Select Committee on Trade and Industry Written Evidence


APPENDIX 16

Memorandum by the Society of British Aerospace Companies (SBAC)

INTRODUCTION

  1.  Aerospace is one of the UK's success stories. Half a million people spread throughout the United Kingdom are involved in a sector that adds over £8 billion of value to the economy each year and accounts for 7% of UK exports. The UK Aerospace industry is second only to the United States and has a strong presence in the civil and military markets, with world-class companies in the airframe, engines and equipment sectors. The aerospace market is forecast to show strong growth over the next two decades and the UK is well placed to take a good share of this growth market.[99]

  2.  Companies that operate in the Aerospace and Defence sectors are high-tech employers, creating high value-added jobs using a highly skilled work force. The impact of the increased business from the additional export sales as a consequence of ECGD support is acknowledged to enhance the sectors' productivity.

  3.  However, if the UK Aerospace industry is to remain competitive in global markets, the presence of a competitive, responsive and adequately funded Export Credit Agency (ECA) is vital. This has been recognised on several occasions by ministers. The Secretary of State for Trade and Industry told the House of Commons on 22 January 2004 that ECGD has a "very important role to play in supporting British manufacturers in a number of different world markets". Further, she asserted that ECGD will go "from strength to strength in supporting aerospace and other parts of British manufacturing". Notwithstanding this and other reassurances from Industry and Treasury ministers, the SBAC is not convinced that this is the universal view of HMG.

  4.  The SBAC is very concerned that increasingly the operation of ECGD has been described as a subsidy to British exporting. This is not only incorrect, but potentially very damaging to the standing of UK export credit support in the light of European Union, OECD and WTO law and conventions. The SBAC contends that rather than acting as a subsidy to British exporting, ECGD has been a net contributor to the Exchequer and through a number of independent reports, shown to have made a positive contribution to the UK economy. [100]

  5.  ECGD has been demonstrated to have a stringent and effective approach to risk management at least as good as that of a commercial financial institution and better than many of its peers. In the past, this has been combined with an ability to respond effectively and flexibly to exporters and their customers. The continuing hiatus over the ECGD's operational status over the last five years has undermined confidence amongst ECGD customers that the UK will continue to have an effective and competitive export credit agency. The uncertainty is already leading some customers to require manufacturers to provide financial commitments to backstop the availability of export credit support. This, in our view, should not be company business.

  6.  This submission reviews the current issues of most concern to major British exporters in relation to the recent and forecast development of ECGD.

THE IMPORTANCE OF COMPETITIVE EXPORT CREDIT SUPPORT

ECGD and the private market

  7.  ECGD and its fellow government supported ECAs occupy a crucial sector of the long-term finance market which is not open to other private market players. While private sources of credit for sales are an important vehicle for UK aerospace exporting, an effective export credit agency provides a long-term consistent presence in the market as well as undertaking to cover difficult credit and country risks. It should also be noted, that for many customers, even high-quality customers such as Emirates Airlines and Singapore Airlines, the absolute size of the financial requirement in purchasing large numbers of aircraft and engines can only be met with the assistance of a national export credit agency. The evidence of Rolls-Royce's Trent campaigns suggests that approximately 80% of eligible commercial airlines have sought some form of comfort with regard to the availability of ECGD support at the outset of a marketing campaign. Of these around 25-35% actually utilise that support at delivery. It is worth noting that in A380 campaigns 100% of eligible airlines have asked for ECGD support. Those customers will not enter into the long lead time commitments to purchase large value assets without the backstop of an export credit facility. In many cases, the facility may not be used, but its presence as a potential "lender of last resort" makes a vital contribution to winning sales and retaining high value customers.

  8.  In aerospace markets, price is not the only issue, but also capacity and the ability to lend long term. Certainly within the regional airliner market, where there has been a significant reduction in the number of commercial lenders prepared to operate post 11 September, the capacity provided by ECGD is a much more significant issue than price. The interest shown by good quality airline credits in export credit finance is a positive indicator for ECGD. The SBAC contends that ECGD should continue to be able to take on a proportion of less challenging clients as a prudent measure to maintain a balanced portfolio. Although the private capital market has difficulty in coping with the long lead time, tenors and amounts associated with aerospace sales, it may ultimately play a role in assisting ECGD in recycling its capital base through active management of its portfolio.

The importance of competitive premium rates

  9.  The UK's interests in Airbus exports face their principal competitor in Boeing, supported by the U.S. Ex-Im. Ex-Im's attitude to their objectives can be summarised in this statement made in February 2002 by their Chairman: "Our job in this changed world is to play the role of the first guys to hit the beach in the US commercial effort to penetrate risky emerging markets. We find opportunities, take risks and try to draw the private sector in. In doing so, we foster stability and economic growth at home and abroad, and sustain well-paying U.S. jobs . . . I will do everything in my power to make Ex-Im accessible and responsive to your needs." Eduardo Aguirre—Ex-Im Bank Vice Chairman Address to US banks and Exporters, February 2002.

  10.  This aggressive commercial approach is reflected in the different levels of premium charged for recent airliner campaigns by Ex-Im and ECGD. In several recent Airbus campaigns ECGD has requested higher than standard premia. This has had a direct impact on sales, with Airbus losing campaigns to its competitor, Boeing, as Ex-Im has been willing to provide financing support at the normal 3% flat rate. Even when Airbus has secured sales ECGD has sought higher levels of premium than its European counterparts, thus increasing the cost of financing Airbus aircraft versus the cost of financing Boeing aircraft. This penalises Airbus customers and will negatively influence later decisions on aircraft purchase.

  11.  At a time when ECGD is increasing premium levels Ex-Im has taken a step to reduce them. For all signatories of the Cape Town Convention Ex-Im reduces its premium by one-third.[101] This has already given Boeing a competitive advantage over Airbus and has contributed to Boeing's success in recent sales campaigns. ECGD needs to be competitive with Ex-Im to ensure a level playing field between Airbus and Boeing and needs to be in line with its European counterparts instead of consistently pushing premia levels higher. The premium level is also an issue in the defence sector. In a recent campaign to upgrade two frigates for the Romanian government, when Romania's rating improved the French competition immediately lowered their premium rates to the minimum for the new risk category. ECGD did reduce their rates upon request, but not to the minimum.

Support for Fixed Rate Export Finance (FREF)

  12.  ECGD should also be able to offer facilities not available from the commercial market such as FREF. Industry is concerned that competitive provision of FREF by ECGD is under threat. FREF has particular value in supporting large defence contracts where customers are making a commitment to repay a substantial loan over a period of 10-15 years. In these circumstances most customers require the choice to be able to fix the interest rate for at least a part of that borrowing. If ECGD's FREF rates are higher than the competition's, this is immediately obvious. Some customers (for example, Chile) have a budget expressed in fixed future amounts, which absolutely require fixed rate finance. If ECGD charges a higher rate than the competition, then the present value of the customer's budget payments will be reduced. SBAC is concerned that current reluctance to support FREF on competitive terms would probably be made worse under Trading Fund restrictions.

ECGD AS A TRADING FUND

Sufficiency of capital

  13.  Airbus sales and defence transactions are high value contracts. Many defence sales are valued at over £500 million. It remains to be seen whether the proposed level of capitalisation will be sufficient to underwrite a regular flow of civil and military deals of this magnitude.

Rate of return

  14.  The level of return (ROCE) to be imposed upon the Trading Fund has risen steadily from a figure of 6% real, originally quoted in 2000, to 8% real in the NERA Report in early 2003 and is now rumoured to have been set at a level of 18% real. Industry has been assured that this is not something that they should be concerned with as premium will remain at levels "broadly similar" to those charged today and a voted payment will be used to top this up. The SBAC is concerned that this voted payment, which is only required because of the artificial level of ROCE imposed, will become branded as a "subsidy" and will be used by ECGD's detractors as evidence of the "cost" associated with ECGD support. In fact, as set out in para 17 below ECGD support does not now constitute a subsidy; on the contrary, it confers significant benefits upon the UK economy. The future availability of ECGD support cannot be left hostage to an annual voted payment. All other national export credit agencies work to the OECD's long-term breakeven guideline. Under current Trading Fund proposals ECGD will be significantly out of step with world standards, and the concern is that UK exporters will as a result be disadvantaged.

DTI Budget

  15.  The SBAC is concerned that in transferring budgetary responsibility for the Trading Fund to the DTI, including liability for catastrophic losses, the demands of underwriting export credit support could impinge upon the DTI's other activities in support of UK business. The aerospace industry is both a long term and a cyclical one and ECGD must have the ability to ride out those cycles and trade through the inevitable periods of claims. It has been suggested that the DTI will have to allocate a portion of its finite budget to ECGD. If this is the case the ROCE must be set at a level such that it does not absorb an amount of DTI resource disproportionate to the risk and the DTI must have the ability to access additional capital to trade through a downturn.

ECGD autonomy

  16.  The SBAC feels that it is somewhat paradoxical that HMG's intent in changing ECGD's status was to free it from direct oversight by HMT yet the result of the current policy would be to chain it to an annual voted payment and Treasury spending targets. There are already signs that ECGD has deferred decisions on difficult cases. In general, Industry is still unsure about exactly how much delegated authority the ECGD will possess under the proposed system of annual voting. The position as we understand it is far from transparent and makes it hard for both Industry and its customers fully to appreciate what conditions will shape business with ECGD in the coming years.

THE ECONOMIC BENEFITS OF ECGD SUPPORT

The NERA report

  17.  ECGD has been the subject of several independent studies including two reports from NERA and a KPMG analysis of ECGD's risk management practices. The last NERA report on ECGD support was eventually published in March 2003. It confirmed that ECGD provided a net benefit to the UK economy of between £4.1 million and £23.1 million over what had been one of the most difficult periods of ECGD's existence, 1992-2002, encompassing the "recession" following the first Gulf war, the financial crisis in Asia and the immediate aftermath of the events of 11 September 2001. This is surely proof of the adequacy of ECGD's premium regime and risk management practises and demonstrates that ECGD support for exports is not tantamount to subsidy.

Wider economic benefits

  18.  HM Treasury, when assessing the economic benefit attributable to ECGD support, takes into account only ECGD's trading profits and the salaries paid to its employees. This analysis ignores the incremental increases in jobs, local economic activity, private and corporate taxation and the large contribution to the UK's balance of trade which occur as a result of additional contracts being won by prime contractors, their sub contractors and suppliers as a result of ECGD support. The impact on the UK economy of a healthy Aerospace industry is significant. The large companies whose customers have traditionally used the services of ECGD are, of course, the "routes to market" for their widely dispersed national supply chains, many of which are SMEs. This principle has not changed since the late 1990s. The SBAC has data on 2,600 companies who supply directly to Rolls-Royce, Airbus UK, AgustaWestland and BAE SYSTEMS aerospace. This does not include UK suppliers to Bombardier Aerospace Northern Ireland.

The impact of customer defaults

  19.  Defaults on ECGD contracts are rare, and a tribute we contend to ECGD's ability to assess risk prudently and over the long term. Airbus deals in Philippines and Jordan are examples of non-defence default and Indonesia was the last defence related default that the SBAC is aware of. Before that, Iraq defaulted on loans made to it in the 1980s; these were in respect of civil and defence business. It should be noted that a default does not equate to a write off. Rescheduled payments from Indonesia are being made.

ECGD'S MISSION AND DEVELOPMENTAL OBJECTIVES

  20.  While change in the face of events and failure should be expected, the aerospace industry argues that the original ECGD Mission statement was clear and to the point, and effectively summarises the appropriate task of an ECA. This was: "to help exporters of UK goods and services to win business and UK firms to invest overseas, by providing guarantees, insurance and reinsurance against loss". The new statement is: "to benefit the UK economy be helping exporters of UK goods and services to win business and UK firms to invest overseas, by providing insurance and reinsurance against loss, taking into account the Government's international policies". The new statement adds, in the SBAC's view, an extra overlay of policy-driven requirements that are both vague and distracting from an ECA's primary function. The detailed list of objectives also relegates the active supporting of exports with due regard to prudent risk from first to seventh place.

  21.  The SBAC contends that the ECGD's new set of objectives obscures the fundamental purpose of an export credit agency, namely to support UK exports. Industry accepts that the provision of export credit should conform to HMG policy generally in respect of the destination of defence equipment and appropriate forms of commercial activity in developing countries. Industry would also expect that an export credit agency should not be a burden on the taxpayer. However, the SBAC contends that export credit and development policy should have a clearly defined degree of separation. It seems again paradoxical that while "tied aid" has been roundly condemned as a means of underpinning economic development, the provision of UK export credits may be in danger of becoming an implicit form of tied aid. Developing countries have the right both to defend their sovereignty and to derive economic returns from running their own airlines. In practice, the latter is increasingly driven by private investment decisions with non-commercial prestige factors playing a less prominent role than in the past.

  22.  Equally, while Industry respects the motives in writing off the debt of the poorest countries, it would be concerned if this were to have a damaging impact on ECGD's trading fund capacity. If it is given a limited capital base and then expected to write off debt, ECGD's ability to support sales might be seriously impaired or called upon to make additional demands upon the Exchequer.

  23.  The aerospace industry fully concedes the importance of meeting environmental targets. Indeed, the industry and its products are subject to increasingly stringent international regulation in respect of noise, emissions and safety. Economic pressures have also led to big improvements in fuel efficiency. As in 1999-2000, the SBAC sees little value in second guessing international negotiation and agreement on environmental regulations. This is a broader issue than the provision of export credit and UK Aerospace is playing a major role in meeting challenging environmental targets. This commitment is underlined in the recent Aerospace Innovation and Growth Team report. However, the SBAC does credit ECGD in negotiating an effective international agreement on environmental standards for ECAs. This was a good example of a measure designed to "level the playing field". However, ECGD led by example, imposing the new regime upon UK exporters a full twelve months ahead of its international obligation, causing UK exporters to comply with terms their competitors did not have to face during this period. In short, exemptions for aerospace and defence remain sensible and appropriate; adding another layer of bureaucracy would not add value.

  24.  In summary, the SBAC is concerned that in diluting ECGD's basic mission, it will lose the ability to act as one of Industry's key competitive weapons. The UK tends to be less aggressive in backing the exporter and while rhetoric should not be taken as a sign of effectiveness, our competitors seem more prepared to nail their colours to the mast, witness the stance taken by the Ex-Im chairman quoted in para 9 above.

FINAL OBSERVATIONS

  25.  The major UK aerospace exporters have a global presence and therefore an increasing ability and incentive to manufacture in locations other than the UK. Decisions with regard to manufacturing location for new and indeed existing programmes will be made taking into account the full package of support available in a particular jurisdiction and a competitive, flexible and committed ECA will be a significant consideration.

  26.  It is vital that there is an end to the uncertainty surrounding the future of ECGD. On 17 December 2002 Patricia Hewitt announced that Ministers had finally decided that ECGD should proceed to Trading Fund status and that work was "well under way" between ECGD and HM Treasury to agree the policy and objectives, financial and regulatory frameworks and operational details of a Trading Fund. There is still substantial debate between the parties however and the trial Trading Fund is unlikely to be implemented by the current deadline of April 2004. A date of July 2004 is now rumoured.

  27.  Such a protracted debate has done nothing to help UK exporters and may have already done much harm to customer perceptions of the long-term commitment by the UK to effective export credit support. While we have been repeatedly assured that the Government has no intention of removing export credit support, we still remain concerned that the effects of what we believe to be the current policy would have the same effect.

  28.  The SBAC would still agree with the view that any fundamental change to the status and role of ECGD must only be undertaken in a multilateral context and any changes to ECGD should also be measured against their consequences for the international competitive position of British exporters. ECGD's primary, perhaps sole mission should be to provide competitive support to UK exporting consistent with a prudent and economically viable approach to risk and return.

  29.  The final points in the Select Committee's 1999-2000 report remain as valid today as they were four years ago. The continued support of the UK government and the advantages conferred by the sovereign guarantee were "more important than the exact status of ECGD". Any threat implied as much as explicit, to remove the State guarantee for export insurance would continue to put UK exporters at a "considerable disadvantage". Industry would still endorse unequivocally the view that the ECGD should be assessed on the basis of autonomy, accountability, commercial freedom transparency and competitiveness. Of these, for Industry, the last criterion should be paramount.



99   Aerospace Innovation and Growth Team Report, Volume B, page 6. Back

100   See, for example, National Economic Research Associates (NERA), Estimating the Economic Cost and Benefits of ECGD, January, 2003. Back

101   The Cape Town Convention is the Unidroit Convention relating to harmonising the system of taking, and registering, security interests in commercial aircraft and engines. Back


 
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