APPENDIX 15
Memorandum by Rolls-Royce
This response is primarily focused on the potential
impacts of the impending Trading Fund and the commercial aviation
aspects of ECGD's business where Rolls-Royce has most direct experience
of ECGD's strengths and shortcomings.
Executive summary:
— Pre-1999 ECGD was held up by its
customers as being a model export credit agency (1999 Mission
& Status Review). The subsequent array of consultations and
reviews have eroded this position and given the impression that
ECGD is battling for survival.
— Between 1992 and 2002 NERA showed
ECGD to be a net contributor to the UK economy. This was a remarkable
performance over an extraordinarily difficult economic period
and demonstrates clearly that there is no subsidy inherent in
ECGD's support for UK exporters.
— ECGD's Benchmarking exercise indicated
that by 2002 it did not compare favourably against other ECAs
in terms of either pricing or availability of cover.
— ECGD's advisory council ("EGAC")
was critical of ECGD's performance (2003 Report). The Council
expressed particular concern about the uncertainty caused by repeated
reviews and highlighted that ECGD should keep the competitiveness
issue at the forefront of its agenda when setting cover and pricing
policy.
— The same report recommended ECGD's
future corporate plans should contain specific reference to enhancing
UK industry's international competitiveness.
Rolls-Royce's three major concerns are:
1. That the move to Trading Fund status
does not impact on the pricing required to offer competitive
rates and any return on capital employed ("ROCE") imposed
on the Trading Fund does not undermine ECGD's competitive position
against other ECAs.
2. ECGD must be allowed a period of stability
to enable it to regain customer confidence.
3. ECGD's clear remit must be to provide
UK exporters with the volume of support and quality of products
that will enable them to compete effectively with their overseas
competitors.
INTRODUCTION AND
BACKGROUND
1. The Trade and Industry Committee's Third
Report "The Future of the Export Credits Guarantee Department"
(11 January 2000) acknowledged that any fundamental change to
ECGD's Mission, status or role would be inconceivable without
reference to the international framework and any decisions relating
to ECGD's future should be measured against their consequences
for the international competitive position of British exporters.
Since the publication of this report ECGD has been subject to
further scrutiny resulting in the publication of several additional
reports, described below, that are relevant to this Review.
2. The first of two NERA reports, "The
Economic Rationale for the Public Provision of Export Credit Insurance
by ECGD" was published in April 2000. The report concluded
that ECGD should continue to provide cover for medium and long-term
capital goods exports. NERA had not identified any subsidy in
ECGD's support but stated that if there were one then it should
be phased out multilaterally over an agreed period. In addition
NERA deemed it undesirable for ECGD's remit to be broadened to
include aid-related, environmental or other objectives not strictly
related to its core business and recommended that it should focus
exclusively on the provision of insurance for medium and long
term exports.
3. KPMG published their report, "ECGD
Risk Management Review" in July 2000 assessing the strength
of ECGD's risk management systems. It concluded that ECGD's approach
to risk management was based on sound principles and that it had
a more robust system of risk assessment than most of its peers.
4. Also published in July 2000 was the "Review
of ECGD's Mission and Status". The report endorsed ECGD's
risk management processes while recommending a move to Trading
Fund status. In his Foreword the Secretary of State for Trade
and Industry stated that the Government accepted the conclusions
of the report, strongly reaffirming ECGD's role in bringing economic
benefit to the UK through its support of UK exporters and investors
in overseas markets. He also added a clear statement that ECGD
is not a drain on the taxpayer.
5. In February 2003 ECGD published the "Report
on the Comparison of Export Credit Agencies". This showed
that in comparison with other ECAs, overall ECGD was providing
the least cover in the fewest countries at the highest margins.
The report was a clear indication of the decline in ECGD's competitiveness
and ability to support UK exporters in an increasingly competitive
environment.
6. Bearing in mind the very positive outcome
of the Mission and Status Review it was surprising that a further
report was commissioned by HMT and ECGD to ascertain whether there
was any benefit to the UK economy of providing export credit support.
NERA's second report "Estimating the Economic Costs and Benefits
of ECGD—A Report for the Export Credits Guarantee Department"
was finally released in March 2003. Focusing exclusively on the
performance of ECGD's portfolio, NERA confirmed that for the period
1992 to 2002, ". . . our estimate of the net benefit of ECGD
is in the range of approximately £4.1 million to £23.1
million". This underlined the Secretary of State earlier
observation three years previously, when he stated that ECGD was
not a drain on the taxpayer. In fact ECGD had been a net contributor
to the exchequer.
THE TRADING
FUND
7. Rolls-Royce has accepted in principle
the concept of ECGD becoming a Trading Fund. However this was
on the basis that it would not lead to any diminution in ECGD's
risk appetite or any further increase in premium levels. For this
to be achievable a number of issues associated with the proposed
Trading Fund regime require further scrutiny. These issues are
discussed below.
8. Adequacy of the Trading Fund's capital
base—HMT has indicated that the capital base will be set
at £1.7 billion, down from an original estimate of £4
billion, with no apparent ability to apply for more capital should
the need arise. There are two reasons why this causes concern.
The businesses that ECGD supports are generally long-term and
cyclical. This is especially true of the aerospace industry, which
goes through regular and pronounced peaks and troughs. Our first
concern is that during periods of strong exporting success ECGD
may find its ability to underwrite business constrained by the
level of capital base. Our second concern is that the capital
base would be insufficient to absorb the claims that inevitably
follow a downturn and ECGD would be unable to trade through these
periods as it has done in the past. It is worth noting that ECGD's
track record in recoveries is second to none, hence its net positive
contribution to the exchequer over time. However such recoveries
occur over the long-term and ECGD's capital base must be flexible
enough to accommodate this.
9. Allocation of capital to individual transactions—The
amount of capital allocated to a particular transaction will have
obvious implications for premium levels, discussed further below.
There is however another issue with respect to the amount of capital
that ECGD will be able to allocate to any single transaction.
It has been suggested that there will be a limit set for individual
deals, calling into question ECGD's ability to allocate sufficient
capital to the "large and lumpy" deals that are typical
of our exports of aerospace and defence goods—this would
be particularly relevant in the context of A380.
10. Level of Return on Capital Employed
("ROCE")—The level of ROCE to be imposed upon
the Trading Fund has increased steadily from 6% real (ie 6% after
inflation), as originally quoted during the consultation process
that followed the Mission & Status Review of 1999, to a level
of 18% real now being discussed between HMT and ECGD. In our experience
of reinsuring risks similar to those carried by ECGD, ie guarantees
carrying downside risk but no upside potential, the returns demanded
by commercial insurance companies are far lower than those being
discussed in relation to the Trading Fund. Regardless of this,
it should be emphasized that the OECD and WTO guidelines for export
credit agencies ("ECAs") simply require that they break-even
over time. ECGD is the only ECA of its type that is being required
to make a profit for its exchequer.
11. Voted "subsidy"—Industry
has been assured that this inflated level of ROCE should not be
of concern as it represents only the "headline rate of return".
An "achievable rate of return" will apparently be set
at a level that will enable premium levels to remain "broadly
similar" to those charged today and an annual "subsidy"
will be voted by Parliament to provide a top-up enabling the headline
rate of return to be met. Rolls-Royce feels very strongly that
the availability of ECGD support should not be left hostage to
an annual voted payment that may or may not be forthcoming. Nor
should there be any suggestion that ECGD is a provider of "subsidy".
Every review that has been undertaken to date has demonstrated
quite clearly that there is no subsidy inherent in ECGD support
and that based upon portfolio performance alone, ie excluding
all the additional benefits of maintaining and creating high value
jobs within the UK, ECGD is a net positive contributor to the
exchequer. We believe that institutionalising a "subsidy",
however artificial it may be, is a dangerous step, opening up
both ECGD and the UK Government to challenge domestically and
internationally.
12. Transferring budgetary responsibility
for the Trading Fund to DTI—There is a suggestion that DTI
will have to allocate a portion of its finite budget to ECGD and
the Trading Fund. Setting the ROCE or "headline rate of return"
at an inappropriately high level would absorb a level of resource
disproportionate to the risk. In addition we understand that DTI
may not have either the benefit of the spread of the existing
portfolio to enable it to absorb catastrophic losses or the ability
to access additional capital, as per paragraph 8, to enable it
to trade through a downturn.
13. Provision of support to "rich markets"—We
also understand that ECGD's strategy and objectives are under
review. Rolls-Royce has become aware of an increasing reluctance
within ECGD to provide support to so-called "rich markets"
such as Singapore, Australia and the countries of the expanding
EU. There are two reasons why we believe this to be inappropriate.
First, airline customers will always have concerns relating to
the availability of long-term commercial funding for new aircraft
programmes with long lead times and high asset acquisition costs.
Even the best credit customers require the comfort of an ECA-supported
backstop before having the confidence to place an order. This
has been clearly demonstrated with the experience of A380 programme,
where every customer to date including Singapore Airlines, Qantas
and Emirates, has requested an assurance with regard to the availability
of export credit support. Secondly, a risk portfolio that excludes
better credits will be much more vulnerable in a downturn than
a more balanced one. This is of particular concern bearing in
mind the issues outlined in paragraphs 8 and 12 above.
THE IMPORTANCE
OF CONSISTENCY,
AVAILABILITY AND
COMPETITIVENESS OF
ECGD COVER
14. Commercial banking markets have contracted
as banks continue to merge. This has led to decreasing capacity
for many sectors, including commercial aerospace, as the merged
bank limits decline. Consequently, as described in paragraph 13
above, airlines are increasingly seeking the comfort of an export
credit backstop at the point that an order is placed. Evidence
from our Trent campaigns indicates that 80% of our eligible customers
seek assurances with respect to the availability of export credit
at the time that an order is placed. Historic data suggests however
that a much lower proportion, perhaps only 25-35%, actually take
up the support in some form at delivery of the aircraft. This
is entirely appropriate in our view, demonstrating that our customers
will attempt to access alternative funding if they can, using
ECGD as a complementary source of funding to the commercial markets.
15. Rolls-Royce has also looked at what
the availability, or indeed the absence, of competitive ECGD support
means to an airline customer in terms of operating costs. For
an average airline the availability of ECA support in a difficult
economic climate equates to around 5% of aircraft operating costs.
As little as a 1% difference in operating costs can win or lose
a sales campaign. If we cannot offer a competitive export credit
product from ECGD but our competition is able to present support
from its ECA our bid will start with a 5% disadvantage. This is
almost impossible to overcome. It would be necessary to reduce
the selling price of the aircraft by 20% or reduce fuel burn by
more than 20% to have the same impact on overall costs!
16. As noted in paragraph 5 above ECGD's
own benchmarking exercise shows that it does not compare at all
well against other ECAs in terms of either pricing or availability
of cover. Rolls-Royce saw ECGD double premiums for two airline
customers when the other agencies involved (US Ex-Im for the one
and Coface/Hermes for the other) had been willing to charge the
standard premium. We have a more recent example for a European
carrier where a relatively small increase in premium (0.15%) by
ECGD over and above that charged by Ex-Im led the customer to
decline the ECGD supported portion of the deal and comment that
this would be taken into account when the next engine order was
being placed. As this customer currently operates both GE-powered
and Rolls-Royce-powered B747-400 freighter aircraft this can be
seen as a serious threat to our future business with them. Clearly
an "all-American" product with full Ex-Im support would
be a more cost-effective solution for the airline if ECGD remains
uncompetitive.
ECGD's objectives, business principles and role in
promotion of sustainable development
17. Criticism has been aimed at ECGD for
not providing sufficient support to SMEs. We think that this is
unfair in two respects. First ECGD's short-term business, where
the products were more suited to SMEs, was successfully privatised
in the early nineties. Secondly, major UK exporters such as Rolls-Royce
have extended UK-based supply chains—(50% of Rolls-Royce
1,400 suppliers are all SMEs). These suppliers benefit indirectly
every time ECGD provides support to Rolls-Royce.
18. The "Review of ECGD's Mission and
Status" contained a new Mission Statement with subtle but
significant changes that appear to us to have detracted from what
should be ECGD's primary focus, ie the provision of competitive
support to UK exporters. There was no longer a statement of high
level objectives that ECGD must "provide the best service
at the lowest cost, consistent with our [ECGD's] accountability
to the taxpayer for prudent and cost-effective management".
Instead there was a new emphasis on providing support that was
consistent with the Government's other policies with respect to
sustainable development and human rights.
19. This change in focus seems to us to
be moving toward using ECGD as a provider of "aid" rather
than as a supporter of UK exports and jobs. Subsequent statements
by Ministers relating to ECGD focusing on the provision of support
to "worthwhile" exports only increase our concern. The
Secretary of State for Trade & Industry said in her foreword
to the ECGD Yearbook, Global Exporter 2002-2003 "Focussing
export credit guarantees on productive projects in these [poorer]
countries is now enshrined as an underwriting theme at ECGD .
. ." and in the Global Exporter 2003
-04 she added that the UK Government's commitment
to help poorer countries develop economic and social fabrics was
reflected in "the drive to focus export credit guarantees
on productive projects—aims incorporated in ECGD's Statement
of Business Principles." If these two statements mean that
ECGD support to these poorer countries should be focused on productive
projects then we would probably have no argument with them. If
however the intention is that ECGD support should only be focused
on productive projects in poorer countries then we would strongly
dispute this. Malcolm Stephens, in his book "The Changing
Role of Export Credit Agencies" (IMF 1999) states that there
are a number of bad reasons for setting up an export credit agency
and lists among them substituting for foreign aid, stating "Export
credit agencies should be involved in supporting commercial credit,
not providing aid." We would certainly agree that ECGD's
role is not as a provider of aid.
20. Rolls-Royce is supportive of the Business
Principles adopted by ECGD in 2001. We also believe that the current
exemption for aerospace and defence exports from the requirement
to complete Impact Questionnaires should continue. The commercial
aviation business is one of the most highly regulated in the world
in terms of operations, safety, noise and emissions and the completion
of an Impact Questionnaire for commercial aerospace exports would
add nothing to this. With regard to defence exports, we believe
that these concerns may be adequately dealt with through the export
licensing process.
21. It is difficult to see how ECGD might
be able to play a role in the "promotion" of sustainable
development. As an export credit agency it is necessarily reactive
rather than proactive, providing support to exporters on request
rather than promoting exports per se.
ECGD'S RELATIONSHIPS
WITH CUSTOMERS
AND OTHER
GOVERNMENT ORGANISATIONS
22. ECGD's relationships with its customers
have become increasingly strained over the four years since the
Mission & Status Review. Much of this has been due to the
uncertainty that has hung over ECGD and the continued debate between
HMT, DTI and ECGD as to its future. During this period ECGD lost
many good staff members and those who remained were put under
increased pressure, particularly those working on commercial aerospace
deals post the events of 11 September 2001.
23. It is vital that ECGD is allowed a period
of stability and certainty so that it can recover the confidence
of its staff and customers. We view the appointment of the ex-banker
Graham Pimlott as ECGD's Chairman as a positive move. However
it is important that the new Chief Executive is appointed quickly
and that both Chairman and Chief Executive are allowed a free
hand to begin the process of rebuilding ECGD's reputation as one
of the most flexible and proactive of the world's ECAs. ECGD's
business is long term and its performance, and that of the new
Chairman and Chief Executive, must also be judged over the long
term. They should not be forced to make inappropriate decisions
based upon the short-termism that an annual voted subsidy might
otherwise impose upon them.
24. It is also worth reiterating that having
ECGD provide indications of support, or simply having them visit
a customer alongside us in a sales campaign is often seen as demonstrating
the support of the UK Government for the exporter and the potential
customer. This can be immensely important in jurisdictions such
as China and the UAE. We also consider that it would be very
helpful if ECGD's remit could be made more pro-active to support
exporters in the same way that US Exim's objectives are more overtly
supportive. This could be used to good effect in enhancing relationships
with exporters and their customers in the many public arenas in
which ECGD engages. However, at present we have concerns about
the messages which ECGD signals in some of these public arenas
without prior consultation with manufacturers— for example
at a recent conference ECGD informed an audience of exporters
and their customers that it would be seeking residual value support
from customers on A380s. Clearly, before any remit could be
enhanced there would need to be a robust consultation process
in place.
25. Despite the comments made in paragraph
24, we find it hard to demonstrate to our customers during sales
campaigns that the UK government are fully committed to Rolls-Royce
when ECGD continues to provide support for US manufactured engines
in Airbus airframes. It seems to us to be wholly inappropriate
that ECGD cover should be given to the US engine manufacturers,
GE and Pratt & Whitney, who have a capable and competitive
export credit agency of their own, dedicated to providing support
for US exporters and US jobs. The advent of the A380 programme
presents the ideal opportunity for ECGD to take a robust stand
to support UK exports and jobs to the exclusion of the US jobs
secured by the sales of engines produced by the GE/P&W joint
venture.
ECGD'S RELATIONSHIPS
WITH THE
COMMERCIAL FINANCIAL
COMMUNITY
26. We have always regarded ECGD as being
complementary to and not a substitute for commercial financing
and we believe that ECGD works extremely well alongside commercial
risk-takers in many of our transactions. ECGD should be providing
a consistent and competitive presence in what is a very cyclical
market, giving our customers the confidence to enter into long
lead-time contracts for the delivery of high cost capital assets.
This is a role that the commercial markets cannot fulfil, although
as described in paragraph 14 above the commercial markets may
well be able to provide the necessary financing at delivery.
27. Active portfolio management will play
an essential part in recycling the limited capacity of ECGD's
new capital base. The reinsurance of ECGD's risks is a role that
the commercial markets should be encouraged to undertake and we
believe that the reinsurance market would be receptive to this.
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