ASIA FOCUS: Staying relevant and flexible - Trade & Forfaiting Review

Feature

posted 1 Jul 2000 in Volume 3 Issue 10

ASIA FOCUS
Staying relevant and flexible

Godwin Chang is a Director and Head of Export Finance for Asia for SG Investment Bank, based in Hong Kong. He is responsible for the business line’s origination and structuring function for the Asia Pacific region. Here, he looks at the role of export credit agencies in export finance transactions in China recently.

Export credit agencies (ECAs) have played an important role in the economic development of China since the implementation of the ‘Open Door Policy’, by providing much needed credit enhancements to support the financing of large-scale projects.

China is a natural market for export finance business due to the sheer size of the country and its huge infrastructure needs. With the rapid economic growth and influx of foreign capital during the past two decades, a huge number of large-scale infrastructure and industrial projects were launched which involved import of capital goods from OECD countries and thus the utilisation of export finance. The Three Gorges hydro-electric power plant project, the Daya Bay Nuclear Power Plant and the Wuhan DCAC Automobile Plant are a few of the more well-known examples in which export finance is a major source of financing.

Export finance is widely used in the Chinese market due also to the difficulties in structuring project finance transactions in China. Structuring project finance transactions in China has its problems. First of all, there are no clear approval procedures for project finance transactions in China. Second, the legal framework in China is not as well-established as in other western countries, which makes it difficult to put together the tightly structured contractual framework required under project finance transactions. Last but not least, assessing project risk in China is not an easy task for banks or investors as there is a lack of transparency and accounting regulations. Strong shareholder support is required during both the construction period and the operating period, which give less incentive for the sponsors to utilise project finance structures.

Getting to know you

ECAs have broad-based transaction experience in China. Most ECAs, including Coface, JBIC/Miti, Hermes, Cesce, US Ex-Im, ECGD and Sace, have provided insurance or guarantees for the financing of a number of projects in China. They are familiar with the major Chinese banks, especially Bank of China, China Construction Bank and China Development Bank and to a lesser extent Industrial and Commercial Bank of China, Agricultural Bank of China and Bank of Communications and have pre-approved transactional limits or overall limits for those Chinese banks.

Due to their long history in China, the ECAs are ready to take the political risk on China or a sovereign obligor. However, they have limited experience in taking Chinese corporate risk. For most transactions done, the ECAs provided their support based on the guarantees of Chinese government or governmental entities or through one of the major Chinese banks as borrower. In addition, the ECA’s experience in supporting project finance transactions is very limited in China except for power plant projects. One example is the Shandong Zhonghua power project, the first large foreign limited-recourse project finance in China.

A classic example of export finance in China is the Three Gorges hydro-electric power plant project. Total investment of the project is around US$20 billion-22 billion, out of which about US$1.9 billion is used to import equipment from Norway, Sweden, UK, Spain, Italy, Germany and Switzerland. The financing for the imported equipment was essentially financed by buyer credits with tied commercial loans. The terms of the tied commercial loans were made possible with the ECAs supporting a good portion of the debt. This leveraging effect is a major incentive for the commercial lenders to provide 100% financing. Giek, EKN, ECGD, Cesce, Sace, Hermes and ERG worked together to provide support to the financing. The support of ECAs ensured the success of the transaction under a difficult and volatile Asian market during the period 1997 to 1999.

China was not as adversely affected as other Asian countries by the Asian financial crisis due to its prudent macroeconomic policy. Private sector projects are still going ahead. In addition, the large fiscal stimulus package brought forward by Premier Zhu enabled more large-scale projects to happen. In 1999, China imported foreign goods with a total amount of US$360.69 billion (18.2% increased from 1998), in which about US$69.47 billion was for capital goods. According to the National Bureau of Statistics, total merchandise imports are expected to grow at a rate of 10% and 8% respectively in 2000 and 2001. Major projects on the drawing board include the Beijing Shanghai high-speed train project and metro projects in various Chinese cities (including Beijing, Shanghai, Guangzhou, Shenzhen and Nanjing).

No clear path

There are a lot of opportunities for export finance in the Chinese market in view of the large number of large-scale infrastructure and private sector projects. However, there are also a lot of new challenges/obstacles for ECAs and banks.

The first challenge is the policy of the Chinese government to encourage localisation. For some projects, especially transportation ones, including railway, light rail and metro, there are requirements and guidelines for localisation. This means shrinkage of the amount of goods and services to be imported from overseas and thus reducing the opportunity to utilise export finance.

Second, as mentioned earlier, most of the large-scale projects launched in the past have had strong support from the Chinese government (in the form of guarantees or letters of support) or used the major Chinese banks as a borrower who then on-lend the money to the project company. However, the Chinese government has been limiting the support it gives to projects. Chinese corporates are encouraged to tap the international financial markets without any form of government support. It is a challenge for both ECAs and banks as they have limited experience in assessing Chinese corporate risk.

Third, Chinese borrowers are much more concerned about foreign exchange risk. Most of the ECA financing provided is denominated in US$, euro, yen or other major currencies. There is a mismatch as the revenues of most of these projects are in renminbi (Rmb). It is difficult to swap the funds back to Rmb as the Rmb swap market is highly illiquid and cannot offer swaps for long tenor transactions. This encourages the Chinese borrower to select local financing rather than foreign currency financing, including export finance.

Last but not least, the cost of local financing is coming down. The official lending rate for Rmb financing is 6.21% with a 10% permitted fluctuation, whereas six-month LIBOR is around 6.92% and the fixed CIRR offered by ECAs for deals with a repayment period over 8.5 years is currently at 7.33%. This made foreign currency financing, including export finance, less attractive to Chinese borrowers.

Keeping up with the times

The question of how ECAs and banks can adapt to maintain the relevance of export financing in China is not an easy one to solve. ECAs need to stay competitive by adapting to the market environment. By being innovative and flexible ECAs will create more business opportunities for exports in China. Some recent examples show that ECAs are starting to evolve and are moving in the right direction.

Traditionally ECAs only accepted Chinese government, government entities or major Chinese banks as the counterparty (borrower or guarantor). But due to the shift to private sector borrowing, ECAs have had to accept Chinese corporate risk. In a number of recent petrochemical transactions in China, they have started to consider Chinese corporates as direct borrowers without any guarantees. They have begun to establish credit appraisal systems for corporates in China. Some ECAs are more advanced than others in this regard.

Rather than competing with other financial products, for ECAs to remain competitive they need to provide cover for different financial products to make export finance complementary to other forms of financing. One example is leasing. Some ECAs offer cover for exports of leased capital equipment and machinery. This is in response to the growing popularity of leasing among Chinese importers to conserve operating capital. ECAs are also trying to strengthen their expertise in project finance to support more effectively limited-recourse project finance in China, rather than requiring a sovereign guarantee. Another sign of progress is that previously ECAs did not take project completion risk but are now doing so.

Lastly, ECAs are trying to speed up financial close of export finance transactions by offering new arrangements such as the ‘one-stop shop’ arrangement for multisourcing deals. Multisourcing is a financing structure that involves multiple exporting countries to one project and thus involves multiple ECAs in a single transaction. Under the one-stop shop arrangement, the ECA with the largest share of the deal will provide the credit support for the whole deal, co-ordinating the support of the other ECAs by fronting the other ECAs and having them provide a backstop for their respective amounts. The lead agency will offer a financing package for the whole transaction based on its own scheme. This arrangement enables greater flexibility in sourcing for the buyer.

Commercial banks also have to adapt to the new market environment. One way is to be more innovative and to package export finance together with other financial products. One example is an export finance lease. Figure 2 shows this.

By utilising an export finance lease, the Chinese buyer/borrower can enjoy both the tax and accounting benefits from tax-based leasing as well as the long tenor and low financing costs under export finance. Besides leasing, export finance can also be incorporated with other financial instruments such as derivatives, securitisation, and so on.

To remain competitive the banks also have to develop their expertise in multisourcing to provide more added-value services to the buyer/borrower. This has been a very important strategic push by SG Investment Bank to provide this important value-added product. This is increasingly important as suppliers are becoming more global and have the capability of sourcing from multiple countries. The banks should be in a position to advise the buyer/borrower on the sourcing considerations from different countries and to harmonise the terms and conditions of all different sourcing elements as well as simplifying the documentation involved. The Three Gorges project (Figure 3 above) is a classic example of a multisourcing export finance transaction in China.

China remains an important and attractive market for export finance. However, like any other market in the world, it keeps on evolving as a result of different local and international factors and poses new challenges to both ECAs and banks. It is the job of ECAs and banks to adapt to the new market environment and to provide services to meet users’ needs.