Export financiers in Asia discuss a more proactive approach to finding new business.
- Aneesh Mahajan, regional head, Southeast Asia, structured export finance, project and export finance, Standard Chartered (chair)
- Anil Berry, CEO, Euler Hermes Hong Kong, head of commercial, Asia Pacific, Euler Hermes
- Rudra Kundu, structured finance – cluster Asia & Middle East, Nokia Siemens Networks
- Michael Lutz, head of STEF APR, UniCredit
- Sumanta Panigrahi, regional head, export and agency finance, Asia Pacific, treasury and trade solutions, Citi
Mahajan: What is the global outlook for political risk insurance (PRI) and trade credit — the sectors that are weathering the storm?
Berry: Business in traditional markets is still increasing overall as a result of an increase in appetite for credit insurance in a context of rising insolvencies and good client retention levels at 92%. In the first nine months of 2012 our top line grew by 5.1%, with growth mainly coming from America and Asia Pacific. In Asia Pacific we are forecasting a year-on-year growth of about 30%, mainly from a significant increase in clients purchasing trade credit insurance (TCI) for the first time as awareness of the product increases.
Looking at sectors and geographical regions, there is an increasing number of industries experiencing difficulties in Europe, where several countries have taken austerity measures. These sectors are construction, distribution, automotive industry and airline transportation. In the US the housing market is still an obstacle, but manufacturing is progressing favourably. In emerging economies, the outlook for sectors focused on domestic demand and infrastructure (roads and railways, automotive) is favourable.
Globally we are expecting insolvencies to increase by 3% in 2013, after a rebound of 4% in 2012.
Mahajan: Are banks keen to adopt insurance programmes? How is this evolving?
Berry: What surprises us is that banks do not regularly engage with us to mitigate their counterparty risk for trade receivables. As you said, in Asia, they will either use export credit agencies (ECAs) or letters of credit (LCs).
There is still a lack of engagement with banks and credit insurers in Asia with regards to the extent that TCI can be used to influence the lending availability of a bank. We sit down with banks, but maybe not the right people in those banks. There are questions we need to ask them, like: ‘What do we need to do with our products? Do you understand our risk assessment? Do you know that if your client has TCI he is less likely to default on a loan? When the default hits, how do we make sure that you get your payment?’
Panigrahi: We should perhaps discuss the important aspect of pricing. The all-in market pricing payable by the client should ultimately be able to accommodate the cost of enhancement. All banks have internal return calculators but differ in their sophistication to be able to factor in the value of credit enhancements. If you look at the enhancements, you are actually improving the nature of the risk taken by the bank and you defend the credit, saying, ‘Look, there are multiple ways out’.
However, the ‘multiple ways out’ actually translate into a lower probability of default which then feeds into the return calculator to give the frontline organisation the flexibility to be able to go back and price a transaction appropriately. I think banks still have some distance to cover in reaching this goal.
Pricing is heavily influenced by liquidity and various stimulus programmes promulgated by governments. Despite increasing risk, pricing is actually trending downwards – case in point being some of the economies in Latin America, India and China where pricing is depressed due to infusion of liquidity by state-owned policy institutions.
Berry: Pricing has come a long way in the TCI industry. 15 years ago pricing was very much based on history. You would look at a customer’s claims history. Today, we look more at risk-based pricing. So we are looking at buyers and their probability of default and give a score, or grade, on what we think is going to happen, which is probably more in line with a bank rating. We are looking at the cost of capital as well, so it is more aligned.
Rates in the credit insurance market have been fairly stable over a number of years, which is something clients and banks that work with us have appreciated.
Panigrahi: General industry practice has been that price is not an absolute level, rather a percentage of the spread. In an ECA, long-term market, the pricing for the enhancement is absolute and quite transparent and teams know what the price of such enhancement is going to be. It is the function of the structure, the country and the credit standing of the borrower. This pricing therefore does not fluctuate with the fluctuating market pricing – which is increasingly a function of the liquidity premia that treasuries charge internally within banks. Therefore having a model where pricing as a function of the spread, which includes liquidity costs and credit spreads, is not sustainable. This needs to change/adapt in order to encourage the use of such mitigation mechanisms.
Lutz: The pricing structure has been discussed a number of times on the private risk insurance market and a lot of insurers came to the conclusion that there are liquidity costs for banks. Banks just need to be frank and disclose their cost of funds, and then you can make a normal calculation on the net profit margin. This is then the price of the risk. For that, however, banks need to disclose their cost of funds to insurers.
Berry: The bank often comes to us through an intermediary as well, so we do not have that direct dialogue with the bank.
Lutz: It is usually through brokers.
Berry: Yes, brokers can add value, particularly with regards to due diligence processes. However, the key for Euler Hermes is to have a three-way dialogue, with the bank and intermediary rather than, as at the moment particularly in Asia, purely through the intermediary, so we are getting everything ‘second-hand’. That can lead to a lack of understanding; open discussion on pricing is needed. We have to sit down, meet and discuss risks and pricing.
If I look at Europe, there is a high awareness of TCI among customers. The customer often says, ‘I have TCI. Can you use that as security against a proposed loan facility?’ In Asia, there is a lack of knowledge about the product. This is probably why it is more in the interest of banks than ever to understand the product and promote it to their client base. That is what businesses need in Asia: banks represent an important sales channel.
When I was working in Europe, I did not spend much time with banks. Now, in Asia, I am beginning to spend more time with them to understand their client base, and explain how trade credit can enable them to lend with confidence.
Lutz: At the same time, when you use private risk insurance as risk mitigation, you do not usually need it on the big names because they have enough limits. Usually you look to the medium-sized companies, and there you encounter the problem that, most of the time, there are no limits available, or it is really difficult to get a quote.
Berry: You are right in that most companies want to insure medium-sized companies in Asia and exclude certain buyers, although often they find we can offer more value by insuring all their buyers. However, I disagree that it’s difficult to get a quote or cover on medium-sized buyers. Our credit limit approval rates show we quote in most cases.
In the past, one of the issues in the credit insurance market was that we did not have enough resources to evaluate those middle-market risks. If you look at Euler Hermes’ resources now, we have virtually doubled our risk team within the last three years, including in markets like China, where we have a significant presence today to assess and increase our appetite for those mid-sized company risks.
Mahajan: Are ECAs giving exporters in Asia what they need in terms of long-term financing and support?
Kundu: Yes and no. To explain this dichotomy, I will divide this into two distinct halves: pre-2008 and post-2008. My comments also are mostly to do with the eastern half of the world, which I handle: Asia, Middle East and North Africa. Pre-2008, most banks had risk appetite as well as liquidity, and therefore, frankly, the ECAs that we dealt with were handling less volumes.
Post-2008, everything changed. The first was risk appetite, where lots of banks, for obvious reasons, could not take on incremental assets, and we started doing lots of deals with ECA support, and it was simply invaluable.
Thereafter, probably from 2010/11 onwards, the liquidity element also came in, so there were two distinct phases. The first was when there was no risk appetite, but as long as we had ECA support, we could do the deals and banks were happy to fund. Then we got into yet another situation where many banks were not even happy to fund, which is the situation we still have today. There are lots of factors behind it – the overall economic situation, the euro, Basel III, and so on.
This obviously leads to what many ECAs are doing, which is direct funding, and there are some challenges in this. The main challenge is that many ECAs are not used to doing it. If I take specific examples, we have dealt with two ECAs a lot: Euler Hermes and Finnvera, given our lineage in Germany and Finland. I am not too familiar with the Euler Hermes funding programme, but Finnvera never had one of that scale. It had a small one for SMEs, but frankly it is nothing compared to the export finance business, with a portfolio of €10bn. Last year, it took a decision that it would come up with one. Ad hoc programmes were put in place before this could be finalised, and finally now the scheme is coming into place.
What, then, needs to be done? On one side, ECAs understand the situation and are working on it. Given the fact that ECAs ultimately are government-owned, it takes time. On the other hand, commercial banks have all along led this business, where ECAs more or less took care of the risk and banks took care of the liquidity. I wonder what is wrong with the traditional model, and when that will change. It needs to change, otherwise banks need to take a decision that this is not a business for them.
Also, different banks deal with this product differently. Some house it within trade finance; some house it separately; some club it with project and export finance. This is a product by itself because it has many facets, and it involves a whole lot of things such as long-term risk analysis. Frankly, that is not really the ball game of a person who handles trade finance products up to a year. The last thing I would say on this is that there is a smaller set of banks which are using this as an opportunity.
They probably do not have that much of a balance sheet constraint, maybe because of the lack of geographical spread they have. They are looking at this not as a niche but as an entry strategy to use now that will hold them in good stead over the years. They are, therefore, not shying away from funding. What they are trying to arrive at is probably a mix, whereby they are not saying, ‘I will fund 100% if I have an ECA guarantee’; what they are probably saying is, ‘Would I want to do the deal? For that, if I want to provide balance sheet, I am happy to’.
Obviously, that is opening lots of doors for them, which would have been closed otherwise, given that Asia has all the international banks that are worth talking about. ECAs often do not have the ability or staff strength to be close to the market. This is another challenge I see, where, given the way the market is changing, and given the way borrowers’ needs are changing, ECAs need to gear up to this as well.
Panigrahi: Asian ECAs have been perhaps the most supportive of their exporters. Take the example of Japan: it has a whole working capital support programme, overseas investment loan programme, natural resource finance programme, buyers’ credit programme, direct funding programme. If you look at the whole suite of products, perhaps they have been the most supportive from their exporters’ perspective.
If you take some other exporters in the region, 60% of Korea’s economy depends on exports. K-sure and Kexim have been quite supportive. If you look at Indonesia or Taiwan, however, again there are a lot of exports, but they do not have an ECA. Even Singapore was discussing having an ECA, but they decided not to. India has an ECA, but it is not a conventional ECA in the real sense of the term. Malaysia, for its exports, is still experimenting, but is nowhere near that scale.
It is the full spectrum in Asia in terms of where support is and how supportive they have been. It is a little more than that; it is the government intention to support as well. In China, for example, Sinosure is perhaps much narrower in the way it looks at exposure, the products, and how bank-friendly and how financing-friendly it is. There, however, the policy banks have stepped in.
Mahajan: From an Asian versus European ECA perspective, European ECAs could strengthen their proposition by expanding their direct lending programmes. The cost of funding for many European ECAs can give them relative advantage over some Asian ECAs. Borrowers in Asia would see, in their all-in cost calculations, this relative advantage.
Kundu: I agree. Again, this is a disadvantage for us, given our lineage. Traditionally, we have depended more on European ECAs. I think these ECAs have stepped up dramatically over the last few years and they have done it rather well. Again, however, I would like to comment on one aspect of this. The reason why it is still a challenge for us is that OECD-driven ECAs, or OECD-group ECAs, have the OECD mandate, and they have to work within that. That probably needs to be looked at again.
Let me just address content. OECD ECAs have content-driven rules and policies. Frankly, as far as I know, Asian ECAs, such as the Chinese, are very different. First, they are not subject to OECD rules. Second, they have their own way of looking at things. It is an undeniable fact that manufacturing, by a very large scale, has moved out from west to east. This is true for almost every industry except a few. Therefore, if you stick to the old rules of content, you will not be able to do business.
This is one major reason why, as a user, we have not been able to use the support of Asian ECAs as much as we would have liked to, in spite of the fact that our manufacturing has largely shifted here. We have not done enough transactions with them, and we do not know them well enough. Support from market participants, like banks, is invaluable for us in opening doors. If a bank comes to me and says, ‘I understand your situation as a user, and I propose this, with the support of Kexim or Sinosure or whatever’ that is a door-opener for me, which is what I need as a user.
Berry: It is interesting that you mention some European ECAs having inefficiencies compared to their Asian counterparts. Yet, European ECAs have competition from the private sector. When you look at K-sure and Sinosure, they have little private sector competition. I would have thought competition would drive efficiency.
Kundu: One reason behind that is probably the strong way many Asian ECAs are driven by government policy and support, like the Chinese banks’ example. An example from our industry is a big telecom operator in India, which was almost bankrupt, with very high leverage. The Chinese trio of China Development Bank, China Exim and an ECA came in with a US$1.7bn funding package. From the point of view of a bank it would be suicidal.
Mahajan: Let’s delve deeper into the issue of direct lending versus insurance.
Kundu: Both are important. The guarantee subject of all ECAs primarily is very important. It has always been there and it will never go away. Even if we have a market awash with liquidity, ultimately, while we talked laughingly about the government policy driving many ECAs, ECAs are instruments for guiding government policy and the economy of that country. That is why they exist. They are not the same as commercial banks, so, by principle, there is not too much wrong with that. Finnvera and Euler Hermes exist to support exporters like us. Their guarantee business has been there and has supported business a lot. Currently direct lending is becoming the need of the day.
It is extremely important, for many reasons. First, commercial banks’ inability to use balance sheet for such transactions in significant amounts. Second, even if they do it, the cost is becoming prohibitive because of various reasons – internal, Basel III, Europe, and so on. The challenge here is that many ECAs are not geared towards handling this.
Therefore, what would happen is the state treasuries would need to get involved in this and probably either train the ECA, or an arm of the state treasury gets embedded into the ECA, where they start raising money from the market and then lending it out along with their guarantee. While, in principle, this sounds simple, it actually involves a whole lot of things. The ECA will need to get rated. Since it will be state supported, one would think that that would be less of a challenge. Second, they will need to put up funding policies, which they would have never done. A bank treasury is more used to doing that, but then if I mention one traditional problem there, something that every bank grapples with is gapping. You have three-month liabilities; you are supposed to make 10 or 15-year loans.
This gapping risk is something banks have stayed with, and many banks have ways of managing it. When many ECAs do not even have the first vestige of a treasury set-up, that is a risk they need to take because of the sort of products we are looking at today. All of them are long-term. Frankly I hardly ever go to an ECA for supporting a six-month exporter. There are enough people in the market to support that.
Panigrahi: The role has to be complementary. It should not be seen from a customer perspective, for example, as a pricing arbitrage. That is not the role of the agencies. If there is a gap, that should absolutely be filled and should be facilitated by the agencies. For example, some of the ECAs led by US Exim pioneered the channelling of capital market funding alternatives into this space.
They also experimented with a “put option” triggered by market disruptions, which helped banks mitigate the gapping risk, something that the banks are not set up to do effectively. Both of these measures have facilitated availability as well as pricing. In the case of the “put option” it allowed the banks to say, ‘This is actually liquid. If there is a crisis, there is a way out for the bank.’ Further, it is a contingent exposure on the part of the ECA.
It is not a direct exposure, so they have to potentially think about treasury, but not immediately. The mechanism is clearly still nascent as the risk did materialise, especially for the European banks facing severe dollar liquidity scarcity. The mechanism has since been temporarily suspended. However, the concept was successful and proved the potential impact such mechanisms can have on the market. As a community we need to work together to think through such mechanisms and broaden the scope to facilitate access to financing.