Tight pricing has cut insurers’s profits to the bone in the structured trade credit.

A key growth story for private insurance players in recent years, the structured trade credit (STC) market typically encompasses standalone, secured transactions involving a buyer or borrower located in an emerging market country – and as such falls into the broad political risk cover arena.

As trade and investment in emerging markets has grown, along with increased privatisation in developing economies, so “requests for STC are on an upward trend,” says James Cunningham, senior vice-president at Marsh Political Risks in London. “In volume terms STCs have become far more significant, and are spread across Latin America, Africa, Middle East, Asia and with a strong focus on Russia and the CIS,” he notes.

Transactions cover a variety of deal types, with obligors spanning both state-linked and, increasingly, private sector obligors, stresses Keith Thomas, director, asset finance and political risks division at HSBC Insurance Brokers. “In particular, the trade finance market is keeping us busy in African markets such as Burkina Faso, Cameroon and Togo, where small pre-export commodity deals need to be covered on a repeat basis.”

Thomas observes that export business into difficult countries, where companies cannot obtain confirmation of letters of credit (LCs) and “some medium-term credit business” are also triggering demand.

According to Kit Brownlees, managing director, political, project and credit risks at insurance brokerage Arthur J Gallagher, medium-term risk is the market’s biggest new story. “The market was once reluctant to write longer than the 18 months, but is increasingly supplying three-to-five-year single buyer risk cover,” he says.

Who are the chief cover providers

Among the market stalwarts are Lloyd’s of London syndicates, Ace Global Markets and Zurich. “QBE has opened up shop in the US and is doing short-term single-buyer cover for domestic and international exposures. HCC Credit is going out to five years, and Zurich to seven,” says Evan Freely, New York-based senior vice-president at Willis Financial Solutions.

Newer faces cited by Brownlees include Liberty Insurance Underwriting, while Exporters Insurance Company and Lloyd’s syndicates are “widening their programmes”, he says. “In Asia I’d pick out QBE – they are admitted in most of the Asian territories,” says Mark Cooper, managing director at TFC Brokerage in Hong Kong. “Atradius also now has people here.”

Single risks on private buyers have provided a significant new market niche for Atradius, as privatisation trends have reduced the STC requests on public sector counterparties, says special products director Mike Holley. “We bring a massive database and good capacity, and write mostly short-term, up to one year,” he says, naming the biggest obligor markets as “the UK, China and Netherlands, and then Turkey and Russia, as you might expect”.

Pricing pressure

The main market story is pricing, which has headed south without a break over the past 24 months as high global financial liquidity has impacted the STC market. “People have turned business away because of the cheap pricing, particularly on medium-term business,” stresses Steve Capon, head of country and credit risk management for Ace Global Markets.

“The pricing for medium-term Russian risk has reached rock bottom,” notes Andrew Underwood, head of political risk at Hiscox Syndicates. Insurers are saying no more. As an illustration of the squeeze, he says Hiscox “is getting orders at ‘margin plus’s – where the banks charges 1% and a fee, then we get a premium of 100% of that 1% plus a portion of the fee.”

Turkish syndicated loans are also “about as low as it can go,” says Capon. “At these prices we believe there is increasingly limited capacity and would venture that refinancing risk could increase through 2007.”

A similar story of rising liquidity and falling margins applies in Brazil, China and India. An Indian short-term oil trade might well carry a 35bp margin, says Cooper. “The question is whether insurers want to sell their capacity for low levels of risk and reward,” he asks.

Capacity questions

Despite its undoubtedly ‘soft’s conditions, the STC market has significant capacity problems in a handful of countries, most notably Turkey, Russia, Nigeria and Ukraine, say underwriters.

To some extent this may be because banks buying STC cover have been driven by capacity, rather than risk issues. “Rising commodity prices have seen banks reaching their country and industry limits, leaving them with the choice to either syndicate the risk with other banks, which discloses the terms of the deal, or take the insurance alternative,” comments Underwood.

Individual insurer limits are also below the larger limits written by the market five or six years ago. “Underwriters will do single lines, but to put together, say, US$600mn in capacity, you would have to include a large part of the marketplace,” observes Cunningham. “On a really nice deal, you often have to go back to the reinsurer to get it done,” adds Brownlees.

Where some markets are cheap, others are plain difficult. Bolivia and Venezuela are “virtually closed for projects”, while “Iran, Iraq, Afghanistan and Sudan are very difficult markets,” says Danny Oades, partner, credit and political risk, JLT Risk Solutions, in London.

What can turn around the tide in the STC market

While oil prices have dropped by US$12 a barrel and broad money growth in major economies is slowing, this “is not enough to get better pricing for the market in the short-term,” underlines Capon. “We might need some losses for that purpose.”

In terms of new business, more demand from Asia is one regularly talked up scenario, but Cunningham argues that the jury is still out on the real financial impact on the market of deal flow from this territory. “A Chinese company selling to Indonesia or an Indian company to Sudan might not consider insuring its country risk, whereas a French company may have a higher perception of the risk,” he says.  The opportunities that do
currently exist often derive from the regional financial centres in Singapore, Hong Kong and Tokyo. Cunningham sees demonstrable growth in demand from Australia.

Another vista is a market re-opening to project finance. “More and more deals are being looked at all over Asia in power, mining and infrastructure,” says Alistair McVeigh, executive director, political and credit risks at Willis’s Asia Pacific political and credit risks unit. “Underwriters were cautious a couple of years ago, but are offering maximum lines and terms now.”

Basel II fallout

What changes Basel II will bring to the STC market remain to be seen. “The full ramifications for the insurance of political risk and trade credit are still very much up in the air, but there will be a real advantage in regulatory capital terms for those banks that are able to successfully mitigate their transactions with Basel II compliant insurance polices,” says Thomas Holmes of Miller Insurance Services.

Brokers say that work is ongoing with the Lloyd’s Financial Guarantee Committee to provide banks with Basel II compliant policies in time for the framework’s 2007 implementation, while individual insurers such as Ace and Atradius have wordings in place for their big clients.

Where there is some uncertainty, argues Holmes, is how regulators will view policies covering only country-risk perils. “The safest prediction is that anything other than comprehensive non-payment policies with very few exclusions will not achieve compliance with the Basel II description of a protection document,” he says.