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Nanang Hendarsah

Director
Task Force of Financial Deepening
Bank Indonesia
Company
LOGO
Jakarta, 20 May 2015

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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Why hedge? The Micro-level arguments


 The activity of hedging is undertaken mainly for shielding
the revenue streams, profitability and balance sheets of
companies against adverse price movements and cyclical
reversals.
 A properly designed hedging strategy enables corporations
to reduce risks. Hedging does not eliminate risks but helps
to transform risks. Hedging, hence, forms an integral part
of the risk management strategies and has various
advantages
Maniar (2010), in a survey of 500 corporate enterprises in India, established three
major answers to the question:

‘Why do companies hedge?’ The most important reason cited in the survey was ‘to
reduce the volatility of the cash flows’. Next in importance was, ‘maximising
shareholder value’; and then, ‘reducing volatility of reported accounting
earnings’.

Why hedge? The Micro-level arguments


Risks at the microeconomic level can be broadly classified into operating risks and
financial risks
Corporate Risks

Business Risks Market Risks Liquidity Risks Credit Risks Operational Risks

• Sales • Foreign • Funding Risks • Commercial • Systems


• Marketing exchange • Long Term v/s • Counterparty • Controls
• Manufacturing • Interest Rates Short Term • Sovereign • Regulatory
• Competition • Commodity • Credit Lines • Settlement • Frauds
• Reputation • Equity • Contingent • Weather
• Inflation • Capital. • Natural Disasters

Paid to Mitigate Paid to Manage Paid to Mitigate

As market imperfections are more of a norm, than exception, it makes risk mitigation an imperative
exercise. The significance of hedging arises due to the omnipresence of various risks faced by all
stakeholders.

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
5

Why hedge? The Macro Level Arguments

Benefits of hedging
A spate of literature has been written justifying the significance of hedging theories,
reinstating the motives and benefits of hedging
1. Price Risk Insurance theory : Hedging acts as an insurance against price risk
• Smith (1922), Marshal (1919), Keynes (1930), Hicks (1939) and Kaldor (1939)
2. Portfolio theory : Hedging is primarily used for insuring against risks, but it
integrates risk avoidance with expected profit maximisation
• Stein (1961) and Johnson (1960) to explain hedging to mitigate risk and earn returns
3. Hedging ensures continuity of cash flows
• Companies, by choosing to hedge, can bring about certainty in their production
process, and ensure continuity of cash flows
4. Hedging encourages capital investment
• By locking input prices, firms are able to protect themselves against the rising
operating costs, and therefore, make concrete plans on capital formation and
expansion
5. Hedging for enhancing a firm’s value
• In the overall strategy of management, reducing corporate risk is an essential
feature. By helping reduce costs stemming from market imperfections, hedging
enhances a firm’s value.

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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 Hedging involves taking an “offsetting position” in a derivative


in order to balance any gains and losses to the underlying asset.
 Hedging attempts to “eliminate the volatility” associated with
the price of an asset by taking offsetting positions contrary to
what the investor currently has.
 The main purpose of speculation, on the other hand, is to profit
from betting on the direction in which an asset will be moving.

Opportunity Gain/Loss
In FX Hedging

Opportunity
Gain

Opportunity Loss
(Biaya Hedging)

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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10

Banks’ Capacity to
Prudential policy for engage in FX
Demand for FX
managing FX risk of Derivative and Provide
Hedging
private external debt FX Line

Adequate risk
management
Developing Active and Resilient FX
Derivative Market for Hedging • Potential Credit
Exposure (Limit)
• Interbank Credit
Line

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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The US Dollar
Super-cycle
(the Fed Exit Policy)
Prudential Policy for Private
External Debt

Domestic Over-Leverage Credit Rating


Demand Private
External Debt Currency Macro
Hedging Ratio
Mismatched Economic
Global Liquidity On the Rise Instability
post Maturity
2008 Crisis Mismatched Liquidity Ratio

The Steady Decline


Of Commodity Prices
(Revenue Fall)

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Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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18.000

15.500 Dollar Super


16.000
Cycle

14.000
12.895
12.150 12.260
12.000
10.755
10.000

8.710 8.460
8.000

6.000
Crawling peg
4.000 Free Float

2.485
2.000 2.105

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%
30,00

27,01

25,00

20,84
20,00 18,91

15,00
14,56
12,73 12,49
10,98
10,36 9,90
10,00

6,08
5,00 4,30

-
IDR INR MYR KRW PHP THB PLN TRY ZAR MXN BRL

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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Monthly FX Supply-Demand

30 SUPPLY DEMAND NET Supply $

$22 Bio
20

10

-
(1) (0) (1) (0) 0
(2) (2) (1) (1)
(3) (3) (2) (3) (2)
(3) (3)
(10)

(20)
$23.7 Bio

(30) Demand $

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NET-ONSHORE DEMAND-SUPPLY
4,0 NET-CAPITAL FLOWS
4

3,0 3
Supply $
2,0

$1.35 bio
1,0

0,0

-1,0

-2,0 (2) $1.65 bio

-3,0
FOMC Demand $

(3) Russia
-4,0
Okt-14
Jan-14

Feb-14

Mar-14

Apr-14

Mei-14

Jun-14

Jul-14

Agu-14

Sep-14

Nov-14

Des-14

Jan-15

Feb-15

Mar-15

Apr-15

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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Million $ Daily Average – Forex Transaction (2014)

14.000

12.000

10.000

8.000

6.000 12.784
11.095
4.000

2.000
5.011 4.733

0
Indonesia Philippines Thailand Malaysia

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Korea
Malaysia

Forward
26%
Swap Spot
41%
Spot
43%
Indonesia 46%

Forward Swap
16% 28%
Swap
28%

Philippines Spot Thailand


Forward
4% 68%

Swap
Spot Swap Spot
49%
43% 46% 41%

Forward
8% Forward
13%

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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Billion $
4,5
Spot Swap Forward Option
4,0

3,5 Spot
$3.03 billion
3,0

2,5

2,0

1,5 Swap
$1.03 billion
1,0

0,5 Forward
$0.2 billion
0,0

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Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
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2001 - 2013

Pembatasan
Pembelian Transaksi
Transaksi Transaksi
Valas Valas
Rupiah dan Valas Lindung
Pemberian
Terhadap Terhadap 7 PBI
Rupiah Nilai Kepada
Kredit Valas oleh Rupiah
Bank
Kepada Bank
(2 PBI & 3
Bank
= 12 SE
(1 PBI & 3 SE) (1 PBI & 1 SE)
(3 PBI & 3 SE) SE)

PBI 7/14, 14/10, PBI 10/37 dan


PBI 10/28
dan 16/9 11/14

Nov 2014
Bank dengan Bank dengan
Pihak Domestik Pihak Asing 3 PBI
1 PBI
1 SE Eks
1 PBI 1 PBI
1 SE Eks 1 SE Eks
3 SE Ekst
PBI No. 16/16/PBI/2014 PBI No. 17/16/PBI/2014

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Some major changes in Bank Indonesia regulation


PBI No. 16/16/PBI/2014
1
Derivative transactions can be
settled by netting through roll
over, early termination, and
unwind position 4
FX derivative transactions above
the threshold of $ 1 million must
2 be supported by underlying
Extension of the coverage of
underlying transactions into transactions.
Trade & Investment, compared
to previously based on 5
products The submission of documents of
3 underlying transaction, for
Extension of the underlying derivative is 5 working days
documents coverage into a
final and forecasts documents,
compared to previously based
on only final document

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
23

BI shortly will abolish requirement for bank to maintain Net Open


Position with 30 Minute Interval to the end of the trading day

30 Minutes Interval
Requirement to
End of Trading Day
Maintain Bank Net
Bank-NOP Max 20% of
Open Position (NOP)
capital
of Max 20% of
capital

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Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
25

Derivative transaction calculation within legal lending limit and risk


weighted asset regulations

Total positive potential


benefits of an agreement /
Derivative Receivables contract derivative obtained Positive
(Ex Post) from the mark to market of MTM / Profit
the agreement / contract
derivative transactions.

Derivative
Exposure (Limit)

All the potential benefits of


the agreement / contract
Notional
derivatives are determined
Potential Future Credit x
based on a certain
Exposure (Ex Ante) Certain
percentage of the notional
Percentage
value of the agreement /
contract derivative
Derivative Exposure calculations to capture the volatility of the transactions.
exchange rate. The higher the volatility, the greater the potential
exposure needs to be provided and the smaller banks notional
limit provided

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Bank that provide Cross Currency Swap (CCS) Line to its customer
must fulfil the following requirements :
1. Have internal guidelines, among others include accounting, skilled human
resources, support systems, and risk management, approved by the bank's
management
 PBI No. 11/25/PBI/2009 tentang Penerapan Manajemen Risiko Bank Umum

2. Provide education on FX Derivative and Risk Mitigation to customers


3. Comply with the regulation of the category of banks that can conduct foreign
exchange transactions (Book 2)
 PBI 14/26/PBI/2012 tentang Kegiatan Usaha Bank Umum Berdasarkan Modal Inti

4. Implement effective risk management


 PBI No. 11/25/PBI/2009 tentang Penerapan Manajemen Risiko Bank Umum

5. Implement mark to market of derivative transactions


 PBI 7/31/PBI/2005 tentang Transaksi Derivatif

6. Perform a self-assessment of the readiness of the bank's risk management


 PBI No 13/1/PBI/2011 tentang Penilaian Tingkat Kesehatan Bank Umum

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
27

DERIVATIVE
DERIVATIVE BANK
BANK NON- BANK

ISDA ISDA FX Agreement


(derivatif>1 yr + (derivative < 1 yr)
derivative complex)

INDONESIAN CONTENTS ?? :
1. Local Regulation
2. Law Jurisdiction Option
3. Bilingual

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Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta
29

Feature Features and Advantages

Forward An over-the-counter (OTC) instrument; • Customised contract between the two parties, in
terms of size, quality and delivery date; • Usually involves no ‘upfront’ payment and ‘cash’
changes hands only at the expiry of the contract;

Swap Traded in OTC markets; • Customised transactions perfectly suiting


hedging needs;• Provides a choice to set the currency you require; • Generally no upfront
payment

Option Helps to lock-in the price but without the compulsion to honour the contract, especially to
benefit from favourable price movements; • No margin calls for options buyers; • Risk is limited
for the buyer of options, contract, i.e., he/she can at the most lose the contracts premium; •
Options can be exercised or offset before expiration
Future Standardised contract in terms of contract size, delivery dates, quality, trading hours, tick size,
and maximum daily price limits; • Exchange traded; hence, zero counterparty risk; • Involves a
‘down payment’ known as the initial margin ; • Transparent pricing •

Deloitte Seminar
Hedging: The Benefits and Implementation Challenges in Indonesia
20 May 2015, Hotel Indonesia Kempinski Jakarta