Examination of Witnesses (Questions 220
- 239)
TUESDAY 20 APRIL 2004 (Morning)
SOCIETY OF
BRITISH AEROSPACE
COMPANIES
Q220 Chairman: A full hand.
Ms Walton: We have tried hard.
Q221 Mr Djanogly: Can you explain
in a little more detail your concerns with the ECGD future return
on capital employed requirements? In your note it was seen that
the industry has been offered assurances that this will not significantly
increase the premiums payable. How does that all tie in?
Ms Walton: It depends on the benchmark
they are using to decide whether or not it is going to increase
premiums. We are not very happy with where they are today, I have
to say. So, any increase at all would certainly be unwelcome.
ECGD, it should be pointed out, is the only export credit agency
that is required or will be required to provide this kind of return
on capital. Every other credit export agency is required to break
even under the WTO and the OECD guidelines. There are two potential
exceptions to that and both of those are actually banks that also
serve an export credit agency function: one is EDC in Canada and
the other is KFW in Germany. Both of those have commercial funding
available and actually lend money at attractive rates to exporters,
to the customers of their exporting companies, but they can also
lend domestically, so they are able to spread their risks more
appropriately across a broader portfolio. The level of return
on capital that ECGD has been working towards has increased steadily
from the very first mission and status review. We were talking
about 6% originally and we have heard most recently a figure closer
to 18% from Treasury officials. We have never seen anything in
writing in relation to this target return on capital. A lot of
these discussions are going on behind closed doors, so it is very
difficult for us to get a real feel for it, but what we have been
told in mitigation is that this is not a real return, it is a
target return. The underlying return will be what ECGD produces
today, which is around 4%. So already, ECGD is able to return
a profit to the Exchequer as the NERA Report stated very clearly.
So, what we are looking at is an artificial institutionalisation
of a subsidy that does not exist between that 4% and whatever
target it is that the Treasury decides is appropriate. Okay, if
it is artificial, maybe that is not a problem, but what is a problem
clearly is that this is an annual voted subsidy. So, every year,
there is an opportunity for the subsidy not to be voted or for
ECGD to be challenged again as a subsidy to big business, to the
people that you see sitting here at this table, and clearly it
is not true on two counts. Firstly, it is not a subsidy. ECGD
has been providing a positive return to the Exchequer. Secondly,
ECGD's products are supporting thousands of jobs within the UK,
not just the headline-grabbing companies but the smaller ones,
our supply chain, the thousands of companies that support us and
without whom we could not export. Many of them are SMEs and ECGD
is providing support indirectly to them. So, this is an issue
of jobs as well and one that has actually been picked up by our
unions as being a real concern to them. They have looked at this
return on capital issue as well and I think they are horrified
at the thought that, every year, the Treasury will get the opportunity
to cut ECGD off, if you like.
Q222 Mr Djanogly: Is it realistic
that they will be able to increase their return on capital without
putting up premiums?
Ms Walton: No, it is not.
Mr Caldwell: The frustrating thing
for us is that trying to reconcile this target, 11%, 18%, whatever
it is, which we know at the outset and indeed the people who are
setting the target know at the outset is wholly unrealistic. So,
I suppose you could put the premiums up enough to achieve theoretically
those levels of return, but then no one would buy the cover and
so the business would not get done. I think there is a certain
amount of bewilderment amongst the exporting community as to why
this artificial voted payment is being created when it does not
actually really need, in our view, to exist at all.
Ms Walton: It is not a question
of the business not being done full stop, it is just a question
of the business not being done in the UK because we have the opportunity
to manufacture outside of the UK. Certainly, Rolls-Royce has not
yet made the decision as to where it manufactures the Trent 1000
for the 7e7. This may seem to be a small part of a decision-making
process but we all have the ability to source outside of the UK.
Q223 Chairman: How big, in percentage
terms, does this feature in your costings? Say on the Trent project,
how much would you save by going from the UK as prices currently
are to, let us say, Canada?
Ms Walton: I could not give you
an absolute dollar figure for that, firstly because I do not have
it and secondly because I suspect that would be something that
is commercially confidential. However, what we did look at was
how much of an impact this had on our customers as to whether
or not export credit was available when they are taking a view
on whether or not they place an order and the availability of
export credit to them actually translated into a substantial overhead
cost. When they are trying to make decisions in relation to purchases
and comparing an Airbus product, for example, with a Boeing product,
0.1 of a % will make a big difference to their decision-making
process. I forget the precise figures—and we can let you
have those later on—but the numbers were an order of magnitude
higher than the level at which a customer would make a decision
to purchase or not and we have some very good analysis of that
and we can provide that to you.
Q224 Chairman: If you could, that
would be helpful because I think there is a sense in which we
are likely to get from the Treasury or from the DTI or from the
ECGD the response, "Well, manufacturers would say that, would
they not?" The fact is that you are pretty good as an organisation
in pleading poverty and getting assistance from government and,
if you do not get it one way, you get it another and you try for
everything, which is fair enough, I mean that is what you are
in business for, but you squeeze everything and, sooner or later,
people become cynical. So, if you diminish our cynicism, it would
be perhaps . . .
Ms Walton: We can certainly provide
you with the evidence you have asked for and hopefully we will
all continue to repay the investment that the UK has made in us!
Q225 Mr Evans: Of course, a number
of us represent areas where manufacturing is taking place: I have
BAe Systems in Samlesbury directly in my constituency and of course
Rolls-Royce which is not too far away. So, I have workers there
as well and of course Airbus is very important too. Do you not
think that we all realise that anyway? You are very concerned
about this voted payment, but do you not appreciate that, irrespective
of whether it seems a subsidy or not, nobody in their right minds
would want to see the export of jobs, we want to see the export
of manufactured goods.
Ms Walton: I think we would all
hope that that is the case. Jobs are important. However, in the
analysis that has been done by Treasury of ECGD, they do not take
into account jobs outside of ECGD when they do their calculations.
They are only focused on premium generation and the value of the
jobs actually within ECGD. They are not taking account of the
value of the jobs both directly through the exporting manufacturers
and indirectly through the supply chain and the support network
for those exports.
Mr Caldwell: We have had a number
of meetings with Treasury on this issue and, if we understand
their argument correctly, as Sue says, the economic benefit which
they attribute to ECGD is solely the trading profit and the salaries
paid to ECGD employees. We can put various examples before you
but one which I think is a good one is that, if you look at the
shipyard in Scotstown which is currently engaged in making type
45s for the UK Government, to do that it needs a certain level
of workforce, there is a certain level of subcontractor and supplier
infrastructure required and there is a certain amount of salary
being paid trickling down into both personal and of course the
higher level corporate taxation. That is all derived from a certain
level of work created by a domestic UK requirement from that shipyard.
If we are successful, with ECGD support, in winning, say, four
export ship orders and those ships are built at Scotstown, there
will need to be a greater number of people employed, there will
need to be a greater volume of work passed down through the supply
chain, more corporation tax will be paid and more personal taxation
will be paid. Those are incremental economic benefits as a direct
result of the first link in that chain which is ECGD support and
it is that argument which at the moment we believe Treasury does
not accept, but that does not mean that we are going to stop trying
to persuade them.
Q226 Mr Evans: Relating to the fairly
thinly-veiled threat that you could all go elsewhere if the situation
deteriorates sufficiently for your customers that they are going
to be very unhappy, do you already have examples of where you
have done that, where customers have been that unhappy that you
have decided to go elsewhere based on just ECGD?
Ms Walton: We have examples not
on the commercial aerospace side of our business but certainly
on the industrial power side of our business where we have actually
actively sourced outside of the UK because there was not cover
available from ECGD for a specific project.
Q227 Mr Evans: It is not just on
the premiums, it was just that there was no cover at all?
Ms Walton: I think it was actually
a combination of two things: cover for the country involved and
the premium level had that cover been made available.
Q228 Mr Clapham: You have obviously
objections to subsidies being provided, yet I note in paragraph
12 that you request that ECGD should also be able to offer facilities
not available from the commercial market such as the fixed rate
export finance. Could that not be seen as a kind of overt subsidy?
Mr Caldwell: Fixed rate export
finance is available within that sector of the market which is
occupied by the export credit agencies. If you look at ECGD's
latest comparison document, you will see that the majority of
the international export credit agencies will provide fixed rate
export finance on internationally recognised terms, that is the
commercial interest reference rate, and these terms apply for
all exports other than large aircraft and there was a separate
agreement on those which has now, by mutual agreement between
the relevant agencies, been withdrawn. Other than for large aircraft,
the commercial interest reference rate rules are applied by the
majority of other agencies in that sector of the market in which
they operate. ECGD has progressively been withdrawing its support
for fixed rate export finance and our concern is—and we
are hearing rumours but there has been no official statement or
consultation on this—that their support will become even
more restricted than it currently is. So, yes, it is a matter
of concern to us that, while our competitors can call upon this
support, we cannot. If fixed rate export finance were to be abolished
overnight amongst all export credit agencies, then that would
be fine. A multilateral approach is fine, a unilateral approach
is not.
Q229 Mr Clapham: Again, is this an
issue that has been discussed with ministers and, if so, what
has been the response?
Mr Caldwell: Yes, it has been
and I think that we are struggling to make headway on this issue.
At the risk of straying into some financial technicalities, one
of the reasons why ECGD has such a problem with fixed rate export
finance is the way in which it is compelled to report its activities
and the way it is required to break even on a deal-by-deal basis.
These constraints are not imposed on other agencies. Other agencies
will report their fixed rate finance business on a cash basis
year by year. So, if they have won some years and lost some years,
that is how they report it. ECGD is required, under its current
rules, to report to market every fixed rate financing which it
supports. So, if rates which it is obliged to hedge against in
the future mean that there is a loss against that deal today,
then that is the loss that is crystallized on ECGD's books. If
in fact, over the next five to 10 years, rates go up and down
and had they accounted for it on a cash basis they would have
broken even, that opportunity is lost forever. So, part of their
problem is the way in which they have to account which is, as
I say, not a requirement on other agencies.
Mr Taylor: If I can come back
on an issue to which James alluded, Airbus benefited from something
called the large aircraft sector understanding which was the interest
rate fixing mechanism, which was not something that was actually
provided from Ex-Im Bank but, at ECGD's suggestion, that was dismantled
and we persuaded the French and Germans to come on board with
a new product and basically we have retained the level playing
field that we need for exports with Ex-Im Bank in that particular
context. So, any ideas that there was a subsidy on interest rates
for Airbus has now been dropped I would say since 1990-2000, but
that is clearly very different from the threat because Ex-Im Bank
did not have that. Therefore, we were levelling the playing field
and that is now achieved but where there is a unilateral decision
such as the increase in premiums that we are seeing, that is where
it hurts in terms of making purchase decisions from an airline.
So, there is a difference really between them and us.
Mr Caldwell: Yes.
Q230 Mr Berry: You criticised, and
indeed Mr Caldwell did earlier, the Treasury's approach to the
economic benefits of ECGD support and I have to say that I entirely
agree with you. It is actually quite bizarre that, given that
the ECGD exist to deal with market failure, they measure the economic
benefit by pursuing prices always telling true cost and benefits
and it is really weird. However, that is the Treasury! You then
point out quite rightly that a proper economic appraisal would
actually look wider than the immediate effects on the books of
ECGD. My question is, have you ever attempted to quantify the
benefits of ECGD support for the aerospace sector? Do you have
the real economic appraisal of ECGD support for aerospace?
Ms Walton: Certainly, the SBAC
has a wealth of information relating to the benefits of the aerospace
industry to the UK but I think there is one very good example
that indicates just how important ECGD is to this industry. We
do not have a representative of Bombardier here today but the
availability of export credit support to Bombardier was a very
key issue in keeping jobs in Northern Ireland rather than seeing
them head back to Canada where EDC was providing them with significant
levels of support. That was a very hard-fought case by Bombardier
with ECGD. ECGD eventually came through and those jobs were kept
in Northern Ireland rather than heading back to Canada. I could
not put a figure on it, I do not have it. I wonder whether Bombardier
might.
Q231 Mr Berry: Obviously there are
two issues: one is the contribution of the aerospace sector to
our economy and, like a number of my colleagues, I have constituents
who work in Rolls-Royce, Aerospace, Airbus and so on, so I appreciate
those arguments. I was asking the more narrow question. Presumably
somebody at some stage has attempted to assess the contribution
that ECGD itself makes to the economy via support for aerospace.
That is the nub of the argument in terms of you are saying to
us that this is a very important activity and it needs to be sorted,
it needs to work efficiently and so on, and, if there is any analysis
of the estimates of the benefits of ECGD support for aerospace
specifically, I am sure the Committee would be very pleased to
receive it.
Ms Walton: We could go back to
the example that we quoted before in relation to the A380 which
was that every customer for the A380 who is eligible for support
has required that we confirm that that support would be available
to them. So, it is clear from that that ECGD and COFACE and Hermes
in this case are also very important to those orders and indeed,
looking at the history of our Trent campaigns where, of our eligible
customers, 80% asked about the availability of support whereas
only 25 to 30% of them actually took it up on delivery. So, I
think the impact of ECGD is rather broader than simply looking
at the figures relating to support for actual deliveries. The
actual guarantees out of the door are only a very small part of
the story. I am not sure that we have dug down deep enough into
that to be able to give you some hard and fast pounds and pence
numbers.
Q232 Mr Berry: When you say to the
Treasury, "Look, hang on, guys. This is not a very clever
way of totting up the economic benefits of ECGD support and certainly
not in our sector", what reply do you get?
Mr Caldwell: It is a continuing
discussion. I am not saying that this is a Treasury view but there
are Treasury representatives who have said to us, "We are
not convinced that your industry needs to exist at all because,
if it did not, then jobs for your employees would be found elsewhere"
and then particularly pointing at the defence sector "and
we could then buy our defence requirements from other suppliers
overseas." So, we are starting from a different perspective,
shall we say, quite far apart.
Q233 Mr Berry: It is a labour free
market.
Mr Caldwell: I thought earlier
on you were suggesting that defence was a special case, so perhaps
not a free market.
Q234 Mr Berry: I think aerospace
is a special case.
Ms Walton: But we have had reassurances
that it is not the Treasury's intention to do away with our export
credit agency and I am sure we all sleep much easier in our beds
knowing that.
Chairman: The Treasury often speak with
forked tongue!
Q235 Sir Robert Smith: You are concerned
about the conflict between the Government's policies to grant
sustainable development, human rights, et cetera and the ECGD's
role in facilitating exports or that being part of their business
statement. Can you provide examples of where the former has interfered
with the latter?
Ms Walton: I think our concern
is really that ECGD's role is one of supporting exports rather
than necessarily being there to promote sustainable development.
I think the two things are very different. I do not think we can
point to examples where a sustainable development issue has stopped
one of our transactions from going ahead because we can very clearly
demonstrate on the commercial aerospace side that these pieces
of equipment are generally generators of foreign currency for
the countries that they are being delivered to. So, you are able
to, if you like, tick the box on the sustainable development question.
It is not something that we face on a regular basis because the
sustainable development issue has only come up in relation to
ECGD's list of highly indebted poorer countries, although their
list is some 20-odd countries longer than everybody else's list.
We have had an issue on Sri Lanka, for example, where the customer
was due to take delivery of a Rolls-powered Airbus aircraft and
Sri Lanka was added to ECGD's list and suddenly we found that
we were having to ask the customer to fill in a few more forms
before they were able to take delivery of their aircraft, but
they were able to demonstrate very clearly that this was going
to be a generator of foreign currency for the economy, so it was
not a real issue, it was more a timing problem.
Q236 Sir Robert Smith: Given that
your view is that the ECGD is not subsidised and given that you
would prefer it to have less interference, do you have any objections
to it being privatised?
Ms Walton: I think it would be
difficult for this end of ECGD's business to be privatised because
it is very long term and it is very long lead time and it is not
something that commercial markets are particularly able to deal
with. They are very fickle markets. We need certainty and consistency
from our export credit agency. The short-term business was successfully
privatised.
Q237 Sir Robert Smith: Despite people
being frightened that it would not be.
Ms Walton: Yes. It was privatised
in a way that enabled the purchaser of the business to take some
comfort from the UK. It has been doing very well subsequently.
Unfortunately, it also means that ECGD does not have that short-term
business to fall back on. It is now only looking at long-term
business. There is not a consistent market for this type of long-term
support that we see in the private commercial markets.
Mr Caldwell: It is very important
to be clear about what one means when you speak of privatising
an export credit agency. There are export credit agencies where
the work is done by a commercial organisation but guarantees that
are issued are fully supported by the Ministry of Finance or relevant
equivalent body in that country.
Mr Taylor: In the Airbus example,
the France and German agencies are technically privatised, they
are part of the Alliance group or part of a banking group and
the people working there are therefore privately employed, but
the guarantees have to be issued by a triple A sovereign credit
so that we have a similar credit backing to the Boeing exports.
Mr Caldwell: The unique selling
proposition of ECGD is its government guarantee which allows commercial
banks to make zero weighted loans.
Mr Taylor: There is a big difference
in subsidy and saying it can be privatised.
Q238 Judy Mallaber: In paragraph
23, you credit ECGD with negotiating a good international agreement
on environmental standards as helping level the playing field
but are then concerned about that new regime being imposed with
those environmental standards 12 months ahead in this country
of the international obligation. Do you have any evidence that
this actually harmed UK exports or any examples that you can give
us?
Ms Walton: It just made it a little
more difficult for ECGD applications to be processed. It is often
difficult for us to say that a specific deal has been harmed,
it is more did this influence the way that a customer will behave
in the future because, at the stage where they are taking delivery
of an aircraft, they are doing everything that they possibly can
to ensure that the financing is available for that aircraft but,
if they have had to jump through rather more hoops than they would
have been expected to by Ex-Im, for example, then, next time around,
that is going to form part of their decision-making process in
that they will want to be sure that they have a process which
is easily understandable and easy for them to know that they have
complied with it appropriately. So, I do not think we can demonstrate
that there has been any loss of business but I think that our
customers will think very carefully next time they place an order.
Mr Taylor: Generally, any harmful
factors will not be necessarily revealed in concrete example until
later when there is another order being discussed and they say
that the ECGD experience was pretty rough going compared to what
they might have had in the Ex-Im Bank and therefore there will
be people in the critical department, which is the financial department
of an airline, who will be recommending that they go for something
which has the support of a lot more tolerant exporter.
Ms Walton: It is worth mentioning
that our commercial aviation business is probably one of the most
highly regulated in terms of its environmental impact and in terms
of emissions and noise in any event, so anything we are doing
additionally for ECGD is likely not to have a significant impact
on what we are already doing because of the international regulations
that we are working within in developing more fuel efficient and
less noisy engines and aircraft in any event.
Q239 Judy Mallaber: Surely you are
concerned that it might put people off in the future because of
this experience which will not happen if that is now meant to
be implemented internationally, so that will not apply in relation
to environmental standards. Are you satisfied that all ECAs are
now following the OECD guidelines on an equal basis and so therefore
that differential should not exist?
Ms Walton: We are not privy to
all of the ECA's compliance I suspect but ECGD's original implementation,
as we said, was 12 months ahead of time. It was probably a more
stringent standard than was ultimately applied by the OECD but,
as I have said, we are already working within a very highly regulated
environment in terms of emissions and noise, so that did not cause
us any particular problem. I think it is more a perception that
ECGD is a more difficult agency to deal with across the board
not just the environmental issues but when you add all of these
things together, there is just a perception that ECGD is making
life a little more difficult for our customers.
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