Based on the rates of treasury bonds plus a margin of 100 basis points, the commercial interest rate of reference (CIRR) is a fixed rate used for officially supported export credits, as regulated by the OECD. The CIRR rates are set on the 15th of each month, and September saw them drop to their lowest-ever level, with euro finance for 8.5-year repayments at 0.14%, dollar finance at 2.49% and Swiss francs at a negative rate of -0.16%.
To discover what these historic lows could mean for the export finance market, GTR speaks to Gabriel Buck, managing director of GKB Ventures, Henri d’Ambrières, former EBF export credit working group chair and CEO of HDA Conseil, and Ralph Lerch, head of export finance origination and forfaiting at DZ Bank, and member of the export finance committee of the ICC.
GTR: Why have CIRR rates gone so low?
Buck: The OECD CIRR rate is a formulaic calculation. There is no subjectivity to it. When there are anomalies in the market caused by quantitative easing which in turn create negative interest rates in certain currencies, this automatically translates to very low or even negative interest rates on the CIRR rates, because one follows the other. It is an unintended consequence of having low interest rates created by central banks across the globe. It is an accidental benefit that those low interest rates are manifesting itself in very low OECD CIRR rates, because of the mechanical, formulaic way that the OECD CIRR rates are calculated.
GTR: What is the implication of these low rates?
Buck: For an exporter, the implications for this are dependent on whether you have access to the CIRR rate. If you are an exporter in a country which provides sufficient CIRR rate capacity then you will be a winner and you should be tapping that support and linking CIRR to your exports. It will make your exports much more attractive from a buyer side. However, not all export credit agencies (ECAs) offer the OECD CIRR rate. Some don’t, and some only offer a small amount because they don’t have a huge appetite or capacity to offer it. If you are in a country that has limited or no capability, then this is really dangerous for you because your competitors are going to be offering financing which is far more attractive than you can get elsewhere.
For the buyer, this is most certainly going to benefit them. Not only that, but with the current uncertainty in the global financial markets, the ability to have an open and transparent and low-cost fixed interest rate is very appealing. I cannot see anything that is not attractive in the CIRR rate from a buyer or borrower’s perspective.
GTR: Could the low CIRR crowd banks out of export finance?
D’Ambrières: Banks are unable to offer CIRR rates on their own balance sheets, because they are not market rates. Therefore, either this is funding from a public entity like UK Export Finance, or there is some kind of interest make-up mechanism like you see in France, Italy or Spain. This distortion was created several years ago, and there is nothing new here. The fact that they are going negative does not change the competition with banks and it might even have the reverse effect, because if states decline to lend at a CIRR rate, the spread between commercial banks and states will narrow. It depends if states or direct funders are willing to lend on a negative basis.
Buck: An illustration of the attractiveness of the CIRR rate is that the Qatari government, notwithstanding its very strong credit rating and access to a whole host of funding across the globe, found the OECD CIRR rate appealing for the BAE Typhoon deal [a US$5bn facility for fighter jets closed in 2018]. If the government of Qatar found it attractive to take the CIRR, can you imagine how powerful this same rate would be for buyers in developing nations?
At GKB Ventures, we tender the funding out to the market to obtain the most competitive quotes on the funding of ECA loans. Our clients, whether they are buyers or suppliers, want to see transparency and what the true market clearing pricing of these loans is at any point in time.
To be candid, many banks find it hard to compete against the CIRR rates. Most can’t even get near them. And therefore, banks that have had a business model of charging higher margins will need to revisit their business model on ECA funding. If they want to remain competitive, and need to charge higher margins than are available under an OECD CIRR fixed-rate funding, then the buyer needs to see some added value. Some ECAs acknowledge that this is a problem and see bank funding as either uncompetitive or not sufficient in quantity to support their exporters, hence some ECAs coming up with their own direct lending programmes. But some ECAs don’t have enough capacity to do all of the CIRR transactions.
Lerch: This is the reason why at the moment I see no great acceptance for the CIRR rate, because for most banks it is uninteresting and unsustainable. We have quite an absurd situation at present where short-term interest rates are higher than the CIRR, and banks cannot offer that same rate. This is one of the reasons why most of the banks are not offering CIRR, except a few under the German scheme because it is fully funded by the German development bank KfW. The issue is that if the CIRR is as low as it is in the EU at the moment, the banks have difficulty in offering it.
GTR: Is the CIRR still fit for purpose?
Lerch: For six or seven years there have been ongoing discussions with the OECD for the reform of the CIRR. It’s difficult as the existing scheme and its national interpretation is already complex, but it needs to be modernised because it is no longer correlated to the funding costs of a bank for long-term financing. Therefore, the CIRR has lost its role as a benchmark for financing costs to emerging market borrowers.
One of the major problems is that the CIRR is no longer that appealing for commercial banks. It is also something not many countries can afford.
During my work for the export credit working group of the EBF we examined and collected data on the countries which have a CIRR regime, and it is only 10 or 11 countries who actually have the CIRR scheme, and the scheme itself differs in each country. Germany for instance has an incremental margin of up to 50 basis points, so as a commercial bank we need to approach KfW, apply for the CIRR, and this allows us to offer CIRR rates. KfW then provides the funding as a whole. When we feel the margin is not sufficient and does not reflect the risk, then we have to add some margin on top. So we would not offer CIRR flat, we would offer CIRR plus, say, 30 basis points.
The procedure is rather sophisticated for the banks, first of all you have to know who the exporter is, whether the destination country where the borrower sits is eligible for CIRR, as at least in Germany it is related only to development assistance countries. It needs also predictability as to whether CIRR funding is still available at KfW – in Germany the volume is defined on a per annum basis, and the maximum size of a transaction is also limited as the scheme is positioned as an SME supporting fund. This makes it very difficult to offer CIRR in a consistent way for different potential suppliers, borrowers and for different ECAs, as the scheme itself is not available in each country and also differs in terms of how it will be provided.
GTR: Should the CIRR be reformed?
Lerch: Reform is necessary and this is something for which many proposals are on the table at OECD level. Intentions differ from country to country dependent on whether a fully funded scheme can be offered. A new CIRR needs to be easy to understand and calculate, to be a benchmark, and of course, to be competitive. The consequence of any reform might be that the CIRR rates will go up.
We are discussing the extent to which the current system differentiates adequately between different tenors. A 15-year term needs to be much more expensive than 12, 10 or 8.5 years, which at the moment has the same pricing. Another challenge is a common understanding of how to cope with breakage costs for the CIRR.
It is at the discretion of the OECD to find a way for the CIRR to reflect a market price that is a realistic benchmark, which is not the case at the moment in euros. There also needs to be a certain consistency in the way countries are offering the CIRR scheme, because if you have a bigger loan with four different ECAs, and you have a borrower who wants to have CIRR as the interest rate, you will then have four different schemes to calculate CIRR and to manage your funding.
Another interesting point about the CIRR is that, under the current scheme, you have the optionality to lock in the CIRR rate before you sign the loan agreement. This costs the borrower an additional 20 basis points, but it gives them the certainty that until the loan agreement has been concluded, the CIRR rate is locked in for the whole tenor of the loan. Therefore, if your expectation is that interest rates will go up, borrowers can make sure that the risk of interest increasing is limited.
This is an issue for those who are offering the CIRR or who are offering interest make-up schemes on it, because if rates go up this lock-in feature may cost them. In the CIRR reform proposals it is also envisaged to limit the risk of this lock-in period.
Buck: The market clearing price is the market clearing price. And today, the best market clearing price is the CIRR rate. Banks have to ask themselves what it is that they do. If their job is to advise a client as to the cheapest form of financing then they should be saying to their clients, you need to be tapping the CIRR. But the trouble for the banks is that the CIRR rate doesn’t make them very profitable. Banks may wish the CIRR regime to change but that will come at the expense of borrowers who may find costs increase. It’s going to be interesting to see how this develops.