IN OCTOBER last year, when it was becoming increasingly clear that the Indonesian Stock Market (IDX) would end the year in a far better state than that of many other countries, Finance Minister Agus Martowardjojo called on local market players to help maintain the reputation of the local bourse.

He had a point. Strong economic growth, low interest rates, a credit rating upgrade and state construction spending seem poised to push the Jakarta Composite Index even higher this year as investors seek to escape volatile Western markets. The last thing the country needs is a few high- profile capital market scandals that might give foreigners second thoughts.

Foreign funds traditionally control more than 60 per cent of daily transactions in the IDX. Volatility in the Indonesian financial market also has a direct impact on the value of the rupiah.

Once widely criticised for being little more than a toothless watchdog, Indonesia’s Capital Market and Financial Institution Supervisory Board (Bapepam) is cracking down on many of the shady practices that have given the local stock market a bad reputation in the past.

The current situation is certainly much different from 2008, when a scandal involving PT Sarijaya Permana Sekuritas – one of the nation’s largest securities houses – rocked the financial sector.

The Sarijaya case was just one of a string of fraud cases during the year involving brokers which brought into question the ability of Bapepam to regulate the financial market effectively. Two firms – Sarijaya and Antaboga Delta Sekuritas – alone allegedly defrauded investors of almost $194 million.

These brokerages took advantage of a loophole in the trading system in which retail investors deposit money with them to be used to buy stocks when instructed. Brokers were then expected to inform the Indonesian Central Securities Depository (KSEI) – a division of Bapepam – of the transaction.

But many traders didn’t bother, and the shares remained in the broker’s name in a sub-account. This produced a situation in which unscrupulous traders had the ability to use the money to buy and sell shares without the investor’s knowledge.

As long as the market was rising, such abuses could be hidden. But when global markets took a dive in 2008, many brokerages faced huge losses.

Since then, Bapepam has introduced a variety of measures designed to prevent rogue traders from misusing the funds deposited with them. These include forcing brokerages to open accounts for their clients in specified banks, and introducing a special card that permits investors to examine their KSEI-registered shareholdings. Cornering stocks, a practice that was common before the 1998 market crash, is now more likely to trigger a Bapepam investigation.

In 2010, Bapepam also introduced tougher rules for fund managers. Each investment manager must now provide a five-year business plan, including proposed products, selling methods and expected contributions from revenue sources. The manager also has to submit projections for financial performance.

The regulations also require fund management firms to vet staff during recruitment and reject any applicants with a criminal background, or those who have been directly responsible for a firm becoming bankrupt.

The stock market authority said it would give existing players one year to adjust to the new regulations. If they failed to comply, then Bapepam would revoke their business permits.

Other planned reforms include a proposal to ban brokerage firms from mixing the functions of selling securities and running an investment management business in the same firm.

Eradicating shady practices is important if rapid growth in the local stock market is to support economic expansion rather than become a potential source of instability. The IDX’s market capitalisation rose almost 8.9 per cent last year after 25 companies floated shares in initial public offerings, raising 19.6 trillion rupiah (S$2.8 billion) to fund business expansion. Market capitalisation now stands at around 3,537 trillion rupiah, equal to 50 per cent of gross domestic product.

Despite the crackdown, however, other abuses remain to be corrected. Sources in the financial sector that The Straits Times spoke to in Jakarta say companies associated with brokerages are still offering investment products with fixed rates of return. These products are also marketed by many smaller operators as capital-protected investments, although in reality they are usually linked to corporate bonds. Under the law, only the banks can offer guaranteed returns.

In tacit recognition that more needs to be done, the IDX announced in November last year that it wants to establish an investor protection fund in the second half of 2012 to help players on the capital market who become the victims of scams.

Such a move may assuage the fears of some investors. But it is no substitute for a well-regulated market.

(C) Singapore Press Holdings Limited