Testing the water

Even the most bureaucratic export credit agencies are redefining their approach to foreign supply as trade flows realign. Bolder agencies are testing the waters with entirely new concepts, supporting subsidiaries in foreign markets or providing political risk insurance for commodity hedging. What is behind this shift? A changing concept of national interest. Erika Morphy reports.

Earlier this year when Export Development Canada (EDC) decided it would advance debt financing for Hanfeng Evergreen of Toronto, the agency viewed the transaction through a narrow prism.

“We approached it from the premise that a Canadian company making an investment abroad is part of our mandate,” says Nicolas Delisle, chartered financial analyst, advanced technology and manufacturing at EDC. “It is helping a Canadian company gain a more competitive foothold in a very competitive market.”

Put that way, it sounds quite simple. Together with the Bank of China (Canada), EDC used an advance from a $10.5m letter of offer for the financing to help the company complete construction on its Jiangyan-based fertiliser plant.

In reality, the deal, which was announced in February 2006, marked the first time EDC directly funded a Chinese borrower held by a Canadian parent. When the plant is completed later this year it is expected to produce 100,000 tonnes annually of a controlled-release nitrogen fertiliser called SCU for the Chinese market.

“Everything we do is based on generating benefits for Canada,” says Robert Pelletier, financial services manager, advanced technology and manufacturing team for EDC. “There are a great number of variables that would go into a decision like this – but that is the overriding concern.”

Even by EDC’s standards, which are viewed as among the most progressive (or aggressive, depending on your ideology) export credit agency (ECA), it becomes clear this was no ordinary transaction.

Best interests

At least, not yet. Increasingly, and in many cases, unobtrusively, ECAs are rethinking their bedrock concept of national content. It is little surprise though, that EDC is the agency to push the concept beyond traditional export-defined boundaries.

“EDC is definitely among the leading ECAs in terms of their flexibility and the types of programmes they offer,” says Stephen Atallah, US head of structured trade and export finance at Deutsche Bank.

He points to an insurance programme it offers for long-term deals and its willingness to cover Canadian subsidiaries based in emerging markets as examples. “Of course, there has to be a Canadian interest involved, but there is more flexibility in their content rules,” he says.

“We are very progressive in that regard,” EDC’s Delisle says. “We look at the bigger picture rather than the old-school version of what trade is supposed to be.” (Another source of national content in the Hanfeng transaction: the plant uses proprietary technology licensed from Ontario-based Nu-Gro Corporation).

Other ECAs are following EDC’s trajectory, albeit not at such great extremes. Bob Hardy, product support and development manager at the UK’s Export Credits Guarantee Department (ECGD), for instance, reports that the agency is currently reviewing its approach to the amount of foreign content (non-UK supplied) that it can support.

The concept of exports has changed quite a bit over the past several years, Lars Kolte, director of Denmark’s Eksport Kredit Fonden (EKF), explains. “It is not that the goods are no longer moving around the world. But increasingly companies are multi-sourcing the production of those goods, designing some components in one country, assembling them in another – all depending, of course, on where the division of labour makes the greatest sense.

“My point is exports have not decreased – if anything their levels have increased. But trade is happening more within the value chain – not after the value chain has been completed.”

This shift has meant many ECAs, including EKF, have moved away from the concept of national content to national interest, he says. “By utilising the international division of labour you actually create jobs in the homeland.”

But although the debate over this key issue is well underway, it should come as little surprise that the ECA community has not reached consensus on what policies should result from this shift.

“ECAs are meant to make transactions possible that would not otherwise be possible,” Kolte says. It is his opinion, for instance, that an ECA should not support the establishment of a factory if the company’s bank facilities are able to accomplish that.

New innovation

National content, though, is not the only issue that ECAs are revisiting. For example, besides foreign content levels, “ECGD is also reviewing whether there is a case for extending its cover for contract bonds to include a fair call made as a result of a commercial event,” Hardy says. “Currently, ECGD cover for contract bonds is limited to unfair calls, and fair calls made as a result of a specified political event."

Another example is Australia’s Export Finance and Insurance Corporation (EFIC), which over the past two years, has launched two new political risk policies to provide cover for plant and equipment and – most recently – commodity hedging.

The hedge cover is targeted at financial institutions that are providing loans to mine metals, says Chang Foo, EFIC’s head of product management and risk transfer.

The initiative, introduced in November 2005 has not yet been used, although the agency is currently in discussion with a number of banks regarding projects in the Pacific and African regions, he says. “The reception to-date has been encouraging and the pipeline looks positive.”

The ideal project would be one in which EFIC is the lead political risk insurer for both the loan and hedge agreements in a project financed transaction for the development, construction and production of an economical mine, according to Foo. “The mine output would likely be a commodity with an established futures market, for example, gold, silver, copper, etc. As the lead insurer, EFIC could syndicate the exposure to risk partners via a reinsurance structure.”

The PRI hedge product is seen as a complement to the lender’s policy where banks not only wish to mitigate the political risks from the underlying loan agreement in project financed mining ventures, but would also prefer to transfer political risks from its underlying hedge agreement, Foo continues.

“It is common for banks to insist on the borrower hedging its mine output to safeguard against commodity price fluctuations in order to give some degree of certainty to the bank of the borrower’s ability to service loan repayments as and when they fall due,” he says.

Other initiatives are less novel, but equally as important to ECA clients. Over the past year in the aerospace sector, ECGD has put into place new financing tools including conduit financing – a cheaper alternative form of finance for the airlines – as well as an approach called ‘engine financing’, which provides support for financing spare engines on their own, but still applying the usual asset-based finance techniques. This is possible as there is a proven residual value for spare engines.

On top of that, it has introduced or significantly expanded cover in a number of markets including Armenia, Georgia, Ghana, Papua New Guinea, Tanzania and Venezuela. It has also supported several structured deals in new telecom markets in Kazakhstan and Pakistan.

EFIC, meanwhile, is teaming with a US surety writer, Liberty Mutual Surety, an operating division of the Boston-based Liberty Mutual Group, licensed to write surety bonds in all 50 states. While Australia’s free trade agreement with the US was being negotiated, it became clear to the agency that exporters wanting to tap the market might have difficulties with requirements that need suppliers to post bonds for up to 100% of the contract value for performance obligations. Typically, most markets require 10-15% of the contract value. It can be a burdensome requirement, especially if it means using existing bank facilities to secure the bond.

New partnering strategies

ECAs are also becoming more competitive in their partnering strategies with other ECAs. Mark Bulger, advisor for international business development in Asia at EDC, says the agency’s agreement with Sinosure, signed in November 2005, is generating a lot of interest. “We are one of the few ECAs that have entered into a reinsurance agreement with Sinosure to provide services to Canadian affiliates that have operations in China.”

The agreement enables EDC to offer export credit insurance to such companies. “It is another broadening of support for Canadian foreign direct investment,” Bulger says. “China’s regulatory environment has a fair number of restrictions on who can offer credit insurance.”

No transactions have been completed yet, although Bulger adds there are a number of deals in the pipeline. “There are still procedural and technical issues to be ironed out.”