There is no such thing as a typical export credit agency. They come in all shapes and sizes. For example:
There is no such thing as a typical export credit agency. They come in all shapes and sizes. For example:
Some export credit agencies are government departments, some are public corporations, and some are private companies (some of which may write most of their business on their own account but retain a link with their governments for at least part of their business).
Some do only short-term business, some do only medium- and long-term business, and some do both.
Some only insure or issue guarantees, some lend, and some do both.
Some are called insurers and some eximbanks.
Some provide only export credit insurance, and some only investment insurance, but most (at least of the larger agencies) do both.
Some are very large, with premium income in the hundreds of millions of dollars, whereas others are considerably smaller.
Some primarily underwrite political risk and some primarily commercial risk, but most cover both categories.
Just as there is no typical export credit agency, neither is there any single perfect model for an export credit agency, applicable at all times and in all countries. It is also very dangerous simply to try to transplant one model in one country to a very different country. The status and facilities of an export credit agency need to take account of the country’s situation, which may well change over time. Thus, for example, in some countries at some times it may be perfectly sensible and appropriate for the export credit agency to be involved in providing working capital, but it may not be in the same country at other times or in other countries. Unfortunately, much energy, time, and resources continue to be wasted in the search for some perfect, timeless, and universally applicable model for an export credit agency and its facilities.
It follows that it is rather dangerous to generalize about the roles, position, status, policies, and objectives of export credit agencies, although much of the remainder of this volume will do just that. However, attention is drawn to the problems that can arise when export credit agencies are writing all or most of their short-term business—and especially their commercial risk business—on their own account, with private market reinsurance. They then have no link with their governments on this business. This can complicate any coordination of responses to countries with large external debt burdens and balance of payments crises, to take account of this and other significant changes in the composition of external debts. Similarly, the word “guarantee” means different things to different export credit agencies (see Appendix II) and should be treated with caution.
Some Basic Models
In looking at the major activities of export credit agencies, it may be helpful first to review briefly and in basic terms where export credit agencies fit into some of the most common trading arrangements.
Basic Mechanisms of International Trade
The most basic model of international trade consists of the exchange of goods and services for cash payment between an exporter in one country (country A in Figure 1) and an importer in another (country B). In the real world, however, it is unusual for an importer to pay cash with its order. Most world trade is conducted on the basis either of payment on receipt of goods or of payment within 180 days of receipt. This need to extend credit in order for most international trade to take place introduces some degree of uncertainty, as does the fact that both the goods and the payments cross borders. Thus, the simple model just outlined needs to be developed to take account of the roles frequently played by banks in the two countries (Figure 2).
Banks may play roles over and beyond simply providing the channel by which money is transferred from importer to exporter. For example, the exporter’s bank may also send the documents giving title to the goods (e.g., shipping documents) to a bank in the importing country, with the stipulation that these should only be released to the importer when the importer hands over the money to pay for the goods.
As a further development, the exporter may not know, or may have doubts about, the importer. This may lead the exporter to look for some way not only of moving the money but also of securing protection against some of the risks of nonpayment or nonperformance on the buyer’s part. Similarly, importers may not know or trust their exporters and will not wish to pay for goods without seeing them. One means of tackling this problem, governed by very widely accepted international practices and conditions, is the letter of credit. These are opened by banks in the importer’s country and sent (now often electronically) to banks in the exporter’s country.
Letters of credit usually contain very strict and precise conditions regarding the circumstances under which the bank in the importer’s country may release title, and so transfer ownership of the goods, to the importer. They also specify the circumstances in which the bank in the exporting country may release payment to the exporter. However, once the terms and conditions of the letter of credit have been fully complied with, the importer’s bank (bank B in Figure 3) is obligated to pay the exporter’s bank (bank A), whether or not bank B has received the money from the importer. But bank A is not obligated to pay the exporter unless and until it has received the funds from bank B.
This gap can be closed if bank A is prepared to confirm the letter of credit opened by bank B. Often it will do so only if it is already holding funds belonging to bank B sufficient to cover the letter of credit. This point is especially important if there are any doubts about bank B’s ability to transfer foreign exchange, for example because of shortages of foreign exchange in bank B’s country or delays in transferring such payments.
The Role of Export Credit Agencies
It is clear from even this simplified model that exporters and their banks face a range of uncertainties and risks. It is against this background that export credit agencies developed. The primary function of export credit agencies is to remove or reduce these uncertainties and risks, or at least to shift them away from exporters and their banks. Two of the principal mechanisms by which they do this are supplier credit and buyer credit.
The traditional and most straightforward model of an export credit facility is called supplier credit, or more precisely, supplier credit insurance (Figure 4). In this model the exporter contracts to export goods and services to the importer, and any credit terms are included in the sales contract. The export credit agency then sells the exporter insurance against some of the risks that the importer will not pay. These usually include both commercial risks (default or insolvency of the buyer, etc.) and political risks (inability to transfer foreign exchange, war, government action, etc.). In an extension of this model, the exporter may assign the benefits under the insurance policy to its bank, as security for the bank advancing the funds (Figure 5).
In certain circumstances bank A might prefer for various reasons to buy insurance directly from the export credit agency rather than rely on assignment of the benefits from the exporter’s insurance policy. For example, buying insurance directly avoids the risk of the exporter voiding the insurance by failing to comply with the policy’s terms and conditions. In a variation of this, bank A may not be prepared to confirm letters of credit issued by bank B unless it is covered against the risk on bank B under an insurance policy issued directly to it (bank A) by the export credit agency (Figure 6).
Supplier credit is most commonly used for short-term credit, which normally includes credits of up to 360 days’ maturity.
The other main technique used by export credit agencies is called buyer credit This is normally used for medium- and long-term credits, for example for the construction of infrastructure and other large projects in which foreign suppliers are involved. The basic arrangement is that an exporter contracts with an importer to supply goods and services. There is then a separate, parallel loan agreement in which a bank in the exporting country lends to a bank in the importing country (banks A and B, respectively, in Figure 7). The exporter is paid by the bank in its country more or less on a cash basis, as work is done or goods are finished and shipped, so that the exporter will have been paid the full amount due by the time the project is completed or commissioned. (The contract may, however, provide for a relatively small retention payment, which is withheld until the project has demonstrated that it meets the contractual conditions or specifications.) Loan drawings will normally only be possible when the exporter submits to the bank appropriate proof that the work has been done or has been accepted by the buyer, as provided for in the contract. The borrowing bank then repays the loan over a preagreed credit period after completion of the project.
The export credit agency in this case issues its facilities directly to the lending bank. The importer must, of course, arrange to repay the loan to the borrowing bank (bank B). And, of course, bank B must be satisfied with the security it obtains from the importer, since it is bank B and not the importer that is responsible to bank A for repaying the loan. The loan agreement will normally specify that the borrowing bank must repay the loan, whatever may have taken place under the supply contract.
In an extension of this arrangement, if construction of the project extends over a long period, the exporter may be concerned about certain risks (especially political risks) that could prevent it from drawing on the loan, or that could lead to the contract being terminated. In these circumstances the export credit agency can issue a separate supplier credit facility for these so-called precompletion risks directly to the exporter, in addition to the facility it is issuing to the lending bank.
The only other significant feature of these arrangements is that there is normally a recourse agreement between the export credit agency and the exporter. In simple terms, this agreement says that if the export credit agency has to pay the bank under the buyer credit facility, but if the borrower’s default comes at the same time as, and/or is directly linked to, contractual default by the exporter, then the agency has the right to recover its claims payments to the lending bank from the exporter.
How Government Gets Involved
The other dimension that helps bring these models closer to the real world concerns the activities of governments at both ends of the transaction. Reference has already been made to political risks, and it is in relation to the actions or inactions of governments that many of these arise. For example, the government of the exporting country may impose export licensing after the contract has been signed, or it may withdraw or cancel a license previously issued. There may, similarly, be embargoes of various kinds on trade with some countries, or even wars. Finally, and importantly, the export credit agency may well be owned or managed by its government or may be writing all or part of its business on behalf of, or on the account of, its government.
For its part, the government at the buying or importing end of the transaction can hamper trade and payments by preventing imports or imposing restrictions on payments. Where large projects are involved, the host government may play a range of roles, either directly or through entities that it owns or controls. Government may, for example, be a supplier of feedstock to the project or a purchaser of its output. It is certainly the ultimate decision maker and enforcer with respect to tax arrangements and regulations. It may also become involved as the final arbiter on tariffs charged by the completed facility, as the issuer of entry visas for key personnel, as decision maker on export or import licenses, as provider of foreign exchange, or as approver of offshore escrow accounts and of transfers of profits, dividends, and loan repayments. When disputes arise, it is often a vital party either in arbitration or in enforcing arbitration decisions. Host governments may also decide whether a project should be started in the first place—and later whether it should be postponed or terminated. In a different context, host governments can provide guarantees to stand behind importers or banks, and some buyers or borrowers may actually be part of the government or owned by it.
The common factor here is the risk of host governments doing things that they have said they would not do, or not doing things that they have said they would do. These actions or inactions can have a vital and direct impact on whether payments are made when due to exporters, lenders, and investors in other countries, and thus on the export credit agencies that insure these transactions and projects.
Finally, in the event of problems, governments at either or both ends of the transaction may become involved in trying to sort things out. Moreover, if debtors encounter difficulties and debts must be rescheduled in the context of the Paris Club, it is governments that will then lead the negotiations.
Some Reasons—Right and Wrong—to Establish an Export Credit Agency
Given this background, the question might well be raised as to whether there is any longer any advantage in establishing an official export credit agency, or in governments taking any initiatives in this area rather than leaving things entirely to the private sector. This is a real question and deserves to be treated as such. It is wrong simply to assume that it is somehow axiomatic that every country must have its own export credit agency, or that export credit agencies should always be established as public sector bodies. There remain a number of good and strong reasons for establishing an export credit agency (and for government being involved), but there are also some bad reasons.
The crucial first stage in deciding whether to establish an export credit agency is to assemble information. The basic information needed includes data on the nature and destinations of the country’s current exports. To caricature the situation, if one’s exports consisted entirely of natural gas sold to a single buyer in, say, Italy, there would likely be little or no value in establishing an export credit agency. (Even then, however, it might be justified if the exporting country had an explicit policy objective to diversify exports and there was some practical possibility of doing so.) The need to gather information may seem obvious, even trite, but it is surprising how frequently it is ignored or overlooked.
It is also important to gather information about how other export credit agencies conduct their operations and to draw lessons from their successes and failures. Again, however, what may well be a good model in one country at one time may not be well suited either to another country or even to the same country later, under different circumstances. Many avoidable problems have been caused by trying to transplant into one country a model that has worked well in another.
For an export credit agency to work effectively, it needs to take full account of the composition of the country’s exports by product and sector, their destinations, and the normal credit terms established internationally in relation to such exports to such destinations. But one must also consider the general domestic framework within which the agency would have to operate. This includes the general commercial situation, the banking system, and the insurance sector, and the extent to which all or any of them may be in significant transition.
Just as there is no single or perfect model for the export credit agency itself, neither is there any perfect or universally applicable status or role for government or any one “right” set of facilities. All of these need to be analyzed individually against the situation in the country itself and against the policy objectives—which need to be much more detailed than a simple wish to increase exports. This analysis and review constitute the vital prior stage to any decision on whether or not to establish an export credit agency.
Given the increasing role, discussed elsewhere in this volume, of the private sector in the insurance and reinsurance of exports, including insurance of political risks, it would be highly desirable for any newly established export credit agency to seek at least some reinsurance on the private market. For example, it could reinsure certain commercial risks and even some political risks on, perhaps, trade with the OECD countries. This is true even if it is deemed useful or, indeed, unavoidable to set up the agency with 100 percent government subscription of its capital, or if all its underwriting will be done on government account. At a minimum, the new agency should take account, in its structure, organization, working methods, and underwriting techniques, of the requirements and practices of the private reinsurance market. It should also review the advantages and disadvantages of entering into various kinds of partnership arrangements with existing export credit insurance organizations in other countries. These need not involve any shareholding but may consist simply of buying information or credit assessments or debt collection services.
An export credit agency offers more to exporters and banks—and to the economy as a whole—than just insurance.
Protection Against Risks
The traditional and still the principal reasons for having an export credit agency are, first, to provide exporters with the confidence to export and, second, to protect them against losses. One bad debt, after all, can be enough to drive a new or a small company into insolvency. An export credit agency can remove some of the most important impediments to exporting by removing or solving some of the major risks, so that exporters can concentrate on exporting, that is, producing, marketing, and delivering their products. These risks are many, but the two categories of risk usually covered by export credit insurance facilities are political risk and commercial risk.
The main political risks are those relating to the actions of governments in buying or importing countries that prevent payments being made for imports. These include restrictions on the transfer of foreign currency, the imposition of import controls, war or civil war, and default by government or public sector buyers or guarantors. However, this area is also subject to some changes in relation to project financings (see below).
The main types of commercial risk are insolvency of the buyer, payment default, and repudiation, or a buyer’s refusal to accept goods or services for which it has contracted. It is a very common—and very expensive—mistake to believe that only political risks give rise to problems and losses, and thus that exports to OECD countries are “safe.” Most members of the Berne Union pay substantial commercial risk claims every year—and especially during recessions—on exports to the United States and the EU countries. This simply reflects the fact that every year a large number of private companies in the OECD countries become insolvent or default on payments for one reason or another.
Access to Bank Finance
Export credit insurance provides a very useful security for exporters to use with their banks to obtain finance. In addition, to provide even greater security, the export credit agency can often issue its insurance directly to the financing bank. This is an important point for most countries, but especially those where the banking system is undergoing significant change, or where new banks may be unfamiliar with the mechanisms and techniques of foreign trade financing or assessing corporate risks even in their own countries, let alone in foreign countries.
Access to Information
Information on overseas buyers and countries is expensive to obtain and keep up-to-date. It is not, therefore, cost effective for each exporter (or even each bank) to try to do this for itself. Worse still would be for them to sell (or finance) blindly, with limited or out-of-date information or none at all.
An export credit agency can thus serve as a single central information-gathering organization, maintaining up-to-date information and exchanging it with similar agencies overseas. In this way it can achieve economies of scale in information management, to the benefit of all those in the country involved with foreign trade. An export credit agency can also be a cost effective way of accessing the huge databases of export credit agencies and credit insurers in other countries, some of which have financial information on literally millions of buyers in all of the major (and most of the smaller) trading countries.
Access to Expertise
Like information, expertise in the technical aspects of foreign trade and trade financing is in many countries both scarce and expensive. An export credit agency provides a focal point within which to concentrate these scarce resources (and a cost-effective way of obtaining and developing them).
Access to Training
An export credit agency can help to train exporters and banks in various facets of export and trade financing practice. By demonstrating to them that there are both commercial and political risks involved in exporting—even in exporting to OECD countries—it can help exporters to survive and grow.
An Instrument of Government Policy
An export credit agency can provide a very flexible instrument for governments in exporting countries in a range of areas of trade, financial, and industrial policy.
International Competition and Cooperation
Once an export credit agency is in place and receiving appropriate support from its government, exporters can offer facilities that are internationally competitive with those being offered by exporters in other countries—including OECD countries. It can also help encourage cooperation with exporters in other countries and participation in multisourcing (e.g., obtaining subcontracts from main contractors in other countries in respect of projects in third countries).
There are also a number of bad reasons for setting up an export credit agency.
Encouraging Exports to Bad Credit Risks
It is not helpful to either exporters or banks or, indeed, to the exporting country itself to stimulate, encourage, or support exports to countries or to buyers that are not going to pay for them. Simply increasing exports regardless of the prospects for timely payment is a waste of time and money.
Export Credit Agencies as Status Symbols
Export credit agencies should be working organizations; they are not useful as status symbols or for decoration. On the other hand, an export credit agency is no panacea; it cannot solve all the problems and difficulties facing exporters and banks and their governments. But it can play an important role in certain specific areas.
Substituting for Foreign Aid
Export credit agencies should be involved in supporting commercial credit, not providing aid. If a country wishes to give away its goods and services, it does not need to waste its time and resources setting up the facade of an export credit agency.
Starting a Credit War
Export credit agencies should support credit terms that are internationally competitive. They should not try to offer longer or cheaper or softer credits so as to “sell credit” rather than sell goods and services. This would be an expensive and, ultimately, self-defeating policy, since other export credit agencies would simply match their terms. And the instinctive reaction of buyers to unusually soft or long credit terms is to check with sellers in other countries to see if they will match or even improve on them.
Subsidizing Working Capital
It is not necessary to establish an export credit agency in order to provide bank finance to exporters at the manufacturing or preshipment stage, especially if such finance is provided at subsidized rates of interest. Providing this kind of overdraft finance is—or should be—a normal commercial bank function. It gets banks—and others—into bad habits if governments involve themselves in these day-to-day commercial decisions on a permanent basis. It is also expensive for the government, which then normally ends up with all the bad debts (this is often one of the features of the relationship between “government involvement” and “market forces”).
Export credit agencies can play a role in facilitating the provision of working capital, but it is best if this is only a temporary role. Agencies can offer partial security (but should not offer subsidies) to commercial banks to encourage them to begin to provide working capital on a regular and continuing basis, so that in due course they can do this without government support.
Subsidizing Medium- and Long-Term Credit
It is expensive and wasteful to use medium- and long-term export credit as a way of subsidizing interest rates paid by overseas buyers. The beneficiary of the subsidy is, of course, the overseas buyer, not the exporter, its bank, or the home government. The OECD countries have learned the hard way how expensive, how distorting of trade, and how wasteful of public expenditure these blanket or general subsidies can be, and they are phasing them out. Unfortunately, like all subsidies, they are much easier to introduce than to withdraw.
Propping Up Inefficient Domestic Companies
The same points apply here as to the subsidizing of working capital and of medium- and long-term credit to overseas buyers, discussed above.
Introducing Government as a Guarantor of Exporters and Banks
Introducing (or reintroducing) government as the guarantor of performance and financial strength of new or old companies and banks risks being the worst of all worlds, because it means taking risks without the benefit of sharing in the profits. Government guarantees may be necessary in extreme circumstances or as a temporary measure, but they should always be very selective and offered for the shortest time practicable.
Encouraging Uncompetitive Export Habits
Governments sometimes encourage bad or uncompetitive habits on the part of exporters. For example, exporters that are short of working capital may be encouraged to ask their overseas buyers for 100 percent cash with their orders. Because exporters in other countries may not be willing to do this, governments sometimes set up schemes to help or encourage overseas buyers. But this does not help exporters even in the short term, let alone in the medium term, because it simply leads or encourages exporters to seek terms that are not internationally competitive.
How Short-Term Business and Medium-and Long-Term Business Differ
As already noted, most export credit agencies underwrite both short-term trade finance business (usually defined as business with a maximum credit length of one year, although in practice most short-term business involves 180 days or less) and medium- and long-term project business. They do very large amounts of short-term business, primarily to cover commercial risks. This is hardly surprising, since perhaps as much as 90 percent of world exports are sold on the basis of cash payments or short-term credit. It is important to understand some basic differences between the short-term and the medium-to long-term business of export credit agencies and the credit and financing infrastructure that supports both.
In underwriting short-term business, export credit agencies tend to adopt a conveyer belt approach. This is necessary both to handle the large volume of individual cases or contracts, often with quite small values, and to minimize administrative expenses. For a variety of reasons, administrative costs are much higher in this kind of insurance than in others. Most export credit agencies therefore seek to sell their exporters a framework policy covering all (or a preagreed part or selection) of the company’s short-term export business.
Official export credit agencies are not in the business of untied finance, that is, financing of exports without regard to national origin. Their objective, after all, is to increase the exports of the home country, not world exports generally. However, export credit agencies are invariably more relaxed about the amount of nonnational goods and services that can be included in short-term facilities, even when underwriting business on government account.
In the short-term area, export credit agencies sell not a guarantee but rather conditional insurance cover. The exporter is offered cover against certain specified commercial and political risks and, when nonpayment occurs, is expected to demonstrate that it has been caused by one of these risks before a claim will be paid. In addition, it is standard practice to insure less than 100 percent of the contract value, so that exporters themselves carry part of the risk of nonpayment. The conventional rationale for this is the avoidance of moral hazard: an exporter covered for less than 100 percent retains a financial interest in preventing problems from arising and in recovering part of those losses that do occur. This should help to avoid or minimize losses.
In this area, the cover given is always of the supplier credit type. As described earlier in this chapter, the exporter extends credit to the buyer as part of the contractual arrangements, and the export credit agency normally issues insurance to the exporter to cover the risks on this credit.
The main risks usually covered by short-term credit insurance can be classed into the two main categories described above: commercial and political. Here commercial risk includes the (protracted) default or insolvency of the buyer and, sometimes, the refusal of the buyer to accept the goods (repudiation). Most export credit agencies do not cover disputes between seller and buyer and will normally only examine a claim after a dispute has been resolved. But this is a very difficult and sensitive area, and insurers are frequently called on to assess whether the dispute is a real one, or simply a frivolous complaint being used as an excuse for nonpayment by a buyer in financial difficulty. Political risks include nonpayment due to war or civil war, the enactment of laws (or the equivalent) that prevent the transfer of funds, and the imposition, after the export credit agency has come on risk, of export or import licensing. Devaluation or depreciation of the local currency as such is not covered as a political risk. Indeed, it is not covered at all unless it is followed by the default or insolvency of the buyer, in which case the claim is normally regarded as a commercial risk claim—that is, as an insolvency or default claim, without regard to the reason for the insolvency or default.
Most export credit agencies will consider issuing cover against risks arising either before or after the goods are shipped. Insurance of risks arising before shipment is referred to as precredit, precommissioning, or preshipment cover, and insurance of those risks arising after shipment as credit, postcommissioning, or postshipment cover.
Premium rates for short-term cover are almost always relatively low. Rarely do they exceed 1 percent of the contract value.
Short-term cover is normally given to the exporter rather than to the exporter’s bank. As already mentioned, however, exporters often assign the insurance policies to their banks as a form of collateral, and some export credit agencies have special arrangements or facilities in place to assist this.
A relatively small number of export credit agencies are prepared to issue separate forms of short-term cover directly to banks. These can include cover for certain specified risks to the banks in those countries that open letters of credit for imports from the country of the export credit agency. On the basis of this cover, the bank in the exporting country may then consider confirming the letter of credit on either an open or a silent basis. (In an open confirmation, the bank issuing the letter of credit is aware of the confirmation; in a silent confirmation it is not.)
But even if a letter of credit is used as the means of payment, this does not remove all risk for the exporter. A letter of credit provides some protection against default by the buyer, since the bank opening the letter of credit in effect assumes this risk. But unless the letter of credit is confirmed (normally by a bank in the exporting country), the exporter still faces risk with respect to the opening bank, including its ability to transfer foreign exchange. Moreover, the exporter must fully comply with the terms of the letter of credit (which may be onerous), and, importantly, the exporter remains exposed to the risk that the contract or order will be canceled before the letter of credit is opened. Thus, even where letters of credit are available, exporters may still face a range of commercial and political risks and will often seek protection against these risks from the export credit agency. It is surprising how often these risks are overlooked.
As discussed later, it is primarily this area of short-term trade finance business that has witnessed greater competition from new insurers. It is also an area in which some—including some governments themselves—have questioned whether it is any longer necessary or desirable for governments in exporting countries to remain involved, either as insurer or as reinsurer.
Medium- and Long-Term Project Business
Export credit agencies’ involvement in the medium- to long-term financing of projects is very different from their involvement in short-term trade finance. First, of course, the horizon of risk is much longer. For example, a power station may take 5 years to build, and repayment of the loan used to finance it may take 10 years more. Thus, export credit agencies that insure (or offer) these credits are faced with risks that can run over 15 years or more. Individual cases can also be very large. It is not unusual for an export credit agency to underwrite a number of cases every year where the contract value or the size of the exposure involved in each case is considerably larger than the agency’s total premium income for the year.
In the past, export credit agencies insured many projects in politically difficult markets, where the risks were perceived as being very high or, at best, impossible to predict. These uncertainties were not solved by a host government guarantee in many of these cases. Also, the absence of any kind of reinsurance market meant that each case represented a large block of exposure, which could remain on the agency’s books for many years.
The combination of these factors meant that, until the last few years, export credit agencies engaged in medium- and long-term finance had something approaching a monopoly product. The importance of the fact that this is no longer true is discussed elsewhere in this volume—not least in terms of the tension between the twin objectives many export credit agencies have of both breaking even and being the insurer of last resort.
In addition, projects involving medium- or long-term credit are underwritten on a case-by-case basis, and policies or facilities are issued individually. The amount of work involved can be large and can extend over several months.
Premium rates are of course considerably higher than for short-term business. In some cases premiums can represent 10 percent or more of the project cost.
The risks covered vary a little from one export credit agency to the next, but in general the insurance offered is more substantial in terms of risks covered (both political and commercial) than that for short-term business. Indeed, except in supplier credit cases (see below), some export credit agencies (e.g., the U.S. Eximbank and the ECGD of the United Kingdom) offer 100 percent cover. This does not, however, mean 100 percent of the project cost, because a 15 percent down payment, which may not be supported by the export credit agency, is required under the rules of the OECD Arrangement. Rather, the agency can cover up to 100 percent of the remaining 85 percent. The facility provided by most export credit agencies is more like a guarantee of payment than an insurance policy. Moreover, it is in this area that some export credit agencies (e.g., the Export Development Corporation of Canada) lend directly to overseas buyers or borrowers rather than issue insurance to an exporter or lending bank in their own country.
Medium- and long-term cover has two main forms: supplier credit and buyer credit. Supplier credit, as in the short-term area, is credit extended to the buyer as part of the contractual arrangements, for which the export credit agency provides cover to the exporter. This is always a conditional form of insurance cover and is never for 100 percent of the contract value.
Buyer credit is now the more normal form of export credit agency support for projects. The credit used to finance the project is contained in a loan agreement, separate from the project contract, between a bank (normally) in the exporter’s country and a bank or borrower in the buyer’s country. The export credit agency’s facility is then issued to the lending bank. As noted above, it can be for 100 percent of the loan value (although the loan itself will be for a maximum of 85 percent of the exported element, plus, possibly, 15 percent for foreign goods or local costs) and is typically more like a guarantee of payment than a conditional insurance policy. The loan is used to pay the exporter, and the buyer must make arrangements with the borrowing bank to provide whatever security it requires before the bank will enter into a firm obligation to repay the loan, regardless of the situation of the buyer or the outcome of the project. In other words, the borrowing bank undertakes an obligation to repay the buyer credit loan, whether or not contractual problems arise on the project being financed, even if the exporter is in contractual default.
A line of credit is a form of buyer credit. It can be issued either in respect of a single project (project line of credit) or more generally (general purpose line of credit). But either can be used to finance a number of separate contracts.
In the area of medium- to long-term business, export credit agencies can cover both the risks that arise in the construction period before a project is completed (precredit risks) and the risks arising in the credit period (credit risks). These risks may sometimes be the subject of two separate facilities. In the first, cover is given to the exporter in the form of supplier credit insurance, usually to cover risks arising before the project is completed or the capital goods are accepted. In the second (in respect of credit risks), cover is given to the financing bank in the form of a buyer credit.
When the export credit agency is in an OECD country, the credit terms that it supports must comply (if more than two years’ credit is involved) with the terms of the OECD Arrangement (formally, the Arrangement on Guidelines for Officially Supported Export Credits). Rules under the OECD Arrangement now apply to the maximum length of credit, the minimum rate of interest, the minimum down payment, the starting point of credit, and the repayment profile. In addition, and of great importance, beginning in 1999 rules also apply to minimum premium rates for political risks.
Finally, in some countries (e.g., Australia and Canada) the export credit agency may itself lend directly to the overseas borrower or buyer, and in other countries (e.g., Austria and the Czech Republic) it can refinance all or part of the lending provided by a commercial bank. Some export credit agencies can offer some kind of contingency funding option if the lending bank experiences problems keeping the loan in place. This can happen, for example, if the bank is lending or issuing a facility denominated in a currency other than its own.
Why Export Credit Agencies Seek Guarantees from Banks and Host Governments
As already mentioned, export credit agencies normally underwrite both political and commercial risks. The key concern in a number of areas is the ability of the buyer (or the borrower in a buyer credit arrangement) to fulfill its contractual obligations. Thus, timely and accurate information about the buyer is vital to the underwriter. This includes status and financial information, supported by audited accounts and, preferably, details of a track record. Such information is needed not just for private buyers but also for public buyers that are wholly or in part government owned but cannot commit the full faith and credit of their government. Unless the government in the buying country will stand behind and be fully and formally responsible for a company’s debts (which is now rather unusual), underwriters need the same kind of information on public (but nonsovereign) buyers and banks that they seek for a private company.
If the information is satisfactory, the underwriter will accept the buyer for a specified sum and specified terms (e.g., $100,000 and six months’ credit on an open account basis). However, if the underwriter is not satisfied that the information available provides a prudent basis for insuring credit, there are a range of possibilities:
The underwriter can seek further and/or more up-to-date information.
The underwriter can seek to reduce some of the risk by declining open account business and stipulating that payment be made by means of a letter of credit or by bills of exchange or promissory notes.
The underwriter can seek a guarantee of payment from some acceptable third party, for example a shareholder or the parent company of the buyer or a bank.
The underwriter can offer cover at a reduced level (e.g., a credit limit of $30,000, where $100,000 was sought).
As explained earlier, the existence of a letter of credit does not mean that exporters are not still exposed to some risks. In other words, letters of credit offer some protection but not total protection.
In addition, there are still the risks of failure of some kind by the bank opening the letter of credit. These may be due to circumstances beyond the bank’s control, for example where a shortage of foreign exchange prevents it from transferring funds to the exporter’s bank. This would normally be part of a countrywide problem in the buying country and not specific to one bank. However, there can also be circumstances where the bank itself is in financial difficulties and so cannot produce sufficient local currency with which to purchase the foreign exchange needed to effect the transfer to the exporter’s bank.
Not all export credit agencies provide cover against the failure of the individual bank opening a letter of credit. Thus, it is vital for exporters to check whether or not they are protected against this risk. If not, then unless they are prepared to take this risk themselves, their only alternative is to seek confirmation of the letter of credit from a bank in their own country or in some acceptable third country.
It follows that underwriters are crucially dependent on reliable and up-to-date information, both on importing companies and on banks in importing countries. Audited accounts for both banks and companies are a vital part of this information. But underwriters also need to have knowledge of—and confidence in—the bankruptcy law in the importing country and the legal system for enforcing it. Important, too, for accepting risks on banks are the system and track record of bank supervision.
Obviously, severe problems will arise when a country is in transition from one kind of economic structure to another, or where a virtual collapse of the exchange rate has sharply increased the real indebtedness of companies that have borrowed in foreign currency. Such a turn of events also causes problems for the banks of such companies, if not for the whole banking and financial sector. These situations make it very difficult for underwriters to continue to support business in a country. There will also be a concern about existing exposure, that is, credit that was insured in the past but has not yet been fully repaid.
One course of action traditionally open to underwriters who find it imprudent to take new risks on importing companies and their banks is to seek guarantees from the host government. Often this is done as a last resort, when confidence in a country and its institutions has fallen severely. But there are other, less extreme circumstances where a host government guarantee may be sought. These arise, for example, where the buyer or borrower (or, sometimes, its bank) is in the public sector yet underwriters are not prepared to accept the buyer as a credit risk. It would then be unusual (but not unknown) for a private commercial bank in the country concerned to become involved via a letter of credit or guarantee. If this is not feasible, the underwriters would either decline the business or seek a guarantee of payment from an entity (e.g., the ministry of finance or the central bank) that—unlike the buyer or its bank—can commit the full faith and credit of the host government.
There can also be circumstances (discussed below) in the context of financing infrastructure or other projects where the host government may not be the buyer or borrower, or even the guarantor, but where government participation and involvement are nonetheless vital to the project’s viability. In such cases a series of understandings, agreements, and comfort letters may be sought from the host government.
The Importance of Country Information
As already noted, timely, accurate, and up-to-date information not only on individual buyers and banks but also on the relevant provisions of bankruptcy laws and banking supervision arrangements is of central importance to underwriters in export credit agencies. But also important is country information, that is, information that enables export credit agencies to form views and make decisions about the ability of countries to service their external debts on schedule. This, of course, not only applies to government and other public sector buyers but embraces all external debts, private and public.
Thus, it is very much in the interest of buying or importing countries themselves to make available information on the repayment profile of their public and private external debt. This, of course, is easier said than done, but both importing and borrowing countries should make renewed efforts to provide the best and most complete information they can. They should also discuss these efforts, if necessary, with insurers, banks, and investors at the earliest possible stage. Making as much information available as possible is vital if the importing or borrowing country is to attract and hold the credit and capital it needs.
Once this information is gathered, access to it should be as free and widespread as is practicable. It should not be classified in an unnecessarily restrictive way or given only to other governments. This does not only reflect the fact that private capital flows are—and should be—much larger than official flows. It also reflects the fact that, if insurers and lenders are expected to bear the consequences of their own decisions (to minimize moral hazard), they need access to the best and most complete information possible and should not be denied information available to other (normally official) creditors. It would also be very helpful if some entity (either an international financial institution or, perhaps, some private sector body, such as a rating agency) were to verify and certify the accuracy of at least some of the key information in some objective way.
Having said all this, however, even if perfect information were available, countries would still have problems from time to time in servicing their external debts. Such problems can arise for a variety of reasons, some of which are beyond the control of the importing country. Examples include a collapse of world prices for the country’s exports or a significant increase in the prices of its imports or in interest rates on its external borrowings.
The Dual Mandate: Promoting Exports While Breaking Even
As already mentioned, with the passage of time the original intentions and objectives of governments in establishing and supporting export credit agencies have become slightly blurred. The key emphasis has been on the support and encouragement of exports, but other issues of public policy (domestic industrial and employment policy, as well as foreign policy) are also involved. In addition, there has been a perceived need to fill a gap in the facilities offered by the private market, both insurers and banks. Hence, some export credit agencies (e.g., in the United States and Germany) have been assigned specific objectives with respect to acting only as an insurer of last resort, complementing rather than competing with the private market.
As discussed below, the problem of defining the export credit agency’s proper role is becoming increasingly complex and difficult, yet also increasingly real, both as the activities of the private market (in both insurance and reinsurance) develop and as many governments seek to reduce their range of activities. In addition, the Subsidies Code of the General Agreement on Tariffs and Trade (GATT) included a requirement (now strengthened and included in the World Trade Organization’s Agreement on Subsidies and Countervailing Measures) that export credit schemes break even over time, that is, that they not be operated as export subsidy mechanisms. These rules now apply to all WTO members, whereas the GATT requirement applied only to signatories of the Subsidies Code.
In addition, the work of the OECD over the last 20 years has steadily squeezed blanket subsidies out of the system. It has done this by means of agreements within the framework of the OECD Arrangement on minimum interest rates, maximum lengths of credit, the blending of bilateral with export credits (mixed credits), and, most recently, minimum premium rates.
Finally, in most of the major OECD countries, the international debt crisis of the 1980s and 1990s had a profound impact on how countries viewed their export credit agencies. The heavy claims paid by export credit agencies have had serious financial consequences, not least for other public expenditure in the countries concerned. One result has been greater interest on the part of governments in general, and ministries of finance in particular, in the background, origin, and rationale of these agencies, as well as their policy objectives. This closer interest and scrutiny—including from legislators—has led to higher premium rates, tougher underwriting, more commercial-style accounting (including the setting aside of provisions against future losses), and a reappraisal of the proper role of governments and the difficult question of competition and overlap with private sector insurers.
One aspect of this issue is how export credit agencies can maintain an appropriate spread of risk as private sector insurers are willing and able to take an ever larger share of the business. In any kind of insurance, spread of risk is important. Hence it is in practice difficult for official export credit schemes to be given the dual mandate of breaking even and, at the same time, serving as the insurer of last resort—in other words, of only doing that business that private sector insurers are not prepared or able to underwrite.
Put more precisely, official export credit agencies face a dilemma. Increasingly they are being asked to leave all of the best, lowest-risk business to other insurers, only stepping in when things go wrong or when those insurers are reluctant to provide new or additional facilities. Yet at the same time they are being required to demonstrate that they operate at no net cost to the public treasury. Indeed, it implies a rather poor view of the private insurance and reinsurance markets to suggest that official schemes can handle on a commercial or break-even basis that business which the private market will not do on its own.
It is thus very dangerous and misleading to believe, or act as though one believes, that the only rationale or motivation for official export credit schemes is a political one, with the objective, especially, of trade or export promotion.
Export Credit and Investment Insurance
Export credit agencies have traditionally made a clear distinction between export credit insurance and investment insurance. Export credit insurance has been associated with the sale of goods and services or with the loans that finance such sales. Such transactions contained clear repayment dates, and the risks that export credit agencies covered normally embraced both commercial and political risks. For investment insurance, on the other hand, the facilities extended almost invariably related to equity investments, which have no fixed repayment schedule, and the risks covered were rather limited and restricted to political events. These, in turn, were normally restricted to three: confiscation, nationalization, or expropriation without compensation; losses on the investment due to war or civil war; and inability to convert and transfer or remit profits and dividends.
One organizational result of this distinction has been that investment insurance and export credit insurance were usually done by different organizations, such as the Overseas Private Investment Corporation (OPIC) and the U.S. Eximbank in the United States, or the Hermes Kreditversicherungs Aktiengesellschaft and C&L in Germany. Where this was not the case, facilities were usually the subject of quite different arrangements within the same organization and were managed and operated by different underwriters, often in separate units or divisions. Moreover, investment insurance has not been—and still is not—subject to the OECD Arrangement, but so long as such insurance was restricted to equity investment, this did not really matter.
However, some investment insurers are now prepared to consider providing investment insurance cover, or something similar, for loans as well as for equity investments. They are also looking at covering political risks that go well beyond the three listed above, for example the risk of host governments violating undertakings of various kinds with respect to projects, as well as other political events leading to nonpayment of an insured project loan. Such undertakings are, of course, an increasingly important part of the security packages for many project financings, especially in infrastructure.
An inevitable result of these changes has been the development of a rather gray area between investment insurance and export credit insurance. This trend may also have heightened the misconception, alluded to elsewhere in this volume, that political risk insurance is the same thing as investment insurance or that political risks are only covered under investment insurance facilities.
For various reasons, some of which are not immediately obvious, the level of business done by investment insurers has, with one or two exceptions, been lower than one might have expected. One reason is that, in many OECD countries (which provide most investment), the bulk of direct investment has in the past tended to go to other OECD countries, rather than to emerging markets or developing countries. But the low level of activity may also suggest that, in the past, the availability of investment insurance was not a major factor in the decisions of investors whether or not to invest. No doubt this was partly because investment insurance, as noted earlier, still leaves the investor with the whole range of commercial risks, and in many developing and transition countries these risks alone may have been sufficient to discourage investment. In addition, a number of investment insurers have only been prepared to provide cover where some kind of investment protection agreement exists between the investing and the recipient country. This has probably tended to enhance the view that such insurance was inherently a public sector activity.
Until recent events in Southeast Asia and Russia, there was also possibly a growing view among investors that political risks—and especially expropriation in its various manifestations—were a phenomenon of the past no longer relevant or worth insuring against.
Foreign Goods and Services
Another important difference between export credit insurance and investment insurance relates to those goods and services that do not originate in the insurer’s country. Whereas medium- and long-term export credit insurance is normally linked specifically to the supply of goods and services produced in the country of the export credit agency, investment insurance is not “tied” in this way. The normal link is to the country of the investor, not to the goods and services that the invested funds may be used to acquire.
However, the frequently expressed view that export credit agencies only cover goods and services from their own country is quite wrong. In short-term trade finance business, rules about the national origin of goods and services are normally fairly flexible and relaxed, especially where the activity does not involve access to government account or reinsurance. And even in medium- and long-term credit business it is standard practice for up to 15 percent of goods and services supplied from the exporting country to be available for covering local costs or “foreign” goods and services supplied to projects. Moreover, an agreement between member countries of the European Union allows for reciprocal arrangements to be applied to levels of nonnational goods and services above 15 percent (up to 30 percent in certain circumstances). And finally, an increasing number of export credit agencies now have bilateral arrangements to take in each other’s washing, so to speak. Under these arrangements, countries agree to treat each other’s goods and services as though they were national goods and services. This is now being supplemented by a willingness to provide reinsurance to each other if these limits are exceeded.
Claims and Losses
One of the features that distinguishes export credit insurance from most other kinds of insurance is the important difference between claims and losses. In some forms of insurance there is very little difference: claims, once paid, are not recovered or recoverable, and so are effectively losses by definition. In export credit insurance, however, and for that matter in investment insurance as well, insurers expect to recover a substantial proportion of the claims they pay, whether for commercial or for political risks, and so they devote—or should devote—a good deal of time and resources to loss minimization and debt recovery.
In the past, the conventional wisdom was that about 20 to 30 percent of commercial risk claims and up to 100 percent of political risk claims would be recovered. The latter figure would now be regarded as unduly optimistic, both in light of the continuing fallout from the international debt situation and in light of the increased blurring between political and commercial risks. Nonetheless, as the tables in Appendix I show, in the last few years recoveries have been a more important source of revenue for the export credit agencies than premiums on new business.
The importance of claims recoveries, together with the very long time cycle from the initial underwriting to finally recognizing a net loss, makes export credit insurance and investment insurance a rather special category of insurance. It also means that an agency’s cash flow figures in any one year can be very misleading. This should be borne in mind when looking at the cash flow figures in Appendix I, especially Table A3. The long cycle also means that the setting aside of loss provisions and certain other practices of commercial-style accounting are rather difficult in this business, but not impossible. Finally, it puts into context the difficulty of defining and measuring the break-even point referred to elsewhere in this volume.