The Middle East has become one of the most active ECA-backed regions in the world, writes Sarah Rundell.
Imagine a cramped, two-seater helicopter topped not by the usual propellers but by a large hoop with 18 small rotors. The world’s first autonomous air taxi flies for up to 30 minutes and includes back-up batteries and two parachutes to reassure nervous passengers. German-made Velocopter is still a couple of years off offering Dubai executives a solution to the city’s congestion, but it is just the kind of novel infrastructure in which the state’s road and transport authority, seeking to switch a quarter of its transit system to autonomous vehicles by 2030, chooses to invest. Like the driverless trains on the metro, a network slated for a US$2.8bn expansion, half of which will be backed by export credit agency (ECA) loans and guarantees.
Investment has been pouring into flagship infrastructure ahead of Dubai’s Expo 2020 and the Qatar World Cup for a while. In the UAE, it is helping stoke growth in trade that is projected to be the fastest of any country in the region at nearly 10% in 2017-18, according to Coriolis Technologies.
Renewable energy is another important story. Solar projects are springing up across the region: Dubai is planning the largest waste-to-energy plant in the world, and Saudi Arabia will develop its first ever wind project at Dumat Al Jandal. In Egypt, Iraq and Pakistan, power projects have dominated infrastructure investment, while in other countries investment is being driven by urgent economic strategies to diversify because of low oil prices, currently languishing at half the highs recorded four years ago.
ECA backing in the region is nothing new, but the recent wave of investment comes on the back of unprecedented ECA support. Of course, top-tier corporates and government entities in the region’s highly-rated countries still easily tap competitive bond and sukuk finance without ECA support. But the low oil prices have left the region’s sovereigns with huge budget deficits, the likes of which they’ve rarely experienced before. In search of urgent solutions, they drained local bank liquidity and issued debt in the capital markets. Still strapped for the cash they need to fund diversification, they’ve now turned to non-traditional methods of funding.
Floodgates open
Cue ECAs with long-term financing via guarantees and direct loans that match infrastructure’s long tenors. It is cheaper than other long-term debt instruments in the capital markets, and acts as a magnet, drawing commercial lenders into projects. Particularly since banks now prefer to lend to projects with ECA cover because of Basel implications.
“It is far better from a balance sheet perspective to lend with ECA or multilateral cover than providing clean lending on a term basis,” says Yusuf Khan, head of trade for Middle East, North Africa, Pakistan and Turkey at Citi. When it comes to large ticket sizes, support from OECD ECAs like UKEF, Coface and Hermes attracts the most interest amongst financial institutions, he says. “The yields tend to be higher with the Asian ECAs, especially the Chinese and Korean.”
That preference becomes insistence in higher risk geographies like Egypt where the commercial bank market is reluctant to lend beyond a certain tenor, and multilaterals have been instrumental in solar power sector financings. In Iraq, where few commercial banks are prepared to venture, ECA financing is just as crucial. Witness UKEF’s direct loans and guarantees for power upgrades across Iraq in support of Enka UK and GE last year.
Now interest from corporates and government entities is also set to jump following trail blazing deals in the oil and gas sector. “Kuwait Petroleum Corporation (KPC) and Saudi Aramco using ECAs is sending signals to other government-related entities that they should consider ECAs for their own projects,” says Charles Emmanuel de Beauregard, director of structured finance, responsible for export, infrastructure and asset-based finance, in Société Générale’s Dubai office. Last year’s US$6.25bn loan to Kuwait Petroleum Corporation to upgrade refinery facilities involved seven ECAs in the largest ECA-supported financing in Kuwait’s history.
Emerging trends
In a reflection of their influence, ECAs have become much more active at pitching their capacity and appetite to provide cover to lending banks. Their proactive strategy extends to a more active role within deals too, observes Mark Castillo-Bernaus, head of White & Case’s Emea energy, infrastructure, project and asset finance group. He says when it comes to large, multi-sourced project financing where ECAs are providing and covering a substantial portion of overall project debt, ECAs now lead the way. “The ECAs will do all the homework and structure the deal themselves, with the banks coming in later following commercial bank launch,” he says.
“ECAs are taking on more of a pathfinder or project development role – transaction structures and terms tend to be agreed with pathfinder ECAs before being launched to the commercial bank market,” agrees Kyle Nevin, senior associate in Dubai for Allen & Overy. It’s a trend traced back to ECAs filling the void left by banks’ exodus in 2008. Even though banks returned to the market in 2015, ECAs have remained at the forefront.
Sponsors which have ECA content across several projects are also innovating. “At times we are seeing sponsors raising ECA finance at a higher level, rather than the individual project level,” says Castillo-Bernaus. “Sponsors are looking to maximise access to ECA financing by pooling a portfolio of new projects with ECA content and then raising the ECA debt at a higher corporate level on a balance sheet recourse basis.”
Wider offering
Some ECAs are also developing a wider product offering. UKEF, energised since Brexit and a renewed need to support British companies abroad, has increased the number of local currencies it is prepared to offer from 14 to 60, many of which are in the Mena region. It means the agency can position itself to partner with governments and sponsors looking to finance projects in their own currency.
“There are risk mitigation benefits of financing local projects in local currency. Supporting transactions in US dollars and euros can expose local sponsors to foreign exchange risk if those projects are not forex generating,” says UKEF’s head of civil, infrastructure and energy, Adam Harris.
Now ECAs could broaden their reach further, says Allen & Overy’s Nevin. “ECAs do a lot to support their contractors in the region today, but they could potentially do even more.” He suggests a wider range of financing options and flexibility of funding sources, like UKEF’s innovative wrapped sukuk, used to finance Emirates Airlines’ purchase of four Airbus A380. It’s something UKEF says it wants to expand on. “We are keen to explore opportunities where we could do this in infrastructure too,” says Harris.
Local banks
ECA finance is increasingly in the sights of the biggest local banks, as keen to diversify their lending portfolios away from the oil sector as sovereign governments. First Abu Dhabi Bank, formed after the merger between First Gulf Bank and National Bank of Abu Dhabi – which itself took part in the UKEF-backed Emirates Airlines financing in 2015 – has led the way developing in-house ECA structuring facilities. “Local banks have started looking at ECA facilities, especially helping with syndication with larger projects. In a few cases we see local banks acting as an agent or sole lender in an ECA facility,” says Marco Ferioli, head of Sace’s Dubai office.
A next step will see more local banks adjust their regulations accordingly, such as aligning with European banks by creating a zero weighting to the loans covered by an ECA guarantee. “This has an impact on the cost of the facility. Although the ECA guarantee is considered strong collateral, it is not recognised as a sovereign guarantee by some local bank regulations,” says Ferioli.
In one future trend, ECAs could also have a significant impact on boosting public-private partnerships (PPPs) in the Mena region. PPPs have been used to finance power and water projects, but bank enthusiasm has been lacklustre outside these sectors – to the frustration of local governments.
If sovereigns use ECAs to help them finance greenfield infrastructure, it will be an important pre-cursor to the growth of the region’s PPP market – more suited to finance brownfield projects with visible and existing cashflows. “With greenfield sites, sovereigns are better to raise the debt, use ECA financing, get the infrastructure up and generating cashflows, and when the time comes, refinance through PPP. In the meantime, the regulatory framework will be in place and PPP can follow on down the road,” says Société Générale’s de Beauregard.
The risks
Despite the booming pipeline, financing infrastructure in the region remains a risky business. The ability of other project stakeholders to supply key inputs within the timeframe is an enduring worry. “Supplier risk is a significant aspect of infrastructure projects and banks pay special attention to the execution capabilities of suppliers,” says de Beauregard.
A lack of transparency amongst local corporates can make assessment of these capabilities a challenge. In some markets, suppliers lack financial information like balance sheets and official annual reports because of different standards in transparency and disclosure, says Ferioli. “Transparent and standardised information is an essential element in enabling foreign companies and financial institutions to make proper decisions.”
The collapse of Carillion, supported by UKEF through both its direct lending facility and buyer loan guarantees to win a series of major contracts in the UAE in recent years, is a case in point. Last July, when the company announced an £845mn hole in its finances, a £314mn portion was attributed to unpaid work in the Middle East.
Correctly forecasting demand-based infrastructure footfall and traffic is another challenge. Get it wrong and new malls, stadiums and hospitals won’t hit revenue streams, or lenders’ returns. Ensuring that projects meet social and environmental standards is another aspect that could impact investment. It is also something that local project developers, now tapping international banks because of the liquidity constraints of local lenders, haven’t necessarily had to consider before. “Sovereigns have only turned to international banks for their borrowing requirements recently and the latter are often more demanding than local banks in terms of structuring, documentation and environmental and social requirements,” says de Beauregard.
Even sovereigns, particularly those sitting behind deals in countries like Iraq, Egypt or Pakistan, pose a risk. “Some governments in the Mena region are perceived as having a better credit position than others,” says Carina Radford, partner in the energy, infrastructure, project and asset finance practice at White & Case. “This affects the ability for financiers to rely solely on government payment streams and can lead to a different approach to risk mitigation in transactions based in, for example, Egypt, Jordan, the UAE and Saudi Arabia.”
Despite the risks, Mena is a now global hotspot for new infrastructure. With ECA activity on the rise, they may even help finance Dubai’s flying taxis – one day.
