBG. “We are still far behind in our exchange-traded derivatives development.”

Reform

As part of the G20, Indonesia is bound by the FSB’s requirements to gradually shift derivatives trading onto exchange platforms and to report OTC trades to a central repository. A deadline was set for end-2013, by which all members must show concrete steps towards central clearing and trade reporting. While BI’s rules require daily reporting of OTC derivatives transactions, in 2011 the then-regulator, the Indonesian Capital Market and Financial Institution Supervisory Agency (now OJK), expanded the definition of commodity futures to cover interest rates, foreign exchange and equities, and introduced a new counter-party model for OTC trading that allows derivatives to be traded on-exchange or settled through a clearinghouse.

However, full compliance remains distant as questions over who would act as a central clearing house remain. “We are still some way off implementing G20 requirements on derivatives,” Setiawan said. “The question is who would act as the central clearing house for derivatives currently traded OTC, especially since banks are barred from trading via the exchange.” BI introduced a new measure in mid-2013 that could spur more demand for OTC products by allowing exporters to use FX-forwards without underlying transactions as a way of hedging currency exposures.

As part of the government’s strategy of increasing domestic value added to Indonesia’s exported commodities, the Ministry of Trade has pushed for onshore exchange trading of key commodities, starting with tin from August 2013. The regulator has called on assistance from the Chicago Mercantile Exchange and the US Commodity Futures Trading Commission to develop its onshore commodity trading in key hard and soft commodity exports. By requiring all 47 tin-ingot exporters to trade on a domestic exchange before shipment, the ministry plans to establish a new global tin benchmark in Indonesia – the world’s largest producer with 40% of global supply – in direct competition to the existing benchmark on the London Metals Exchange (LME). “The purpose of trading physical tin via the bourse for export is to make Indonesia the place for international tin-price discovery,” Sutriono Edi, head of the Commodity Futures Trading Regulatory Agency, told Bloomberg in October 2013.

Commodity Benchmark

The only existing onshore tin contract is hosted on ICDX and backed by five tin producers, including the world’s largest – state-owned Timah. But although the government wants to centralise tin trading on a single exchange, rival JFX planned to introduce a tin contract in the fourth quarter of 2013 with the backing of 18 smaller tin smelters. It was still awaiting CoFTRA approval in December 2013. The ICDX-listed tin contract was first introduced in 2012 and relaunched in 2013 following lacklustre trading, which saw transactions trail off after 116 lots were traded in 2012. Tin trading is available under five contracts during five seven-minute sessions, with five-tonne lot sizes of 99.9% purity. Physical delivery takes place at four storage points in Bangka Belitung province, offshore East Sumatra, replacing the system of tin spot sales on global exchanges such as LME or in long-term supply contracts with end-users. By October 2013, 24 trading firms had joined ICDX, including major traders like South Korea’s Daewoo. The new regulations prompted Timah to declare a state of force majeure on its existing supply agreements. As a result, the tin producer cancelled its shipments, slowing tin exports to 786 tonnes in September 2013, down from 9874 tonnes a year earlier (see Mining chapter).

Prices jumped as a result. In that month alone, prompted by the drop in shipments from Timah, LME tin prices rose 21% year-on-year. Although it was unclear in October 2013 whether JFX would be allowed to launch a rival tin contract, its management argued more competition would benefit efficiency. “As the two commodities exchanges strive to make their products more attractive, we think the futures trading community will benefit,” Lukas Lauw, head of the information technology and trading division at JFX, told OBG.

Stock & Rate Futures

Indonesia’s main stock exchange also plans to develop more equity and fixed-income hedging instruments. While the Jakarta and Surabaya exchanges once hosted single-stock futures (SSF) and stock index futures, respectively, they have been inactive since their merger in 2007. In late 2014, IDX aims to re-launch both types, starting with large-cap SSFs and a futures contract on the benchmark LQ45, a capitalisation-weighted index of the 45 most heavily traded stocks on the IDX. “The next step once we relaunch single-stock and index futures at year-end 2014 will be interest-rate futures, using different maturity bond indexes published by the Indonesian Bond Pricing Agency,” Poltak said. IDX is conducting a study in conjunction with the Debt Management Office due for completion in 2014. The aim is to launch interest rate futures based on one-, three-, six- and 12-month bond indexes published by the Indonesian Bond Pricing Agency. As this trading infrastructure develops, investors will welcome a wider range of instruments that allow more flexibility for onshore-hedging.

Exchange Traded

On-exchange derivatives are developing at a faster rate. The JFX, owned by 29 futures traders, opened in 2000, although trading only accelerated from 2010 with its new trading platform. By 2013 it offered 11 commodity futures contracts including olein, cocoa and gold (with three dollar-gold contracts), with plans for a tin contract in the fourth quarter of 2013. The rival ICDX, backed by 12 commodity firms including major foreign buyers, launched in 2009 and hosts four metal contracts, two palm-related, five in energy, 14 agricultural commodities and 34 currency pairs. The four market makers for OTC derivatives are the global custodians – HSBC, Standard Chartered, Deutsche Bank and JP Morgan – who must report transactions daily to BI. However, it will be vital for the authorities to implement rules coherently, while exchanges will need to expand infrastructure for physical delivery.