Mixed market adjustments - changes in MLT export credit insurance

Feature | 18 June 2012

Medium and long term (MLT) export credit insurance, once considered the preserve of the ECAs, is inexorably changing, says CHARLES BERRY

The growth of the private political risk insurance (PRI) market is producing a new MLT export credit insurance market, where ECAs and private insurers compete with each other to provide comprehensive non-payment and related covers for capital goods exports, foreign projects and their financiers.

A competitive marketplace will deliver benefits to exporters and banks by offering choice and by strengthening both export credit agencies (ECAs) and private insurers. But for it to truly thrive, regulators must update their view of export credit insurance, as many in the private PRI market feel the playing field is tilted in favour of the ECAs.

Addressing the misperceptions

The PRI market now writes about US$1.5bn of premiums per annum and can be said to have had a ‘good’ financial crisis. The PRI market did not cancel policies or withdraw limits and, despite a significant volume of claims since 2008, has increased its capacity and continued to write new business. The robustness of the PRI market has defied 
its naysayers.

However, almost none of the PRI market’s activities fall into the area defined as ‘marketable risk’ by the EU authorities who set out the rules for export credit insurance. This is narrowly defined as meaning short-term (credit periods up to two years) export credit business within the EU and certain OECD countries. It is rightly a narrow definition as ECAs are forbidden from writing marketable risk. To be clear, we as brokers representing clients do not want to see the ECAs activities further restricted by broadening the definition of marketable risk to embrace the PRI market’s activities.

EU regulators see the export credit market as two dimensional: that which is not marketable risk is by definition ‘non-marketable risk’. By definition, the PRI market therefore writes ‘non-marketable risk’. However, it does not have capacity across this whole area. Therefore, in reality, the export credit market is three dimensional in EU language:

  1.  ‘marketable risk’;
  2.  marketable ‘non-marketable risk’; and
  3. non-marketable ‘non-marketable risk’.

Admittedly, these latter expressions 
are pure Rumsfeld, but you cannot have 
a sensible conversation without appreciating the differences.

Fleshing out the distinction, the marketable non-marketable risk written by the private PRI market includes most areas of short-term export credit business in emerging markets and the vast majority of investment insurance business. In the MLT area the picture is more complex but marketable non-marketable risk includes MLT manufacturing risk policies for capital goods exporters and construction companies (for which the private market has been competing head to head with the ECAs for decades), supplier and buyer credits of five to seven years with private buyers and borrowers, and loans to government buyers and borrowers with credit periods up to ten or even 15 years.

To illustrate the market’s appetite for MLT business, BPL Global recently produced an incomplete list of its export finance transactions where non-payment insurance from private insurers supported traditional buyer credit loans. The exports and projects supported ranged from transport, power and water infrastructure to telecoms, electrical and industrial equipment. The list included five-year cover in such countries as Angola, Ethiopia, Gabon, Ghana, Indonesia and Laos. There were seven and eight-year deals in Gabon and Turkey, and non-cancellable policies of 
ten or 12 years in Azerbaijan, Ghana, Turkey and Vietnam.

The private market has both capacity and appetite in the MLT area and wants to write more. Exporters and banks who only recognise ECAs in the MLT arena will increasingly find themselves at a competitive disadvantage. Despite the fact that most MLT business is still written by ECAs, we believe most MLT business is marketable non-marketable risk rather than non-marketable non-marketable risk.

The need for ECAs

Obviously in arguing for a mixed market in the MLT area, we believe that EU ECAs should be allowed to compete for marketable non-marketable risk. More fundamentally, however, the global system for supporting international trade and investment would be critically undermined without strong and effective ECAs operating in the MLT arena. We were surprised at the recent debate in Washington about the very existence of Ex-Im Bank.[1] In particular, we acknowledge the counter-cyclical role the ECAs need to play – well illustrated in the recent global financial crisis. Nor do we think ECAs can be mothballed in times of plenty, only to 
be awoken like some sleeping beauty when 
a crisis arises. Rather, we think that, during the good years, ECAs should be kept lean and healthy by sparring with their private sector rivals.

Nevertheless, we do not believe that the ECAs should indulge in unfettered competition for marketable non-marketable risk. Happily we feel the necessary restraints on unfair ECA competition are already in place. Generally ECAs are required to operate on at least a break-even basis. As long as ECAs stay within the terms of the OECD arrangement that limits competition between the ECAs and now includes minimum premium rates for credit risk, we think private insurers should not complain of unfair competition.

Levelling the playing field

However, while tolerating fair competition from ECAs in the marketable non-marketable risk arena, private insurers in the PRI market should be entitled to a level playing field. Essentially, there are three areas that raise regulatory issues: Basel regulation, premium tax and cooperation between ECAs and private insurers. In the first two, the private market has had to battle against regulations that continue to tilt the field in favour of the ECAs.

Issue one: Basel regulation

Happily, one of the most prominent areas of regulatory discrimination in favour of the ECAs is being unwound. Historically, banking regulations gave banks capital relief for ‘guarantees’ from ECAs, but not for private insurance ‘policies’, even where there was often little real difference between the two. Additionally OECD ECAs were given 
a zero risk weighting.

The first step towards levelling the playing field in this area was taken when the Basel II regulations opened the door to a wider range of credit risk mitigants, including private market insurance policies, subject to certain conditions. Now Basel III has recognised that OECD governments are not risk free (by removing their zero risk weighting). As the new rules engage, this will further level the playing field between the ECAs and the private insurers.

Ironically, the same Basel III provision will unlevel the playing field between the ECAs themselves. Even if the OECD Arrangements are strictly followed, will an exporter from Spain or Italy with a finance package from their BBB+ rated ECA, compete on a level playing field with a German exporter whose finance package is supported by an AAA rated ECA? This undermines the central principle around the consensus OECD arrangement on officially supported export credits, namely “to encourage competition among exporters based on quality and price of goods and services exported rather than on the most favourable officially supported financial terms and conditions.”

This Basel III regulation will therefore have a profound effect on the debate 
around MLT export credits and are a major step in the direction of creating the flexible, competitive and dynamic mixed market 
of ECAs and private insurers that we 
see emerging.

Issue two: premium tax

Meanwhile, the focus has turned to another area of discrimination against the private insurers, namely the subject of premium tax. Some countries exempt their ECAs from paying premium tax on export credit policies, but levy the tax on the private insurers competing with them. This issue is most pressing in Germany. Cover from the official German ECA comes without premium tax; but the same export credit policy for the same transaction offered by the private PRI market attracts premium tax of 19%.

It would be unfair to suggest that the German government is deliberately protecting its ECA from private market competition. If you think of export credit insurance as two dimensional, it seems quite reasonable to tax marketable risk policies written by private insurers protected from ECA competition, and equally reasonable to exempt the ECA operating in the area of non-marketable risk. However, in the real, three-dimensional world that includes marketable non-marketable risk it is clearly grossly unfair to impose a 19% tax on the private sector insurers and exempt the ECA competing for the same business.

Issue three: cooperation

Currently, cooperation between the 
ECAs and the private insurers is hailed 
as something that should always be encouraged, yet its merits depend very 
much on the circumstances and the nature of the cooperation.

Cooperation between insurers for marketable risk is rightly forbidden, except in the very limited areas permitted by competition law. For non-marketable non-marketable risk, we of course agree that it is right for the normal prohibitions to be relaxed and for public and private insurers to cooperate to try to find solutions.

In the third dimension, however, the issue becomes more contentious. As brokers representing clients’ interests, we believe that syndication of marketable non-marketable risk between ECAs and private insurers should be subject to insurance subscription market best practice, just like any other large and complex but marketable insurance risk. This best practice ensures that the syndication process is a competitive one that benefits the client, rather than a cooperative one, that benefits the insurers.

Certainly, the mixed market raises many complex issues and we accept that not everyone will agree with our opinions on these. However, we hope that by identifying the mixed market and the area of marketable non-marketable risk we have at least set the framework for a sensible discussion.

[1] See: www.tfreview.com/news/trade-commodity-finance/ex-import-bank-gets-reprieve

Charles Berry is chairman of BPL Global


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