The general re-assessment of risk and the dramatic drop in liquidity following the onset of the financial crisis has seen Asia’s export-driven economies take some beating. With supporting exports being one of the critical elements for achieving national goals and economic recovery, Asian governments – especially those of export-oriented countries such as China, Japan and Korea – have been injecting an abundance of liquidity into their export credit agencies (ECAs), empowering them to take on additional roles through a relaxation in policies and a series of innovative product inventions. Thanks to ECAs stepping in to support many trade finance transactions, export credit is now one of the largest cross-border growing businesses in Asia. Indeed, ECAs are experiencing a renewed purpose in today’s trade finance business. They are once again under the spotlight as they become increasingly indispensable in light of the retraction of private sector insurers and commercial banks from the trade finance market.
It was only in recent memory that ECAs were criticised for their shrinking performance, strict product specifications and rigidities in reacting to market conditions. But the unexpected twist in events in the financial markets in the last nine months has seen ECAs become an important source of liquidity in both emerging markets and developed economies.
More tellingly, even blue chip companies that traditionally tap the debt and capital markets are looking to ECAs for support. India’s Tata Group and Reliance, for instance, are now turning to ECA-backed financing for equipment import.
“Historically, Asia’s blue chip borrowers haven’t had to utilise the export credit market. However, the current market conditions have seen a number of well-rated companies turn to the ECA market – even those that are under no immediate pressure. The driving force has been the ability for banks to deliver lower all-in pricing, longer tenor and higher levels of funding under the ECA cover,” notes Christopher Green, head of export finance, Asia Pacific at HSBC in Hong Kong.
Tapping ECA financing, adds Michelle Ling, Société Générale’s regional head of export finance, Asia, Hong Kong, is not just in reaction to a dearth of liquidity in the debt and capital markets nor is it a case of debt becoming too expensive. “ECA financing also allows borrowers to secure tenors of up to 10 years for a much bigger deal size – terms which would have been difficult to achieve for corporate loans,” she says.
Boosting capacity and new schemes
Anticipating demands such as these, leaders of major Asian ECAs convened at the special meeting of the Berne Union Asian regional cooperation group in November last year to pledge their support for global trade and investment flows through a number of initiatives.
Taiwan’s Exim Bank TEBC was among the first to set up, in November 2008, a special fund for additional reinsurance capacity. This year, the Korean Export Insurance Corporation (KEIC) will be injecting an additional US$260mn in capital as well as increasing its annual export insurance limit to US$170bn, up from US$130bn in 2008.
Over the next two years, Nippon Export and Insurance Investment (Nexi) will top up an additional US$16bn in export credit insurance coverage on top of the US$90bn that it already provides annually. Japan Bank for International Cooperation (JBIC) has also set aside US$6bn in direct lending for the next two years.
Meanwhile, a number of measures are being considered for implementation by Asian ECAs. ASEI of Indonesia will be boosting its capital to facilitate its underwriting capacity, and Thai Exim has proposed setting up a ‘National Export Credit Insurance Fund’ that will act as a reinsurance fund to partially indemnify claims from Thai Exim’s customers. Support from India’s ECGC will come in the form of additional indemnity to small, medium and large exporters, in addition to providing protection from 75% to 85% to cover bank advances to exporters.
Even Cambodia is planning to launch an export-import bank to provide financing to SMEs as well as to develop the country’s export base. The project will come under the auspices of the ministries of finance and commerce, and National Bank of Cambodia, to be supported by the UN development programme.
What is considered a major leap forward, however, is a series of unprecedented initiatives and products mooted in recent months by various ECAs in response to the difficult market conditions. With banks’ shrinking asset value following plunging stock market prices earlier this year, coupled with the need to meet Basel II requirements, odds have been stacked against banks.
To this end, Nexi is providing untied loan insurance to Japanese banks lending to overseas Japanese companies for working capital purposes. This is the first time that the untied loan insurance scheme is being designed to meet the ongoing working capital needs of overseas subsidiaries of Japanese corporations.
According to Shinji Hirai, chief representative of Singapore-based Nexi, the untied loan insurance scheme is a concept that traditionally supports loans with tenors of more than two years for infrastructure projects and was never directly tied to export finance until now. A temporary measure created in response to the current crisis, the new untied loan insurance will be reviewed in March 2010.
Going beyond their original mandate in supporting trade, ECAs now also support M&A financing pertaining to state-owned corporations or strategic industries in countries that require natural resources, namely China, Japan and Korea. “These countries have a strong demand for natural resources and they have been acquiring shares in overseas companies that own natural resources or reserves. Chinese companies have invested in Angola and Nigeria, Korean companies in Brazil and Japanese companies importing crude oil from Africa and Latin America,” says Société Générale’s Ling.
Aircraft and telecoms
HSBC’s Green believes ECAs’ support of overseas investments is a fundamental shift that will persist as it ensures that companies from their home countries are able to invest in overseas projects of national interests and critical to the countries’ needs.
Aircraft financing is another area where ECA financing is being actively sought. Recent ECA-backed deals include a US$100mn ATR aircraft financing for Vietnam Airlines mandated to HSBC and supported by Coface and Sace; a US$1bn Boeing deal mandated to JP Morgan; and a US$600mn ECA loan jointly arranged by BNP Paribas and Calyon for Thai Airways with coverage from Coface, ECGD and Euler Hermes.
As Asia’s telecom sector continues to grow exponentially, particularly in emerging markets such as Indonesia where financing for the sector is expected to hit US$1.5bn this year, export credit agencies’ support will be imperative for companies to finance growth. “These will be very significant cross-border transactions because tenor, pricing, tax exemption all come into play, making ECA financing attractive to tap,” says Green.
That ECAs are also exercising greater flexibility particularly in respect of cover ratio has been another breakthrough. KEIC, Asia’s most active ECA and the largest in terms of business volume, has started to provide 100% commercial risk coverage, up from 95% in the past.
“KEIC has been doing its best to react to market demands, bearing in mind international rules thereto. Given that ECAs were created to cure market failure over half a century ago, it is believed that ECAs should play an active role in this global economic crisis since many commercial players have been leaving the trade finance market, especially for medium and long-term businesses,” says Jang-Hee Park, deputy director, project development team at KEIC in Seoul.
Certainly, banks welcome such moves as they get comprehensive risk coverage and in some cases there is even no residual risk for them to bear. Because of ECAs’ involvement, longer tenor transactions are starting to appeal to banks again. While banks would typically commit US$10mn-$20mn to a syndicated loan, they are now prepared to hold a minimum of US$100mn in some ECA-backed transactions.
As it goes one step further in meeting current market needs, KEIC is also offering risk coverage on bridge loans as well as taking refinancing risks to some extent on “mini-perm bridge structures”. Park concedes that ECAs, including KEIC, in the past have been hesitant to bear refinancing risks embedded in a financing structure such as mini-perm, but the current economic conditions do not provide much leeway for banks to create repayment schedules that would safeguard against their lending. As such, it becomes inevitable now for ECAs like KEIC to take on such risks to some degree, even after taking into account all the potential risk factors for a project.
“When the financial crisis is over and there is no need for these schemes in the market, we will re-model our products to react to market changes,” adds Park.
Nonetheless, such a gravity shift in the role of ECAs has seen a simultaneous rise in their business volumes. KEIC saw a surge in business volume in 2008 to W130tn (US$100bn), up by about 30% from the previous year. While the increase was more a result of new products being created to meet market demand, rather than a direct consequence of the financial crisis, business volume is expected to rise this year, says Park.
The current economic environment has created potential revenue streams for ECAs. To the extent that domestic banks are able to leverage on their relationships with ECAs, they could stand to benefit by lending to ECA-backed transactions. This is evident in the push by the Chinese authorities to have domestic banks involved in transactions supported by Sinosure, which is under the ministry of finance’s supervision.
The economic downturn has also given rise to a lot of demand for the Asian Development Bank (ADB) to play an enhanced role. As ADB provides both guarantees and liquidity on its trade finance programmes, which have been in existence since 2004 focusing on Asia’s emerging markets, its trade finance volumes grew exponentially in 2008. Last year saw a 570% growth in trade finance volumes collectively in countries like Bangladesh, Pakistan and Sri Lanka, according to Steve Beck, ADB’s head of trade finance.
“Since March 31, we have received approval to expand our programme to assume more risks. ADB is now able to assume US$1bn in risk at any one time and due to the average tenor of 160 days in its portfolio. This US$1bn exposure could rollover once a year, providing US$2bn per year, excluding any contributions from our private sector partners in ADB trade finance support,” he adds.
As part of its focus on the more challenging markets like Cambodia, Nepal, Pakistan, Sri Lanka and Vietnam, ADB in May sealed agreements with eight Vietnamese banks to help Vietnamese corporates gain access to trade finance.
“As we ramp up exponentially, we constantly gauge the market to see if we are getting it right; providing support where it is needed,” says Beck.
One of the interesting developments of late is that some ECAs are said to be treading into direct lending, which could potentially mean that ECAs will encroach into banks’ territory when the market is back to equilibrium.
Banks appear unfazed by this latest development. Green sees direct lending by ECAs as temporary until such time as project pressure is reduced and banks are able to provide funding at attractive prices.
The fact is that the financial crisis has eroded much of banks’ capital base, and capital constraint will be a rein on their lending activity as they assess how best to allocate their capital. Given that many US and European banks are now counting on government support to keep them afloat, the priority would be to rebuild that capital base before they return to profitability.
As Joris Dierckx, head of global export and project finance, Asia at Fortis Bank and general manager at the Tokyo branch points out: “Market liquidity issues will not be solved overnight. Banks that were nationalised would need to repay their government for the capital support received before the crisis. Tier 1 ratio generally stood between 6-7%, but going forward, banks may be required to maintain Tier 1 ratios well above that level. Given all this, banks will still be reluctant to lend because of reduced capital base. It will take a few years before their capital expands again.”
Banks would also need to have a higher return on capital before they would commit to a deal, adds Dierckx. “Because internally, banks are competing for liquidity and capital. For the same liquidity, banks prefer deals that consume less capital. This is even more so in emerging markets.”
The extent to which ECAs should play in the market has been an ongoing debate. Ultimately, it depends on the policy goals of each country and how important export is for the national economy. In export-driven countries such as Korea, Japan and Germany, there is a strong demand for ECAs in the market, but the less export-driven countries are hesitant to have ECAs play an active role, says KEIC’s Park.
“Where banks start leaving the trade finance market, like what is happening now, this is when ECAs should step in to fill the gap. That ECAs should act as a last resort during difficult times is one of the important philosophies for their existence,” he adds.
One of the looming questions regarding heightened ECA activity is the implication of newly implemented measures on their long-term profitability.
Perhaps that is best explained by looking at the fundamental difference in business models of public sector export credit agencies and those of private insurers. While private insurers seek to minimise loss and are accountable to shareholders, export credit agencies are in the business of breaking even. The latter’s business model would be unfeasible to private issuers.
“Nexi’s business model takes 20-25 years to break even. This is a time for Nexi to provide cover actively and maybe in a few years time we may face a large amount of claims and we may take another 10-15 years to break even again. Having said that, we continue to follow strict and sound underwriting principles, so business is as usual for us,” Nexi’s Hirai says candidly.
While KEIC is taking more risks to some extent, Park says KEIC is equally cautious in the security package in addition to the creditworthiness of the supplier/buyer. “With respect to profitability, there would be negative impact in the short to medium-term but it has been proven that in the longer term ECAs could meet their break-even obligations in the context of OECD export credit arrangement,” he says.