Friday, January 25, 2013

The OECD Arrangement on officially supported Export Credits – Cause and Consequence of Export Growth

Since 1964, the size of world merchandise exports has been multiplied almost 114 times. Recently, exports have dropped, in 2009, by 23 %, due to the global financial crisis. However, this drop has been canceled immediately by significant export increases in the 20 % range in 2010 and 2011.

In this context, public export support schemes can be seen as both consequence and cause of global export growth.

In 1978, the OECD has adopted its first Arrangement on officially supported Export Credits. This gentlemen's agreement has been updated numerous times since then, most recently on January 11, 2013. The basic idea of the arrangement is to foster a level playing field for official export support and to ensure that exporters compete on quality and price rather than on the best financing scheme.

Scope of application

On the merits, the arrangement applies to export credit support and tied aid.

Export credit support can take the form of

  • a guarantee;
  • an insurance;
  • a direct financing;
  • a refinancing;
  • an interest rate support.

Tied aid touches upon government support to countries, sectors, or projects with little or no access to financial markets. However, it excludes non-governmental aid programs.

Export credit support and tied aid for military equipment and agricultural commodities are also out of the arrangement’s scope.

Currently, Australia, Canada, the European Union, Japan, Korea, New Zealand, Norway, Switzerland, and the United States participate in the OECD arrangement.

Export credit support

The OECD export credit support framework comprises the following:

  • Down payment
    The purchaser is bound to pay 15 % of the contract value prior to the export credit support. However, the contract value does not necessarily include the premium paid for the export credit, which might be financed or insured at 100 %.

  • Export credit cap
    As a general rule, export credit support is only allowed up to 85 % of the contract value, thereby excluding the above described 15 % down payment. Exceptionally, credit insurance and guarantee schemes can cover such down payment, but only regarding pre-credit risks.

  • Local costs
    Official support for local costs can be granted, but only if it doesn’t outstrip 30 % of the export contract value.

  • Repayment Terms
    The arrangement sets a cap for the repayment terms: Depending on the importing country’s gross national income, the cap is either 8.5 years (for high income countries) or 10 years (for low income countries). In addition, repayment terms usually comprise equal installments at least every 6 months.

  • Commercial Interest Reference Rate (CIRR) / Minimum Premium Rate (MPR)
    Interest refers to annual or semi-annual bank charges paid throughout the repayment period. This does not include insurance / guarantee premiums, fees and commissions, and withholding tax imposed by the importing country.
    According to the OECD arrangement, interest must be charged at least at the sum of CIRR and MPR. CIRR compensates for market risk and MPR for credit risk.

Interest rate calculation

The interest rate calculation can be summarized as follows:

CIRR calculation

Depending on the maturity of the export credit support, the CIRR base rate is

  • either the 3 year government bond yield in case of maturities up to 5 years
  • or the 5 year government bond yield in case of maturities beyond 5 years.

MPR calculation

MPR calculation is a rather complex task. Its main parameters are country risk, time at risk, buyer risk, political risk, and commercial risk.

The above outlined calculation steps are summarized hereinafter:

  • The country risk is classified along a scale from 0 (lowest risk) to 7 (highest risk) and depends on the likelihood of the country to serve its external debt. The classification is based on a quantitative assessment (payment experience, financial and economic situation) as well as a qualitative assessment (political and other risk factors).

  • Depending on the country risk classification, Annex VI of the OECD arrangement sets country risk coefficient and country risk constant.

  • The same is true for the buyer risk coefficient, which, in addition, depends on the buyer risk classification.

  • The buyer risk classification is a function of the buyer's senior unsecured credit rating and varies from CC5 (worst) to SOV+ (best).

  • The horizon of risk depends on the disbursement and repayment period of the export credit. Its calculation depends on the repayment profile and is specified in Annex VI of the OECD Arrangement.

  • The local currency factor is between 0 and 0.2 and can be increased by using offshore escrow accounts or local currency financing.

  • The credit enhancement factor is between 0 and 0.35 and can be increased by assigning receivables, providing securities over assets, or using escrow accounts.

  • The product quality factor relates to the quality of the export credit, not the underlying good or service. The OECD Arrangement distinguishes below standard products (= The insurance does not cover interest for the period between the due date for the obligor’s payment and the due date for the insurer’s reimbursement or only covers this period in return for a premium surcharge.), standard products (= The insurance covers the above described period without premium surcharge.), and above standard products (= Export credit is granted in form of guarantees). The product quality factor then is as function of the country risk classification (see Annex VI of the OECD Arrangement).

  • The cover percentage factor depends on three variables, e.g. cover percentage of buyer risk, the cover percentage of country risk, and the country risk classification. Details are described in Annex VI of the OECD Arrangement.

  • If the buyer is classified SOV+, the better than sovereign factor is 0.9. Otherwise, this factor is 1.

Tied aid

Under the OECD arrangement, tied aid must respond to three imperatives – country eligibility, project eligibility, and minimum concessionality level.

Sector Understandings

Sector understandings govern 5 sectors:

  • Ships (Annex I)
  • Nuclear Power Plants (Annex II)
  • Civil Aircraft (Annex III)
  • Renewable Energies and Water Projects (Annex IV)
  • Project Finance (Annex X)

In their respective sector, they complement the OECD Arrangement and, thus, provide for details or amendments to the above described general regulations on export credits and tied aid.