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As UK Export Finance (UKEF) deliberates the launch of a new foreign exchange (FX) cover scheme, the British government is warning of a “significant gap” between the agency’s risk appetite and industry expectations for the product.

As part of a wide-ranging parliamentary inquiry into the work of UKEF conducted last year, the International Trade Committee, a cross-party group of MPs, recommended that UKEF, the country’s official export credit agency (ECA), consider creating an FX risk solution.

A letter from the Department for International Trade, sent to the committee in early May, reveals UKEF has since begun assessing the viability of the tender-to-contract product, which would cover an exporter’s FX risk in the period leading up to a contract being signed.

According to the memo, UKEF has conferred with export credit agencies (ECAs) in other countries that currently offer pre-contract FX risk protection, of which there are only a handful, and there is “little information” about their activities publicly available.

UKEF has also held discussions with the British Exporters Association (BExA), an independent industry association, which has been lobbying the government to set up such a programme for well over 12 months.

BExA published a whitepaper in February 2021 which outlined why such a product was necessary, stating FX rate risk is “one of the major reasons” UK businesses have shied away from exporting their goods and services.

“Most FX you can cover off fairly easy with third-party products in other financial markets, FX forwards and the like. But this tender cover is a peculiar beast,” Marcus Dolman, an honorary vice-president at BExA, tells GTR.

“An exporter needs flexibility as they are trying to cover their risk against unknown cash flows, and the tender period may elongate, or may shorten. You don’t want to be left with the obligation to buy foreign currency at that stage in a deal,” he says.

But, as revealed in the letter from the DIT to the trade committee, UKEF and BExA are at odds over the proposal, amid government concerns the scheme could ultimately incur financial losses.

“UKEF has produced model portfolios based on historical data to assess possible scheme parameters and pricing. This has revealed a significant gap between what BExA is seeking and the nature of product that UKEF could provide consistent with its mandate to operate at no net cost to the taxpayer,” it says.

The agency and BExA have agreed to hold further meetings to “explore options” and UKEF is set to report back to the government on whether any of these could lead to formal product development in the future.

A UKEF spokesperson tells GTR that following recent discussions with the industry association it has an “improved understanding” of how BExA’s proposal would ensure the scheme breaks even over time.

Nonetheless, they say there is no specific timetable for launching the scheme, “as UKEF is still considering whether it is appropriate to introduce this product, bearing in mind commercial alternatives, market feedback and operational constraints”.

 

No private market option?

While there are broader solutions in the private market to cover FX risks for exporters, BExA says these fail to meet the needs of companies during the pre-contract phase.

An FX forward requires a company to buy a defined amount of one currency for an agreed amount of another, at a set point in the future; while an FX option allows a firm to opt out but typically comes with a premium to do so.

BExA argues these solutions are expensive and inflexible, leaving many exporters to trade at spot FX rates and taking the risk, or simply not exporting at all.

With UK exporters generally having to bid for contracts in foreign currencies, rather than the pound, there is a very real threat that a small movement in the exchange rate between the two currencies could wipe out the firm’s profit margin, or force it to take on the contract at a loss.

“There is no private market solution for tender to contract (or pre-contract) risk periods. An FX forward is more likely to create a risk, and a FX option should only be purchased when the tenderer has a very high probability, typically more than 50%, of winning a tender. We therefore ask UKEF to put in place a tender to contract FX scheme matching the schemes provided by other ECAs,” BExA’s whitepaper says.

Atradius in the Netherlands, as well as France’s Bpifrance are two ECAs that offer this type of support to their exporters.

According to the DIT letter, one major ECA providing an FX cover scheme had indicated to UKEF that business volumes were “extremely low”. The letter does not name the particular ECA.

Industry figures suggest UKEF could set up a programme that is cheaper than those on offer from other agencies, which would drive interest in exporting overseas and help boost British trade.

“Foreign ECAs do not offer the same as what BExA is proposing. Their offerings are slightly different and are quite expensive,” Dolman tells GTR. “We are trying to get UKEF to adopt a product that is cheap and accessible to all exporters and also success-based, ie they only pay UKEF a premium when they win the deal.”

While a chief concern for the UK government is the possibility of incurring losses, Dolman argues BExA’s proposal would ward off this potential threat.

BExA says in the whitepaper that any losses on the FX rate should be borne by UKEF, but so too should any gains. It also advocates UKEF should take a “small premium” from companies to offset any losses.

“UKEF will be the ones to bear the cost if there is a loss, so they should also get the upside. That’s how this whole thing works on a portfolio basis: there will be losses, there will be gains, but the portfolio should come out net zero –  or hopefully, slightly net positive,” Dolman says.