APPENDIX 6
Supplementary submission by British Exporters
Association
EXPORT CREDITS
GUARANTEE DEPARTMENT—BOND
SUPPORT
One of the ways in which ECGD could improve
its support to exporters, and especially to SMEs, would be to
introduce a bond support scheme similar to that offered by several
other Export Credit Agencies. We were encouraged by the Committee's
interest in such a scheme and we are pleased to submit, as promised,
a copy of our paper entitled "The Case for ECGD to support
the Issuance of Bonds and Guarantees" that we sent to ECGD
in February 2003. (Copies of the paper were also sent to the International
Trade Minister, HM Treasury and the Export Guarantees Advisory
Council), together with:
— a table showing the bond support
facilities available from a range of Export Credit Agencies, up-dating
the information contained in paragraph 7 of our paper; and
— a note by Aon Ltd on the collapse
of capacity in the international surety market, which is an updated
version of the note that was attached to our original paper.
Since February 2003, we have repeatedly explained
the need for bond support at meetings with senior officials and
with ministers (both DTI and Treasury), and we have further pressed
our case in several letters. But this has so far been to no avail.
Indeed, the enduring theme of the written responses we have received
from DTI ministers has been along the following lines:
"I appreciate producing concrete and
verifiable evidence may be difficult, but to date ECGD has only
seen a few instances of bonding difficulties all of which appear
to relate to company rather than market problems. Only if such
evidence can first be provided to ECGD would a further meeting,
to revisit this issue, be useful."
(Extract from letter to BExA from Mr Mike O'Brien
MP, Minister of State, Trade & Investment, 27th October 2003)
It is almost impossible to provide the sort
of evidence that would satisfy ECGD, but we believe that we have
demonstrated a clear need for ECGD bond support to help exporters
accept contracts that require them to arrange bonds. It is not
only companies with weak balance sheets that are seeking such
support. Relatively strong companies are also finding that, for
capacity reasons, the commercial banking and surety markets cannot
always deliver the level of bonding that is demanded by many of
their overseas customers.
British Exporters Association
1 April 2004
THE CASE FOR ECGD TO SUPPORT THE ISSUANCE
OF BONDS AND GUARANTEES
Contents
Introduction
The Need for Bonds
Providers of Bonds
Current Availability of Bonds
(1) Surety Market
(2) Bank Bonds
(3) The position of individual BExA Members
What ECGD can do to Provide Bond Support
The SME Perspective
International Competition
Conclusion
February 2003
INTRODUCTION
Exporters are frequently required to provide
bonds against advance payments made by their buyers under their
contracts (Advance Payment Bonds) and to provide comfort to their
buyer that all their obligations under the contract will be satisfactorily
performed (Performance Bonds).
There is a severe shortfall of capacity in the
surety and bank market for contractual bonds and both large and
small exporters are experiencing significant difficulty in raising
the bonds required to meet their future contractual obligations.
It is feared that this capacity shortfall will continue and that
it will be exacerbated by the introduction of Basle II disciplines.
Whilst ECGD and the private insurance market
offer coverage for the unfair calling of these bonds ("buyer
risk"), there exists no ECGD cover to assist the exporter
in raising the bonds from their banks or the insurance market
("exporter risk") at this time of unprecedented market
capacity reductions.
This market failure is not limited to the UK.
Several Export Credit Agencies already provide exporter risk coverage
on bonds—on a risk-share basis with the banks—and
other ECAs are actively considering the introduction of such programmes.
BExA's members believe that there is an urgent
case for the British Government to follow suit by providing bond
risk support to ensure that UK exporters are able to remain competitive
in the international marketplace.
THE NEED
FOR BONDS
The requirement for some form of bonding has
become almost universal in major projects and, indeed, all domestic
and international trade that involves a performance risk and/or
progress payments.
The amount of bonding required by the customer
on a particular project or contract will depend on a number of
factors including:
— Location: In North America, it is
commonly the case that 100% bonding is required (albeit those
bonds are often conditional by nature).
— Contractual Responsibility: If the
contractor is responsible for construction/erection, it is likely
that a performance bond of at least 10% will be required.
— Payment Terms: Any advance/progress
payments (including loan drawings) made available before completion
of the project are likely to be bonded—initially 100% of
each payment (typically 20-25% of contract value), but possibly
with a reduction mechanism related to deliveries or commissioning.
— Project Finance: The lenders (and
ECAs) will usually require developers of projects to insist on
high levels of bonding.
— Offset Performance Bonds: Generally
required for 5-10% of any offset obligation, and remaining valid
for the duration of the offset programme (often 10 years or longer).
— Warranty and maintenance obligations:
The requirement for warranty/retention bonds of at least 5% of
the contract value is not uncommon.
— Tenders: It is a common requirement
for a tender/bid bond of at least 2% of the tender price to be
submitted with a tender.
Following the award of a contract, the tender/bid
bond will not be released until the performance bond and/or advance
payment guarantee has been issued. Similarly, on completion of
the project, the performance bond may not be released until the
warranty bond has been issued.
The inability of the contractor to provide a
bond that is required by the contract could easily result in the
contract being terminated and any existing bonds being called.
Similarly, the inability to extend the validity of an existing
bond (eg due to a delay in completion of the project) would almost
certainly result in that bond being called.
Thus, when bidding for a project, contractors
not only have to provide a tender/bid bond, but they also have
to be certain that they will be able to raise the contract bonds
as and when they are required—and to extend them if necessary
(not necessarily for reasons within the control of the contractor).
In an ideal world, of course, customers would
trust contractors to perform according to the contract specification
and to use progress payments for the purpose for which they were
intended. But in the current world economic and political climate,
including several high-profile corporate failures and insolvencies,
the requirement for bonds is increasing rather than diminishing—especially
in international trade.
One SME member of BExA observes that "There
is a growing demand amongst customers to ensure the integrity
of bid and of supplies . . .". The growing demand for bonds
and guarantees is an issue that needs to be addressed internationally.
Until more benign market conditions are restored, however, the
ability to provide increasing volumes of bonds and guarantees
remains vital to the winning of orders.
As prime contractors are finding it increasingly
difficult to procure bonds for export contracts, so too are their
sub-contractors. Many of these sub-contractors rely on the "trickle-down"
benefits of obtaining business from major British-led export projects.
[Because prime contractors are having difficulty
obtaining back-to-back bonding from their sub-contractors, we
should be grateful if ECGD would consider reversing its recent
decision to remove from its Bond Insurance Policies any liability
for loss arising from the capricious calling of a bond due to
an event attributable to a sub-contractor.]
PROVIDERS OF
BONDS
There are two distinct markets for the provision
of bonds and guarantees:
— insurance companies who issue surety
bonds; and
The surety market generally resists issuing
bonds that are callable "on-demand" because insurance
companies prefer to satisfy themselves that the contractor is
in breach of his obligations before honouring a bond call. Also
they like to have the opportunity to remedy the situation that
led to the bond call. For these reasons, most customers stipulate
that bonds must be issued by banks, even though the credit rating
of most banks is lower than that of most surety companies. Conversely,
most contractors would, for the same reasons, prefer to provide
surety bonds—especially as surety bonds do not erode the
contractor's hard-pressed banking facilities.
Outside of North America, customers usually
require bonds that are callable "on-demand", rather
than the "conditional" bonds that are favoured by the
surety companies. These "on-demand" instruments can
be dangerous in the wrong hands because the issuer is obliged
to pay the beneficiary on first demand, without any regard to
the justification of the bond call. Most contractors purchase
insurance against the capricious/unfair calling of such bonds—either
from ECGD (through the Bond Insurance Policy) or from the private
insurance market.
In some countries it is a requirement that bonds
are issued by local banks (in which case, the contractor usually
has to arrange for his relationship bank in the UK to act as an
intermediary).
In North America, banks generally issue standby
letters of credit, which are similar in effect to bonds.
CURRENT AVAILABILITY
OF BONDS
4.1 Surety Market
Recent research by Aon suggests that the capacity
of the surety bonding market has collapsed over the last couple
of years. This is dramatically illustrated in the attached chart,
which shows that the capacity of the two largest players (AIG
and Chubb) has declined from, respectively, $500-$1,000 million
in 2001 to $150 million in 2003; and $700-$900 million to $150
million. And other players have simply left the market. Global
surety capacity has fallen from $6,850-$8,150 million in 2001
to only $1,400 million in 2003.
Contractors in all countries have felt the effect
of this dramatic reduction in surety market capacity. Until 2001,
many large multinational contractors would typically have enjoyed
significant bonding lines with several surety companies. In many
cases, those contractors now have much-reduced surety lines that
are full (and in many cases overfull) with existing bonds, leaving
no capacity whatsoever to issue any new surety bonds.
The reasons for the reduction in surety capacity
include:
— knock-on effects of September 2001;
— collapse for formerly high profile,
respected, companies (Enron, World Com); and
— general reduction (or perceived reduction)
in the capital value of many major companies arising from declining
share prices.
These factors have caused a "perfect storm"
of events and resultant losses causing some insurers and re-insurers
to withdraw from certain areas of cover. The surety market is
one that has been particularly hit by a reduction in capacity.
This all amounts to a market failure that is
damaging the ability of contractors to bid for contracts, particularly
in North America. Whilst such contracts do not tend to require
ECGD-supported finance or ECGD insurance, there is an urgent case
for ECGD to provide some degree of bond support in order that
UK contractors can continue doing business—and, particularly,
large projects—in the important North American markets.
4.2 Bank Bonds
There is also a severe reduction in capacity
in the bank market to provide exporters with the bonds required
to perform their export contracts.
The export finance banks offer their corporate
clients a range of finance facilities, often including bonding
lines to support their export activities. According to each bank's
own strategy, these bonding line facilities will be viewed either
as a stand-alone product or offered as one of a range of products
to existing corporate relationships. In both cases the banks will
analyse the corporate credit risk and ensure it is one acceptable
to the bank.
When reviewing a request for bonds the bank
will therefore address three issues:
Credit—An acceptable credit risk
is a pre-requisite to the bank providing any bonding lines. Put
simply, if the bank cannot get comfortable with the corporate
risk, then no bonding facility will be provided.
Pricing/Return—Pricing is dictated
by supply and demand in the marketplace. With the introduction
of Basle II, it is hoped that the banks will be free to select
their own level of risk capital allocation according to their
respective risk assessments. Banks that perceive bond facilities
as low risk will require less risk capital and pricing should
be relatively low. The converse will also apply. There is therefore
likely to be a greater disparity in the risk perception and bond
risk pricing in the bank market under Basle II, with most of the
leading banks in London likely to adopt the advanced approach
to credit risk capital.
Pricing in the market has generally been on
the increase over the last 12-18 months, partly driven by risk
capital returns being taken more seriously in anticipation of
the new disciplines of Basle II being introduced in 2003-04, but
also by a perception that corporate credit risk has generally
deteriorated.
Capacity—Capacity on a specific
corporate risk is a problem for a bank from time to time, especially
when the exporter has been successful in winning business and
has a strong relationship with the bank, which may be a core bank
for the exporter. That bank's own policy and operational guidelines
will frequently determine a maximum level of bonding facilities
per corporate client/exporter. Prime considerations may include
the net worth and commercial reputation of the particular corporate,
its overall level of exposure to that corporate, and overall relationship
issues. In some cases the upper limit on the bond facility will
be absolute, in other cases the bank might consider adding additional
capacity to the limit if it can obtain additional security, for
example in the form of cash collateral. [However, it is often
impractical for corporates to provide cash collateral for bonds—not
just because of other demands on their cash and in some cases
the constraints of financial covenants, but also because they
need to use the contractual progress payments for their intended
purpose—to finance work-in-progress.]
Following major corporate failures such as Enron,
banks are increasingly unwilling to bear high concentrations of
risk on any one corporate and this has resulted in an overall
reduction in the exporter risk market. As a result, many manufacturing
members of BExA are finding that their bank bonding facilities
are full (or overfull) with existing bonds and that there is no
capacity for the issue of new bonds, regardless of price.
Moreover, in the absence of any capacity in
the surety market, contractors are now having to offer bank bonds
to customers who would have been willing to accept surety bonds.
This is putting increased strain on contractors' bank bonding
lines.
As in the surety market, therefore, there are
real signs of market failure in the bank bonding market too. In
normal times, it might have been possible to ameliorate the problem
in the banking market by turning to the insurance sector—but
because of the crisis in the surety market this is not a practical
solution to the current problem. The only way of creating increased
capacity, therefore, is to look outside of the normal markets,
hence BExA's urgent plea for HMG to provide support, either through
ECGD or through some other means.
4.3 The position of individual BExA Members
In view of the commercial and financial sensitivity
of information about the borrowing/bonding facilities of individual
contractors, and of the attitude of individual banks and surety
companies towards bonding lines, we have asked our members to
provide supplementary information directly to ECGD. We would ask
that all such information is treated as commercially confidential.
5. WHAT ECGD
CAN DO
TO PROVIDE
BOND SUPPORT
To date, ECGD has expressed reluctance to provide
support for bonds/guarantees because it suffered considerable
losses on an earlier ECGD Bond Support scheme in the 1970s as
a result of the insolvency of one major UK corporate. At the time,
ECGD provided 100% bond support to corporates that could not obtain
bonding lines from their banks. BExA maintains that that loss
was incurred because of inadequate underwriting disciplines. There
is no suggestion that ECGD should, in today's environment, provide
a last-resort facility, nor that 100% cover is required.
Indeed, our proposal is for ECGD to risk-share
with banks. This would increase the overall bonding capacity available
to an exporter whilst at the same time ensuring that ECGD did
not take un-commercial risks.
There are several ways that this support could
be provided, for example:
— General Bonding Line: Where an exporter
has a general bonding line with a bank or surety company, ECGD
would increase the exporter's bonding capacity by providing a
guarantee/indemnity to the bank/surety for a proportion of their
exposure on a portfolio of existing and/or future bonds, thereby
increasing overall capacity.
— For a particular export project with
a large bonding requirement: ECGD might join a bonding syndicate
for 50-70% of the value of each bond. (Either overtly or by providing
guarantees/indemnities to the fronting banks/sureties).
In either case, ECGD would rely on a counter-indemnity
from the exporter that ranks pari-passu with the counter-indemnity
given to the banks/surety companies.
Both ECGD and the banks/surety companies would
receive commission from the exporter, broadly in proportion to
the risk each was taking on the exporter. This should be compatible
with ECGD's break-even objective.
ECGD should provide this facility even if it
is not providing other forms of support for the project in question.
6. THE SME PERSPECTIVE
A bank member has argued that the most difficult
scenario relates not to large customers, but to SMEs. They may
not be "poor credits" but their balance sheets are often
not sufficiently large to support the combination of bonding and
working capital required for new overseas business. Some form
of support should be considered for SMEs, even if it has to be
taken outside of ECGD's normal trading activities.
As mentioned earlier, many SMEs obtain work
as sub-contractors on major export projects, and they are usually
required to provide bonds to the prime contractor. It is therefore
important that such sub-contractors are eligible for bond support
even though their contracts might not involve direct exports.
7. INTERNATIONAL
COMPETITION
Exporters in several other countries already
benefit from various forms of bond support provided by their official
ECAs—and more ECAs are recognising the need for such support
and are seriously considering the establishment of new schemes.
— AUSTRIA: OeKB are currently not yet
providing exporter bond risk support.
— AUSTRALIA: EFIC provides exporter
bond risk programmes.
— BELGIUM: OND provides exporter bond
risk programmes.
— CANADA: EDC provides exporter bond
risk programmes.
— FINLAND: FINNVERA provides bond risk
support on a case-by-case basis. Cover may be up to 85% but usually
they prefer a risk sharing on a 50/50 basis with a bank.
— FRANCE: The French Authorities are
currently considering a scheme under which bonds issued by commercial
banks will be partially insured by Coface against exporter risk.
— GERMANY: Hermes are currently not
yet providing exporter bond risk support.
— ITALY: SACE is currently discussing
with exporters the provision of bond risk support.
— NORWAY: GIEK provides exporter bond
risk support programmes and covers up to 50% on private risks
and charges the same premium as the bank.
— SPAIN: CESCE has for many years provided
exporter/buyer bond risk support programmes to provide insurance
against the calling of bonds for any reason—fair or unfair.
— SWEDEN: EKN has operated a "counter-guarantee
facility" for seven or eight years. Normal cover is 50-75%
and the premium varies between 0.5-2.00% per annum, payable annually.
Approximately 75% of the premium relates to the Exporter risk.
There is no requirement that this guarantee should be complementary
to any other EKN guarantee.
— SWITZERLAND: ERG is currently discussing
the provision of an exporter bond risk support programme, however
it may require a change in law to achieve it.
— UK: No bond support scheme is currently
available.
As bonding capacity has dried-up, the absence
of ECGD support is becoming an increasingly important component
in the competitiveness of British exporters—and, in some
large multi-national groups, it is already an important factor
in sourcing decisions.
8. CONCLUSION
BExA strongly recommends that an HMG Bond Support
scheme along the lines described above should be introduced as
a matter of urgency in order to prevent a further reduction in
the competitiveness of government support for British industry.
At a time when the UK's visible trade balance is at an all-time
low, HMG intervention as a result of market failure would be more
than justified. Such support would be very much in accordance
with ECGD's mission to help exporters win business.
British Exporters Association
February 2003
EXAMPLES OF ECA BOND SUPPORT
|
| Country | Bond Support?
| Notes |
|
| Austria | No |
|
| Australia | Yes | If involved in a large export project and the exporter's bank limit has been reached, EFIC may either issue bonds directly or provide guarantees to banks issuing bonds. Security requirements depend on bond type and risks involved.
|
| Belgium | Yes | OND provides exporter bond risk programmes.
|
| Canada | Yes | Under its Bid or Performance Guarantee programmes, EDC can insure banks against any call made on letters of guarantee given to buyers. The bank is fully protected (100%) by EDC so the exporter's working capital is not affected.
|
| Czech Republic | Yes | EGAP provides insurance against "fair calling" of guarantees (bonds) as a result of non-fulfilment of the Czech exporter's obligations.
|
| Finland | Yes | FINNVERA provides bond risk support on a case-by-case basis. The Bond Guarantee can be a counter security for a bank issuing a bond on behalf of the exporter in favour of a foreign buyer. If there is a claim, Finnvera recovers from the exporter the full indemnity paid to the bank. The Bond Guarantee can also be used simultaneously both as a counter guarantee in favour of a bank and as risk insurance in favour of an exporter. The standard Bond Guarantee coverage for the bank is 100% but risk sharing on a 50/50 basis with a bank is preferred. The bond may be given by either a Finnish or a foreign bank or insurance company.
|
| France | Case-by-case | The French Authorities have introduced a scheme under which bonds issued by commercial banks can be 65% insured against exporter risk.
|
| Germany | No | Hermes can act as Surety, but without government support.
|
| Italy | Not yet | SACE has been discussing with exporters the provision of bond risk support.
|
| Malaysia | Yes | For certain classes of contract, Malaysia Export Credit Insurance Berhad is able to provide support either by way of insurance bonds, or by giving indemnity to banks for issuing such bonds.
|
| Norway | Yes | GIEK provides exporter bond risk support programmes and covers up to 50% on private risks and charges the same premium as the bank.
|
| Poland | Yes | KUKE S.A. can either issue bonds or provide re-guarantees as a security for guarantees issued by a bank.
|
| Portugal | Yes | Advance payment and reinforcement bonds can be provided by means of COSEC's Bond Insurance Policies.
|
| Slovenia | Yes | Slovene Export Corporation can issue bonds.
|
| Spain | Yes | CESCE provides exporter/buyer bond risk support programmes to provide insurance against the calling of bonds for any reason—fair or unfair.
|
| Sweden | Yes | EKN's counter guarantee product will be explained by Susanne within a separate session.
|
| Switzerland | Not yet | ERG is considering the provision of an exporter bond risk support programme, however it may require a change in law to achieve it.
|
| UK | No | |
| USA | Yes | OPIC guarantees repayment to US financial institutions in the event that guaranties, typically letters of credits and bonds, are drawn. OPIC's Financial Contractors Programme expands the ability of US financial institutions to issue additional contractor guaranties, thus enhancing the liquidity available to contractors. US contractors, especially small and medium-sized businesses, with an established track record, demonstrated financial viability and the ability to establish a credit relationship with an issuing financial institution are eligible for the OPIC program. Up to 75% of the amount of bonds can be covered by the OPIC guaranty, with financial institutions assuming 25% or more of the transaction.
|
|
British Exporters Association
October 2003
|
INTERNATIONAL SURETY CAPACITY 2001-04
(per account, in US$ millions)
|
| Company | 2001 capacity
| 2002 capacity |
2003 capacity | 2004 capacity
|
|
| AIG | 500-1,000
| 500 | 150
| 225 |
| Chubb | 700-900
| 200-400 | 150
| 300 |
| CIGNA | 500-700
| Nil | Nil
| Nil |
| CNA | 500-700
| 75 | 75
| 75(1) |
| Firemen's Fund | 1,800
| Nil | Nil
| Nil |
| Kemper | 600
| 100-150 | Nil
| Nil |
| Liberty | 500-700
| 100-200 | 75
| 100 |
| St Paul | 750
| 750 | 200
| Nil(2) |
| Travelers | 500
| 500 | 500
| 500(3) |
| Zurich | 500
| 500 | 250
| 300(4) |
| Total | 6,850-8,150
| 2,725-3,075 | 1,400
| 1,500 |
|
Notes:
1. Outside USA, open for accounts in UK and Canada only.
2. Being merged with Travelers.
3. Outside USA, open for accounts only in Australia and
the European Union, although Canada and Mexico may be added after
completion of the merger with St Paul.
4. Special acceptance by reinsurers required for accounts
in Argentina, Brazil, Japan and Mexico; capacity of $400 million
available for accounts rated investment grade.
The following chart incorporates the maximum amounts in the
above ranges.
January 2004
| 
