Margin Requirements for Non-Centrally Cleared Derivatives Transactions

To:
Conventional Commercial Bank Boards of Directors, At your location.

COPY
CIRCULAR LETTER OF THE FINANCIAL SERVICES AUTHORITY REPUBLIC OF INDONESIA NUMBER 17/SEOJK.03/2023 CONCERNING MARGIN REQUIREMENTS FOR TRANSACTIONS OF DERIVATIVES NOT CLEARED THROUGH A CENTRAL COUNTERPARTY INSTITUTION

In light of the implementation of Financial Services Authority Regulation Number 27 of 2022 concerning the Second Amendment to Financial Services Authority Regulation Number 11/POJK.03/2016 concerning Minimum Capital Provision Obligations for Commercial Banks (State Gazette of the Republic of Indonesia Year 2022 Number 35/OJK, Additional State Gazette of the Republic of Indonesia Number 26/OJK), hereinafter referred to as POJK KPMM, as referred to in Article 42B of POJK KPMM that Banks are required to meet margin requirements for derivative transactions not cleared through a central counterparty (CCP) institution, it is necessary to regulate implementation provisions regarding margin requirements for derivative transactions not cleared through a CCP institution in this Circular Letter of the Financial Services Authority as follows:

I. GENERAL PROVISIONS

1. Over-the-counter (OTC) derivative transactions are exposed to systemic risks arising in financial markets. Therefore, in POJK KPMM, provisions are regulated regarding the obligation of Banks to meet margin requirements, specifically for derivative transactions not cleared through a CCP institution, hereinafter referred to as non-centrally cleared derivative (NCCD) transactions.

2. The application of margin requirements for NCCD transactions refers to the following 8 (eight) principles:

a. Scope of Derivative Transactions
Margins are applied to all NCCD derivative transactions, with exceptions for specific derivative instruments as referred to in this Circular Letter of the Financial Services Authority.

b. Scope of Parties Required to Meet Margin Requirements Banks must meet margin requirements for NCCD transactions conducted with each counterparty as referred to in this Circular Letter of the Financial Services Authority. Exchanged margins include initial margin and variation margin according to the risk posed by the counterparty resulting from the transaction.

c. Minimum Amount and Methodology for Initial Margin and Variation Margin Calculation
Margin calculation methods apply consistently and are aimed at fully protecting counterparty risk exposure.

d. Assets Meeting Margin Requirements
Assets used to meet margin requirements must meet criteria including being liquid and maintaining their value under financial stress conditions after accounting for appropriate haircuts.

e. Treatment of Received Margins
Initial margin must be exchanged on a gross basis. Received margins cannot be rehypothecated or reused.

f. Transactions with Affiliates
The exchange of margins as referred to in this Circular Letter of the Financial Services Authority is not mandatory for transactions with affiliates.

g. Cross-Border Transactions
Margin requirements are applied consistently and do not overlap for NCCD transactions in other jurisdictions.

h. Application of Margin Requirements
The application of margin requirements applies to new NCCD transaction contracts agreed upon by parties after the implementation obligation of margin requirements as referred to in this Circular Letter of the Financial Services Authority takes effect.

3. The procedure for applying margin requirements for NCCD transactions as per the principles in number 2 is contained in the appendix which is an integral part of this Circular Letter of the Financial Services Authority.

II. MARGIN MANAGEMENT

1. Initial Margin Management
   Initial margin must be calculated and collected at the beginning of the transaction, then collected routinely and consistently based on changes in potential future exposure. Banks must perform revaluation and additional initial margin calculations monthly or faster in the event of material changes.

2. Variation Margin Management
   Variation margin must be accounted for NCCD transactions daily; however, the exchange period may be determined based on agreement between transacting parties considering prevailing general practices.

3. Agreement Between Parties Conducting NCCD Transactions
   The mechanism for administering exchanged margins, including matters related to the party storing the margin and dispute settlement procedures, must be stipulated in a bilateral agreement between transacting parties and agreed upon before the start of the transaction.

4. Data Administration by Banks
   Banks must adequately maintain and manage all forms of information related to NCCD transactions and exchanged margins from said transactions. If needed, the Financial Services Authority may request such data from the Bank.

III. IMPLEMENTATION OF MARGIN REQUIREMENTS

1. The obligation to apply initial margin and variation margin requirements applies to NCCD transaction contracts agreed upon since September 1 of the year following the first qualifying CCP (QCCP) begins operations in Indonesia. A QCCP is an entity having permission to operate as a CCP, including permission to obtain exemptions, and obtaining permission from the relevant regulator or supervisor to operate as a CCP according to the products offered.

2. Application of Initial Margin Requirements

a. Banks that consolidately have an average aggregate notional amount of NCCD transactions for end-of-month positions in March, April, and May of the current year equal to or greater than IDR 10,000,000,000,000.00 (ten trillion rupiah) must calculate initial margin for NCCD transactions. Initial margin is calculated for the Bank's NCCD transactions with each counterparty.

b. Initial margin calculation for Banks meeting the conditions as referred to in letter a is performed for a 1 (one) year period, namely from the position of September of that year to the position of August of the following year. The obligation to calculate initial margin remains applicable even if the notional amount of NCCD transactions decreases during that period.

c. In the event of a decrease in the notional amount of NCCD transactions at the end of March, April, and May so that the Bank no longer meets the conditions as referred to in letter a, the Bank does not need to account for initial margin over new contracts from the position of September of that year until the position of August of the following year. Treatment of initial margin already collected in previous periods is adjusted by agreement between both parties.

d. Exchange of initial margin between Banks meeting the conditions as referred to in letter a with counterparties is done after accounting for thresholds as contained in the appendix which is an integral part of this Circular Letter of the Financial Services Authority.

3. Application of Variation Margin Requirements
   Variation margin requirements apply to all Banks conducting NCCD transactions regardless of the notional amount size.

This copy corresponds to the original
Legal Director 1
Legal Department signed
Mufli Asmawidjaja

IV. CLOSING
Provisions in this Circular Letter of the Financial Services Authority take effect on the date of determination.
Determined in Jakarta on October 19, 2023

EXECUTIVE HEAD OF BANKING SUPERVISOR
FINANCIAL SERVICES AUTHORITY
REPUBLIC OF INDONESIA,
DIAN EDIANA RAE signed

APPENDIX
CIRCULAR LETTER OF THE FINANCIAL SERVICES AUTHORITY REPUBLIC OF INDONESIA NUMBER 17/SEOJK.03/2023 CONCERNING MARGIN REQUIREMENTS FOR TRANSACTIONS OF DERIVATIVES NOT CLEARED THROUGH A CENTRAL COUNTERPARTY INSTITUTION

PRINCIPLES IN APPLYING MARGIN REQUIREMENTS
FOR TRANSACTIONS OF DERIVATIVES NOT CLEARED THROUGH A CENTRAL COUNTERPARTY INSTITUTION

TABLE OF CONTENTS
I. PRINCIPLE OF SCOPE OF DERIVATIVE TRANSACTIONS.................................... - 4 -
II. PRINCIPLE OF SCOPE OF PARTIES REQUIRED TO MEET MARGIN
REQUIREMENTS......................................................................................... - 4 -
III. PRINCIPLE OF MINIMUM AMOUNT AND METHODOLOGY FOR
CALCULATION OF INITIAL MARGIN AND VARIATION MARGIN.............. - 6 -
IV. PRINCIPLE OF ASSETS MEETING REQUIREMENTS FOR MARGIN - 8 -
V. PRINCIPLE OF TREATMENT OF RECEIVED MARGINS ................. - 10 -
VI. PRINCIPLE OF TRANSACTIONS WITH AFFILIATES ....................................... - 11 -
VII. PRINCIPLE OF CROSS-BORDER TRANSACTIONS............................................. - 11 -
VIII. PRINCIPLE OF APPLICATION OF MARGIN REQUIREMENTS ............................. - 11 -

I. PRINCIPLE OF SCOPE OF DERIVATIVE TRANSACTIONS

1. Types of derivatives subject to margin requirements in these provisions include:
   a. derivatives with standard contracts that can be cleared through a QCCP in Indonesia; and b. derivatives with non-standard contracts, which are transacted by Banks bilaterally with counterparties without going through a CCP. For transactions as referred to in letter a, margin requirements are applied in the month following the type of derivative transaction is established as capable of being conducted through a QCCP.

2. Specifically, forward and physically settled currency swaps are exempted from initial margin requirements.

3. For cross-currency swap transactions having a portion of principal exchange that is physically settled, initial margin calculation refers to the interest rate portion as per the Initial Margin Calculation Table.

4. Application of variation margin from physically settled derivative transactions remains necessary given that variation margin is essentially risk management in accordance with prudential principles in limiting the increase in systemic risk from OTC derivative transactions.

II. PRINCIPLE OF SCOPE OF PARTIES REQUIRED TO MEET MARGIN REQUIREMENTS

1. Banks must meet margin requirements for NCCD transactions conducted with counterparties consisting of financial service institutions and non-financial entities.

2. Counterparties as referred to in number 1 do not include:
   a. parties included in the category of portfolio receivables to the government according to the Financial Services Authority Circular Letter regarding risk-weighted asset calculation for credit risk using the standardized approach for commercial banks; b. multilateral development banks with a 0% (zero percent) risk weight according to the Financial Services Authority Circular Letter regarding risk-weighted asset calculation for credit risk using the standardized approach for commercial banks; and
   c. Bank for International Settlements.

3. Banks must exchange initial margin for amounts above a certain threshold agreed upon with each counterparty, with provisions:
   a. the threshold is set at a maximum of IDR 60,000,000,000.00 (sixty billion rupiah); b. the threshold is applied at the consolidately grouped level and is based on all NCCD transactions between the two consolidately grouped entities. The provision that the threshold is applied at the consolidately grouped level is intended to prevent proliferation of affiliates and other legal entities with the aim of avoiding margin requirements. Example:
   Bank "B" is involved in separate derivative transactions executed based on separate legally enforceable netting agreements, with 3 (three) counterparties namely "A1", "A2", and "A3". Counterparties "A1", "A2", and "A3" are included in 1 (one) consolidation group. It is assumed that the initial margin requirement is IDR 100,000,000,000.00 (one hundred billion rupiah) for each netting set of Bank "B" with counterparties "A1", "A2", and "A3". Thus, Bank "B" transacting with these three entities must collect initial margin of at least IDR 240,000,000,000.00 (two hundred forty billion rupiah) (IDR 240,000,000,000.00 = IDR 100,000,000,000.00 + IDR 100,000,000,000.00 + IDR 100,000,000,000.00 – IDR 60,000,000,000.00) from counterparties "A1", "A2", and "A3". Allocation of the IDR 60,000,000,000.00 (sixty billion) threshold among 3 (three) netting sets depends on agreement between the Bank and the counterparty. Bank "B" is not allowed to apply a threshold of IDR 60,000,000,000.00 (sixty billion rupiah) for each netting set with "A1", "A2", "A3", so the total initial margin collected is only IDR 120,000,000,000.00 (one hundred twenty billion rupiah) (IDR 120,000,000,000.00 = (IDR 100,000,000,000.00 – IDR 60,000,000,000.00) + (IDR 100,000,000,000.00 – IDR 60,000,000,000.00) + (IDR 100,000,000,000.00 – IDR 60,000,000,000.00));
   c. the requirement to apply the threshold at the consolidately grouped level fully applies to both transacting parties.
   Example:
   In the previous example, Bank "B" has 3 (three) subsidiaries "B1", "B2", and "B3" and each of these subsidiaries is also involved in NCCD transactions with "A1", "A2", and "A3". In this case, the application of the IDR 60,000,000,000.00 (sixty billion rupiah) threshold applies to Bank "B", "B1", "B2", and "B3", so all members of Bank "B"'s group aggregately apply no more than IDR 60,000,000,000.00 (sixty billion rupiah) initial margin threshold for overall transactions with "A1", "A2", and "A3"; and d. in the event that it is not possible to identify NCCD transactions of group members located outside the country, threshold calculation may only be imposed on the consolidation group located in Indonesia.

4. Banks conducting NCCD transactions must exchange variation margin bilaterally without a threshold (zero threshold).

5. Parties may establish a minimum transfer amount (MTA) with an amount not exceeding IDR 600,000,000.00 (six hundred million rupiah) for each margin exchange (initial margin or variation margin).

III. PRINCIPLE OF MINIMUM AMOUNT AND METHODOLOGY FOR CALCULATION OF INITIAL MARGIN AND VARIATION MARGIN

1. Methodology for calculating initial margin and variation margin serving as the basis for determining margin submitted by counterparties:
   a. applies consistently and reflects potential future exposure (initial margin) and current exposure (variation margin) related to the NCCD portfolio; and b. is aimed at ensuring that all counterparty risk exposure is fully protected with a high degree of certainty.

2. Initial Margin Calculation

a. The required initial margin amount is calculated using the standardized margin schedule method, referring to the Initial Margin Calculation Table as follows:

Table 1
Initial Margin Calculation
Derivative Asset Class Initial Margin Requirement (% of Notional Exposure) Credit with duration ≤ 2 years 2 Credit with duration > 2 and ≤ 5 years 5 Credit with duration > 5 years 10 Commodities 15 Equity 15 Currency Exchange 6 Interest Rates with duration ≤ 2 years 1 Interest Rates with duration > 2 and ≤ 5 years 2 Interest Rates with duration > 5 years 4 Others 15 Duration in the table refers to the duration of the instrument listed in the agreement.

b. Minimum initial margin requirements are calculated by referring to the percentages in the Initial Margin Calculation Table by adjusting the gross initial margin amount with the amount related to the net-to-gross ratio (NGR) accounting for all derivative transactions in 1 (one) legally enforceable netting set. The minimum initial margin amount is calculated in 2 (two) steps, namely:

1. the initial margin percentage in the Initial Margin Calculation Table multiplied by the gross notional value of the derivative contract. This calculation is performed for each derivative contract. This amount is called gross initial margin; and
2. the gross initial margin amount is adjusted with NGR using the following formula:
   Net standardized initial margin = 0.4 * gross initial margin + 0.6 * NGR * gross initial margin where NGR is defined as net replacement cost against gross replacement cost for transactions subject to 1 (one) legally enforceable netting agreement. The minimum initial margin requirement amount for a portfolio is equal to the net standardized initial margin amount.

c. In the event that the counterparty to the derivative transaction has no risk (zero counterparty risk), no initial margin is required to be charged and can be excluded from the standardized margin schedule calculation.

d. Initial margin must be calculated and collected at the beginning of the transaction, then collected routinely and consistently based on changes in potential future exposure, for example when transactions are added or removed from the portfolio. Banks must perform revaluation and additional initial margin calculations monthly or faster in the event of material changes.

e. Banks must have adequate dispute settlement procedures in derivative contracts with counterparties before the start of a transaction. The initial margin requirement to be collected from 1 (one) party by the other party is the result of the standardized margin schedule calculation. The specific methods and parameters to be used by each party to calculate initial margin must be agreed upon and recorded at the beginning of the transaction to reduce the potential for disputes. In the event of a dispute regarding margin, both parties must make all necessary efforts adequately, including initiating dispute settlement protocols in a timely manner, to resolve the dispute, and exchange the required initial margin amounts in a timely manner.

3. Variation Margin Calculation

a. Parties must exchange variation margin necessary to guarantee the entire mark-to-market exposure of NCCD transactions.

b. To reduce adverse liquidity disruption and to effectively mitigate counterparty credit risk, variation margin is calculated and exchanged for NCCD transactions subject to 1 (one) legally enforceable netting agreement. Variation margin calculation must be performed daily, with exchange frequency adequate, for example, daily.

c. Valuation of current exposure of derivative transactions tends to be complex and can become a dispute for one or both parties. Relatively illiquid NCCD transactions and lack of price transparency further complicate the process of agreeing on the current exposure amount for variation margin calculation purposes. Therefore, Banks must have adequate dispute settlement procedures in derivative transaction contracts with counterparties before the start of the transaction. In the event of a dispute regarding margin, both parties must make all necessary efforts adequately, including initiating dispute settlement protocols in a timely manner, to resolve the dispute, and exchange the required variation margin amounts in a timely manner.

4. Netting agreements used by parties conducting NCCD transactions must be effective under the law of the relevant jurisdiction and supported by regularly updated legal opinions.

IV. PRINCIPLE OF ASSETS MEETING REQUIREMENTS FOR MARGIN

1. Assets used to meet initial margin and variation margin requirements must meet the following requirements:
   a. can be liquidated within a reasonable timeframe so as to generate sufficient amounts to protect the receiving margin entity from losses in NCCD transactions when the counterparty defaults; b. assets are liquid and maintain their value under financial stress conditions after accounting for appropriate haircuts. Consideration must be given to conditions where assets that are liquid under normal market conditions can quickly become illiquid during financial stress;
   c. assets are not exposed to excessive credit and market risks, including when there is a difference between the currency of the margin and the currency of the transaction settlement. In the event that the value of the assets is affected by said risks, risk-sensitive haircuts must be applied;
   d. asset values do not show significant correlation with the creditworthiness of the counterparty or the underlying value of the NCCD portfolio which could reduce the effectiveness of protection provided by margin (wrong way risk). Thus, securities issued by the counterparty or related entities of the counterparty cannot be accepted as margin; and e. received margins are prioritized to be adequately diversified and not overly concentrated on 1 (one) issuer, specific issuer type, or specific asset type.

2. Types of assets meeting requirements include the following:
   a. cash; b. demand deposits, savings, or time deposits issued by the transacting Bank;
   c. gold;
   d. Government Securities (SUN) issued by the Government of the Republic of Indonesia including state bonds and treasury bills as referred to in the Law regarding government securities; e. Indonesian Government Sukuk (SBSN) as referred to in the Law regarding sukuk securities; f. Bank Indonesia Certificates (SBI) and Sharia Bank Indonesia Certificates (SBIS); g. covered bonds meeting requirements according to the Financial Services Authority Circular Letter regarding risk-weighted asset calculation for credit risk using the standardized approach for commercial banks which have ratings and are rated by rating agencies recognized by the Financial Services Authority with a minimum rating equivalent to BBB-; and/or h. securities with ratings and are rated by rating agencies recognized by the Financial Services Authority with a minimum rating:

1. equivalent to BBB- if issued by parties included in the coverage category of portfolio receivables to foreign governments;
2. equivalent to BBB- if issued by parties included in the coverage category of portfolio receivables to public sector entities;
3. equivalent to BBB- if issued by parties included in the coverage category of portfolio receivables to multilateral development banks and international institutions;
4. equivalent to BBB- if issued by parties included in the coverage category of portfolio receivables to banks;
5. equivalent to A- if issued by parties included in the coverage category of portfolio receivables to corporations; or
6. equivalent to A-2 for short-term securities.
   Establishment of portfolio categories according to the Financial Services Authority Circular Letter regarding risk-weighted asset calculation for credit risk using the standardized approach for commercial banks.

3. Types of assets that can serve as margin consider the types of margins accepted in transactions with CCPs in Indonesia.

4. In the event that the Financial Services Authority assesses that assets used as margin do not meet requirements in number 1, said assets must be replaced with other assets meeting requirements.

5. Haircut calculation refers to the Schedule-Based Haircut Table as follows:

Table 2
Schedule-Based Haircut
Asset Class Haircut (% of Market Value)
Cash and cash equivalents in the same currency 0 Securities issued by governments and central banks with remaining maturity ≤ 1 year 0.5

Asset Class
Haircut
(% of Market Value)
Government and central bank securities with remaining maturity > 1 year and ≤ 5 years Government and central bank securities with remaining maturity > 5 years 4 Securities other than those issued by government and central banks or covered bonds with remaining maturity ≤ 1 year Securities other than those issued by government and central banks or covered bonds with remaining maturity > 1 year and ≤ 5 years Securities other than those issued by government and central banks or covered bonds with remaining maturity > 5 years Gold 15 Additional haircut for assets where the currency of the derivative liability differs from the margin currency 8

6. Margin may be denominated in the currency in which payment of the liability is made in the NCCD transaction or in a foreign currency with high liquidity with an appropriate haircut to reflect the inherent exchange rate risk.

7. In the event of a dispute regarding the value of eligible margin, both parties must make all necessary adequate efforts, including initiating timely dispute resolution protocols, to resolve the dispute, and exchange the required margin in a timely manner.

8. Assets provided to meet margin requirements may be needed for other purposes by the margin provider before the end of the derivative transaction contract. For this purpose, margin may be replaced or exchanged during both parties agree to the substitution and the substitution is carried out in accordance with the provisions applicable in the agreement between the two parties. Alternative assets must meet all the above requirements and have sufficient value to meet the margin requirements after the application of the haircut.

V. PRINCIPLES OF TREATMENT OF RECEIVED MARGIN

1. Given that the exchange of initial margin on a net basis may not be sufficient to protect both market participants with large gross derivative exposures to each other in the event of default, the exchange of initial margin must be done on a gross basis.

2. Received initial margin must be stored in such a way as to ensure that:
   a. the received margin is immediately available to the margin recipient if the counterparty defaults; and b. the received margin must be subject to arrangements that legally protect the margin provider in the event that the margin recipient becomes bankrupt.

3. Agreements regarding margin as referred to in item 2 must be legally effective under relevant law and supported by regularly updated legal opinions.

4. Assets received as initial margin or variation margin cannot be rehypothecated or reused.

VI. PRINCIPLES OF TRANSACTIONS WITH AFFILIATES

1. The application of margin requirements as referred to in this Circular of the Financial Services Authority does not apply to NCCD transactions conducted by Banks with affiliates.

2. In the event that an affiliate is an entity outside the country, transactions between the Bank and its affiliate must be subject to regulations consistent with the legal framework and regulations of each respective jurisdiction.

3. Transactions with affiliates refer to the standards of financial accounting regarding the disclosure of related parties.

VII. PRINCIPLES OF CROSS-BORDER TRANSACTIONS

The application of margin requirements as referred to in this Circular of the Financial Services Authority does not apply to NCCD transactions conducted by:

1. Bank subsidiaries outside the country; or
2. offices outside the country as referred to in the Financial Services Authority Regulation regarding commercial banks.

VIII. PRINCIPLES OF APPLICATION OF MARGIN REQUIREMENTS

1. In calculating the aggregate average notional amount of NCCD transactions as the basis for determining the Bank's obligation to account for initial margin, the Bank must account for the notional amount of all NCCD transactions conducted by the Bank on a consolidated basis, including transactions excluded from the application of margin requirements as referred to in this Circular of the Financial Services Authority such as physically settled forward and swap transactions.

2. Initial margin requirements apply to new NCCD transaction contracts agreed upon by the parties after the implementation of the obligation to apply margin requirements as referred to in this Circular of the Financial Services Authority. Thus, there is no requirement for initial margin for NCCD transaction contracts that already existed before the aforementioned period.

3. Variation margin requirements apply to new NCCD transaction contracts agreed upon by the parties after the implementation of the obligation to apply margin requirements as referred to in this Circular of the Financial Services Authority. The exchange of variation margin for other contracts follows the bilateral agreements agreed upon by both parties.

This copy is consistent with the original
Legal Director 1
Legal Department signed
Mufli Asmawidjaja

4. General amendments to existing contracts are not classified as new derivative contracts. However, amendments to extend contracts with the purpose of avoiding margin requirements must be classified as new derivative contracts and subject to the obligation to apply margin requirements as referred to in this Circular of the Financial Services Authority.

Determined in Jakarta on October 19, 2023

EXECUTIVE HEAD OF BANKING SUPERVISOR
FINANCIAL SERVICES AUTHORITY
REPUBLIC OF INDONESIA,
DIAN EDIANA RAE signed