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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