IDM: The future for RI financial market<\/p>\n
Kahlil Rowter, Head of Research, Mandiri Sekuritas<\/p>\n
Despite having been forced to issue domestic securities (IGS-
\nIndonesian Government Securities) a few years back, recent
\ngovernment initiative have yielded well.<\/p>\n
Up and until the economic crisis in 1997 the government never
\nhad a plan to issue domestic debt. It mainly relied on foreign
\naid for most of its funding shortfall. But in 1998 the government
\nhad to issue two main types of IGS. The first was to pay for Bank
\nIndonesia liquidity support (better know by its Indonesian
\nacronym, BLBI), amounting to over Rp 200 trillion.<\/p>\n
The second was to recapitalized banks whose loans were
\ntransferred to the Indonesian Banking Restructuring Agency
\n(IBRA). This amounted to over Rp 400 trillion. The first IGS was
\nnever intended to be sold to the market while the latter was
\ndesigned to be marketable. The purpose was for recapitalized
\nbanks to sell it and get funds they can then use to extend loans.<\/p>\n
At the beginning trading volumes were very small. In part,
\ninterest rates were high at the time which means these bonds can
\nonly be sold at a loss; something recapitalized banks can afford
\nto do.<\/p>\n
Trading really picked up in 2001 when the monthly average
\nreached close to Rp 6 trillion. In 2002 the monthly average rose
\nclose to Rp 10 trillion. With lower interest rates, these bonds
\ncan be sold without incurring too much loss. From the demand side
\ninvestors were also looking for assets, preferably safe ones,
\nthey can place money into.<\/p>\n
Whereas in the beginning trading mainly took place among banks
\nin 2002 a significant change took place. Not only did trading
\nvolumes picked up significantly, but demand from mutual funds
\nalso took off. Mutual funds which before relied on institutional
\nsponsors suddenly changed into mass-market retail.<\/p>\n
And the size of fixed income fund which in early 2002 was
\naround Rp 5 trillion grew to over Rp 37 trillion by December of
\nthe same year. The main driver was, of course, IGS funds. Just
\nthe top three IGS funds were recorded around Rp 26 trillion in
\nDecember 2002, and the amount is sure to grown further since.<\/p>\n
Seizing this opportunity, the government pushed ahead with the
\nGovernment Securities Bill. This explicitly states that the
\ngovernment guarantees the timely payment of principal and coupon
\nof debt securities it issues. This law significantly enhances the
\ncredibility of IGS. Therefore the next logical step was to cater
\nto the market itself. That is why the government along with the
\ncentral bank assisted by the Surabaya Stock Exchange formed a IGS
\nworking group tasked with finding a way to enhance IGS market. An
\ninitial step was to seek ways to increase liquidity and
\nefficiency and transparency of the secondary market. Hence the
\nformation of the Inter-dealer Market (IDM).<\/p>\n
A key feature of efficiency is the way in which prices are
\nformed. One of the best ways for this is through an auction
\nmechanism, much like the way in which stock prices are formed in
\nthe Jakarta Stock Exchange. Another key feature is a level
\nplaying field in terms of risk. It was thus decided that a
\nlimited participation market needed to be established.<\/p>\n
The major benefit of limited participation is that the same
\nrisk is faced by any particular participant vis a vis the others.
\nFurthermore trading should be done on house or own-positions not
\nthat of clients whose credit risk varies and can be difficult to
\nascertain. Open participation can only by achieved by having an
\ninstitution that can insure against settlement failure. Given the
\nsizes of the transaction in this market no such institution can
\nbe envisaged.<\/p>\n
Having an IDM does not curtail members trading outside the IDM
\nplatform as well among members and non-members. It is just that
\ntrading among IDM members is expected be the deepest and most
\nliquid leading to the best prices. IDM members can certainly earn
\na margin when it trades with non-members -- the main incentive of
\nbecoming a member.<\/p>\n
The next step was to select which institutions can
\nparticipate. The basic criteria here is capital, which is the
\nfirst input into any risk assessment exercise. The other less
\nimportant factors include past participation in the market and so
\non. Thus 15 banks have been selected: Mandiri, BNI, BRI, BCA,
\nBuana, Danamon, Lippo, Mega, Niaga, Panin, ABN Amro, Deutsche
\nBank, HSBC, Citibank, and Standard Chartered.<\/p>\n
Certain large securities houses are also expected to apply.
\nWith their wider reach to non-bank end- investors, securities
\nhouses can help widen the reach of IGS trading.<\/p>\n
Participants are not all recapitalized banks. Even more
\nsignificant is that there are several foreign banks in the list.
\nFor these banks to participate they must have had headquarters
\napproval. This underscores that trading is widespread, even among
\nnon-recapitalize banks. The participation of foreign banks
\nsignifies the return of confidence in domestic banking as well as
\ndebt markets. Granted their first major participation is in risk-
\nfree IGS. But this is a very good start.<\/p>\n
Transparency is achieved by having the IDM transmit price on
\ntransacted deals to the market at large.<\/p>\n
Besides increased liquidity, efficiency and transparency, a
\nregular auction-based price making mechanism produces a vital
\nbenchmark. This is essential to set the basis for which the cost
\nof other debt instruments can be set. And the implications of
\nhaving such basis is profound.<\/p>\n
Take bank loans or corporate bonds. One contributor to the
\ncrisis is the short-term nature of most investment horizons. This
\nmyopia can be traced to the absence of a credible long-term debt
\npricing benchmark in the past.<\/p>\n
No more! Once the benchmark yield curve produced by the IDM
\nprice mechanism is accepted, one can easily pick a particular
\ntenor along the curve to price a long-term debt. This will be the
\nIGS yield at that particular maturity plus the appropriate spread
\ndue to the issuer's credit risk. Such method is routinely
\nemployed elsewhere. And now we can do so in Indonesia.<\/p>\n
This should give more incentive for creditors to lend and for
\nborrowers to calculate accurately their cost. In turn this will
\nmake project feasibility studies more credible. One can hope that
\nthis will help improve the investment climate in the country.<\/p>\n
In most countries a benchmark yield curve along with a deep
\nand liquid government securities market is the cornerstone of the
\nentire financial market. It provides the basis for the creation
\nof myriad forms of derivative products that caters to investors'
\nneed to speculate and hedge.<\/p>\n
We can scarcely find a vibrant hedging market in Indonesia,
\nwhich leaves investors in a naked position. This could all change
\nshould a hedging market, based on IGS liquidity and pricing
\nbenchmark, appears. In its way this development strengthens the
\ndomestic financial structure against shocks, both that originate
\nfrom within the country and from outside.<\/p>\n
Having a deep and liquid IGS market and, one day, its repo
\nmarket, also permits that central bank to change its monetary
\noperations mechanism into one which signals are given indirectly
\nthrough changes in the IGS repo rate which is the way several
\ncentral banks in developed countries are going.<\/p>\n
This is a lot more efficient and cost-effective compared to
\nthe central bank dealing directly with outright monetary
\nabsorption or expansion.<\/p>\n
Lastly, having a deep and liquid IGS secondary market prepares
\nthe ground for the government to issue debt in the future at the
\nlowest cost and at minimum risk.<\/p>\n
With so many benefits to be reaped, the formation of the IDM
\nreally opens the future for a more modern Indonesian financial
\nmarket structure.<\/p>",
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