Asian export finance: is the rulebook being rewritten?

What role do ECAs play today, and is the western model unsuited to meet the dynamism and potential of Asian agencies? Leading export finance specialists in Asia offer their opinions.

Roundtable participants:

• Erwin Boon, regional head Asia, global export and project finance, ABN Amro (chairman)
• Paul Gardner, managing director, head of structured trade & export finance, Asia, Deutsche Bank
• Christopher Green, managing director, head of export finance, Asia Pacific, HSBC
• Simon Jones, head of structured export finance, Asia, ANZ
• Michelle Ling, managing director and regional head, export finance, Asia, Société Générale
• Marina Vettese, head of Hong Kong office, Sace

Boon: At the beginning of 2011, the Singapore government conducted a study to see if setting up an ECA in Singapore would make sense. Did they miss a chance here to set up a regional ECA?

Jones: The question Singapore asked itself was: is there a market gap to fill? In the first instance they convinced themselves there was not, because they felt they were already supporting SMEs in a big way and had not really got their mind around the market gap for the bigger projects like shipbuilding and oil and gas services. It’s not clear if they have given up on this or not.

There are some companies – such as Keppel and EOCL – that are still promoting the fact that they cannot compete with Korean yards (for instance) for certain types of business.

Green: If Singapore introduced a programme, they would be well served to look beyond the natural tied financing structures, because if you look at GIC (Singapore’s sovereign wealth fund) or Sembcorp, they have considerable intent to expand both within and outside of Asia. Similar to the way the Japanese and Korean ECAs operate, it is an effective way to ensure debt support to projects that Singaporean sponsors are promoting. The Singapore government could help even the playing field for Singapore investors with regard to their Japanese/Korean competitors through untied policies designed to ensure availability of debt to the projects structured offshore. Beyond investment support, Singaporean offshore production vessels are at a distinct disadvantage to Korean yards in the form of pure export credit support.

Jones: ECAs have outgrown their original remit and have evolved into something different. They haven’t in all countries – in the US for example, US Exim is an ECA, it covers exports, end of story. However, ECAs, particularly in Asia, have evolved into something more meaningful and pragmatic for market requirements. They do fill market gaps. They do provide direct lending. They have their own agenda for their countries’ strategic interests. They do cover export growth, there is no doubt about that, but they also cover internationalisation. If you look at support the Korean government is providing to the nuclear sector in Abu Dhabi, that is all about exports, to a certain extent, but it is also about internationalisation.

There is also security around strategic resources. You see that with JBIC, Nexi and Kexim. Can we really call this new breed of organisation that fills market gaps in the project market an ECA? Not many of them are pure ECAs anymore. There is a definite need for them and they fill gaps, but they have outgrown the export tag.

Boon: On one hand, what the ECA wishes is leveraging private capital to the market by supporting it in an insurance programme. If you are looking more at direct lending business, you are using taxpayers’ money. In this environment you could argue if that is the right way to go. On the other hand, we saw two years ago there were some governments that came up with a bank lending programme that they did not have before and it worked fairly well to give lending programmes a boost.

Jones: They have to solve current problems. ECAs historically have had two agendas. There was the individual agenda of driving and supporting exports from their own country. That was their reason for being. However, more recently they have not wanted to compete with the commercial markets but to provide support where market gaps exist. They still call themselves export credit agencies because that was the term used for describing largely what they did. Listening to Kexim, for instance, they want you to know they are supporting whatever is Korean and will go the extra
mile to do so.

Boon: Sace is one of the most policy oriented ECAs in Europe, having quite a flexible approach on these things.

Vettese: It was a necessity for us to expand the eligibility criteria and introduce flexibility. Especially before the crisis, we were seeing volumes of tied transactions decreasing so we had to figure out a new model that was still protecting Italian interests but allowing more flexibility for the benefit of Italian exporters. If we are too strict on insisting that everything is produced in Italy maybe we are not really benefiting our exporters, because with more flexible sourcing they might be more competitive in the offer they can make. Therefore we introduced the ‘made by’ principle whereby we can support contracts entered by Italian companies or their subsidiaries without having the strict requirement of minimum Italian content.

Of course there must be an Italian interest in the transactions we support because we are using taxpayers’ money. We came to the conclusion that if we can adopt more flexible eligibility requirements, we would be supporting Italian companies in a more effective manner. Considering market trends, especially in Asia, Italian companies have to compete with companies that may have more flexible or competitive cost structures.

Boon: Italy does not have a funding vehicle, does it?

Vettese: No, Sace only offers insurance policies or guarantees. Nonetheless, we have recently entered into an agreement with Cassa Depositi e Prestiti-CDP (an Italian state-owned financial institution) and banking foundations with the scope to provide funding at market conditions to banks benefitting from Sace’s guarantee. Under this scheme, CDP could in principle also act as a lender with Sace’s guarantee, in case of banks’ unavailability to finance the transaction.

Boon: Is there discussion in Italy on the need for any direct lenders?

Vettese: We have seen the solution with CDP as the most appropriate one to respond to the need for liquidity in the circumstances in which constraints arise.

Gardner: If there is no liquidity gap but a risk issue, then ECAs need to provide guarantees. Asian ECAs are very much political entities. Japan is doing deals into Venezuela where offtakers are all Japanese, so clearly it is utilising its ability to put financing in play to secure a stake. The Chinese are past masters at this and are doing significant amounts into Africa to secure offtake of raw material and resources.

The old guard of ECAs in Europe are based on historical concepts that they have had to question over time and are still scared of being overtly political, as is acceptable in Asia. You have to put history aside and look to the future. US Exim is a prime example where they have not been able to ditch some of the historic baggage and are now not playing as equally as some of the other players in the ECA market.

Green: US Exim volumes have gone up steadily but they continue to be dominated by aircraft.

Gardner: As have their direct loans.

Green: Yes, they have gone up quite a lot, but the Europeans have gone half way with their measures. Sace has had an untied programme to help further introduce Italian interests into transactions and shows reasonable flexibility. The Nordics have taken on ‘made by’ and not ‘made in’. Coface, however, is very much sticking to its ‘made in France’ requirements for support.

France is a great exporting country, they can still do deals, but it is going to be challenging for them to win market share. Total is an example of an entity that could use considerable untied support for its investments and offtake of major upstream and downstream oil and gas and petrochemical projects globally. Japanese trading companies have this advantage, as do the Koreans. The Chinese benefit from very well-funded policy banks that can deploy exceptionally large funding to projects with well defined China interest.

However, the problem becomes more acute with US Exim and it is not going to change. I do not see US Exim changing its stripes. The Europeans have introduced measures that have pushed them further towards Asia, however probably still not far enough.

Gardner: What will be interesting is how ECAs interpret the new premium pricing rules. Will there be a difference in interpretation between the US, Europe and Asia? Because the way the rules are in the consensus manual leaves a lot to be discretionary. How do you choose appropriate funding rates? Do you take the average funding rate for the last 15 years for that corporate? Do you take the last two months? Do you take the last week? Every one of them is going to give you a different argument, but every one of them is allowed under the scheme of the premium.

They are trying to not compete with banks in developed markets and provide some assisted financing. The concept is that financing should be no better than can be obtained in the market. The issue with that is we are talking about deals that there is no market for. The whole concept that we have been talking about today is that we need an ECA on a 15-year deal because there is no bank market for the 15-year deal. Therefore, how do you then assess what the appropriate premium is for a market that does not exist anyway?

Boon: It is the same discussion we had 10 or 15 years ago when we started to try to have a benchmark for sovereign risk. To what can you compare it?

Green: It is also untied structures. Posco entered into a deal with AES for a power project that just closed in Vietnam. Is that a Doosan tied financing or do the Koreans have a lot of leeway in terms of looking at this as an untied structure, because it is 40% owned by Posco? If they go the untied route, all of a sudden they can throw the minimum premium benchmarks out of the window and decide the deal that makes sense. This is the power of ECAs looking to untied structures to promote national interests.

Jones: It has certainly caused confusion, especially at the ECAs. Even though they may have been given some direction on this, from the ECAs we have been speaking to, some think they have been given direction and are quite clear on it and it is fine. However, others have not understood how to interpret the guidelines and have just been trying to do their own thing and work out their own system. Even though it has just been introduced, some ECAs have been adopting it for some time because they knew it was coming and wanted to see what impact it had on premium rates. We were quoted a premium (in early September) based on the new system by an ECA and we had a two-month negotiation. It went up fourfold and we brought it down to half of what the highest one was in the end.

Vettese: The idea is to create a level playing field for exporters to compete on the quality and pricing of goods and services they can provide, rather than on the level of support by their respective ECA. ECAs can have a supporting role playing by the same rules. Initially ECAs implemented guidelines for the minimum premium rate for transactions with sovereign counterparties. However, it was felt that the minimum premium rate for sovereigns reflected a reality in which transactions with sovereign risk were a large part of the volumes of an ECA’s portfolio. The reality now is that a large part of an ECA’s portfolio is represented by transactions with private counterparties. Therefore, there was the necessity to set out common rules to determine how we assess the risk of a private borrower and the minimum premium we have to charge.

Gardner: In aiming for that goal, which is an honourable one of a level playing field across the globe, the way this is implemented it might have you doing the opposite, because it does not say, as the premium rate does, ‘for this category country the minimum premium rate is X’. What it says is ‘here are seven ways you could measure a credit and using any of these seven ways, ascertain the premium rate’. That is so open to manipulation. There is no way banks are going to come up with exactly the same data, because if I pick the price of a loan today it is not what it was trading at yesterday, and it is not what it will trade at tomorrow, particularly in today’s market. If I take a CDS, it is even more volatile. Therefore, rules that have been produced are going to create more volatility in premium rates than stability.

If you had come out with a rule that said ‘a single B credit in a developed market must be a minimum premium of X’ that would have worked; ‘a double B credit must be a minimum premium of Y’ that would have worked. Everybody, including bankers looking at these deals and suggesting to a company whether or not an ECA financing makes sense, would have clearly known on day one what the cost was going to be, over and above which we add the variable of funding cost and the margin for the bank. That clarity would have done far more than the scheme that we currently have.

Vettese: For category zero countries, even before the introduction of the new guidelines, ECAs were required to apply ‘market conditions’. What the agreement is trying to do now is to give an indication of the basis and appropriate criteria on which you can determine the market conditions.

Gardner: Are you going to get an agreement between Japan, Korea and Italy, all competing for the same transaction? I am not sure you will.

Jones: You certainly will not. I have a good example on this particular case where it was being reinsured by a second ECA. The first ECA quoted a premium rate. When we went privately to the second ECA to quote for the same deal it was about two thirds the original premium rate. They did not want to tell the first ECA that it was, because they did not want to lose out. The point is they have been given too much scope. It is too much open to interpretation. They have been given four or five benchmarks, it is up to you to determine which one you want and then, once you have chosen, it is how you interpret how to calculate against that benchmark. There are just too many variables. I think it will take a while to bed down.

Gardner: We have just provided another layer of uncertainty on what used to be very stable, predictable finance. Now we have to say: ‘It is stable and predictable, but the premium is not.’

Green: There is also the interpretation of what the quality of the underlying product is. Whether it is a guarantee or an insurance policy. Do you look at the rating of the country as part of that policy, so if the rating of the country is different they have the opportunity to downgrade their premium and by what amount?

Vettese: This is embedded in the new mechanism for setting the minimum premiums. Of course there will be a monitoring period and ECAs will report their activity and compare experiences.

Gardner: I can see why you would need to do it: if you are using taxpayers’ money you should not use it to subsidise loans in tier one markets. However, I think the flip side is we are potentially impacting loans that will not be done without ECA assistance and some of the long term bigger projects that simply are, in today’s balance sheet constrained world for banks, beyond their capacity both in terms of dollar amount or tenors to be able to do. We are going to perhaps handcuff those sorts of transactions from what would have been a relatively simple process where no bank would put their hands in the air and yell foul play by an ECA because we could have done this in the syndicated loan market.

Green: Over time, Marina, do you think this will go through a review process and in a couple of years will they ascertain whether or not the premiums issued for developed countries are actually working and achieving the goals set by the OECD?

Vettese: The idea is that ECAs will be able to compare their experience, and then, if needed, implement a revision. The guidelines for category zero countries, however, are only one part of the picture. The level playing field is being created for borrowers’ classification for all country categories, so you are only looking at part of the changes that have been introduced. For category zero, moreover, even before the changes, the consensus rules required ECAs to determine the premium based on ‘market conditions’. There were no guidelines on how to determine market conditions, therefore it was open to interpretation by ECAs. Therefore, the changes that have been introduced only provide common guidelines to which ECAs can refer to to establish what market conditions are.

Boon: Do we have the arguments for more ECA support in the Asian region and should it be a direct lending type or should it focus on insurance and guarantees?

Gardner: If there is a gap, do you need an ECA to fill it or can you fill it with a bank like China Development Bank (CDB) or China Exim, because they both perform relatively similar roles? Do you need an ECA or can you utilise existing infrastructure, which would be an existing bank in Singapore authorised to run a certain programme to support exporters for national interest or whatever the gap is that Singapore decides. That would be the quickest fix rather than just create a whole new organisation.

Green: If it is an instrument of government policy, then it probably needs to be similar to what Natixis does in France.

Boon: I think volume is probably one of the issues, but there are many other countries in Asia that have the same issue.

Ling: If a new ECA is required it should be in India. There are a lot of exports from India and a lot of Indian investors investing overseas.

Green: Malaysia, Thailand, Indonesia, Philippines, all have exim banks in some form or other, but their mandate is less clear.

Ling: They are more like a guarantor to domestic projects or they take the domestic project risk and add the export credit cover on top.

Boon: If volume and rating are issues, that should support the idea for a regional ECA.

Gardner: In the eurozone, Germany appears to be taking the brunt for the rest of Europe. You are going to have the same in Asia. The best credit quality in that pack will be the one that banks and their lenders look at to bail out that ECA should it be hit with a loss. You could agree to put X amount in on day one and everybody contributes, but then you are collateralising it and at that point you do not have any leverage and the efficiency to the taxpayer has gone, because you cash collateralise it with taxpayers’ dollars.

Boon: Should a guarantee programme of the Asian Development Bank (ADB) be playing a bigger role? We hardly see them using it at all.

Ling: The process is taking too long.

Gardner: The day ADB measures its success on a deal being done rather than its credit approval process will be the day I celebrate, because if you celebrate deals getting done that are not done what sort of a measurement is that?

Boon: If you compare multilaterals, indeed ADB, but also I think it goes for the African and probably also Inter American Development Bank (IADB), if you look at the difference between lending and guaranteeing, it is probably 99% lending and 1% the guarantee programme. Interesting enough if you look at the EBRD it is almost the other way around, so they are able to have a process that works.

Gardner: The EBRD is the exception. It has a very commercial bank approach and is less political. If we could envisage an EBRD type institution, there are roles for that type of institution in Asia.

Green: There is going to be something like US$20tn of investment over the next five years globally. In Asia, US$10tn of infrastructure development is needed. Asia still has very poor infrastructure; power, ports, roads, with the exception of a few countries.

The opportunity is there. The structure is there at the federal government level – or not – to support this. There is liquidity available in the local banking market, but there is a huge opportunity in the ECA space and for multilaterals. In fact, everybody needs to play a role to realise the kinds of numbers out there.

One topic we have not covered, the cost of funding, is how come, from the export credit product perspective, we have not been able to come to terms with structuring more effective capital market solutions? There is all sorts of money on the sideline looking for ways to invest. It is not necessarily in banks, but in insurance companies, pension funds; it is in those areas where they need long-term assets.

Gardner: It is in retail too. You offer me, as a private investor, a note that is 100% guaranteed or even 95% capital guaranteed, that yields me seven times what my deposit account is yielding, that is at least an AA rating, and I will take it. The problem is I am not allowed to sell and partly that problem is the ECAs will not let me sell. They do not want to separate the 5% from the 95% covered. They do not want their bond rating contaminated by other instruments in the market. They do not want an individual retail investor knocking on their door asking for their money back. It is time to grow up. If we are to get past Basel III, ECAs have to let us distribute this, because our balance sheets say we will not be big enough to do the
deals otherwise.

Green: The Koreans are signing up something like US$70bn of contracts in the next 12-18 months. They are taking market share from the Japanese.

The numbers are big and if Korean ECAs, for example, wanted to play a role of US$5bn/15bn/20bn between Kexim and K-Sure, how many ECA banks are there in the world? 20? Is each of our banks going to take US$1bn of new Korean ECA credit risk every year? I doubt it.

Opportunities are there and the benefit to this is if we can tap the right liquidity and bring these structures to bear then the cost of this comes down and it is a benefit to exporters and borrowers, and more trade can develop and infrastructure gets built. The discussion should be about how to use ECAs to be effective tools to allow term financing, be it in the bank market and/or a combination of the bank market and capital markets to allow for economic development.

Gardner: It is leveraging the guarantee.

Green: Then tenors can extend out to durations that these projects need to have for effective payback periods.

Gardner: We came close before the crisis with project bonds. Some ECAs were covering bonds and, in fact, Sace covered a bond or two, and bonds are freely tradable. If we can make that sort of jump, it is not much further to go to allow a bank and you can see how private wealth management guys sell that stuff: ‘We are going to give you a couple of billion every year of AA, AAA paper that you can sell to your private investor base.’ They are going to love it.

Green: This structure can work for a variety of reasons, meaning banks do not have to be disintermediated. Effectively what banks can do is take three, four or five year project risk, warehousing that, not worrying about bond structures during a drawdown period. Then we package that and deliver it to the retail/institutional investor base, but we manage it and we have a responsibility to continue to manage those project risks and the deal itself.

Ling: In the past, project bonds were not that popular, because they are more costly than project loans, but that is going to change due to current market conditions, so a project bond will be much more attractive to the end user.

Green: One of the reasons why ECA-wrapped bonds have been less attractive is that their structure is inconsistent with what capital markets have historically wanted – notably amortisation (versus bullet) and prepayment risks. It is hard to find those types of investors – so education and development of the investor base would be a priority.

There are all sorts of aspects to this, but again I do not think it is beyond our collective capacity as banks and ECAs to figure out structures that can be utilised.

Gardner: Maybe Basel III will be the catalyst, because it is going to shrink banks’ balance sheets or at least increase tier one capital. In today’s environment I do not know anyone who wants to buy equity in a bank to increase tier one capital, so how are banks going to do it without internally generated funds? You cannot match it out, so, by definition, your balance sheet is going
to shrink.

Green: Export credit financing is financing into the real economy – you are financing power plants and real economic development, which has a longer payback period. The loan tenors need to be  longer and it is that duration of tenor which is creating a problem under Basel III and having to allocate more capital to it.

Jones: For banks to try to convince the regulator is one thing. ECAs and their governments similarly need to step up.