Responding Institution: PT Kliring Penjaminan Efek Indonesia. Jurisdiction(s) in which the FMI Operates: Republic of Indonesia

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2 Responding Institution: PT Kliring Penjaminan Efek Indonesia Jurisdiction(s) in which the FMI Operates: Republic of Indonesia Authority Regulating, Supervising or Overseeing the FMI: Indonesia Financial Services Authorities The date of this disclosure is December This disclosure can be found at For further information, please contact our hotline at or KPEI (5734) 2

3 I. Executive Summary PT Kliring Penjaminan Efek Indonesia (KPEI) was established based upon the Capital Market Law No. 8/1995 to provide orderly, fair, and efficient clearing services and transaction settlement guarantee. KPEI was established as a limited liability company by the Deed of Establishment No. 8 on August 5th, 1995, in Jakarta. KPEI is owned entirely by PT Bursa Efek Indonesia, the national regulated exchange, as manifested by the total shares valued at Rp15 billion. KPEI was granted the status of the legal entity on September 24th, 1996, an action made legal by the Ministry of Justice of the Republic of Indonesia. Two years afterwards, on June 1st, 1998, the corporation was granted its commercial permit to operate as a Clearing and Guarantee Institution, based on the Bapepam Decision Letter No. Kep-26/PM/1998. PT Kliring Penjaminan Efek Indonesia is a self-regulatory organization (SRO), and plays a central role in shaping the direction of Indonesian capital market development. As a Central Counterparty (CCP) to trade transactions, KPEI provides for clearing and guarantee services of stock exchange transactions settlement. KPEI functions to improve efficiency and provide certainty for trade transactions settlement for bargains on Indonesia Stock Exchange (IDX). KPEI performs clearing process to determine clearing members (CMs) rights and obligations in terms of securities and/or cash which must be settled on settlement date. As a CCP, KPEI is the only seller for every buyer and the only buyer for every seller for every transaction settlement over every investment instrument that is traded in the stock exchange. This is possible by means of netting clearing process through novation. As a Clearing and Guarantee institution, KPEI provides services that mitigate any counterparty risk that might arise from stock exchange transactions settlement. II. Summary of Major Changes since the Last Update of the Disclosure This is KPEI s first PFMI disclosure document. III. General Background on KPEI General Description of KPEI and the Markets It Serves On August 5th, 1996, the Jakarta Stock Exchange (JSX) and Surabaya Stock Exchange (SSX) established Indonesia Clearing Guarantee Corporation named PT Kliring Penjaminan Efek Indonesia (KPEI) with shareholdings of 90% and 10%, respectively, and paid-up capital of Rp15 billion. KPEI then registered as legal entity, confirmed by the ratification from the Minister of Justice of the Republic of Indonesia on September 24th, On June 1st, 1998, the Supervisory Agency of Capital Market (Bapepam) officially published the Operational Permit for KPEI as Clearing and Guarantee Institution (LKP) by Decree No: Kep 3

4 26/PM/1998. Following the merger of JSX and SSX to be incorporated to Indonesia Stock Exchange (IDX), thus the 100% shareholding of KPEI is owned by IDX. KPEI s role in the capital market industry is to conduct clearing and guarantee function of the securities transaction settlement. The clearing process is carried out to determine that every Clearing Member (CM) understands their rights and obligations to be completed on the settlement date. While the guarantee function in completing the securities transaction is to ensure the fulfillment of CM s rights and obligations occurred from the transaction. Indonesia Capital Market Structure Picture 1. Organizational Structure Picture 1. Indonesia Capital Market Structure Governance Structure of KPEI KPEI is governed by its board of directors and board of supervisors, a two-level oversight structure inherited from Dutch colonial days. The authorizations and responsibilities of both bodies are documented. The overseers of KPEI come from the exchange, private sector and public bodies, assuring that the direction of the infrastructure meets both commercial and public good requirements. Exchange groups have that dual function, and this is embedded in the governance set-up. These persons bring diverse experience to the tasks before these bodies, and they are properly vetted. When required, these bodies can elect to take advice from outside experts. They are held liable for their decisions in overseeing KPEI. Meetings are held monthly in Jakarta, and directors performance is evaluated. Questions of business risk and development are aired. In conducting its supervisory functions, the Board of Commissioners is assisted by the Audit Committee to encourage the sound Company management in line with the CG principles. In performing its duties, the Audit Committee works closely with the Board of Directors, Credit Policy and Risk Management Committee, Internal Audit and External Auditors. 4

5 The audit committee reports directly to the board, not to senior management of KPEI. The roles and responsibilities of the management team are defined. The chief executive officer position is separated from that of the chairman. To enhance the accountability and the responsibility of every Company operations plan, as well as to assist the Board of Directors in decision-making process, the Board of Directors established the committees with specific duties and authority, which are responsible to the Board of Directors. These committees include Credit Policy and Risk Control, Haircut Committee, and Investment Committee. Product Coverage Stock Exchange Transaction Clearing and Settlement Services Clearing process is the process of determining the rights and obligations of Clearing Member (CM) that occurred from exchange transactions conducted in Indonesia Stock Exchange (IDX). Results of clearing activities is Clearing Result List (CRL). This CRL will be sent to CM as a receivable upon the carried out transactions and must be settled within the settlement period. Each of securities products has different methods of clearing and settlement period. Clearing and settlement services based on type of transaction was explained as follows: a. Clearing and Settlement of Stock Transaction There are two methods of clearing for stock transactions namely netting and per-transaction. These applications of two methods were distinguished by the type of market. Netting method was intended for stock transactions in regular and cash market, in which regular market had settlement period of up to 3 trading days upon time of transaction (T+3) and cash market had settlement period on the same day of trading day (T+0). While per-transaction method is used for stock transactions in negotiable market whose settlement period had up to 3 trading days upon time of transaction (T+3). Implementation of Straight Through Processing mechanism since 2012 has enabled the process of stock transactions clearing and settlement can be executed up to client level. KPEI utilize a web-based system called the Electronic Clearing and Guarantee System (e- CLEARS) to conduct all process of stock transactions clearing and settlement. b. Clearing and Settlement of Derivative Transactions The derivative product which can be transacted in IDX are Index Futures (KBIE) and Stock Options (KOS). Clearing and settlement of both products transaction currently were conducted by involving Payment Bank up to the CM level. Clearing for derivative transactions carried out by netting method. Derivative transactions was conducted in regular market with settlement period up to 1 trading day from the transaction day (T+1). Clearing of derivative transactions was processed with Risk Monitoring Online (RMOL) system and its settlement was processed using Cash Management (CM) system. Both systems worked through desktop based technology. c. Clearing and Settlement of Bonds Transactions KPEI strongly support bonds trading and transactions conducted by IDX. There were two types of market provided for bonds transactions, namely regular market with settlement period up to 2 trading days from the day of transaction (T+2) and negotiable market with settlement period of 1 to 7 trading days from the day of transaction (T+1 to T+7). Clearing for bonds is conducted by a 5

6 system named Electronic Bonds Clearing and Guarantee System (e-bocs), for both netting and per-transaction method. In addition, the system was also used related to confirmation and affirmation of settlement process, as well as the tax administration. Guarantee and Risk Management Services KPEI s guarantee function mean to provide assurance of CM rights and obligations that occurred from exchange transactions. Provisions regarding Exchange Transaction Settlement Guarantee experienced an improvement in 2014, in which protected by OJK Regulation No. 26/POJK.04/2014 regarding the Exchange Transaction Settlement Guarantee. In performing this function, KPEI employ systems and tools of risk control, named by e-clears and risk management system called RAZOR. Through a proper and prudent implementation of risk management principles, KPEI look forward to provide best, safe and attractive service thus increasing confidence of the investors upon the Indonesian capital market. Securities Borrowing and Lending Services Basically, Securities Borrowing and Lending (SBL) is to shift (lending) temporary rights of use on securities from lenders to borrowers in a certain period. This facility provide benefits for its users, including assistance in fulfilling the needs of securities handover in exchange transaction s settlement, as well as in supporting transaction strategy of short selling, margin trading, and as additional income for long-term investment. The transaction process up to the settlement of SBL products is conducted using e-clears system and Front End SBL applications. Collateral Management Services KPEI provide collateral management services in the form of cash and stock owned by the CM and its clients. The collateral from CM, managed by KPEI as the collateral upon the liability of Exchange Transaction Settlement either for CM or CM s client. Meanwhile the collateral placed by CM s client is as the guarantee upon the liability of Exchange Transaction Settlement from CM s clients. Collateral consists of Online Collateral, which is stored in the collateral account, recorded electronically namely cash, stocks, bonds, and Offline Collateral which come in the form of bank guarantees, deposits, certificates of Bank Indonesia, the minimum cash funds, and stock exchanges. The total value of offline collateral and online collateral is used as base of the calculation of trading limit from each CM. Information Services a. Member Interface (MI) MI helped CM to obtain a comprehensive and integrated information related to the CM s activities, in alignment with KPEI s function to conduct the stock exchange transactions clearing and settlement. MI application was developed based on flow process of Straight Through Processing (STP). b. Mobile Clearing and Guarantee System (m-clears) m-clears was short message service delivered to mobile phone regarding various information of clearing and guarantee. m-clears services can be obtained in Alert mode or On Request mode. The client can set the options accordingly to their needs. 6

7 Customer Care KPEI Customer Care KPEI is a one-stop service that provides information regarding KPEI s products and services, as well as to provide answer to a questions, to receive feedback, and complaints from by users and also stakeholders. Participants of KPEI KPEI has only one participant, namely Clearing Member (CM). At the end of 2014, there were 109 active members and 8 suspended members. Risk Management Framework The risks that KPEI faces include liquidity risk, counterparty risk, as well as reputational, operational, legal, and general business risks. Most of these risks are identified, assessed, managed under the Enterprise Risk Management Framework. Counterparty risk management relating to clearing members is handled by the Risk Management Division. The risk management framework is reviewed every year. Both positive and negative incentives are in place to encourage clearing members to contain the risks they pose to KPEI. The e-clears system and the Member Interface provide clearing members with comprehensive information to enable them to monitor and manage their own credit and liquidity risks. KPEI closely monitors its own liquidity reserves and financial strength, and has controls and procedures in place, as well as disaster recovery and business continuity plans, to manage its own operational risk. Exposures to clearing members are managed by collecting margin deposits prior to trade execution, requiring NAWC daily maintenance and reporting, and adjusting the trading limit. Business continuity plans have been established to cope with scenarios that may potentially prevent the organization from providing its core services. A resolution plan is still to be developed. Operational Reliability KPEI, as a CCP has primary operational objectives to provide via e-clears, its clearing and services on each business day as scheduled and to ensure that system recovery can be achieved within two hours following a disruption to KPEI s critical functions, under specific contingency scenarios. Legal and Regulatory Framework The clear and well-founded legal bases of a market infrastructure institution are critical, and should have a heavy weighting in a CPMI-IOSCO self-assessment. Law is fundamental for securities markets. For KPEI, law and presidential decree have the highest position in terms of relevance, followed by regulation issued by the OJP and then KPEI s own rules. The capital markets authority does review all KPEI rules, investing them with legitimacy; and market consultations are conducted for rule changes. As is true in many other jurisdictions, most of the overall legal and regulatory framework has been built up over the years in different pieces and circumstances, as is perfectly normal for infrastructures. KPEI has documented these bases. 7

8 Most but by no means all critical concepts for operating a central clearing house are to be found in the documents presented. Much is implied, or derived from a different part of the law contracts, for example, which do provide a sense of implicit legal backing for ownership of securities. These other parts of the law were not explicitly written for the securities markets environment, but they do provide some assurance. KPEI s business is almost entirely based in Indonesia, and therefore only the Indonesian legal and regulatory framework is immediately pertinent. Indonesia is a G20 country, and with that status come the responsibilities of leading on the implementation of high global standards. System Design and Operations KPEI has developed and implemented its own system, which are e-clears to support clearing and settlement for equity market, RMOL to support clearing and settlement for derivative market, and e- BOCS to support clearing and settlement for fixed income market. KPEI also provides risk management system through RAZOR to support guarantee services. Member Interface is also provided as the integrated tools for CM to update the information regarding CM s position and collateral. CM can simulate their own position and collateral through this system. As a CCP Exchange Trades All of Equities Exchange Trades (100%) on regular market are cleared under the e-clears System. Trade Capture, Novation and Netting IDX transmits details of Exchange Trades directly from its trading system (JATS) to e-clears system in batching. KPEI performs clearing process to determine clearing members (CMs) rights and obligations in terms of securities and/or cash which must be settled on settlement date. As a CCP, KPEI is the only seller for every buyer and the only buyer for every seller for every transaction settlement over every investment instrument that is traded in the stock exchange. This is possible by means of netting clearing process through novation. Securities Settlement under the C-Best System Settlement of e-clears Positions is on a T+3 basis. All securities settlements are effected through bookentry transfers between stock accounts in KSEI. CMs with Positions can deliver securities to KPEI by inputting delivery instructions or through multiple batch settlement. KPEI as a clearing house is not responsible for the final settlement of securities in the market. The CCP relies on KSEI, the CSD, to conduct the actual delivery-versus-payment (DvP) settlements. All trades cleared by KPEI are settled on a DvP basis: the final settlement of cash obligation takes place only if the final settlement of the linked securities obligation occurs. 8

9 Money Settlement under Payment Banks KPEI uses the payment banks appointed by KSEI to settle cash. KSEI has designated five local banks as payment banks, through which all funds settlement must take place. 9

10 IV. Principle-by-principle Summary Disclosure Principle 1: Legal basis An FMI should have a well-founded, clear, transparent, and enforceable legal basis for each material aspect of its activities in all relevant jurisdictions. Overview 1.1 In KPEI, law and presidential decree have the highest position in terms of relevance, followed by regulation issued by the OJK and then KPEI s own rules. 1.2 The capital markets authority does review all KPEI rules, investing them with legitimacy; and market consultations are conducted for rule changes. 1.3 Most of the overall legal and regulatory framework has been built up over the years in different pieces and circumstances, as is perfectly normal for infrastructures. 1.4 Most critical concepts for operating a central clearing house are to be found in the documents presented. Material Aspects 1.5 The material aspects of KPEI s activities that require legal certainty are: a. Operational Permit as an institution providing clearing guarantee services b. Rights and Interest in financial instruments c. Netting d. Novation e. Settlement finality f. Dematerialisation g. DVP arrangement h. Collateral arrangements for the guarantee fund and margin i. The procedures and the recovery in the event of default Legal Soundness 1.6 KPEI complies a well-founded, clear, transparent, and enforceable legal basis for each material aspect by providing documents as follows: a. An institution providing clearing guarantees to the regulated marketplace is cited in the Capital Market Law of b. The rights and interests in financial instruments are provided in national law and by presidential decree as well as regulation. c. Netting is defined by Regulation III.A.10, published in December

11 d. Novation should also be covered explicitly by law. Novation is covered in contract enforceability, which comes in the Indonesian Civil Code. e. Collateral arrangements for the guarantee fund and margin are covered by a regulation, not law. These are cited in KPEI Rule II-5. One sees references to dematerialised collateral in KPEI II-10, which is mislabelled a regulation when in fact it is a rule of the clearing house. KPEI Rule II-12 updates the concepts of collateralisation. f. Default procedures is covered by law, though not explicitly in the capital markets context 11

12 Principle 2: Governance An FMI should have governance arrangements that are clear and transparent, promote the safety and efficiency of the FMI, and support the stability of the broader financial system, other relevant public interest considerations, and the objectives of relevant stakeholders. Governance of KPEI 2.1 The FMI s objectives cover all the key areas of the organization s activities. The objectives include targets in the following material aspects: participant satisfaction, financial stability, risk management, service efficiency, system efficiency and effectiveness. 2.2 The instruments used by the FMI to measure performance include: financial indicators, key performance indicators (non-financial data, settlement statistics, etc.), qualitative assessments, participant feedback. 2.3 KPEI is governed by its board of directors and board of supervisors, a two-level oversight structure inherited from Dutch colonial days. The authorizations and responsibilities of both bodies are documented. 2.4 The overseers of KPEI come from the exchange, private sector and public bodies, assuring that the direction of the infrastructure meets both commercial and public good requirements. Exchange groups have that dual function, and this is embedded in the governance set-up. These persons bring diverse experience to the tasks before these bodies, and they are properly vetted. 2.5 Meetings are held monthly in Jakarta, and directors performance is evaluated. Questions of business risk and development are aired. The audit committee reports directly to the board of supervisors, not to board of directors of KPEI. 2.6 The roles and responsibilities of the management team are defined. The chief executive officer position is separated from that of the chairman. 2.7 The FMI s board of directors has an acceptable mix of skills. This implies that the organization can rely on its members of the board s experience and background to provide a qualified view on the functioning of the FMI. 2.8 The roles and responsibilities of the management team are clearly defined in the KPEI charter and in job descriptions. The objectives of the FMI s management team are decided by the board of directors by itself. 2.9 The performance of the FMI s management team is assessed using key performance indicators (KPI), financial results, systems uptime, and a qualitative assessment. The management team assessment takes place every quarter 12

13 2.10 The management team of the FMI uses the following mechanisms to gather the views and thoughts of the participants (direct and indirect) and stakeholders: public consultation processes, participant/user survey, user group, informal channels (networking, social media, word-of-mouth, etc). The Board of Directors uses a range of mechanisms to gather the views and thoughts of the direct and indirect participants and stakeholders. These mechanisms include informal channels (networking, social media, word-of-mouth, etc) The FMI discloses its major decisions to participants, shareholders and the general public during its general meetings, both annual and extraordinary. It uses newsletters and s, its website, direct mail, and local media channels. 13

14 Principle 3: Framework for the comprehensive management of risk An FMI should have a sound risk-management framework for comprehensively managing legal, credit, liquidity, operational, and other risks. Risk Management Framework 3.1 KPEI has relatively clear lines of responsibility to identify and assess risks. a. Board of Commissioners Audit Committee; b. Board of Directors -- Credit Policy and Risk Management Committee, Haircut Committee, and Internal Audit; c. Risk Management Division -- Guarantee Funds and Collateral Management Unit, Risk Analysis Unit, and Risk Monitoring Unit. 3.2 KPEI has adopted the Enterprise Risk Management (ERM) Framework as its overall framework for identifying, assessing, controlling, communicating and monitoring risks. The risk management framework is reviewed once a year. The risks that arise in or are borne by KPEI include: a. Liquidity risk The risk that KPEI fails to meet its cash flow obligations when they become due because of difficulty to liquidate assets or to obtain sufficient funding. KPEI is exposed to liquidity risks posed by margin and guarantee fund collected from clearing members, and its proprietary investments. b. Counterparty/credit risk The risk that a counterparty defaults on its contractual obligations leading to a financial loss to the KPEI and / or its clearing members. KPEI s credit exposures mainly arise from the clearing services provided to clearing members in its role as the central counterparty. c. Reputational risk d. Operational risk e. Legal risk f. General business risk 3.3 Under the ERM framework, KPEI identifies risks by: audit (internal/external), processes and procedures analysis, and feedback from participants. The scope of the identification and documentation of risk exposures and controls is wide (all areas, processes and procedures are covered). 3.4 The risk management tools used at KPEI include: risk registrar, specialised software, and risk matrix. Less than 25% of risk controls are manual. The manual intervention mainly arises from the checking of physical securities. 14

15 Risk Management Disclosures, Policies, and System 3.5 KPEI advises participants of key risk-related information concerning the business/operations of KPEI via: the website, annual reports, newsletters, contract, e-clears and Member Interface, as well as education & training programmes. 3.6 KPEI also operates a Member Interface, which provide clearing members with comprehensive information related to their positions, trading limits, and collateral from the risk management system (Razor). This provides the data that clearing members need for their own risk monitoring and management. The main facilities supported by Member Interface include: Clearing & Settlement; Collateral Management; Risk Management; and Securities Lending & Borrowing. 3.7 KPEI offers training sessions for clearing members in order to enhance their understanding of the technical details of the CCP operations. The training sessions cover a wide range of topics including the calculation of NAWC (Net Adjusted Working Capital) and trading limit, margin model, clearing and settlement based on netting per counter Single Investor ID (NPC-SID), etc. 3.8 KPEI has put negative incentives in place for participants and, where relevant, their clients to monitor and manage the risks they pose to the CCP. KPEI may change a member s risk profile, and recommend financial penalties or suspension of clearing to IDX when the member fails to manage and monitor its risk at a level that is acceptable by the CCP. 3.9 If the event of a default, KPEI shall impose sanctions set out in KPEI Rule II-8 and report the default to IDX and the regulator. Sanctions may be imposed on conditions other than a default event, including a failure to pay the Guarantee Fund or the administration fees and interests. The sanctions may take the form of the following: a. Written Reprimand; b. Written Reprimand plus a fine; c. Administration fees; d. Suspension of clearing; e. Revocation of clearing membership. With regard to the second type of sanction, for the first written reprimand, KPEI shall charge a fine up to IDR 2.5 million and / or request IDX to suspend the member from trading for up to ten trading days; for the second written reprimand, the maximum fine will rise to IDR 5 million and the suspension of trading can be as long as 20 trading days; the third written reprimand shall remain valid for one year and any further violation will lead to freezing of both the trading and the clearing membership. KPEI will charge an administration fee to the defaulting clearing member. The fee equals 0.25% of the default value for each calendar day until settlement of the default (30 calendar days at maximum) KPEI closely monitors its own liquidity reserves and financial strength, and has controls and procedures in place, as well as disaster recovery and business continuity plans, to manage its own operational risk. Exposures to clearing members are managed by collecting margin deposits prior to trade execution, requiring NAWC daily maintenance and reporting, and adjusting the trading limit. 15

16 3.11 Clearing members can receive a variety of reports on the clearing and guarantee processes via Member Interface system and e-clears system. The main facilities supported by e-clears include: Clearing & Settlement; Collateral Management; and Securities Lending & Borrowing. Recovery and Wind-down Plan 3.12 KPEI identifies scenarios that may potentially prevent the organization from providing its core services. a. Natural disasters, including but not limited to: earthquakes, floods, and fires. b. Security problems, social, political, including but not limited to: the threat of a bomb explosion, and riots. c. Technical problems in the system or IT services that affect business processes or services of KPEI. d. Technical problems in the IDX trading system and / or KSEI Depository and Settlement system KPEI has plans in place for business continuity. The recovery process includes the following steps: a. Implementation of the action plan after activation of BCP / DRP. b. Mobilisation of resources for recovery of critical business processes. c. Recovery of business processes in accordance with a predetermined recovery strategy With regard to resolution (orderly wind-down of an FMI), KPEI s owner, IDX would inject more capital into KPEI in case that KPEI becomes insolvent. Such parental guarantee would provide critical financial support to the CCP in times of crisis. KPEI shares its recovery plans with the authorities, which are subject to annual review. 16

17 Principle 4: Credit risk An FMI should effectively measure, monitor, and manage its credit exposure to participants and those arising from its payment, clearing, and settlement processes. An FMI should maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence. In addition, a CCP that is involved in activities with a more-complex risk profile or that is systemically important in multiple jurisdictions should maintain additional financial resources sufficient to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the two largest participants and their affiliates that would potentially cause the largest aggregate credit exposures to the CCP in extreme but plausible market conditions. All other CCPs should maintain, at a minimum, total financial resources sufficient to cover the default of the one participant and its affiliates that would potentially cause the largest aggregate credit exposures to the CCP in extreme but plausible market conditions. Credit Risk Framework 4.1 KPEI s credit risk management framework consists of membership requirements, margin collection, trading limit, alternate cash settlement, and guarantee fund arrangements. KPEI s main credit exposures are from clearing members and payment banks. 4.2 KPEI s Risk Management Division reviews and updates the framework annually as well as on an adhoc basis if circumstances warrant. An ad-hoc review / update can be triggered by changes in market conditions, changes in market practices, or introduction of new cleared products. The regulator (OJK) and the KPEI s internal auditors are involved in the review of the framework. The review by OJK and internal auditors also take place once a year. 4.3 KPEI has credit exposures to the following entities: Clearing members; Settlement banks and other banks; Stock loans counterparties. Sources of credit risk from clearing members include weak financial condition of clearing members, daily and intraday price movements, and large/concentrated positions. Sources of credit risk from banks include cash settlement with clearing members, deposits from clearing members as margin or Guarantee Fund contributions, and KPEI s own cash deposits. Sources of credit risk from stock loan counterparties include margin variation and loan value depreciation. 4.4 With regard to clearing members, a variety of tools have been adopted to control credit risk, including DVP settlement, margin requirements, daily maintenance and reporting of NAWC, and trading limits. KPEI is not involved in the selection of the payment banks and does not perform risk monitoring on these banks. 4.5 The financial resources KPEI collects or maintains to cover the CCP s exposures include variation margin, initial margin, Guarantee Fund, the Credit Ring (replenishments from clearing members), KPEI s own funds, and liquidity facilities provided by a commercial bank. All these financial resources 17

18 can be accessible immediately, except for the Credit Ring which is a requirement for all nondefaulting clearing members to replenish the Guarantee Fund within 30 days. 4.6 KPEI determines the sufficiency of its financial resources by performing stress testing. The stress tests are carried out on a monthly basis and are based mainly on historical and hypotical scenarios. CP Admission Requirements and Regular Risk Scoring Analysis 4.7 Currently, corporation which is stipulated as Securities Company by OJK, as Exchange Member by IDX, and as Participant by KSEI can be admitted as CMs. OJK and IDX act as front line regulators to supervise and monitor the CMs, while KPEI is responsible for monitoring CMs settlement activities and their compliance with the rules, and KSEI is responsible for custody services. 4.8 KPEI sets CM admission requirements to ensure that the risk profile of each CM meets the required standard, which are regulated in KPEI Rule II-12 regarding Collateral arrangements for the guarantee fund and margin and KPEI Rule II-3 regarding Clearing Member. Mark-to-Market, Margining and Collection of Collateral Marks 4.9 To cover its current credit exposure, KPEI collects Marks for the mark-to-market losses of a CM s open Positions as a result of unfavorable price movements of the underlying stocks prior to settlement. Marks calculation is processed near real time using the latest positions and price information. For further details regarding Marks, please refer to the description under Principle 6: Margin KPEI has the capability to obtain the data and recalculate the measures near real time. With access to the real-time price data on IDX and Bond Pricing Agency, risk management system (Razor) can update trading data, collateral amount, and the resulting trading limit for each account within minutes. Margin 4.11 KPEI adopts a value at risk approach to calculate Margin requirements. Margin is used to cover the future exposure between the last Marks calculation and the projected closing-out price under normal market conditions. Margin calculation is conducted real time using the latest positions and price information. KPEI has the capability to obtain the data and recalculate the measures near real time. With access to the real-time price data on IDX and Bond Pricing Agency, risk management system (Razor) can update trading data, collateral amount, and the resulting trading limit for each account within minutes. In arriving at a CM s Margin requirement, a margin credit up to IDR 1 billion is granted to every CM. A CM will only be required to provide Margin for the amount in excess of the Margin Credit. For further details regarding Margin, please refer to the description under Principle 6: Margin. 18

19 Concentration Collateral 4.12 KPEI requires a CM to provide Concentration Collateral. Frequency of calculation for Concentration Collateral is calculated monthly. For further details regarding Concentration Collateral, please refer to the description under Principle 6: Margin. Guarantee Fund and other Financial Resources Guarantee Fund Contributions 4.13 KPEI maintains a Guarantee Fund to meet its obligations and liabilities as a CCP if losses arising from one or more CM defaults cannot be fully covered by the Marks, Margin and other collateral collected from the defaulting CMs. The Guarantee Fund can also be used as a source of liquid funds to meet any immediate payment obligations of KPEI in relation to a CM default. The Guarantee Fund comes from CMs contributions. Stress Testing Sufficiency of Financial Resources 4.14 The Risk Management Division has the responsibility to conduct the stress tests and to communicate the results to the General Manager and the Board of Directors. There are clear procedures to report the test results to these decision-makers If the stress tests identify a shortfall in the financial resources, KPEI will not make or ask for immediate additional contributions to the Guarantee Fund to fill such a shortfall. The nature of the Guarantee Fund is quite different from a normal default fund of other CCPs. KPEI s Guarantee Fund is accumulated through a standard market charge paid by the end investors (1 basis point of transaction value). Therefore, it is impractical to call for ad-hoc contributions to the Fund unless an event of default occurs. However, KPEI does take immediate action to fill any shortfall in margin through the mechanism of trading limits On a monthly basis, the assumptions and parameters used in the stress testing are examined. Currently, KPEI does not perform such examination on an ad hoc basis. Further, a full validation of the risk management model is carried out every year. The method, model, and parameters used to determine the size of the guarantee fund is reviewed by the Risk Management Division and the General Manager, and then reported to and approved by the Board of Directors. Use of Guarantee Fund and other Financial Resources the Waterfall 4.17 In the event of a CM default, KPEI will first use the available non-pooled resources, such as Marks, Margin and other forms of collateral collected from the defaulting CM to cover any default loss. Thereafter, KPEI will apply other financial resources in accordance with OJK regulation no 26 (article 21). Please refer to the description under Principle 13: Participant-default Rules and Procedures. 19

20 Allocation of Default Losses and Replenishment/Repayment Arrangements 4.18 The replenishment of resources is stipulated by: a. KPEI rule No.II-4 Guarantee Fund and Additional Guarantee Fund b. KPEI rule No.II-14 Credit Ring Allocation of credit losses and the order in which the financial resources will be utilised are stipulated by: a. OJK Regulation No ; b. KPEI rule No.II-4 Guarantee Fund and Additional Guarantee Fund; c. KPEI rule No.II-5 Clearing and Settlement of Equity Securities; d. KPEI rule No.V-1 Clearing and Transaction Settlement Guarantee of Debt; e. KPEI rule No. III Future Transaction Clearing And Settlement Guarantee; f. KPEI rule No. IV Stock Option Transaction Clearing and Settlement Guarantee. 20

21 Principle 5: Collateral An FMI that requires collateral to manage its or its participants credit exposure should accept collateral with low credit, liquidity, and market risks. An FMI should also set and enforce appropriately conservative haircuts and concentration limits. Acceptable Collateral 5.1 KPEI considers liquidity, credit risk, volatility, availability of reliable and timely market prices, and the ease with which security interest can be perfected when determining the list of acceptable collateral. 5.2 Eligible collateral is classified into two categories: online collateral and offline collateral. Online collateral includes cash bonds, stocks, while offline collateral includes time deposits, bank guarantees and certain money market instruments. Valuation and Haircut 5.3 KPEI normally marks its collateral to market on a daily basis using price data from IDX and Bond Pricing Agency. Mark-to-market can be conducted intra-day in times of high volatility. KPEI has the right to value assets differently from the market when market prices do not represent the true value. This right is stipulated in KPEI Rule II As regards online collateral, non-idr cash is subject to a cross-currency haircut. Bond haircuts are based on credit rating, with a 0% haircut for government securities and a 20% haircut for BBB rated corporate bonds; stocks are grouped into eight categories and haircuts vary by category. This categorisation is based on a weighted average score calculated for each stock. KPEI scores each stock on its transaction data (volatility, volume, and trading frequency) and the issuer s fundamental data (equity, net income, price-to-earnings ratio and return-on-equity ratio). Stocks fall under the first category will be subject to a haircut of 5%-40%, while a 100% haircut will apply to the eighth category. When determining the value of stock collateral, KPEI will use the lowest price of that stock during the last four days, and then multiply it by (1 haircut). 5.5 KPEI has established a Haircut Committee which reviews and updates the haircuts for stocks monthly. Members of the Haircut Committee include representatives from clearing members, Directors of IDX, KPEI, KSEI and capital market experts. KPEI takes a conservative approach in setting haircuts. A wide range of fundamental and statistical data is taken into account. 5.6 To mitigate concentration risk, KPEI sets limits on each type of online collateral that clearing members can post. For stocks, one clearing broker can post no more than 10% of the total scriptless shares of a listed company to the CCP. 21

22 Cross-border (or Foreign) Collateral 5.7 KPEI does not accept cross-border collateral other than cash and time deposits in USD and SGD. The exchange rates used for these currencies are the rates published by the Directorate General of Taxation. Foreign exchange risk is taken into account by the imposition of a cross-currency haircut. At present, this haircut is set at 5%. Collateral Management System 5.8 KPEI has a set of collateral management systems, composed of e-clears, ARMS & Razor. KPEI operates e-clears for online collateral and ARMS for offline collateral, and both of them are supported by Razor. 22

23 Principle 6: Margin A CCP should cover its credit exposures to its participants for all products through an effective margin system that is risk-based and regularly reviewed. Marks 6.1 To cover its current credit exposure, KPEI collects Marks for the mark-to-market losses of a CM s open Positions as a result of unfavorable price movements of the underlying stocks prior to settlement. Marks calculation is processed near real time using the latest positions and price information. Margin 6.2 KPEI adopts a value at risk approach to calculate Margin requirements. Margin is used to cover the future exposure between the last Marks calculation and the projected closing-out price under normal market conditions. Benchmark Margin Rate (Benchmark Rate) 6.3 KPEI determines the Benchmark Rate with reference to the projected volatility of daily closing of the 99% of confidence level for all cleared products. Two-tailed confidence interval of 99% (2.33 standard deviations) using an exponentially weighted moving average model with reference to a historical data period of 505 days. A five-day close-out period is assumed in the model. Concentration Collateral 6.4 KPEI requires a CM to provide Concentration Collateral. Frequency of calculation for Concentration Collateral is calculated monthly. For further details regarding Concentration Collateral, please refer to the description under Principle 6: Margin. Price Data for Marks, Margin and Collateral Calculations 6.5 The sources of price data for the margin system of KPEI are: a. For on-exchange equity products, the real-time traded prices on IDX; b. For bonds, the daily prices provided by a third-party. 6.6 This third party price provider for bonds is the Indonesia Bond Pricing Agency (IBPA). IBPA was established under Bapepam-LK Regulation No. V.C.3 to conduct valuation on debt securities, Sukuk, and other securities to produce objective, independent, and credible prices. The ownership of IBPA is equally shared among KPEI, KSEI, and IDX. 23

24 6.7 KPEI has procedures in place for estimating prices when prices are not available or reliable. To estimate prices, KPEI will use different methods for liquid and illiquid securities. A security will be treated as liquid if it was traded at least ten times a day during past 505 days. For liquid securities, KPEI will adopt the price on the last trading day for margin calculation in case no reliable price is available on the current day. With regard to illiquid securities, KPEI will use interpolation to estimate the price 50 data points are needed within every 10 days. Back-testing of the Margining Model 6.8 KPEI conducts back-testing of its VaR margin model on a weekly basis in the Razor system. Observed price fluctuations are compared with the outputs of the margin model to evaluate margin coverage. On each test, KPEI validates the total exposure during the last 5 days (HsVaR) or 10 days (Alt VaR). The testing is based on a 99% confidence level and a measurement period of 505 days. The exceptions (where calculated margin proved to be insufficient) identified over the measurement period should not exceed 5 times. In case that the model did not provide sufficient coverage, KPEI would consider changing the margin parameters, or review the whole model. 6.9 The results of its back-testing will be reported on a monthly basis. Razor will make a snapshot of the results and automatically send it to KPEI s warehouse data. The report normally includes the number of observations, the expected number of exceptions, and the actual number of exceptions. In case the margin model is deemed to be inaccurate, a warning will be included in the report which will be flagged as a high level report for review. 24

25 Principle 7: Liquidity risk An FMI should effectively measure, monitor, and manage its liquidity risk. An FMI should maintain sufficient liquid resources in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would generate the largest aggregate liquidity obligation for the FMI in extreme but plausible market conditions. Sources of Liquidity Risks 7.1 The major sources of KPEI s liquidity risks are as follows: a. Default of CMs as a CCP, KPEI is exposed to liquidity risk primarily in relation to the funding of the defaulting CM s money settlement obligations; b. Default of liquidity providers KPEI has arranged committed credit intraday with selected liquidity providers to meet the liquidity needs of securities transaction settlement, hence KPEI also arranged committed credit facilities with one liquidity providers to face the default of CM; c. Operational or financial failure of Payment Banks KPEI also faces liquidity risks related to the inability to meet the release of surplus Margin, Guarantee Fund, and collateral of CMs and/or use buying CMs cash prepayment to settle its money settlement obligations to selling CMs due to failure of Payment Bank(s). KPEI also takes into account the liquidity risk associated with the default of any entity that takes on multiple roles, e.g. where a Payment Bank is also a liquidity provider; d. Illiquidity of investments or collateral KPEI s Investment Policy aims to ensure that investment portfolios are sufficiently liquid at all times. This is described in greater detail under Principle 16: Custody and Investment Risks. Liquid Resources 7.2 KPEI invests Guarantee Fund and Guarantee Reserve only in assets with low credit, market and liquidity risks in accordance with the Investment Policy. The Investment Policy also sets out minimum liquidity requirements on investments and a concentration limit for each Payment Bank to ensure that KPEI has sufficient liquid resources to meet projected and stressed funding requirements. 7.3 KPEI does not have access to central bank services; however, KPEI has arranged unsecured committed credit facilities with options to draw down on the same day in five commercial payment banks. In a CM default situation, these facilities, together with the defaulting CM s Marks, Margin, collateral, the Guarantee Fund, reserved funds would be available to meet the liquidity needs over multiple days following the occurrence of the default. 25

26 Managing Liquidity Risk and Stress Testing 7.4 KPEI must monitor cash, and most notably collateral liquidity risk. The FMI has the tools and mechanisms to identify, measure and monitor settlement and funding flows. KPEI does get settlement information from KSEI. 7.5 KPEI can see participants cash balances or get the information on those figures at several points in the day, but not continuously. In practice, the FMI monitors the cash balance in the participant s account more than once per day at pre-arranged and fixed times. KPEI uses this information to feed its risk management model. Given the very good track record for clearing, this appears to work well. KPEI has set up an alert that would be triggered if there are not enough funds in the participant s account. This cash check takes place less than 10 minutes before each batch run. 7.6 When participants do not seem to have sufficient securities to cover their daily obligations, KPEI alerts the participant that there is a potential deficit in their account, warns participants that might be affected if the trade fails, and alerts the FMI s management team. The securities shortfall alerts would be triggered less than 10 minutes before the batch run. In the event that an alert is triggered indicating that a participant may not be able to fulfil their obligations, the FMI has in place the following resolution procedures. 7.7 KPEI conducts stress tests in order to assess whether it has enough liquid resources. It uses historical data and puts them in hypothetical simulations. It has to be remembered that some half of the margin is in bank deposits, with the securities collateral kept in separate accounts with the custodian banks. There is a very solid cash base in this CCP to absorb shocks; this is a simple, effective, and prudent way to organize liquidity. 7.8 The stress testing has been reviewed by an independent consultant. The hypotheses of the tests are reviewed annually by KPEI, and tests are conducted monthly. The scenario(s) used imply high securities price volatility and/or FX speculation in financial markets (e.g. a 30%-change in FX rate against US dollar in a short period of time). In terms of data frequency employed for the historical stress testing, KPEI uses more than a year of daily data. 7.9 The estimates give results in which KPEI management has at least 99% confidence. The results of the stress test are accessed by the management team and the Board of Directors. The FMI s stress testing model is an in-house design, with the methodology reviewed by a private consultant. Replenishment of Liquid Resources 7.10 For the replenishment of the Guarantee Fund, please refer to Principle 4: Credit Risk for more details. 26