Growing tall, growing wide: Authorities steer the market to capitalise on favourable conditions

An upgrade of Indonesia’s sovereign credit rating by two of the three international ratings agencies in early 2012 was a watershed in the recognition of the country’s currently healthy investment outlook. Foreign investors, who are already the dominant players in the nation’s equity market and are growing in the bond segment, see significant potential to realise capital gains in Indonesia’s increasingly liberalised market structure.

Strong domestic consumption and economic growth, resilient corporate earnings and an expanding supply of new securities are trumping concerns over corporate governance and political risk. Although the Indonesian Stock Exchange’s (IDX) performance has been outshined by neighbours like Thailand and the Philippines, whose indices grew 36.3% and 33%, respectively over the course of 2012, IDX’s steady growth of 12.94% in the same period shows its relative insulation from global headwinds.

While 2012 witnessed uneven performance in both equity and bond markets, with a rally starting only in September, traders see significant prospects for growth, particularly for the second half of 2013. In a world of stagnating growth, Indonesia stands out as one of the most promising emerging economies, reflected by the strong positioning of foreign bond investors.

The authorities will have to carefully negotiate the transition to a new regulator in 2013 to avoid disrupting market sentiment, but the integration of oversight over all financial institutions will bring a more comprehensive approach to market development. With still-shallow capital markets, the regulator’s aim will be to promote new, sophisticated investment instruments and greater participation by Indonesian, particularly retail, investors.

PRICING EQUITIES: Although IDX’s market capitalisation has grown significantly since its creation in 2007 by merging the Jakarta and Surabaya exchanges, its size remains a poor reflection of the wider economy. The market’s value more than doubled from Rp1988.33trn ($198.8bn) in 2007 to Rp4300trn ($430bn) by the end of 2012, with the largest gains recorded in 2010 when capitalisation grew 62.1% in a year. Yet the combined value of the 462 listed companies by December that year accounted for a mere 45.7% of GDP, the lowest share in the region – compared to Singapore’s 217%, Malaysia’s 152.7%, Thailand’s 91.7% or the Philippines’ 92.5%. However, the exchange’s management aims to double the equity market’s total size by 2015 to over $750bn to become the largest stock exchange in the ASEAN region by encouraging a new supply of shares and greater liquidity through new instruments, and by prolonging trading hours from six hours to seven in 2013.

While the number of listings has grown in recent years, the average size of floats remains relatively small, between Rp300bn ($30m) and Rp1trn ($100m), despite fiscal incentives (see analysis).

TRADE CLIMATE: Trade on the exchange has grown in value from $103.676bn in 2010 to $109.191bn in 2011, according to the World Federation of Exchanges. It remains liquidity-driven by foreign investors, who account for approximately two-thirds of trading on the exchange, with only 363,000 domestic investors registered.

“Domestic participation in the equity market is still very low, with less than 1% of the population investing,” Destry Damayanti, chief economist at Bank Mandiri, told OBG.

Domestic investing remains dominated by institutional investors like banks, insurance companies and mutual fund managers, who tend to adopt more of a buy-and-hold strategy favouring dividends than foreign investors driven by capital gains considerations. The majority of individual investors in the capital markets do so indirectly, via mutual funds or the public pension scheme (Jamsostek), with only approximately 100,000-200,000 active traders on the exchange. A Standard Chartered survey of high-net-worth Indonesians in April 2012 found a significant preference for gold, real estate and high-interest savings rather than equities or bonds, higher than the regional average.

Although Indonesian stocks account for only some 3% of the MSCI Emerging Markets Index, foreign investors have been the key drivers of traditionally volatile trading, focusing particularly on blue-chip stocks, which account for approximately 80% of market capitalisation and 75% of annual turnover, according to IDX. Yet only 30 blue-chip stocks are actively traded. Many smaller share issues remain majority family-owned with an average free float of 20%. Market sentiment has therefore remained heavily influenced by currency fluctuations and macro-economic considerations. “Investors were quite worried about the widening current account deficit and falling currency until September, when the market started to rebound,” Wisnu Wardana, economist at Bank CIMB Niaga, told OBG.

RELATIVE PERFORMANCE: Foreign investment banks see the presence of a large number of commodity-linked stocks as the main reason for IDX’s relative underperformance in 2012. Although capital inflows into the equity market reversed from April to June 2012 on the back of macroeconomic fears, the market has rallied since September amid an easing current account deficit and recognition of the significant economic driver of domestic consumption. A new round of quantitative easing in the US and unconventional monetary policies in the EU and Japan in September that year had an immediate effect on capital inflows, which surged from a net outflow of $540m in August 2012 to a net inflow of $1.3bn in September, according to data from UNESCAP. Over the last decade, however, Indonesia has been the most consistent performer in Asia, outperforming eight of the Asia Pacific markets (excluding Japan), according to American bank JP Morgan, which sees IDX’s performance lag in 2012 as a result of other markets’ recovery from bear runs in the second half of 2011.

“Indonesian equities have underperformed relative to the region in 2012 because they over-performed for the past two years,” Anton Gunawan, chief economist at Bank Danamon, told OBG.

As commodity prices globally dropped in the second quarter of 2012, shares of firms operating in plantations and natural resources – particularly palm oil and coal – have fallen the most. The value of shares in leading listed coal producers Adaro and Indo Tambangraya (the only coal producer still included amongst the index’s top 20 by late 2012) dropped 22% and 24%, respectively, in the year to December 2012. Meanwhile, stocks linked to domestic consumption led growth in 2012, with the most notable sector increases in the year through October being property at 39.7% growth, infrastructure (32.7%), trade and services (26.3%), consumer goods (22.2%), light manufacturing (19.7%) and finance (11.6%), according to Mandiri. Heavy equipment producers and vendors, while affected by the loss of business linked to plantations and mining, have not dropped sharply, given sustained demand from the construction sector. Trade in bank shares yielded lower valuation rises despite a recovery with healthy second quarter results in July 2012. A traditional driver of stock value, however, banks remain a favourite pick of investors with a new bank index (Infobank) launched in mid-November 2012, covering the 15 largest bank capitalisations.

HIGH VALUATIONS: Another factor influencing investor appetite is the perception that significant price gains have already been realised in the past two years, causing price-to-equity ratios to appear expensive relative to the region.

“Indonesian equities underperformed in 2012 because the currency weakened and valuations seemed comparatively expensive,” Fauzi Ichsan, the managing director and senior economist at Standard Chartered Bank, told OBG.

Price-to-equity ratios have risen from approximately 13 times in February 2012 to approximately 14.7 times by the end of the third quarter of 2012, higher than Thailand’s 13.6 times, Singapore’s 14.1 and Hong Kong’s 11, but lower than the Philippines’ 16.2 and Malaysia’s 15.5. However, average corporate earnings growth reached above 28% in 2011 and are widely forecast at between 18% and 20% for 2012, driven by surging fixed investment, consumer spending and bank lending, representing significant stored value that could justify further growth.

“Stock valuations do not seem that high if you factor in the rapid corporate earnings growth we’ve witnessed in recent years,” Damayanti said.

Indeed, earnings-per-share (EPS) growth of 15% in Indonesia has outpaced all neighbours except Thailand (with 24%) in 2012, and stands much higher than Malaysia’s 0.9%, the Philippines’ 5.9% and Singapore’s EPS contraction of 13%. One of the region’s largest independent brokers, CLSA, has forecast return on equity of 25% in 2012-13, outperforming Thailand and China.

OVERWEIGHT STATE BONDS: While equities underperformed in 2012, bonds were the darling of foreign investors despite a slowdown in the second quarter of 2012. Trading in government bonds has grown significantly since the government’s Debt Management Bureau resumed issuance in 2002. With Rp883.5trn ($88.35bn) in outstanding local currency government bonds in the third quarter of 2012, sovereign securities far outweigh limited corporate bonds, whose total value reached Rp171.3trn ($17.13bn) in the third quarter, or just 16.3% of the bond market, according to the Asian Development Bank (ADB). Since 2005 the government has sought to rebalance its deficit financing towards domestic sources. The ratio of domestic to foreign debt rose from 45% to 54% between 2005 and 2010, according to Bank for International Settlements (BIS) data, despite issuance of foreign-denominated debt in 2005, 2008, 2011 and 2012. Meanwhile, debt tenors have been prolonged, with over 90% of sovereign domestic debt held in medium- to long-term maturities, with the longest-maturity bonds in emerging East Asia, according to ADB.

The government has remained the key issuer in 2012 with Rp159.1trn ($15.9bn) in net public debt financing in the revised 2012 budget (up from Rp134.6trn, $13.46bn in the original budget) according to local risk ratings agency, Pefindo, and has announced plans to raise Rp177.3trn ($17.7bn) in a mix of domestic and global bonds in 2013, primarily to finance higher investment in infrastructure. With government-debt-to-GDP ratio narrowing from 24.4% in 2011 to 23.9% in 2012, according to the IMF, there is still significant scope for issuance.

Foreign investors’ holdings of government bonds have hovered around the 30% mark in recent years, with a peak of 36% in July 2011, and then reaching 31%, or a record of Rp258.6trn ($25.86bn) in November 2012, around the same level as holdings in Malaysia, but double Thailand’s 15%, according to ADB. Domestic institutional investors like insurance firms tend to hold bonds to maturity, while mutual funds’ holdings of government debt remain low.

BALANCING CONCERNS: Indonesia’s sovereign upgrade to investment grade by Fitch and Moody’s in December 2011 and January 2012, respectively, was a significant catalyst for foreign investment in the medium term. The initial inflow of capital to Indonesia’s bond market was muted from April 2012 onwards by concerns over a falling currency and a widening current account deficit, before recovering over the summer.

“The foreign bond sell-off from April to June 2012 was due to a growing current account deficit, a falling currency and a perception that the central bank was considering capital controls, a perception that has been rectified since then,” Gunawan said.

Yet global real money managers tend to follow global emerging market benchmark indices, which have been raising exposure to Indonesian bonds. Two of the leading global bond index managers, HSBC and JP Morgan, allocate 12% and 10% of global bond exposure to Indonesia, respectively. In light of the fact that Indonesia’s local currency government bond yields are among the highest in the world, investors tend to allocate at least this amount out of a fear of underperformces in the global indices.

LOCAL INTEREST: Significant in driving foreign demand for government bonds over other local currency assets was imposition of a minimum holding period for central bank certificates (SBIs), an instrument for soaking up liquidity in the domestic market, in 2011. “The enactment of the six-month holding period for SBIs encouraged a shift by foreign investors to rupiah-denominated government bonds, of which they hold between 28% and 31%,” Bimo Epyanto, senior economic analyst at Bank Indonesia, the central bank, told OBG.

Concerned over the use of short-dated SBIs as an instrument to speculate on the local currency, Bank Indonesia has tightened issuance radically. The rate of issuance of SBIs has dropped dramatically since 2010, with the stock falling from $38bn in April 2010 to $7bn in the third quarter of 2012.

Over the longer run, significant capital inflows into the bond market and a relatively flat yield curve have pushed down yields on government bonds closer to the central bank’s benchmark interest rate of 5.75%. Yet growing exposure to international investors is a double-edged sword. “One of our challenges is in deepening the domestic financial markets,” Luky Alfirman, head of the Ministry of Finance’s centre for macroeconomic policy, told OBG. “Much of our sovereign debt is held by foreign investors, which is a good sign of confidence, but in addition it exposes us to volatility.”

BOND BIND: While local governments led by DKI Jakarta have entertained plans for sub-national bond issues, progress slowed following election of a new governor in the capital opposed to such plans. A 2008 law allows local governments to issue bonds earmarked for specific cash-flow generating projects, subject to Debt Management Office approval, and these were used as financing sources used during the Suharto years. Other governments like Bandung, South Sulawesi and North Sumatra are unlikely to pursue plans without a pioneer issue, however. “While we have seen interest from several local governments in issuing domestic bonds, they are all waiting for a pioneer issue by DKI Jakarta,” Salyadi Saputra, ratings director at Pefindo, told OBG. “But several governments would have to establish public Debt Management Offices and gain authorisation from the Ministry of Finance for bond issues, which must be linked to specific projects.” However, the Ministry of Finance, concerned over policy coordination between the three tiers of government, has not proved to be the most enthusiastic supporter of the scheme. A more likely avenue under consideration is a two-step loans scheme whereby the central government floats bonds that are used to issue loans to local authorities.

CORPORATE ISSUES: Although still marginal, corporate bond issues have grown fastest in 2012, with outstanding government bonds falling from 11.8% of GDP to 10.9% in the year to the third quarter of 2012, while corporate bonds rose from 1.9% to 2.1% in the same period, according to ADB. Enticed by low interest rates, significant market demand and the establishment of a risk-free government yield curve, traditional corporate bond issuers like state-owned enterprises, banks and multi-finance firms have been joined by new issuers recently, most notably property and plantations companies.

Scared away from launching initial public offerings (IPO) in the first half of 2012, corporates have rushed to the bond market to lock in low interest rates. “We have seen a new record high in corporate bond issues in 2012, mainly driven by issuers linked to the domestic consumption story and finance companies in particular,” Saputra told OBG. “As long as we have low interest rates and strong domestic consumption, we are likely to continue seeing significant activity in primary issuance.”

RECORD ISSUES: Corporate bond issues reached a record high of over Rp60trn ($6bn) in 2012, up from Rp45trn ($4.5bn) the year before, according to Pefindo. These have lower average maturities than sovereign bonds, at between three and five years with only a few bonds of seven- to 10-year maturities, and are of smaller sizes, around the Rp1trn ($100m) mark. Traditional issuers like Adira Dinamika Multi Finance, which raised Rp1.6trn ($160m) in one- to five-year bonds with yields of 6.5% to 8.25% in September, and Bank CIMB Niaga, which raised Rp2trn ($200m) in three- to five-year bonds yielding 7.35% to 7.75% in October, have been joined by the likes of property developer Bumi Serpong Damai, which raised some Rp1trn ($100m) in three- to seven-year bonds yielding 8% to 9.5% in July, and plantations operator Sinar Mas Agro Resources & Technology, which issued Rp1trn ($100m) in five- and seven-year bonds yielding 9% to 9.25% in June.

Meanwhile, an increasing number of banks, such as the Bank Internasional Indonesia and Bank Artha Graha, have been issuing bonds in order to bolster their capital adequacy ratios.

Despite a growing rate of issuance, secondary trading in corporate bonds, via the Indonesian Bond Pricing Agency platform, remains virtually non-existent. Although foreign investors have grown their holdings of corporate bonds, reaching 11% of total corporate bonds by September 2012, liquidity remains an issue. “Liquidity is still an issue for corporate bonds given the small size of issues and the prevalent buy-to-hold strategy of domestic investors,” Damayanti said. “Still, foreign demand is growing, albeit from a low base.” The Ministry of Finance raised the prospect of tax incentives for corporate bond issues in late 2012, modelled on Turkey and the US’s tax breaks for municipal bonds, in a bid to entice larger issuers to the market.

INTEGRATED APPROACH: While both main markets have grown steadily in recent years, authorities are keen to deepen the markets by encouraging more issues, enhancing transparency and governance standards, bolstering the regulator’s powers and attracting more individual investors. Working with the ADB since 2009 and under a law establishing a new regulator for all financial services industries in October 2011, 2013 is set to witness significant regulatory upheaval. The ADB agreed to extend a $300m loan to this effect in September 2012, aiming to expand the assets of the non-bank financial sector to 65% of GDP by 2014, up from 60% in 2010, raise the level of domestic ownership of government securities from 70% to 73%, and develop the capacity of the new independent regulator, the Indonesia Financial Services Authority (Otoritas Jasa Keuangan, OJK). The OJK replaced the previous regulator, the Capital Market and Financial Institution Supervisory Agency (Bapepam-LK) under the Ministry of Finance, in January 2013, and will assume bank supervision functions from Bank Indonesia in 2014. The shift is expected to cost $24m in 2012 alone according to the ADB. While it is expected to pursue existing policies covering the capital markets, the most significant initial impact will be to detach the supervisory functions from government control, a significant development given the state’s stakes in a number of blue-chip stocks. The regulator’s four-year master plan to 2014 aims to create more hedging products, encourage more secondary trading in corporate bonds, facilitate access to the markets for individual investors, and enhance transparency and governance amid allegations of market manipulation dating back to the Krakatau steel IPO in 2010. Clearing and settlement of trades is done within three days of trade (T+3), involving the central depository agency (Kustodian Sentral Efek Indonesia, KSEI) and the clearing agency ( Kliring Penjaminan Efek Indonesia, KPEI). The regulator established a central repository for a new system of Single Investor ID cards based on the AKS es cards launched in 2009, with nearly 300,000 registered members by year-end 2011, to allow for more efficient tracking of trade settlements and to reduce the scope for counter-party risk.

While reform of the capital markets laws was still under way in late 2012, granting immunity to the supervisor and enhanced resolution powers, Bapepam-LK is moving towards convergence with international accounting standards. The regulator’s investigation into possible corporate governance abuses in listed subsidiaries of the London-listed Bumi, prompted by infighting between major shareholders of the Bakrie and Rothschild families, has attracted yet more attention to strengthening regulatory enforcement powers.

A number of reforms have already been passed, including stricter rules on annual reporting, which require disclosure of details on principal shareholders with over 20% stake up to the individual level. The regulator additionally plans to create an investor protection fund to allow investors to monitor their own portfolios and insure compensation in the event of failure of a market participant. An IT glitch on August 27, 2012 when only a few traders were allowed access to IDX’s servers temporarily, reminded market participants of the need for technology upgrades as well as regulatory reforms.

ASEAN ASSET CLASS: The regulator has joined the effort to integrate trading platforms across ASEAN through electronic linkages, a system launched in autumn of 2012 with initial linkage between the Thai, Malaysian and Singaporean exchanges, with a combined 2200 listed companies and over $1.4trn in market capitalisation, accounting for approximately 67% of the region’s total. The linkage, which allows brokers in one market to place orders on linked exchanges directly from their home platform, is expected to increase liquidity on the participating exchanges, improve arbitraging opportunities and allow the exchanges to jointly market themselves as a single ASEAN asset class. With a more balanced offering of blue-chip stocks, the linkage of the region’s seven exchanges would have a market capitalisation of over $2trn and over 3600 listed stocks.

With trades regulated by the relevant exchange’s regulator, the level of regulatory reform required is less than for full integration, but Indonesian brokers will need to be sensitised to linked exchanges’ regulations, and cross-border investment marketing will need to be launched. Although Indonesia is only expected to join in the next few years, Indonesian blue-chip listed corporates are joining an ASEAN road show alongside regional peers. ASEAN markets partnered with London-based FTSE to establish an ASEAN index weekly report in 2012 based on a set of ASEAN instrument codes by financial information provider Thomson Reuters.

While it remains unclear whether participating exchanges will indeed attract greater investment from neighbouring countries, with each exchange expecting significant inflows in the medium term, the creation of a regional asset class will further raise the profile of blue-chip stocks amongst the global investment community.

FRAGMENTED INTERMEDIATION: Such linkages could prove a significant business opportunity for the large number of brokers competing aggressively on the domestic markets and could benefit smaller brokers seeking growth opportunities in particular. The market remains fragmented with over 120 brokers despite introduction of a Rp25bn ($2.5m) capital requirement for brokers a decade ago. In line with growing appetite from foreign investors, Indonesia has witnessed an inflow of new brokerages. “We have seen an influx of new foreign-linked brokerages in the last two years,” Wardana said. “As long as the market remains bullish, we are unlikely to see any consolidation.”

Foreign investors are allowed to hold up to 85% of an unlisted securities firm and 99% of a listed one. State-owned brokers Danareksa and Bahana Securities are major players, as is the largest independent firm, Trimegah Securities, and bank affiliates that were led by Bank Mandiri’s and Bank Negara Indonesia’s subsidiaries. Large foreign brokers like Credit Suisse and Deutsche Bank handle primarily foreign institutional business. Yet the entrance of online brokers like eTrading Securities, 19.9% held by South Korea’s Daewoo Securities, and Indo Premier Securities has disrupted the market as they have aggressively grown their share of retail broking in particular. While brokers like CIMB, Maybank Kim Eng and Philip Securities have expanded their online broking, they have suffered pressure from purely online brokers with lower costs.

HEAD-TO-HEAD: Driven primarily by institutional investors and competition from online brokers, the rivalry between brokerages has been intense, with average commissions between 0.15% and 0.25%, razor thin by regional standards. The Indonesian Securities Association was considering in late 2012 a minimum commission structure of at least 0.176% (including fees and taxes) to sanitise the playing field somewhat. Despite the shift towards online brokering, online actors are still required to interview their clients under “know your client” rules. While IDX has been establishing market information centres beyond key the locations of Jakarta and Surabaya to encourage more retail participation and prompt brokerages to move beyond the capital, only bank-affiliated brokerages have the ability to expand their reach by leveraging existing branch networks, given the intense price competition.

MUTUAL FUNDS: Domestic investors have flocked to the mutual fund industry as an aggregator for trades rather than participating themselves, with the number of registered individual investors on IDX remaining relatively flat in recent years at approximately 0.2% of the population.

Since the inception of Danareksa’s first mutual fund in the mid-1990s, the industry has grown significantly, after a hiatus during the Asian financial crisis. Mutual funds’ assets have grown consistently in recent years, from Rp114trn ($11.4bn) in 2009 to Rp168.2trn ($16.8bn) by year-end 2011, of which 36% was placed in stocks, according to Bank Mandiri data. Despite this significant growth, and expectations of 20% annual growth in coming years, assets under management account for a mere 3% of GDP, pointing to significant growth potential, according to accountancy Ernst & Young.

Falling deposit interest rates have prompted depositors to seek alternative investment channels, while tighter restrictions on mutual fund investments following a sharp drop in their value in 2008, such as barring funds from investing in offshore instruments, has reassured a sceptical public.

The market of 84 mutual fund managers is dominated by foreign and state-owned asset managers, with Schroders holding a quarter of the market by the start of 2012, followed by insurer Manulife, BNP Paribas and Bank Mandiri, which together account for over half of assets under management. Schroders has dominated the equity fund segment, Danareksa has led in index funds, Mandiri has specialised in money market funds and Bahana has dominated the bond fund segment, while bank-affiliated fund managers like Mandiri and CIMB have led in Islamic mutual funds. Exchange-traded funds (ETFs), allowed since 2006, have not been so popular, however, with only two listed vehicles by 2012.

SHARIA COMPLIANCE: Spurred by a rapid growth in Islamic banking, albeit from a low base, sharia-compliant capital markets instruments have emerged over the past decade as a fast-growing segment. The first sharia-compliant investment product was launched in 2003, and the 2005 capital markets master plan set out a clear policy to develop sharia instruments from equities to bonds and mutual funds in a bid to attract Middle Eastern investors. The market for Islamic bonds, or sukuks, has grown by an average of 100% per year since 2006, according to ADB, reaching Rp57.4trn ($5.74bn) by 2010. By March 2012 the sukuk market accounted for 3.64% of the total bond market, according to Bapepam-LK, although it made up 10.53% of new issues. IDX’s Indonesia Sharia Stock Index joined the Jakarta Islamic Index in May 2011.

The Islamic council Majelis Ulama Indonesia (MUI) introduced new rules for sharia stocks in March 2011 to establish clear certification principles. The Debt Management Office launched the first three sovereign sukuks worth Rp7.34trn ($734m) dedicated to retail investors in February 2011. The ninth series of three-year retail sukuks worth Rp12.7trn ($1.3bn) was launched in September 2012.

In offshore sukuk issues Middle Eastern investors have proven the most eager source of demand: in a $1bn offshore sukuk float in November 2012 they accounted for 30% of total demand, followed by 23% from Asia, 20% from Indonesia, 15% from Europe and 12% from the US.

While the number of sharia mutual funds – diversified among mixed income, stocks, fixed income and protection funds – grew from 26 in 2007 to over 50 by 2011, with Rp588.43trn ($58.8bn) in funds by April 2012, demand for sukuks and other sharia instruments has far outstripped supply. BapepamLK data in July 2012 reflected a 20% average growth in corporate sukuk issuance compared to 40% growth in sharia banking assets. This under-supply has caused sukuk yields to drop significantly in 2012.

Underwriters have called for enactment of tax incentives for sukuk issuance, given the higher cost of structuring such issues, to promote growth in the number and size of floats.

However, the pace of issuance of both sovereign and corporate sukuks is projected to rise significantly in coming years. In 2012 the government announced its intention to invest over half of its public haj funds into new sovereign sukuks dedicated to infrastructure investment over the long term. The haj fund already withdrew some Rp7trn ($700m) of its existing Rp15.24trn ($1.5bn) in haj funds under management from bank deposits in the second quarter of 2012 to invest in an Indonesian Haj Funds Sukuk. The government has also successfully tapped the offshore sukuk markets, with yields tightening significantly in 2012 on the back of the sovereign credit rating upgrade.

TAPPING G3 CURRENCIES: Capitalising on its rating upgrade in early 2012, both government and corporates flocked in growing numbers to the offshore public debt markets. A total of 17% of the government’s $141bn in debt by November 2012 was floated offshore, according to the Debt Management Office. Raising some $10.3bn in the first three quarters of 2012 in bonds denominated in G3 currencies ($, euro and yen), 50% higher than the $6.7bn raised in 2011, according to data from Dealogic.

Indonesia’s lead in emerging market debt issuance is set to continue in 2013 according to Barclays, which expects the government to issue some $5bn to $6bn in a mix of sukuks and conventional offshore bonds during the course of the year. The biggest issues in 2012 came from the government’s float of $2bn in 10-year bonds and $1.75bn in 30-year bonds at a narrow 3.75% and 5.25%, respectively, in April and September, as well as from utilities firms like Pertamina, which sold two-tranche bonds totalling $2.5bn, half in 10-year bonds at 4.875% and half in 30-year bonds at 6%, in May. Corporates like the leading plantations operator, Golden Agri Resources (GAR), additionally looked to the offshore sukuk market, with GAR floating a RM1bn ($325.4m) sukuk in Malaysia in November 2012.

The government intends to broaden the mix of currencies in which it issues offshore debt in coming years to better hedge volatility amongst the world’s major currencies. In November 2012 it successfully returned to the Japanese bond market via private placement with a “Samurai” bond issue of ¥60bn ($50.4bn) in 10-year bonds priced at 1.13% coupon, with a particularly good reception from Japanese banks and insurers.

To handle an inflow of foreign currency due to export earnings from repatriation measures implemented from June 2012, the government is also planning to launch an onshore dollar-denominated bond in early 2013. While corporates have issued onshore dollar bonds in the past, they have been of smaller sizes than the planned float, announced at $250m in five- to 10-year bonds, with Medco Energy floating the last such bonds in a two-tranche issue worth $50m in October 2011. The aim is to diversify dollar instruments for domestic banks and corporates and reduce downward pressure on the rupiah evident throughout 2012. While the government works to diversify the onshore dollar offering, new hedging instruments are gradually developing on onshore futures markets.

DERIVATIVE CLASSES: A key plank of authorities’ ambition to deepen the onshore market lies in developing new products, particularly for hedging, in addition to existing equity and bond offerings. Although the Jakarta Futures Exchange (JFX) opened over a decade ago in 2000, growth in derivatives instruments has remained slow relative to the equity and bond markets. Joined by new competition since 2009 in the form of the Indonesia Commodity and Derivatives Exchange (ICDX), however, the number of contracts is growing. The two futures exchanges operate under a pre-funded trading system (T+0), reducing counter-party risk yet hampering growth in liquidity. But while ICDX operates its own clearing and settlement subsidiary, ISI Clear, JFX uses the same KPEI as IDX. JFX, owned by 29 futures firms, trades in commodities, indices and foreign exchange futures, although trade is dominated by commodities contracts such as gold and palm olein, and it recently introduced coffee and cocoa futures.

Trading on JFX only took off following the implementation of a new trading platform in 2010. Competition from ICDX, backed by 12 commodity firms since 2009, has centred on commodity contracts, with the new platform launching futures of crude palm oil, gold, palm olein and physical tin. Since July 2012, it has also traded 27 currency pair contracts for the main G7 currencies, the first exchange to receive approval for currency products – the most actively traded being gold. ICDX, open 24 hours a day with over 40 registered brokers, has been the most active of the two in introducing new products and plans to launch a tin futures and a rupiah-dollar futures contract in 2013.

CURRENCY TRADING: The scope for currency futures is significant, according to the exchange, given the discrepancy in currency trading interbank, which amounts to up to $500m a day, and offshore currency trades reaching $2bn daily. The central bank’s support came in the context of repatriation of export earnings onshore, with the new currency contracts an added means of hedging risk.

“The key objective is to shift over- the-counter derivatives trading to exchange-based trading, following recommendations from the G20 Financial Stability Board,” Megain Widjaja, chief executive officer of ICDX, told OBG.

The exchange furthermore seeks to create a regional rubber market with Malaysia and Thailand by the end of the first half of 2013, by standardising rubber contracts in dollars and harmonising regulations. Traders in physical commodities rather than financial institutions have dominated trading on the two exchanges, however, hampering the growth in liquidity – the number of participants on the two exchanges reached 87 futures brokers and 23 futures traders by the end of the first half of 2012.

While major foreign trading houses like Wilmar are registered members of ICDX, the level of direct buying through the exchange has remained low in the first year of trading. IDX reintroduced derivatives trading in equities in the first half of 2012, launching stock options and futures contracts on a new automated platform after having suspended trading in 2009 for upgrades.

Another option for hedging Indonesian risk was launched through Singapore in July 2012, when a new MSCI Indonesia Index Futures was created to track onshore stocks but denominated itself in dollars. The new platform will be a means for transferring derivatives on Indonesian assets from being traded over the counter to an exchange.

REGULATION: The two private onshore futures exchanges are regulated by the Ministry of Trade’s Supervisory Agency Commodity Future Trading (BAPPEBTI), which lifted restrictions on foreign investors in July 2012, allowing them to own up to 40% of any new commodity futures trading platform, paving the way for potential foreign takeover. Based on recommendations from the G20’s Financial Stability Board, BAPPEBTI enacted new rules in 2011 broadening the definition of commodities to interest rate, equity and foreign exchange derivatives, demutualising the derivatives exchanges to improve competitiveness and approving a new counter-party model for over-the-counter derivatives transactions, which must now be traded through an exchange or via a clearing house.

This regulatory reform broadened the scope of instruments allowed, including currency pairs. However, while all financial services regulators will be subsumed under the new OJK, the regulating body will remain an agency under the Ministry of Trade. “There needs to be harmonisation of regulatory oversight between OJK, Bank Indonesia and BAPPEBTI in order to promote greater participation in the commodity and derivatives markets,” Widjaja said.

Beyond commodities and currency futures, the process of securitisation has remained marginal thus far. State-owned mortgage lender BTN has launched four series of mortgage-backed bonds since 2009, packaging AAA-rated mortgages. While other banks like Mandiri and CIMB have expressed interest in issuing such asset-backed securities, the impetus for securitising assets like mortgages, credit card debt and auto loans is reduced by the high liquidity of leading Indonesian banks. “The process of asset securitisation has been very slow, with only a few mortgage-backed securities issued by BTN,” Pefindo’s Saputra told OBG. “While the double taxation issues have been resolved, issuers (mainly banks) do not need the new liquidity offered by securitisation, and investors have poor awareness and perception of such products.”

OUTLOOK: Although growth in both equities and bonds has been steady rather than spectacular in 2012, the market’s fundamentals appear strong by regional standards, with a steady flow of new listings in a portfolio of different sectors, a gradual development of new hedging products and a healthy domestic consumption engine that insulates the market from over-reliance on export industries such as commodities. The integration of regulatory functions under a single body in 2013, while initially disruptive, will foster a more integrated approach to developing Indonesia’s capital markets.

Nowhere is this more apparent than in the context of sharia-compliant instruments, where growth, while having been rapid, has not kept up with the demand from domestic Islamic financial institutions and foreign investors. Despite the political uncertainty that has arisen in the run-up to the upcoming elections in 2014, brokerages are forecasting a rally in equities during the second half of 2013 that will be more significant than that achieved in the fourth quarter of 2012. Inflows into the bond and equity markets are likely to be sustained, given the loose monetary policies in Western economies.