Examination of Witnesses (Questions 202
- 219)
TUESDAY 20 APRIL 2004 (Morning)
SOCIETY OF
BRITISH AEROSPACE
COMPANIES
Q202 Chairman: Ms Walton, would you
like to introduce yourself and your colleagues?
Ms Walton: There are three of
us here representing the SBAC, which itself represents over 180
companies throughout the UK, and 80% by value of UK aerospace
industry; all of the leading aerospace companies and over a hundred
supply companies—many of those SMEs—being members
of the SBAC. The SBAC's role is to promote the interests of UK
aerospace and to develop—we hope anyway—government
practice in relation to the UK aerospace industry. I am the General
Manager for Rolls-Royce Capital, dealing with issues relating
almost exclusively in the past few years to ECGD; on my left is
James Caldwell, representing BAe Systems, and on my right Nigel
Taylor, representing Airbus. Between us, we have a huge amount
of experience with ECGD. We are certainly very pleased to be here
to be able to discuss ECGD issues with the Committee, particularly
because we have seen ECGD go through some pretty difficult times.
It was very heartening to us to see from the NERA report on ECGD
that during the most difficult period of its history, probably
1992 through to 2002, when it was facing the crisis post-September
11, the crisis from the first Gulf War, and the crisis in Asia,
the ECGD managed throughout all of that very, very difficult time
to produce a return to the Exchequer of somewhere between £4.1
and £23.1 million. We think that that is a huge feather in
ECGD's cap, and we would like to start from that very positive
point.
Q203 Chairman: It is interesting
that you are prepared to give credit. On the other hand, I do
not think that your memorandum is wholly praising of the work
of ECGD. You criticise it over the uncertainty of its future operational
status. You say that this has undermined confidence amongst customers
in paragraph 5. What evidence do you have to support this? If
things are so good, why are they so bad?
Ms Walton: I think we should try
and separate the two issues because ECGD's people have done a
very good job, we think, over the past very difficult times; but
you are quite right to say we highlighted the uncertainty that
has been hanging over ECGD since the original status review in
1999. Clearly, that has served to the detriment of ECGD and its
personnel, and morale has plummeted there. During those difficult
times however they still managed to run ECGD with the best practice
of a good financial institution. Again, the NERA report, the KPMG
reports and so forth highlighted all of this. If you have uncertainty
hanging over your organisation for such a long period of time,
it is bound to affect the way that you behave. ECGD has done the
best that it can within the constraints that have been imposed
upon it by the Treasury. The trading fund has been heralded as
the saviour of ECGD. We have been very supportive of that, seeing
it as freeing ECGD from the daily oversight of the Treasury, which
we do not think has been particularly positive. Unfortunately,
the trading fund has moved off further into the future again,
and the uncertainty remains. One very clear piece of evidence
from a Rolls-Royce perspective that this uncertainty is damaging
is that during the very recent campaign we entered into with the
7E7 at Boeing, where Rolls-Royce was competing with two US manufacturers
of engines, Pratt & Whitney and GE. A major consideration
in that campaign from Boeing's perspective was whether or not
export credit support would be available from our export credit
agency for that aircraft. We had a lot of very difficult negotiations
with Boeing on that issue, to the point where Boeing was asking
for a backstop for that. That probably is a very good illustration
of the concerns that we have seen. Nigel might have others from
an Airbus perspective, where backstops have been an issue.
Mr Taylor: If I may, I will backtrack
a little to recall what Airbus has done over the last 20 years,
to a large extent with ECGD support. As Sue was saying, looking
back ECGD has been extremely helpful, and we are more fearful
of the developments into the future at a time when Airbus is now
a single competitor to Boeing, so it is a clear duopoly. Going
forward we have the major A380 project for which the UK is a major
lender to the tune of £530 million, and a major project industrially
in the UK in terms of jobs in North Wales and in terms of all
the ancillary related supply chain for the landing gear and engines.
From that perspective, one of our major concerns going forward
with ECGD is the volcanic rumblings that have been going on about
the support that ECGD may or may not get from the Treasury, and
where we have therefore been in major competition with Boeing.
Ex-Im bank has been giving greater support, and to allay the fears
of customers we have likewise been needing to backstop the form
of support that finance would be available at the time you take
an aircraft from Airbus.
Q204 Mr Djanogly: What does "backstop"
mean exactly?
Mr Taylor: It is when we, as
a commercial institution, would have to say that if there were
no support from the export credit agency, we would have to step
in and replace that as a funding vehicle. To give you one concrete
example we had last year, deliveries to Middle East Airlines in
the Lebanon, where we had to backstop because the Lebanon was
unsure of ECGD's position to support that delivery. We had to
end up financing all five A321s to the Lebanon with IAE engines,
which are partly Rolls, because of ECGD's reluctance to support
that particular campaign. If you magnify that by the campaigns
on the scale we have on the A380, it could look a very worrying
situation and one which industry cannot alone support when, on
the other side, supporting either 7E7 or 777, you have a very
politically driven supportive Ex-Im bank.
Q205 Chairman: Taking the Lebanon
as an example, the UK is a country of 60 million population against
the US population of 260 million. That is a very crude way of
looking at it, but American resource is that much greater, so
you can understand why they are prepared to put more behind it.
Lebanon is not one of the countries that you would necessarily
want to bet on, and in some respects that is what an ECA has to
do, and one with more limited resources than the US might therefore
be more conservative. Is it the case that the backstop diminishes
as time goes on? If the Lebanon becomes a better bet, would the
significance of the backstop be quite so great, and would the
ECGD be prepared to come in, once the Lebanon is less risky?
Mr Taylor: There are two issues
there. ECGD tends not to come in after there has been an export,
and, as you rightly point out, Lebanon is a relatively small country
and therefore it will probably not order lots of aircraft over
a short period of time, so if you miss that one opportunity there
probably will not be another one for 10-12 years. Aircraft have
been operated in the Lebanon for the last 40 years and there has
been no default situation. In the Airbus context in particular,
we have ECGD working with the French and German export credit
agencies, who in this instance were ready to support that export;
so it was a very obvious example where it was a particular ECGD
issue. The second issue is resources. We have to be clear when
we are talking about resources. We do not believe—and I
think this will be endorsed by my colleagues—that we are
using the resources of the United Kingdom, or of the French and
German ECAs, in terms of drawing on cash or taking away from budget,
because we are using the credit strength of the economy by way
of guarantee, and it is a guarantee which is issued. The resources
are cash-funding coming in from banks in the commercial sector
which are being guaranteed. Therefore, I would not say we are
draining resources. We have had ECGD itself saying that there
are limited levels of support they can give us, providing we can
meet the criteria they set. There is a concern that the criteria
are going to be higher and higher.
Q206 Mr Hoyle: In the case of the
ECGD, should the main role not be one of last-chance saloon?
Ms Walton: That is a very interesting
question, and one that I think probably ECGD has a little bit
of schizophrenia about as well. "Lender of last resort"
is probably the term that we are looking for here. There are two
ways of looking at it. It could be the lender of last resort,
but then you are always going to end up with the Middle Eastern
Airlines situation, so if ECGD cannot provide support to airlines
like MEA, it will be doing very little business. As a trading
fund, though, do you want to have a portfolio that is dominated
by those poorer credits; or do you want to have a more balanced
portfolio that includes the likes of Emirates or Singapore Airlines
or Qantas? Our view is very much the latter, that you need a balanced
portfolio in order to enable ECGD as a trading fund to ride through
the cycles of this industry, which is a very cyclical industry.
It is interesting that on the A380 campaigns that we have looked
at, 100% of our customers have asked for export credit support,
and that includes countries like Australia and Singapore. It is
not because they have any doubts about their credit—not
at all; but they do have concerns about the very fickle nature
of the commercial lending markets, when you are talking about
orders that are placed many years ahead of delivery, and for substantial
volumes of financing, because the A380 is a big aircraft, and
it is no surprise that the price tag matches that. Airlines like
Singapore Airlines and Qantas are looking for this umbrella that
will cover them when aircraft are delivered three, four or five
years down the road, and ECGD is the provider of that umbrella.
We had a look at the history of the Trent campaigns to see how
many customers had asked for export credit support and how many
had actually taken it up at the time when the aircraft delivered.
I think the numbers surprised us, but they were subsequently confirmed
by Airbus's experience as well. Eighty% of our customers who were
eligible asked for export credit support, but when it came to
delivery only 25-30% of those customers were taking it up, because
the market was there for them to be able to finance themselves
for the balance of those deliveries in the commercial markets.
That is exactly how I think ECGD should be behaving. It should
be there to provide the backstop for these very long lead-time
deliveries, when customers are taking a view of being able to
finance equipment in six or seven years time, but that the customers
will then do whatever they can to finance themselves in the commercial
market at the point when delivery takes place. Export credit availability
is key to winning those orders. When ECGD says it has supported
X billion dollars worth of aerospace exports, that is only a very
small part of the story, because we would not have won the whole
order if that export credit had not been available to our customers
from the outset.
Q207 Mr Hoyle: Would it be fair to
say that people were buying an aircraft and an engine off-plan
and were not sure whether it would take off? I am not being funny,
and I believe there are success stories there, but is that why
people are nervous, and the banking industry is more nervous as
well?
Ms Walton: There is certainly
some element of that. If you are looking to purchase an aircraft
that is off-plan, has not flown and got off the drawing-board
yet, then clearly there is some element of needing to have an
umbrella of support from your export credit agency because the
financial community is not going to share in that risk. There
is also a role for the manufacturers in that, and we do stand
side-by-side with our export credit agency in providing support
for the asset value on a number of these deals, particularly in
new programmes. That is the right split of responsibility. ECGD
is there to provide the guarantee for a proportion of the financing,
and the manufacturer is there to provide support for the asset
value at the end of that financing. We are very happy to continue
to do that and to underwrite our asset values. My colleague is
smiling wryly!
Mr Taylor: There are a couple
of issues there. First, please remember that ECGD would help us
in certain markets which are eligible, but we as manufacturers
are having to bear the burdens notably of any financings in the
US, or locally, which in the context of Airbus means in Spain,
France, Germany and the UK. We have a fair degree of burden therefore
that we are taking away from the ECGD. Secondly, for a programme
such as an A380, like the Boeing 747 at its launch, the support
of the export credit agencies at the outset is an assurance given
to the market; so a lender of last resort would mean there would
be havoc in the market at the start of a programme. Once a programme
is launched, people are comfortable that the aircraft can fly
and that it is selling well. Then it is borne into the market
and the market can step in a lot more, but that initial support
for a major programme is essential to assure the markets.
Q208 Mr Berry: ECGD support for civil
aerospace exports is by no means as controversial as for military
exports, and when the British Consultants and Construction Bureau
gave evidence, they argued that ECGD activity in relation to military
and non-military exports should be dealt with separately and transparently
in that respect. Do you have a view about that?
Mr Caldwell: The first point to
make probably is that if you look at ECGD's latest annual report,
it is clear that in terms of their portfolio defence accounts
for about 20%, so it is a significant part but it is not an overwhelming
part of their business. The second point is that if you look at
the annual report you will find that it does report overall results,
but also it splits the results down by sector very, very transparently
and very clearly. You can see aerospace, defence, oil and gas
and other projects. At the moment therefore you have a very clear,
very transparent reporting by ECGD of all the sectors of British
industry that it supports. There is really an issue here for ECGD's
own economists about whether they would really want to de-merge
one particular part of their business from all the rest. Given
that defence exports are, I would say, 100% made to sovereign
customers, it does give a balance to their total business, where
they are obviously dealing with airlines that are both sovereign
and commercial organisations, and other parts of their business
which may be substantially with commercial organisations. They
have a balanced portfolio of both sovereign and commercial risk
at the moment, but it is reported by sector. As far as I can tell,
there is a great deal of transparency there already, and I am
not absolutely certain what benefit would be served by making
a further division.
Q209 Mr Berry: The argument might
be that there are additional issues raised by arms exports than
non-arms exports, although we could take the perfectly reasonable
view that you are talking about legal exports, period, and therefore
ECGD criteria should be the same. But others would argue that
there are separate issues. In relation to military exports, we
do not have the view in government that the DTI should look after
all exports; there is DESO (the Defence Export Services Organisation),
a quite distinct, independent organisation operating in the MoD
which, in terms of military exports, is therefore in a very unique
and special category in relation to other areas of work. I guess
that some might say that logically perhaps it should apply to
ECGD as well. From your point of view is it purely an operational
matter, and you do not really mind one way or the other, as long
as the system responds speedily to your demands upon it?
Mr Caldwell: I suppose it depends
upon what form of separation you are envisaging. At the moment,
we deal with a team at ECGD which is not exclusively devoted to
defence and deals with other things as well; but that team deals
with all defence submissions, so we already have a specialist
team. When we look at the report and accounts, we can see what
defence business has been done, and that is separated out. To
that extent, we are catered for. Indeed, anyone who is interested
to see to what extent ECGD is supporting the UK defence business
can see that very clearly from the current evidence.
Q210 Sir Robert Smith: In paragraphs
10 and 11 you give examples of situations where the ECGD has requested
higher premiums than other ECAs. Are these isolated incidents
or do they reflect a generally more cautious approach from the
ECGD?
Ms Walton: Unfortunately, they
are not isolated incidents. You could say that these are reflecting
a more cautious approach by ECGD to the risks involved. However,
the pricing of particularly commercial aerospace deals, is pretty
transparent to our customers, particularly where, for example,
we are putting a UK-manufactured engine on to a US-manufactured
airframe. So the customer can see precisely what the US export
credit agency is charging them, and precisely what the UK's export
credit agency is charging them. We have had instances where there
has been dramatic difference between the two, where ECGD has charged
double the premium being required by Ex-Im. We have an instance
where a customer of ours for Rolls engines on to a 747 was charged
an increased premium by ECGD despite the fact that the customer's
credit had improved over time. They could not see what ECGD's
justification was for that increase in premium, and we had a very
interesting conversation with the customer, who said: "I
am going to be in the market for more 747s in the very near future;
if I know that I am going to get the 3% premium from Ex-Im, why
would I ever choose a UK engine again?" This customer operates
engines of both types in its fleet, so it was not an idle threat;
this was something which could have a severe impact on our business.
From the Airbus perspective, clearly Airbus sees a number of different
agencies in every one of its deals and can very clearly demonstrate
who is at the higher end of the premium. I am sure that Nigel
can give you some examples of that. ECGD's own benchmarking exercise
showed very clearly that across the board it was charging higher
premiums, giving lower cover rates, and was available in fewer
countries. It is not just our examples.
Q211 Sir Robert Smith: You described
the American approach as "aggressive commercial". Is
it aggressive uncommercial or aggressive commercial?
Ms Walton: The proof of that will
be in the performance of their portfolio; but their portfolio
is not doing too badly at all at the moment. It is aggressive,
but we do not see them doing deals that should not be done. We
do see them pricing deals very differently.
Q212 Chairman: What is the significance
therefore of the OECD parameters within which people are supposed
to operate?
Ms Walton: The OECD provides a
floor below which the export credit agencies cannot go. What we
see is most of them operating to that floor, so they are charging
the minimum that is allowable by the OECD, whereas ECGD is charging
above that.
Q213 Chairman: What about Ex-Im?
Ms Walton: Ex-Im is complying
with the OECD guidelines. It is not doing anything at all in breach
of those guidelines.
Q214 Chairman: You are saying that
ECGD is charging twice what the minimum should be.
Ms Walton: We have seen that,
yes.
Mr Caldwell: There is the paper
that has been recently published, the most recent ECGD report
on the comparison of export credit agencies, which we can provide
you copies of, if that would be useful. They look at pricing for
sovereign loans and for commercial credits. On the sovereign analysis,
ECGD is the only export credit agency to charge above benchmark.
Obviously, when it comes to corporate pricing there is a much
wider range, but ECGD typically is significantly higher, certainly
than Ex-Im, in most cases more than double; and significantly
higher than most of the European export credit agencies. It is
worth having a look at that data, I would suggest.
Q215 Sir Robert Smith: What would
you put the conservatism down to?
Ms Walton: We have asked the question
on a number of occasions, as to why their pricing is what it is.
The response has always been, "that is what the model throws
out". Their risk management model is providing more conservative
pricing.
Q216 Sir Robert Smith: Do you think
it is anything to do with the move towards a trading fund status
approach?
Ms Walton: Our suspicion is that
that is probably the case.
Q217 Mr Clapham: You have made it
quite clear in your submission that you would like to have more
certainty regarding the future of ECGD, but it does not appear
as though we are going to get trading fund status for at least
not another year, if it comes then. Is that delay going to be
significant for the operation of the department?
Ms Walton: It is clearly a concern,
but I would hope that the appointment of a new chairman and chief
executive at ECGD will do a lot to boost the morale at ECGD to
get things back on track and to ensure that the trading fund does
come in on its new timetable. We have been hearing about the trading
fund for a very long time, and our customers have been hearing
about it, as have our competitors. The market perception is that
ECGD is foundering, and that there is not wholehearted support
for ECGD from the Government. That is the market perception, and
it has been very damaging.
Q218 Mr Clapham: Has that view been
made plain to ministers?
Ms Walton: Yes, it has by individuals
and by the SBAC.
Q219 Chairman: Ministers in which
departments—we will not necessarily go for personalities?
Ms Walton: DTI and Treasury, and
indeed to the PM.
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