Indonesia: CPSS-IOSCO Recommendations for Securities Settlement Systems
The Equity and Corporate Bonds Securities Settlement Systems

This paper discusses findings of the joint IMF–World Bank Indonesia Financial Sector Assessment Program (FSAP) undertaken during 2009– 10. The assessment was conducted on processes and functions, as opposed to institutions and with the cooperation of the Bapepam-LK, the Bank Indonesia. It was found that the legal framework governing the clearing and settlement operations of the equity and corporate bond market supports some, but not all, of the key elements of the clearing and settlement process.

Abstract

This paper discusses findings of the joint IMF–World Bank Indonesia Financial Sector Assessment Program (FSAP) undertaken during 2009– 10. The assessment was conducted on processes and functions, as opposed to institutions and with the cooperation of the Bapepam-LK, the Bank Indonesia. It was found that the legal framework governing the clearing and settlement operations of the equity and corporate bond market supports some, but not all, of the key elements of the clearing and settlement process.

I. Summary, Key Findings, and Recommendations

Introduction

1. This assessment forms part of the joint International Monetary Fund (IMF) -World Bank Indonesia Financial Sector Assessment Program (FSAP) which is being undertaken during 2009-2010. The assessment, which covers the private sector equity and corporate bonds securities system’s observance of the CPSS/IOSCO Recommendations for Securities Settlement Systems, was conducted during an ad hoc mission (12–19 December 2009). The assessment focuses on two types of trades. First the clearing and settlement process is assessed as regards equity transactions traded on the stock exchange IDX, cleared through the KPEI clearing system (e-CLEARS) and settled through the KSEI settlement system (C-BEST). In addition, the assessment focuses on corporate bond transactions, which are traded outside the exchange and settled through the KSEI settlement system (C-BEST).

2. The assessment was conducted on processes and functions as opposed to institutions. Given that the corporate bonds are mostly traded over the counter, the processes relating to trades outside KSEI were also examined. Also, the cash settlement arrangements with four payment banks have been analysed.

3. The assessment was conducted with the cooperation of the Bapepam-LK, the Bank Indonesia and benefited from discussions held with participants in the equity and corporate bond securities settlement market. The assessment was undertaken by Froukelien Wendt, Senior Policy Advisor of the Oversight Department of De Nederlandsche Bank on request of the World Bank. The assessment was drafted in close cooperation with the assessors 1 of the Bank Indonesia Scripless Securities Settlement System to ensure consistency between the assessments of the two Securities Settlement Systems in Indonesia.

Information and methodology used for assessment

4. The sources of information gathered during the course of this assessment included interviews held with relevant officials from the Bapepam-LK, Bank Indonesia (BI), the Stock Exchange, KPEI, KSEI, a securities company, and three custodian banks of which two are also “payment” banks. Several documents were provided by the authorities prior to and during the mission, including a detailed self assessment of the equity and corporate bond securities settlement systems. Other sources of information were (i) information posted on the websites of Bapepam-LK, IDX, KPEI and KSEI, (ii) the Capital Market Law, (iii) Government Regulation No. 45 (iv) Bapepam-LK Regulations, (v) Rule book of IDX, (vi) Rule Book of KPEI, (vii) Rule Book of KSEI, and (viii) the Bankruptcy Law.

5. The tools used to assist and guide the assessor in achieving the objectives of this assessment were the IOSCO-CPSS publications “Recommendations for Securities Settlement Systems” and “Assessment Methodology for Recommendations for Securities Settlement Systems” and the Bank-Fund “Guidance for Writing Detailed Assessments for Reports on Observance of Standards and Codes”.

6. The assessor wishes to express special appreciation to the Bapepam-LK, for their dedicated cooperation and support. In addition, the assessor wishes to thank IDX, KPEI, KSEI and the banking industry representatives and securities market participants for their cooperation and willingness to meet with the assessor at the requested times.

Institutional and market structure—overview

7. The regulatory responsibility for the trading, clearing and settlement of equities and corporate bonds in Indonesia lies with the Capital Market Supervisory Agency, hereinafter referred to as Bapepam-LK. Bapepam-LK is responsible for guidance, regulation and supervision of the Indonesian capital market, including trading, clearing and settlement of securities in the secondary market and the various activities of the securities companies and custodian banks. Among other functions, Bapepam-LK also has the authority to grant business licenses to securities exchanges, clearing guarantee institutions and central securities depositories. Bapepam-LK reports and is responsible to the Minister of Finance of The Republic of Indonesia.

8. Three Self Regulatory Organizations (SROs) are responsible for the organization of the trading, clearing and settlement of equities and corporate bonds in the capital market of Indonesia. The three SROs are (i) the Stock Exchange (IDX), which has to provide rules, systems and facilities for trading securities, and must supervise its members’ activities; (ii) the Clearing Guarantee Institution (KPEI), which is the central counterparty (CCP) that clears and guarantees the settlement of securities exchange transactions and must provide rules for that purpose; and (iii) the Central Securities Depository (KSEI), which acts as a central custodian for custodian banks, securities companies and others, and must provide rules for that purpose (see figure 1).

9. The Capital Market Law of 1995 provides Bapepam-LK and the SROs with the power to exercise their regulatory and self regulatory responsibilities and clarifies the authority and responsibilities of all participants in the capital market. Other relevant elements of the capital market legal framework are the Indonesian Civil Code, Government Regulation No. 45, Bapepam-LK Regulations, the Rules of IDX, KPEI and KSEI, the contracts between the SROs and their participants, and the Bankruptcy Law.

10. The market participants in the equity and corporate bond market are issuers, securities companies, custodian banks, registrars and investors. As at end of December 2009, KSEI counted 489 issuers, 130 securities companies, 22 custodian banks, 10 registrars and 386.436 sub accounts. From the securities companies, 120 are exchange and clearing member, of which 114 are active. In the current structure all exchange members are clearing members.

11. A range of securities are tradable on the stock exchange and these include stocks, exchange traded funds (ETFs), corporate bonds, government bonds, stock options index futures and asset backed securities. The securities are traded in one of the segments of the Stock Exchange, being (i) regular market, where trading is conducted using an electronic order book and settlement taking place on T+3; (ii) cash market, with trading being conducted in the morning session using continuous auctions and settlement taking place on T+0; (iii) immediate market, which is currently closed and (iv) negotiated market where trading is conducted using advertising screens and where settlement cycles are negotiable and may be longer than T+3. Trades concluded in the negotiated market segment are not netted, but cleared trade by trade. In value terms, the total turnover of the stock exchange is on average IDR 4.49 trillion per day while that of corporate bonds is on average IDR 161 billion per day. As at end of December 2009, the equity market capitalization amounted to IDR 2,019.38 trillion and the corporate bonds outstanding amount was IDR 88.33 trillion. In practice, stock exchange turnover comes mainly from equity trades. Stock exchange volumes for corporate bonds and government bonds are low, since market participants prefer to trade these bonds over the counter (OTC). Stock exchange volumes for ETFs, stock options and index futures are close to zero. All securities issued and traded in the Stock Exchange after the introduction of the scripless system in 2000 are held in dematerialized form. Stocks which are still held in physical form cannot be traded on the exchange.

12. OTC trades are bilaterally concluded between market participants and settled by KSEI. The reporting of OTC trades is done through the Beneficiary of Securities Transaction Report which is generated by a computer based system provided by IDX. The central registry and settlement for corporate bonds is handled through KSEI with settlement of trades taking place two days after trading (T+2). All bonds issued after the introduction of the scripless system in 2000 are held in dematerialized form.

13. Cash settlement for equities and corporate bonds takes place in the cash accounts of one of the four “payment” banks. Every broker is required to open a cash account with one of the payment banks (settlement banks) in order to facilitate settlement. The four settlement banks are Bank Mandiri, BCA, Bank CIMB Niaga and Bank Permata. In addition, securities accounts in the C-BEST system of KSEI reflect not only the securities of a specific account holder, but also mirror the cash accounts of that account holder at the payment banks for settlement purposes. KSEI has developed a settlement mechanism in which the securities and cash legs are transferred simultaneously followed by reconciliation within the cash accounts (KSEI’s Nostro Account) in the payment banks. Six times a day (09:00, 10:30, 11:30, 13:30, 14:20, and 15:10) the accounts of the payment banks are realigned using the RTGS system of Bank Indonesia (BI-RTGS). For government bonds traded on the stock exchange and OTC between KSEI’s participants, cash and securities settlement is conducted in KSEI. For OTC trading in government bonds between KSEI’s participant and a sub registry member of BI, the securities transfer is directly effected in the BI-SSSS system and cash settlement directly effected in the BI-RTGS system. The volumes of stock exchange traded government bonds are however very low. The possibility of linking the KSEI system to the BI-RTGS system for equity and corporate bonds is under discussion.

Figure 1.
Figure 1.

Market structure for government securities, equities and corporate bonds

Citation: IMF Staff Country Reports 2012, 186; 10.5089/9781475504927.002.A001

Main findings

Legal framework

14. The legal framework governing the clearing and the settlement operations of the equity and corporate bond market supports some, but not all, of the key elements of the clearing and settlement process. Three key concepts are not appropriately addressed in the legal framework, which are netting, finality and delivery-versus-payment (DVP). Finality of settlement is not covered directly in the legal framework nor is it specified when a trade is considered to be irrevocable and unconditional. DVP is not defined in the Rules of KSEI for all types of transactions and the legal framework does not provide guidance to the cash settlement arrangements within payment banks. It is recommended that the legal framework includes these concepts, in line with international definitions.

Pre-settlement risk

15. The settlement cycle of the stock exchange segment ‘negotiated market’ has no standardized settlement process, so settlement can take place later than T+3, if participants agree. The segment is mainly used for block trades. In 2009, 17% of the total value of transactions were concluded in the negotiated market. Serious analysis should be devoted to making T+3 the settlement standard for all stock exchange transactions.

16. KPEI, being the CCP for all stock exchange trades, broadly observes the requirements for CCPs. It has addressed legal risk, financial risk and operational risk in its rules, financial and operational framework. Nevertheless, it is recommended that the CCP further improves its access criteria, financial risk methods and operational procedures. With regard to legal risk, the CCP as part of the capital market will benefit from specific legal requirements for netting, finality and DVP. On access criteria, the risk profile of the CCP will improve if only the largest, best capitalized securities companies are clearing members of the CCP. Currently, all stock exchange members are clearing members. Since 2002, four securities companies have defaulted.

17. The financial risk calculations of the CCP may benefit from the use of more advanced models, with parameters based on historic price movements and historic volatility to calculate margin, taking into account the characteristics of different types of securities. KPEI should introduce back tests for its margin model as well as regular tests to check the adequacy of all its resources in case of the default of the clearing member with the largest exposure in extreme market circumstances. This will provide guidance on the appropriate size of the guarantee fund as well. Furthermore, a cap needs to be introduced for the replenishment of the guarantee fund by clearing members, in case of a loss which cannot be covered by the existing guarantee fund. Currently, no such cap exists, so clearing members are exposed to significant risks that they themselves cannot control.

18. Finally, the operational system would need procedures to avoid data loss. We encourage that consideration be given to a larger distance between the primary and secondary site.

Settlement risk

19. Cash settlement takes place in the accounts of four dedicated “payment” banks. These payment banks have to fulfill a range of requirements from KSEI to ensure that the cash settlement poses little or no credit or liquidity risk to its members. Settlement volumes are sufficiently spread over the different payment banks. Nevertheless, it is recommended to seriously analyze the introduction of cash settlement in the BI-RTGS system, since this will reduce the risk of the capital market as a whole. The use of settlement banks means that all market participants are exposed to settlement bank risk, which is the risk that one of the payment banks may fail. This can be an operational failure; currently, an operational outage of one of the payment banks affects all other payment banks. It can also be a financial failure, where market participants may be confronted with liquidity problems. The surviving payment banks and/or KSEI are exposed to the failing payment bank, in case it is unable to deliver cash during the realignment process. In a similar situation that took place on 12 November 2009, where the settlement system was only able to settle securities at 9 pm and the RTGS closed before 9 pm, payment banks are exposed to each other, either directly or indirectly via KSEI, since realignment of the end of day cash positions was delayed until the next morning. As long as the payment bank settlement system remains in place, it is recommended that KSEI and the RTGS system harmonize their opening hours in case of extreme situations like the one highlighted above.

20. KSEI has developed a settlement process in which securities and cash transfers occur simultaneously in the C-BEST system. As such the technical framework ensures DVP. However, since KSEI has no real cash account in C-BEST, the C-BEST accounts only mirror the cash accounts at the payment banks. The legal framework does not provide enough comfort for the cash transfer in C-BEST as being a final transfer. This comfort is necessary, since a time lag exists between the securities transfer in C-BEST and the real cash transfer in the payment banks to the participant account and from the participant account to its own or client accounts. In the absence of a clear definition of finality it is possible that the final delivery of securities precedes the final transfer of cash. This may cause systemic risk to the system, for example, in the case of a bankruptcy of one of the payment banks.

Other issues

21. Bapepam-LK has regulatory responsibilities over BI-SSSS, as well as over IDX, KPEI and KSEI, whereas BI has an oversight responsibility over BI-SSSS, a system which it owns. It is recommended to review this structure in such a way that all systems, especially the two CSDs are regulated in a comparable way. BI should also include KSEI and KPEI into their oversight scope as systems relevant for the financial stability of Indonesia. The latter suggests that BI should give consideration to fulfilling the role of lender of last resort for the CCP, in case this is needed, taking into account the risk of moral hazard. Bapepam-LK and BI may consider underlining their intentions to exercise their respective responsibilities in a cooperative way, for example in a covenant or a memorandum of understanding.

Table 1

Summary Observance of the CPSS-IOSCO Recommendations for Securities Settlement Systems-ROSCs

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Recommended Action Plan and Authorities’ Response

Table 2

Recommended action plan to improve observance of the RSSS

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Authorities’ Reponses

22. Bapepam-LK disagreed with the assessment that netting, finality and delivery versus payment were not adequately supported by the current legal framework and made reference to various sections of the law, rules and regulations which the assessor had examined. It should be noted that mere reference to a process does not give it legal basis. In the absence of explicit provisions therefore the assessment on RSSS 1 (Legal framework) could not be varied.

23. With regard to settlement cycles (RSSS 3), Bapepam-LK believes that the current arrangements comply with best practice even though the T+3 settlement cycle is not met for the negotiated market. Authorities advised that some of the concerns highlighted in the report with regard to RSSS 4, are in the process of being addressed and these include review of access criteria, enhancement of risk management arrangements and increasing the distance between the primary and the secondary site.

24. Authorities advised that KSEI is in the process of developing straight through process (STP) capabilities within C-BEST in order to increase efficiency by replacing some manual processes currently in place. Also, harmonization of operating hours between the RTGS system and KSEI is being considered.

25. On regulation and oversight, (RSSS 18) authorities noted that KSEI, as a sub-registry for government securities, was already under the BI supervision. BI and Bapepam-LK were in discussion on the possibility of merging the two depositories and establishing a Memorandum of Understanding to enhance cooperation between the two regulatory bodies.

II. Detailed Assessment

Table 3

Summary Observance of the CPSS-IOSCO Recommendations for Securities Settlement Systems

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Aggregate: Observed (O) 10–, Broadly observed (BO) 4–, Partly observed (PO) 3–, Not observed (NO) 0–, Not applicable (N/A)2–

Table 4

Detailed Assessment of Observance of the CPSS-IOSCO Recommendations for Securities Settlement Systems

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1

Alice Zanza and Bruce Summers.

Indonesia: CPSS-IOSCO Recommendations for Securities Settlement Systems: The Equity and Corporate Bonds Securities Settlement Systems
Author: International Monetary Fund