A steady rise in the use of insurance by the mature markets of the North has been eclipsed lately by new demand from the emerging economies of Latin America. Tim Evershed reports.
A combination of factors has driven remarkable growth in both trade credit insurance (TCI) and political risk insurance (PRI) across the Americas in recent years. One factor behind the rise is an increase in awareness of political risk as evidenced by the findings of 2013’s Aon Global Risk Management Survey.
Political risk and uncertainties broke into the top 10 risks for the first time in 2013. This is due to the increasing civil wars and social and political conflicts around the world. This risk is projected to move up to number six in the 2016 survey.
Events in the Middle East and North Africa during the Arab Spring have further raised awareness of TCI and PRI products. But they have also highlighted the fact that these risks exist in the first place. And the eurozone crisis has underscored the fact that the risk of non-payment or even sovereign default can happen anywhere.
“The first step in utilising risk insurance is realising you have exposure. Events from Algeria to Libya to Egypt and now Syria have firmly underscored that these risk exist,” says Jim Thomas, head of the Americas team for political risk and structured credit at Zurich North America. “We’ve also seen events in South America with a number of expropriations in Venezuela and a very high-profile expropriation in [oil company] YPF in Argentina.”
“The financial and political crises obviously developed awareness and increased risk perception among suppliers and banks,” says Peter Aitken, vice-president, special products at Atradius trade credit insurance. “This awareness has meant increased use of TCI and that in turn has driven economic growth because capital and credit is being made available where it perhaps wasn’t before.”
The key markets for TCI across the Americas are the US, Canada, Mexico and Brazil.Brazil alone has seen a 17% increase in demand for TCI so far this year, according to its insurance regulator SUSEP. TCI premiums for the first four months of 2013 rose to R$145mn, up from last year when total premiums were R$370mn.
“We’re doing quite a bit of business in Brazil. Zurich set up some unique capabilities back in 2009; we’re providing structured credit insurance locally in Brazil, mainly to Brazilian banks,” says Thomas. Traditionally, banks across the Latin American region have mainly utilised TCI for domestic trade where a company’s whole turnover is covered.
Since the crisis, however, insurers are seeing a great deal of growth in structured cover. “This is a demand that didn’t exist before 2009: it was mainly whole turnover and multi-buyer,” explains Zurich’s Thomas.
Brazil’s demand for trade credit coverage is largely on the back of commodity exports. Meanwhile, in Mexico a remarkable change is occurring as the country moves from a narco to manufacturing economy. Thomas says: “We are seeing quite a lot of structures where Brazil is sending commodities, like soya beans or iron ore, to China and consequently we’re seeing a lot more activity from Asian banks in Brazil.”
“I think a very interesting development over the last couple of years is the real rise of the manufacturing sector in Mexico. The cost of labour there has come down to compete with or even better China’s. Mexican exports go to the US and benefit from the North America free trade agreement, so we’re seeing a lot of demand from Mexico,” he adds.
“Brazilian and Mexican banks are utilising trade credit coverage to extend more credit, and on the borrower’s side, there is a greater availability of credit as a result. A lot of these banks are now comfortable extending these credit lines because
they are able to mitigate those risks.”
It looks as if regulatory factors could promote further use of TCI in the region. Basel II terms dictate the characteristics that credit enhancement has to have so that banks can take some capital relief, which includes TCI products. And the introduction of Basel III looks unlikely to reverse this.
“The insurance market has responded to that in order to support trade and that is kind of an alternative source of capital,” says Stuart Barrowcliff, vice-president, senior underwriter, political risk and trade credit at XL Group. “So as well as selling participations in a loan to the secondary market to other banks, they can also use the insurance market to reduce the capital on what they keep and distribute the risk in that fashion.”
Thomas adds: “The general direction of Basel III seems to be towards the benefits of TCI being recognised. I think it will become a more prominent tool in the trade finance arsenal. So, banks are able to maintain and grow a relationship with a client that they would not otherwise have been able to do.”
TCI coverage is readily available for the large economies in Latin America such as Brazil, Mexico, Colombia, Peru and, to a certain extent, Chile. Argentina, Venezuela and Ecuador are currently deemed more high-risk and coverage can be more difficult to find. This is partly due to the poor health of the economies in these high-risk countries, and then there are other factors such as currency restrictions around the flow of foreign exchange.
Export credit agencies (ECAs), such as US Exim, SBCE (Brazil) and Bancomext (Mexico) have been known to step in and ease some of the capacity shortage across the Americas. XL’s Barrowcliff notes that even though they act as competitors to the private market, in some of the more difficult markets, ECAs “certainly have a role to play”.
“During the financial crisis the ECAs around the world, and certainly US Exim, really stepped up to help plug some of the funding gaps that occurred as the banks pared back their lending.”
Aligned to the increase in use of TCI is a marked uptick in demand for PRI across the Americas. Again, events on the ground have prompted companies to reassess their risk in certain territories.
Issues such as resource nationalism, expropriation, sovereign default and regulations on foreign direct investment are all on the radar for exporters and investors.
Barrowcliff explains: “What has happened a number of times recently in Argentina in terms of expropriation has certainly raised the awareness of a lot of the companies that we work with in terms of political risk. It helps crystallise in their minds what happens when you can’t get access to your assets or your company or they are taken away.”
The increase in demand is also due to the number of large infrastructure projects being undertaken across Latin America. Peru, for example, is building roads across the Andes to link the eastern and western parts of the country. There is also a lot of investment in power plants across the region.
Brazil’s range of international sporting events in the coming years are prompting investment in airports, railway lines and roads. This has caused a rise in credit coverage on sovereign non-honouring on Brazilian sub-sovereigns and state-owned entities.
Thomas at Zurich says: “It has increased due to the upcoming World Cup and Olympics. What we are seeing is a lot of municipalities undertaking projects stadiums, train lines, subways and airport upgrades. These sorts of projects are being undertaken at the municipal or state level.
“It is not necessarily a reflection of the credit risk, but rather shows the volume and the scope of these projects, which is unseen in the past for these construction companies. They need protection for their balance sheets.”
He adds that the firm is also seeing demand for sovereign non-payment in Peru and in Mexico where there is a market for municipal lending, much of which goes to infrastructure projects.
Equally, Latin American firms are now also looking for increased protection around the globe. “The fascinating thing for PRI at the moment is we’re seeing demand from within Latin America, namely Mexico and Brazil, from corporates looking to protect their investments abroad. This is something that wasn’t happening five years ago,” says Zurich’s Thomas.
He adds: “It coincides with the growth of the ‘multi-latina’ and an increasingly sophisticated risk management approach. Much is being said about south-south trade, but there’s also a great deal of south-south investment taking place.
“For example, corporates such as Embraer and Marco Polo have made large investments in manufacturing facilities in China. As Latin American companies operate in new markets there’s a greater demand for PRI.”
Investors have also been cautioned to keep an eye on developments in low risk areas such as North America.
Jonathan Wood, analyst at Control Risks says: “We’re at an interesting and unique geopolitical moment for North America due to the energy developments there. It is changing North America’s global position but also changing the relationship between the US and Canada.
“A relationship that has been stable for a long time and even increasingly close is now marked by a renewed sense of strategic play on energy, security and trade issues. We don’t see political instability as such but there is certainly some skin in the game.” And there is ongoing concern over the deadlock in Washington, particularly over the federal budget.
Wood explains: “There is lot of concern, particularly from investors, that political tension between Republicans and Democrats would lead to negative economic developments. We haven’t seen that happen yet. There was a step over the fiscal cliff in January but these haven’t resulted in the kind of cataclysmic predictions some made.
“There’s a lot of posturing in the US political systems but at the end of the day they always manage to reach a deal.”