Regulatory framework for private equity investing in Indonesia
By Kuntum Apriella Irdam, Melli Darsa & Co
In recent years, private equity firms (PEFs) have played a significant role in the global economy including in Indonesia.
Certain jurisdictions, such as the US, the UK, India and China, differentiate the regulations or rules applicable to sophisticated (qualified) investors and non-sophisticated investors. Indonesian laws and regulations, however, do not make such a distinction. All investors will be deemed as investors in general, notwithstanding the fact that they could be sophisticated investors, strategic investors or financial investors. In other words, there are no specific regulations or rules that specifically govern the rights and obligations of sophisticated or qualified investors. All investors are deemed the same and will need to be protected equally.
Due to the lack of regulation, PEFs do not have to form any entity in Indonesia in order to conduct their activities. In any event, the types of entity that could arguably be used to conduct activities as PEFs may not hold sufficient appeal. The types of entity under Indonesian law that perhaps can be used to conduct private equity activity are the investment manager securities company and the venture capital company. The investment manager company must be in the form of an Indonesian limited liability company licensed by the Capital Market and Financial Institution Supervisory Board/Badan Pengawas Pasar Modal & Lembaga Keuangan (Bapepam-LK), and are subject to stringent regulations.
Venture capital companies, on the other hand, are a type of financing institution whose main activity is to provide financing or conduct shares participation in an investee company for a maximum of 10 years for the purpose of developing the investee company. This company is also under the auspices of Bapepam LK. It must take the form of a limited liability company or cooperative and must be licensed by Bapepam-LK on behalf of the Minister of Finance. A foreign business entity may own up to 85% shares of the total issued capital of the venture capital company. There are currently less than 20 venture capital companies in Indonesia whose shares are partly owned by a foreign business entity, none of which are well-known local or global PEFs.
In addition, tax considerations constitute an important reason for using a company as a shareholding entity in an Indonesian company that holds assets that interest a PEF. In this case, PEFs usually hold their Indonesian investments through companies set up in a tax treaty or haven country (such as Singapore, the Netherlands, or the Cayman Islands or BVI), thus allowing the payment of any dividend, interest or fee at the most attractive tax rates. The decision to include such jurisdiction may also be due to the availability of companies that are easily manageable through professional directors or nominees. Setting up in a tax haven country may also allow for a certain level of anonymity that the PEF may want to have, especially if the Indonesian assets are publicly listed companies.
A lack of regulations applicable for the establishment and nature of PEF in Indonesia has resulted in a number of global PEFs entering the Indonesian market by establishing cooperation arrangements with Indonesian local parties that are interested in conducting private equity business with funds established outside of Indonesia. Notwithstanding the above, within the last few years, PEFs have been actively involved in investments in Indonesia. The investments made by PEFs are largely in M&A in the fields of retail, pharmaceutical, energy, mining, infrastructure and communications. Foreign PEFs that have a presence in Indonesia include Texas Pacific Group, Avenue and CVC, and there is a long line of foreign PEFs that are chasing opportunities to enter the Indonesian market.
We set forth below several applicable regulations that should be considered by PEFs in pursuing investments in Indonesia. Some of these can be deemed as barriers to entry, while others may be seen as incentives to conduct investment in Indonesia.
Foreign shareholding limitation
The basic concept is that all business fields are open for foreign investment, except for certain fields that are stated by the relevant laws as being closed or open with requirements. In this regard, the Government has issued President Regulation No. 39 of 2010 on the 'List of Business fields Which Are Closed for Investments and Business fields That Are Conditionally Open for Investments', also known as the 'Investment Negative List' (this can be accessed at www.bkpm.go.id). The Investment Negative List provides a list of certain business fields that are open with certain requirements, such as maximum foreign shareholding percentages.
The Investment Negative List does not apply to non-direct investment or portfolio investment transacted through the stock exchange. The Capital Investment Coordinating Board/Badan Koordinasi Penanaman Modal (BKPM) and Bapepam-LK have different views on what should be considered as 'non-direct investment'. Notwithstanding, this has been interpreted in the market that foreign shareholding restrictions are not applicable for investments made by foreign parties in publicly listed entities in Indonesia. We note that there are several publicly listed entities whose foreign shareholding exceeds the threshold as determined by the Investment Negative List, but who so far have never been questioned by BKPM.
Foreign shareholding in financial sectors' entities is regulated by laws and regulations other than the Investment Negative List. Foreign parties may currently own up to 99% shares in a bank, 85% shares in a multifinance company, 80% in an insurance company and 85%-99% in a securities company.
Except for financial institutions that are governed by specific laws and regulations, under the Investment Law, a foreign party may own a non publicly listed Indonesian limited liability company in the form of a foreign investment company or PT Penanaman Modal Asing. Any investment made into a foreign investment company is subject to BKPM approval.
Investments in certain other specific areas are governed by government authorities other than BKPM. For example, foreign investment in banks is regulated by Bank Indonesia (the Indonesian central bank); foreign investment in securities companies, multifinance companies and insurance companies is regulated by Bapepam-LK and the Minister of Finance; while foreign investment in the upstream oil and gas sector is regulated by BP Migas/Pertamina. Any investment made in these types of entities will be subject to the approval of the relevant regulator. The process could be cumbersome in certain areas. For example, the regulatory approval process for bank acquisitions may take anywhere from three months to more than one year to complete.
Several regulatory regimes, particularly in financial sector, only allow individuals or legal entities to hold shares in an Indonesian entity. As such, if the direct entity that will be used for the investment is in the form of a partnership, then this will lengthen the regulatory approval process as the regulator will need to understand the structure of the investor first.
In addition, regulations in the financial sector require the shareholders of a bank to have a net equity that is (i) 100% equivalent with its investment in a bank, and (ii) 200% equivalent with its investment in a multifinance company. That said, the Indonesian regulator will not entertain any SPV used by PEFs that does not meet such requirements.
PEFs usually use a special purpose vehicle specifically set up for the purpose of a specific investment in a country. In the financial sector, the regulations require full disclosure all the way up to the ultimate controller of the acquiror. In the context of PEFs, this may lead to the ultimate individual owner of the general partner who has control over the PEF, and also to disclosure of the limited partners participating in the investment.
In certain transactions, the tendency is not to disclose the ultimate controller or the general partner. This reluctancy will usually cause a prolonged regulatory approval process.
Mandatory tender offer
In acquiring more than 50% shares in a publicly listed entity, or a lower percentage of shares but control over a target, a PEF is required to conduct a mandatory tender offer for the shares held by the public shareholders. This is followed by a sell down requirement that will be discussed further below.
If a PEF owns 80% of the paid-up capital of a publicly listed entity as a result of a mandatory tender offer (subsequent to a takeover), it is obligated to transfer the shares of that company to the public. This is so that shares owned by the public are at least 20% of the paid-up capital of the publicly listed entity and are owned by at least 300 parties. This must be done within no later than two years since completion of the implementation of a mandatory tender offer, except where the publicly listed entity in question has already undertaken the necessary corporate actions to ensure such conditions are fulfilled. If, however, 80% of the paid-up capital threshold is passed by the takeover alone (which triggers the mandatory tender offer requirements in the process), then the sell down requirement will be limited to that portion of shares acquired during the mandatory tender offer – although the requirement for 300 parties will apply equally.
The two-year period abovementioned can be extended by Bapepam LK in certain circumstances, including when the share price at the time of the sell down is the same as or higher than the tender offer price, and/or the new controlling shareholder has made efforts to sell down the shares but fails to achieve the size required under the regulation.
This sell down requirement has in fact become the most considered issue by investors, including PEFs, when acquiring publicly listed entities in Indonesia.
PEFs tend to make investments for a period of only three to five years. This is generally not an issue for investment in many businesss sectors, since there is no law imposing a certain 'lock-up' period for the investment. However, in the banking sector, the regulation allows Bank Indonesia to impose such a lock-up period and, in practice, this is usually for a minimum of five years for investment in Indonesian banks.
PEFs are usually structured like webs whereby one general partner manages different funds. As such, a fund used by a PEF when conducting investment in Indonesia usually has affiliates worldwide. When conducting investment, a PEF tends to become the substantial shareholder in a publicly listed entity that is privy to insider information of the entity. It is important to ensure that such insider information is not leaked to a PEF's affiliates, or those affiliates may be subject to Indonesian insider trading restrictions.
A PEF has committed funds and certain processes to conduct a capital call to its limited partnership. In the context of bank acquisitions, Bank Indonesia imposes obligations for the shareholders to provide liquidity support to a bank in the event that it is facing difficulties in its operation. This may cause a problem to a PEF in the event that the committed funds have all been used or the limited partners do not approve the capital call.
Capital gain tax
There is a large difference in capital gain tax incurred by a seller when selling shares in a private company and a publicly listed company. A sale of shares in a private entity will cause a seller to be subject to a capital gain tax of between 25% and 30%. However, a sale of shares conducted at the stock exchange will cause a seller to be subject to a capital gain tax of 0.1% or 0.6% (for founder shares). Given the large difference, an approach that is always considered by a PEF is to conduct an exit once the acquired entity has become listed at the stock exchange.
This particular issue also has an impact during the entry of investment whereby, in certain cases, a PEF may only complete share purchase transactions after a target entity has been made listed – in which case a seller will obtain the much lower capital gain tax.
Some market players may view that the regulatory framework in Indonesia could form a barrier for foreign PEFs to invest in Indonesia. Others may see that the applicable rules are somewhat 'manageable', and there are various possible transaction structures that can be considered to help PEFs achieve their purpose when conducting investment in Indonesia.
Notwithstanding the above, Indonesia, with its vast natural resources and home of approximately 240 million people, is expected to be the fastest growing economy alongside China and India. Therefore, Indonesia is still considered as one of the key emerging markets that attracts PEFs from all over the world.
About the author
Kuntum Apriella Irdam
Melli Darsa & Co
Menara Standard Chartered
Jl. Prof. Dr. Satrio No. 164
T: +62 21 2553 2019
F: +62 21 2553 2020
Kuntum Apriella Irdam became a junior partner of MDC in April 2010 and specialises in M&A and corporate commercial matters.
First joining MDC in January 2003, Irdam has in the last six years been actively involved in numerous bank acquisitions in Indonesia and also acquisitions of other types of financial institutions. She also advises clients in financing transactions as well as regulatory banking and corporate governance and commercial transactions generally.
Irdam holds a law degree from the University of Indonesia (1999) and a master of law degree from Erasmus Universiteit Rotterdam, The Netherlands (2004).
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