EITI & the Beneficial Ownership program – a step away from KKN

EITI & the Beneficial Ownership program – a step away from KKN.

Introduction.
The fall of Suharto (1998) was in part due to his success in educating the people to realize that Koruption, Kolusion and Nepotisim (KKN) were no longer tolerated. During the height of the riots, Amien Rais managed to redirect the mob sentiment from revolution to reformation and so maintain the democratic system of government. The process of reformation to an open and fairer government is ongoing, with the EITI issuing a roadmap to develop transparency through the Beneficial Ownership program in the extractive industry. This article reviews this roadmap and related issues.

The Roadmap.
The Final Report “A Roadmap of Beneficiary Ownership Transparency in the Extractive Industries in Indonesia” was issued in December 2016 by the Coordinating Ministry for Economic Affairs (Financial Action Task Force) through the Extractive Industries Transparency Initiate (EITI) Indonesian website. The background to this initiative is that better information will lead to better & more transparent decision making, and in detecting potential tax avoidance and other illegal activities. Hiding the real owners of businesses may encourage corruption in the extractive industry. The worst type of corruption is State-Captured corruption, wherein the legislation has been formed by the policy makers in such a way to benefit a particular business group. “Corrupt business owners may influence the policy making process through their channel of government officials, turning public policies into their private favor instead for the benefits to the society”. To counter such corruption, improvements in transparency & inter government coordination are required from Indonesia’s institutional and regulatory frameworks. Without transparent beneficial ownership then business activities such as applying a tender or auction process may not be efficient if the participating companies are colluding or are controlled by the same owners. For investors, a competitive and transparent market has lower transaction costs, thus the economy ought to run more efficiently. Ultimately it would increase business confidence for investing in Indonesia. The road map and more information on EITI can be found at www.eiti.ekon.go.if/en/

Indonesia already has some beneficial ownership regulations in the financial markets and banking sectors. There are no regulations that specifically require the extractive industry companies to disclose who their beneficial owners are. Unfortunately there are many types of legal entities and agreements permitted under Indonesian law, wherein it is relatively easy to prepare “under the counter” agreements that are not formally recorded or observable by the law enforcers. Indonesia has joined several international initiatives (EITI, G20) regarding transparency and beneficial ownership. The road map report is to outline the path to adopt a beneficial ownership policy, legal framework and implementation mechanism. The report sets out three stages to develop this program, Stage 1 is to define beneficial ownership in the Indonesian context, Stage 2 to develop suitable institutional and regulatory framework by end 2017, and Stage 3 to implementation through parliament and establishment of institutional support systems in 2019.
Roadmap Development Issues.
EITI requires member countries to disclose information on beneficial ownership by 1 January 2020. This development program may include independent consultants, wherein the issue of funding this program is to be resolved. Unfortunately some inadequate regulatory framework and institutional ego, plus lack of trust continue to hamper coordination amongst various government bodies and may be obstacles to achieving this time table. Note that much of the regulatory development is to be implemented in the election year of 2019. Additional care is to be undertaken to avoid poor implementation that may have unintended consequences.

The roadmap is the start up plan for the beneficial ownership program. The development process will have many implementation issues to consider, such as;-
• How transparent will the beneficial ownership list be – for general public, for interested private parties such as accounting firms and forensic audit firms, or only for restricted government use such as the KPK, OJK, police etc?
• Will the list overlap with other planned data files, such as the Politically Exposed Persons (PEP)?
• Will the beneficial ownership program only produce a list, or will there be some further involvement in the detection of financial crimes or undue political influence, plus the prosecution of offenders.
• How to interact with foreign bribery & criminal investigating bodies and such.

International Perspective.
The 2004 United Nations Convention Against Corruption (UNCAC) identified corruption as an evil phenomenon, and sets out a number of articles designed to fight corruption through promoting transparency and good governance for public and private institutions. UNCAC Article 12.2.c “Promoting transparency among private entities, including where appropriate, measures regarding the identity of legal and natural persons involved in the establishment and management of corporate entities”. There are many other UNCAC articles related the issue of identifying and penalizing illegal activities that may be related to beneficial owners, including illicit enrichment, bribery, overcoming bank secrecy etc. Indonesia’s next compliance review with the UNCAC convention is scheduled for 2017.

The ADB/OECD Anti-Corruption Initiative for Asia and the Pacific notes from the 2014 steering group meeting provides a summary of Indonesian anti corruption activities in reference to the UNCAC articles. These notes make no direct reference to Article 12, but does mention anti corruption action (Article 5) undertaken in the “mineral sector to develop action in preventing bribery and corruption in the mining sector”, and intention to develop “a one stop service” for mining licenses at the Directorate General of Minerals and coal (ESDM)”, plus capacity building to improve public participation in preventing corruption. Indonesia’s next compliance review with this initiative is scheduled for 2017.

In 2015 the international Financial Action Task Force (FATF) acknowledged Indonesia had made significant regulatory progress in countering money laundering and combating terrorist financing, wherein Indonesia was dropped from the international money laundering black list. The Beneficial Ownership program in the mining sector is a further step to improve Indonesia’s compliance rating on the FATF. This is particularly important for a number of countries when considering investment in Indonesia. Indonesia’s next compliance review with this task force is scheduled for 2017.

The Indonesian Factor.
The International concept that any direct involvement by politicians in business or businessmen’s involvement in the mining business is viewed as a potential conflict of interest, or as unethical may take on a different perspective in Indonesia. The mining business is generally happy if the appointed minister has a business or academic background in oil or mining, feeling that their business concerns will be better understood and translated into more supportive government regulations for ease of doing business.

There are some mining related State Owned Enterprises (SOE’s) such as Aneka Tambang, Bukit Asam, Timah and Pertamina (oil & gas) that have an element of private participation, and may also be listed on the IDX. The recent appointment of the vice minister of Mines & Energy, Arcandra Tahar, as a commissioner to Pertamina is viewed as a consolidating move between industry and government by some, but others are concerned about potential conflict of interests. Some people may consider there is collusion between the ESDM and the SOE of PT. Timah Tbk in reference to the revising of the list of allowable tin export products, or adopting temporary halts to tin exports, which may have had a detrimental effect on Timah’s local competitors.

Some years back we saw the Bakrie group provide loans to the District government to take up the regulated compulsory divestment of Newmont shares. Unfortunately the loan terms were excessive for the District, wherein the regulations were later revised to disallow this type of private funding for District governments. More recently, a KPK investigation found that a key politician / business man had secured potential beneficiary ownership through providing a 75% share mortgage to a BUMD. Unfortunately the political momentum towards divestment has now spilt over into the oil & gas sector, [ESDM Minister Regulation 37/2016] wherein 10% shares are to be allocated to local BUMD /or BUMN, and paid for by the divesting oil company. Clearly the ongoing management of such BUMD / BUMN will need ethical management. Beneficial ownership related to undue political influence should be watched to ensure the divestment regulations are not changed to further increase the governments share, as was the case of the 2009 mining law where mineral & coal divestment of IUP’s was initially set at 20%, but later advanced to 51% divestment.

The EITI roadmap and UN consider that sometimes there can be a strong link between beneficial ownership and fraud & corruption. The director of forensic accounting studies at the Islamic University, Hendi Prabowo, makes a number of relevant points in the Jakarta Post article (9/1/17);-
• The Association of Certified Fraud Examiners report to the nations on Occupation Fraud and Abuse (2016) states that over 80% of fraud offenders were once “good guys”.
• Control Risks consulting firm survey found that nearly 46% of Indonesian firms felt they lost deals due to unethical competitors.
• The Indonesia survey respondents considered the failure to pay bribery demands could result in major delays, or even cause their business to grind to a halt.
• An Ernst & Young 2012 survey found that 60% of Indonesian respondents believed it was acceptable to pay cash to secure new business opportunities, whereas 44% believe providing entertainment to decision makers to win new business was also acceptable.
• Kinship has often been used to justify the unlawful distribution of political power among family members, which eventually leads to the emergence of corrupt political dynasties.

Lobbying.
Like all open democracies, there are well established industry groups, key business players and NGO’s that openly undertake political lobbying for their own interest (tobacco, meat imports etc). Even the Roadmap on beneficial ownership is a form of lobby for the government to fund more studies and activities in the development of this area. So the plan for beneficial ownership may need to distinguish between open lobbying and behind the scenes lobbying, and look closely to define potential conflict of interest. For example, the American president elect D. Trump has placed his extensive business empire in the hands of his family and arranged to be excluded from any and all business decisions. In Indonesia the mining moguls of Bakrie, Luhut and others are very open about their involvement in the exploration / mining industry and politics. The development of a beneficial ownership program may help the public see how ethically independent such moguls are, or what potential beneficial interests they may seek, and how they might use their open political position to take advantage over their business rivals and others.

Political & Social Capital.
There are many sociology works that identify the acquisition and use of various forms of capital (cultural, political, social and financial) that are needed to launch and maintain a successful political career or business in Indonesia. It is common knowledge that some people of limited capital have used, or been used by their connections (political capital), to become owners of IUP’s or local partners of PKP2B / COW. The tenement and attached exploration / mining business may become a conduit for mutual benefit for all parties. Where these connections are hidden, then there is more opportunity for unethical business activities and corruption.

There is an element of public mistrust that assumes that money politics is an element of immoral politicians, and until there is a clear change of behavior, then confidence in politicians will remain weak. Recently, key politicians were brought before the House ethics committee for apparently planning to extort Freeport. This shows that some in government may be practicing money politics, while others in government are working hard to improve transparency and political ethics. Certainly the implementation of a beneficial ownership program would make such types of political extortion more difficult to hide.

The development of a beneficial ownership policy is based around the concepts of detection, prosecution and punishment. Following Hendi Prabowo’s suggestions, we may further emphasize the programs various forms of public education to change our cultural behavior towards a more ethical society.

Open & Hidden ownership is not so simple.
There may be three types of beneficial owners, 1) those that are open with nothing to hide, 2) those that are both open and also hide parts of their business, and 3) those that hide all of their business. Beneficial owners may work through puppet shareholders, or through front men acting as commissioners, directors, managers, or through external agencies such as a trading company, bank or some extension of local government. The KPK, the Tax office, police and other branches of government, are building up much experience in the various ingenious ways in which people / business hide their wealth and influence. Clearly the determination of beneficial ownership shall be a difficult task.

Not all beneficial owners are inclined to hide their wealth or avoid taxes. Most of the mineral COW companies and other major mining companies are listed on a foreign / local stock exchange, wherein they are scrutinized regularly to provide annual financial reports plus lists of major shareholders, and are already included in the EITI financial reconciliation process. The ESDM and corporate lawyers acknowledge many of these companies have complex foreign ownership structures in order to facilitate the ease of raising foreign investment, or for ease to buy and sell shares in a holding company, rather than indulge in huge amounts of red tape to adjust the share ownership of the Indonesian tenement holding company.

The Home Ministry recently released data that “at least 371 regional leaders in provinces, regencies and cities, out of a total of 541 were involved in criminal cases, mostly graft cases in 2016.” Also, in 2016 the Corruption Eradication Commission (KPK) arrested 78 governors, regents, mayors. It is generally acknowledged that a number of the Regents (Bupati) have issued IUP tenements to their family, friends and business associates as a way of creating favors and private wealth. The huge number of IUP overlap cases and other factors indicate the extractive industry is a good place to extend the beneficial ownership program beyond the financial sector.

General experience would suggest that the great majority of hidden beneficial owners are within the much larger pool of IUP companies. For example;-
• A major shareholder of a coal company turned out to be a retired low level district mines department official. His nominal ownership was offered as a retirement plan (small monthly director’s fees) for the wealthier hidden true owner.
• All the share holders (3) of an IUP company turned out to each have a false address listed with the ESDM and on their business license.
• A Regent appointed his brother (ex high school teacher) to be the district mining officer. All IUP’s were signed out of the office, and files kept in the back of his car. The formal district mines department was completely cut out of the loop, and there was no coordination with the previous Regent’s issuance of IUP’s. The resultant overlap of IUP’s was then seen as a further opportunity by the Regent to auction his influence to resolve these overlap issues.

Many of these IUP companies may be non-producing or producing small returns. There is an assumption that small companies that do not make the $2 mill threshold to be included in the EITI financial reconciliation process and may not be included in the beneficial ownership process, regardless of the extent of the negative influence upon the local people. We do not know yet if the proposed Roadmap will be designed to produce regulations and systems to target all players, regardless of their size and sphere of influence.

Hidden beneficial ownership may be sought by some IUP players not to conduct clandestine activities, but to minimize extortion by local authorities and communities. For example;-
• By hiding the true ownership of the company the tenement holder felt he could compensate land on fair terms. Indeed we have seen exorbitant claims and time wasting land compensation over many of the government’s infrastructure & power projects.
• A Regent considered the IUP owner to be wealthy and successful, wherein he refused to sign documents to advance a coal project from exploration to production phase (with full compliance on all technical aspects) unless his young daughter was made a significant partner in the coal company.
• A coal company with a foreign investor partner sought to renew their local business license. They were asked to first join the chamber of commerce (controlled by the Regent), and pay an immense non refundable fee, but have no rights on such chamber.

A number of mining companies listed on the Jakarta Stock Exchange (IDX) are well known for having very little volatility, and relatively few trades, despite a requirement to have a set minimum number of shareholders. There may be several reasons for this, though one possibility may be that most of the shares are held by colluding shareholders, and some may also have beneficial owner linkages. It is not necessarily that these actions have a negative influence to reduce the net benefit of mining companies towards society. Indeed providing some sense of market stability in volatile times can have a positive social impact. However there are cases where one shareholder has exerted excessive influence in the direction of the company, to the detriment of the remaining shareholders. For example the tussle for control over Bumi Resources between Bakrie and Rothschild exposed some grey practices in the boardroom, and wherein the immense loans and interest payments plus other business dealings meant less cash remained in Indonesia etc.

Parallel Approach.
The road map sets out a formal professional approach that is likely to take years, with government funded costs that may not be recovered until the Beneficial Owner program has been underway for some time. If there are hidden beneficial owners in a strong lobbying position, then we may expect the Beneficial Owner law / regulations may be stalled or watered down. A parallel approach is suggested herein to develop some parts of the data collection for the beneficial ownership program, with only minor adjustments to the existing implementing regulations. This may have the effect of A) uncovering hidden wealth, slowing improper political influence and recovering lost taxes and fees and B) test running certain aspects of the full beneficial ownership program prior to developing a more complete legal case, and C) demonstrate forward momentum to gain better international reviews on such bodies as the UNCAC, FATF and OEDC etc.

The parallel approach is suggested herein to consider;-
1. C& C certification could be modified to include a requirement to provide the ESDM with a digital copy of each IUP’s/ COW companies legal establishment papers (Akta Notaris) and their updates. This should include the shareholders details and their tax number (NPWP) etc. This data set could be accessed by the appropriate body to identify the level of tax activity of the shareholders, director & commissioners, wherein dummy shareholders could be indicated by very low levels of tax payment activity. This may also lead to the identification of false address, or a number of seemingly unrelated shareholders / directors etc that may have the same address or same notary etc.
2. The C& C certification could be expanded for each company (regardless of thresholds) to provide a signed letter to comply with EITI to seek information from the company’s bank for their historic equity deposit (reflecting on the validity of the companies). This could be cross checked with the shareholders personal tax records to confirm the validity of the shareholders financial status at the time of incorporation, or if they are could be a dummy shareholder. The copy of bank records for deposit of equity may also indicate if such companies were indeed incorporated at the correct time with regards to the IUP application cut-off date, or that back dating may be involved.
3. Expand the existing cooperation between the tax office and various Financial Authorities, to examine the tax records of all shareholders NPWP’s to speed up the identification of reasonable and suspicious players in the extractive industry.

Conclusion.
1. The EITI roadmap to expose beneficial ownership appears to be a well planned, and worthy of the significant effort that will be required to implement this program. It will not be easy, to coordinate the more than 30 stake holder group parties (various government branches, industry groups, NGO’s etc) to deliver a unified result. Furthermore, the completion of this program could be made more tenuous as the presumed beneficial owners may already have considerable political influence to delay, weaken or stall this program.
2. The State Captured corruption aspect of the beneficial ownership program should take into account the twin evils of business exerting unfair influence over government, and government attempting to extort business.
3. The Beneficial Ownership program is largely developed by centralist bodies and consultants wherein there is a tendency to impose a high threshold for easier and more efficient implementation. For example the EITI’s raised their threshold from $0.5 mill to $2 mill. However the Beneficial Ownership program’s purpose includes an aspect of detection of improper political influence. Herein small players in remote Districts can have a significant local impact, but remain under a low financial threshold. It is important that all companies in the extractive industries be included in the implementation of the beneficial ownership program.
4. That a parallel form of implementation be undertaken, wherein existing ministerial regulations are adjusted to commence a data collection system (details of shareholders, directors etc). The implementation of an early phase of the data collection process may fast track the development of the main program.
5. Without the Beneficial Ownership and similar programs, the 1998 lesson of stability through transparency and fairness is lost, and we risk a step backwards to the KKN days that ended in such terrible riots.