Indonesia: Guaranteeing the future

Author: | Published: 1 Sep 2010
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In the next five years, there have been predictions that Indonesia needs to allocate 1,429 trillion rupiah to finance the provision of infrastructure, out of which only 511 trillion rupiah would be financed by the state budget. Typically, the financing gap would be addressed by inviting private entities to participate in the provision of infrastructure.

In a public-private partnership for infrastructure projects the contracting parties include the government institutions, (the ministry state-owned companies or regional governments (the Contracting Government Institutions)), and involve public policies and state-owned assets. Therefore, in addition to any potential commercial risks, the investment risks in the provision of infrastructure could also be the result of the legal uncertainty due to weaknesses in law enforcement, existing conflicting laws, or unclear regulatory policies, lack of accurate information available for investors on feasibility of projects, and the uncoordinated implementation of government policies.

Private investors would like to see the consistency and credibility of government policies and legal certainty guaranteed. This factor is critical in relation to the application for project financing schemes to financial institutions or potential creditors. To boost the participation of private investors in infrastructure projects, government guarantees are important in infrastructure project financing. The following discusses the policies and updates relating to government guarantees with respect to infrastructure projects.

Infrastructure project and cooperation agreement

Pursuant to Presidential Regulation No 67 of 2005 as amended by Presidential Regulation No 13 of 2010 (PR on Public-Private Partnership), the following infrastructure categories are eligible for public-private partnership: transportation, road, irrigation, potable water, waste water, telecommunication, power plants, and oil and gas. Public-private partnerships for the provision of infrastructure can be in the form of a cooperation agreement or licensing.

A cooperation agreement is entered into by the contracting government institution and the entity (contracting entity) as determined through a public tender. The cooperation agreement must at least contain the following provisions:

  1. scope of cooperation;
  2. term or period;
  3. performance guarantee;
  4. tariff and mechanism to adjust tariffs;<
  5. rights and obligations, including the allocation of risks;
  6. standard of service performance;
  7. assignment of shares prior to the commercial operation of infrastructure projects;
  8. sanctions for breaches of contract;
  9. termination of contracts;
  10. financial reports of the contracting entity in implementing the cooperation agreement, which should be audited annually by independent auditors and the audit results of which should be announced in the national newspapers;
  11. mechanism of dispute settlement;
  12. supervisory mechanism of the contracting entity's performance under the cooperation agreement;
  13. the use and ownership of infrastructure assets;
  14. surrender of infrastructure or the said operation and management to the relevant ministry, state owned company, or regional government;
  15. force majeure;
  16. representations and warranties of the parties on the legally binding power of the agreement in accordance with Indonesian laws and regulations;
  17. the use of Bahasa Indonesia in the agreement and Bahasa Indonesia should prevail if the agreement is signed in bilingual term; and
  18. governing law.

The PR on Public-Private Partnerships also requires that within 12 months after the cooperation agreement is signed, the contracting entity must have secured the financing for the infrastructure project. In order to satisfy the above requirement, the financing documents must have been signed and part of the funds must have been disbursed. Failure to secure the financing of the infrastructure project within that period may result in the termination of the cooperation agreement and the performance guarantee being called upon. The initial 12-month period may only be extended for an additional period not exceeding another 12 months.

Risk categories and risk management

As specified above and expressly indicated in the PR on Public-Private Partnerships, the management of risks should be expressly stipulated and agreed by the parties to the cooperation agreement.

The detailed categories of risks in the provisions of infrastructure are provided under the Minister of Finance (MoF) Regulation No 38/PMK.01/2006 dated May 19 2006 (MOF Regulation No 38). This regulation defines the risks of the public-private partnership in the provision of infrastructure as follows:

Political risk

This risk relates to government policies, actions and decisions resulting in financial loss of the contracting entity. This includes the acquisition of assets by the government, the changes to laws and regulations, the restriction of currency conversion as well as the restriction on fund repatriation.

Project performance risk

This includes location risks, such as delay or failure in land procurement and operational risks, delay in commencing operation, tariff adjustment.

Demand risk

It refers to all risks resulting from the low demand of the goods/services produced by the contracting entity under the public-private partnership scheme.

MoF Regulation No 38 also provides for allocation of the following risk events:

  • With respect to a political risk, the Indonesian government may undertake to provide compensation to the asset owner or the contracting entity;
  • For a delay of land procurement by the government, the government may either extend the concession or offer another form of compensation as approved by the MoF. These options are also applicable to risks resulting from the increase in land prices with the additional possibility of the government bearing the shortfall amount for the increased land price;
  • For any delay in the determining the operation, delay of tariff adjustment, cancellation of tariff adjustment, or the determination of initial tariff which is lower than the amount set out in the agreement, the government may extend the concession or offer compensation in another form as approved by the MoF;
  • For any change of output specifications different from the specifications agreed by the contracting government institutions, the government may compensate the contracting entity by recalculating the production cost; and
  • In relation to demand risk, where the realisation of income is less that the guaranteed minimum income by the Contracting Government Institution, the government may offer financial compensation or compensation in other forms as approved by the MoF. On the other hand, if there is excess income above the agreed level of potential income, the government should also enjoy the financial benefit of such excess income.

Government support and government guarantee

As part of the measures to minimise the potential risks in investments for a public-private partnership for infrastructure projects, the PR on Public-Private Partnerships, particularly Presidential Regulation No 13 of 2010, sets out the government's role in supporting the private-public partnership in the provision of infrastructure through the following:

Government support

It refers to either fiscal or non fiscal contributions provided by the minister or head of government agencies or, the head of regional government and/or the MoF in accordance with their authority to improve the creditworthiness of the public-private partnership for the provisions of infrastructure.

There are some requirements with respect to government Support:

  • Government support in the form of fiscal contribution should be provided for in the state budget or the regional government budget.
  • Government support in the form of licensing, land procurement, support partly of construction, or others should be in line with prevailing laws and regulations.
  • Government support in the form of tax incentives should be approved by the MoF based on the proposal of the contracting government institution.
  • Any government support, if any, must be stipulated in the public tender documents.

Government guarantee

This is the financial compensation or other compensation undertaken by the MoF for the benefit of the contracting entity through risk-allocation schemes in the public-private partnership for infrastructure project.

A government guarantee must take into account the principles of managing the financial risks of the state budget. Therefore, under the PR on Public-Private Partnerships, the MoF is authorised to control and manage the risks of government guarantees in respect of a public-private partnership in the provision of infrastructure, including:

  • to determine the criteria for the provision of government guarantees;
  • to ask for and obtain data and information from the contracting parties to the cooperation agreement;
  • to approve or reject the proposal for granting government guarantees;
  • to determine the types and forms of government guarantees.

The information on the existence of a potential government guarantee must also be made available in the public tender documents for the relevant infrastructure project.

Article 17C of the PR on Public-Private Partnerships relating to government guarantees in the form of financial compensation also requires the establishment of a government entity specifically for the purpose of providing guarantees relating to infrastructure projects.

Procedures for obtaining government support or guarantees

The existing regulation on the procedure for the grant of government support is MoF Regulation No 38. This regulation has yet to be amended to comply with Presidential Regulation No 13 of 2010. This MoF Regulation does not differentiate between government support and government guarantees. It only utilises the definition of the government support, which actually has the same meaning as a government guarantee pursuant to Presidential Regulation No 13 of 2010.

In order to obtain government support under the MoF Regulation No 38, the relevant contracting government institutions should prepare the proposal to the MoF through the Committee for the Acceleration Policy of the Provision of Infrastructure (KKPPI). After evaluating the proposal, KKPPI will submit the evaluation results of the proposal to the Risk Management Unit at the MoF. The proposal should enclose copies of the report on the results of pre-feasibility study, the plan-of-cooperation form, the financing plan for the project and source of funds, details of the planned cooperation (schedule, process, and assessment), and the result of the public consultation in respect of the project.

Upon receiving the recommendation from the Risk Management Unit, the MoF will issue the approval in principle for the government support, which will be discussed with the House of Representatives in the draft state budget. The recommendation by the Risk Management Unit should contain at least the basic terms and conditions of the government support, which includes the maximum terms of the government support, allocation scheme of risks among the contracting entity, insurance company, and/or other financial institutions, and risk management alternatives based on the prevailing laws and regulations.

Once the House of Representatives approves the proposed draft state budget containing the proposed government support, the contracting government institutions will commence the tender process for the infrastructure project. The final process of tender shall be minuted and submitted to the MoF for processing the final approval for the government support. The MoF will normally also consider any input from the Risk Management Unit. The contracting government institutions will sign the cooperation agreement of the infrastructure project after the final approval by the MoF on the granting of government support.

However, MoF Regulation No 38 does not specify the procedure on how the government support should be presented. It is also unclear as to how this regulation is relevant if the support is in the form of issuance of licences or permits which are under the authority of a different government institution. This regulation does not expressly provide the procedure for the government guarantee, which will create a financial contingent liability to the government.

In addition, Article 17C of the PR on Public-Private Partnerships, which has only recently been provided for in Presidential Regulation No 13 of 2010, specifies the requirement to establish a guarantee provider entity. It is expected that the Indonesian government will issue an amendment to MOF Regulation No 38 to address the above loopholes in due course.

Establishing the Indonesia Infrastructure Guarantee Fund

From an investor's perspective, the approach used in Article 17 C of the PR on Public-Private Partnerships to minimise the said investment risks is preferable. It would reduce the bureaucratic and long procedure as provided under MoF Regulation No 38 and provide more certainty to investors.

As an update, it was reported in May 2010 that the Indonesian government has officially commenced the operations of PT Penjaminan Infrastruktur Indonesia (Persero) (Indonesia Infrastructure Guarantee Fund or IIGF). IIGF is expected to become a credible guarantee provider in the provision of infrastructure and to improve the creditworthiness of infrastructure projects.

IIGF is a limited liability company. It obtained its status as a legal entity by the Minister of Law and Human Rights on January 2010. Its shares are 100% owned by the Indonesian government. Pursuant to Government Regulation No 35 of 2009 (GR No 35 of 2009), the Indonesian government has injected 1 trillion rupiah for its initial capital. This legal entity is designed to protect the government's contingent liability under the provision of guarantee by ring-fencing of the IIGF's assets.

Unlike other state-owned companies where the Indonesian government's ownership is represented by the state minister of state-owned enterprises, GR No 35 of 2009 explicitly provides that the MoF is acting as the shareholder or the general meeting of shareholders representing the Indonesian government. The appointments of the members of both the board of directors and the board of commissioners of IIGF are made by a MoF decree, which would then be confirmed in a shareholders resolution.

IIGF's financial support is not solely relying on its own capital. It should be able to attract multilateral development agencies and other parties to support IIGF's capital and operation, which can be in the form of credit facilities or guarantee facilities. It was reported that the World Bank together with Singapore Cooperation Enterprise would support IIGF's operational capacity to cover guarantee amounts exceeding than $2 billion in deal flow. Such cooperation is also designed to formulate the corporate governance, standard operation procedure and operating procedure (appraisal standard, cash management, monitoring of guarantee, and guarantee and claim process) and also to establish a sizable AAA-rated World Bank guarantee facility to support IIGF guarantee operations.

Government guarantees by IIGF

IIGF's scope includes the issuance of a guarantee relating to contracting government institution's obligations (a ministry, state-owned company, or regional government) under a public-private partnership to develop infrastructure in Indonesia. It is intended to mitigate risks that are difficult for the private sector to address through other means. Therefore, the guarantee should only be in respect of the contracting government institution's liabilities as set forth in the project documentation. Project sponsors will assume the commercial risks and other risks beyond the contracting government institution's commitment.

IIGF itself has declared that the guarantee covers the risks as a result of any delay or failure in land acquisition, securing licenses, permits, approval; regulatory risks given any change in law or regulation; failure or delay in financial closing; breach of contract; any shortfall as a result of adverse changes in pricing, revenue, demand; failure to integrate with network; failure to enforce against illegal activities; risk of early termination of contracts. However, IIGF guarantees will not cover risks for which investors can purchase insurance coverage from the private market (like foreign exchange risk).

Single window policy

In order to establish a credible guarantee provider, it is necessary to ensure that all the operational processes of IIGF are run independently, free of political interference, and to very high standard of transparency and disclosure. This is also to support the intended purpose of IIGF as a single window for appraising, structuring, and providing guarantees for the public-private partnership infrastructure projects. A single window is important for a consistent policy on appraising guarantees, a single process of claims, transparency and consistency to the process to create a strong market's confidence on the credibility of guarantees issued by IIGF.

An IIGF guarantee also requires a recourse agreement being established between IIGF and the relevant contracting government institutions. Under this arrangement, once the guarantee is called upon by the investor, the contracting government institutions should reimburse IIGF. This arrangement is critical to ensure IIGF's financial viability and sustainability. This should also encourage accountability of the contracting government institutions.

The regulatory road ahead

As discussed above, we may expect to see significant amendment to MoF Regulation No 38 in the near future. The government may also need to issue another regulation detailing the risk allocation in infrastructure projects.

Nevertheless, following the launching of IIGF, there have been updates on several infrastructure projects supported by IIGF, including Steam Power Plant 2x1.000 Megawatt in Central Java in the amount of $3 billion, railways project of Soekarno Hatta Airport – Manggarai in the amount of $900 million, and the integrated rubbish recycling in Bandung in the amount of $95 million. IIGF has really begun to come into its own and it will be very interesting to monitor the relevant development of IIGR in the years ahead.

About the author

Enrico Iskandar is the managing partner of BASTAMAN ENRICO. He focuses on the firm’s corporate and commercial, investment, M&A, real estate and hotel, mining and natural resources and pharmaceutical practice. He has also involved in a substantial number of M&A transactions, as well as property and real-estate projects and transactions and increasingly, he has been heavily involved in the legal and commercial aspects of the energy and natural resources sector, information technology, health as well as plantations areas.

Enrico previously practiced with one of the largest and established Indonesian law firm, Soewito Suhardiman Eddymurthy Kardono for eight years and following his elevation of his law career, joined a leading boutique law firm, Christian Teo & Associates in 2004 and then became partner in 2007.

In 2008, the Asia Pacific Legal 500 – The Guide to Asia’s Commercial Law Firm 2008/2009 Edition noted and recognised Enrico as one of leading individuals in the real-estate category. In addition, the 2009/2010 edition of Legal 500 has also recognised his newly established firm BASTAMAN ENRICO as one of leading corporate and commercial firms in Indonesia.

Contact information

Enrico Iskandar
BASTAMAN ENRICO

Plaza Asia, Zone 12C
Jl. Jend. Sudirman Kav. 59
Jakarta 12190
Indonesia

Tel: +62 21 514 01 380
Fax: +62 21 514 01 379
Email:enrico@bastamanenrico.com
Web:www.bastamanenrico.com


About the author

Bagus Nur Buwono is a partner at BASTAMAN ENRICO. He focuses on the firm’s banking and finance, corporate and commercial, investment, M&A, and capital markets practice area. He has involved and represented numbers of Fortune 500 companies (or their subsidiaries) for various cross-border transactions, including M&A, banking and finance, insurance, and investment during his previous practise with one of the largest and established Indonesian law firm, Soewito Suhardiman Eddymurthy Kardono for nine years.

Following the elevation of his law career, he then joined Bank Mizuho Indonesia, a subsidiary of Mizuho Corporate Bank, Japan as the senior vice president and head of the legal department; and later, PT Bank Barclays Indonesia, subsidiary of Barclays Bank, UK as the country head of legal and company secretary.

Bagus received several awards for his significant contributions in supporting the business development activities during his services for Bank Mizuho Indonesia. While handling various corporate and banking transactions as in-house legal counsel, he also experienced in reorganising roles and functions of legal department, setting up various standard legal documents, and conducting various legal training programs.

Bagus holds an International Certificate in Banking Risk and Regulation issued by the Global Association of Risk Professionals for and on behalf of the Indonesian Risk Management Certification Agency.
Enrico and Bagus worked on this article with assistance from the Firm’s publication team members

Contact information

Bagus Nur Buwono
BASTAMAN ENRICO

Plaza Asia, Zone 12C
Jl. Jend. Sudirman Kav. 59
Jakarta 12190
Indonesia

Tel: +62 21 514 01 380
Fax: +62 21 514 01 379
Email:bagus@bastamanenrico.com
Web:www.bastamanenrico.com