Saturday, April 26, 2014

Berne Union Yearbook 2013 – How to finance trade when banks lack liquidity.

The Berne Union federates the major export credit agencies. It has recently published its yearbook 2013 that describes what happened in the industry in the past year. Here are the main points:

Commemorative Logo for the 80th Anniversary

Banks lack liquidity.

In 2013, banks had difficulties financing trade. This was especially true for long-term, USD, and investment projects.

How did ECAs react? They developed (more or less) direct lending programs:

  • They encouraged investors to refinance trade finance banks through securitization guarantee schemes. The major example is Euler Hermes' securitization guarantee scheme.
  • ECAs provided loans directly to exporters.
  • Many ECAs put working capital covers in place.
  • The European Commission installed a regime for short-term trade credit insurance under the premise that private insurance coverage is insufficient.

Naturally, ECAs only intervene to fill the gaps of commercial markets, not to displace private market appetite.

Basel III compromises trade finance.

In 2013, the Basel Committee continued discussing new bank capital requirements. The leverage ratio (a minimum of capital that banks must hold, as compared to their total exposure) created particularly strong reactions in the trade finance community.

The basic idea of the leverage ratio is to set absolute minimum standards, i.e. exposure = exposure, irrespective of the risk involved. As trade finance involves low risk (and low margin), the community didn't like the new leverage ratio. It argued (and, in the end, succeeded), that banks would lend less to the real economy (trade finance = real economy!), as a consequence of the leverage ratio.

Both commercial risk and political risk are omnipresent.

The yearbook points out that political risk often realizes as a surprise, despite improving statistical analysis tools. However, the Berne Union writes that countries with authoritarian or totalitarian regimes tend to be particularly vulnerable.

In terms of country risk, this is not only linked to the sovereign's solvency but, more and more, to its technical capacity to pay. Moreover, country risk and obligor risk often overlap, especially when quasi-sovereign entities such as Dubai World or systemically important banks are involved.

ECAs brave frontier markets.

Which countries were particularly relevant in 2013 or will become important for ECAs?

  • The Berne Union sticks to so-called frontier markets such as Vietnam, Gabon, Ghana, Nigeria, Kenya, Tanzania, Congo, Mongolia, and Zambia.
  • With the rise of inter-Asian trade, ECAs expect the continent becoming more important in the near future.
  • Due to its strong growth, Latin America is considered a promising market for export and investment insurance in the next decade. Top markets today are Brazil, Bermuda (cruise ship registration), Mexico, Panama, and Argentina.

(More or less) meaningful quotes and buzzwords

The annual report is a marketing document and, as such, contains many nice business language. Some make me think, others simply make me laugh. Please judge yourself:

“Credit and investment insurers stand by their customers in difficult times, and grow with their customers in more prosperous times.”

“Both commercial risk and political risk are omnipresent.”

“The world of plentiful liquidity, low borrowing spreads, and high risk appetite that we experienced until 2007 will not come back any time soon.”

“Some risk management models may be too complicated: By reducing complexity, accuracy may improve. Risk management in the export credit business is relatively easy: It is a business with large and concentrated exposures. Monitoring requires simple tools.”

“Notwithstanding the benefits of improving technology and risk management techniques and software, political risk will always remain difficult to predict.”

“Good underwriting is more an art than a science.”

“In general when analyzing risks in developed countries we tend to emphasize the credit risk of the buyer or the borrower and not consider sufficiently the functioning of the banking sector or foreign exchange market and other political risks related to the host country.”

“If we [export credit agencies] cannot get in the space and really understand the evolving needs for proper capital relief within banks' trade, export, and project finance teams, we [export credit agencies] will lose our relevance at the end of the day.”

“US Exim has sought to systematize its ability to understand and evaluate customer needs by establishing a new functional area within the bank focused exclusively on customer experience. This function is providing a mechanism for US Exim to comprehensively assess the needs of its bank partners (and other customers) and evaluate program, product or progress changes to better serve their needs and ultimately to maximize the volume of support provided to exporters.”

“We understand that holding long-term, ECA-backed assets may become less attractive to banks, but the asset is a good fit for the capital [bond] market.”

“ECAs play an important role in letting products and services compete on a global market.”

“Awareness of credit insurance is still below the optimum level in Asia.”

“The atmosphere [among Prague Club members] is very informal and there is a free exchange of information. The members are not in competition with each other, so there is much room for sharing and helping each other.”

“The third round of the Basel accords will continue to limit the ability of banks to provide trade finance to benefit importers and exporters.”

“Insurance companies are slowly starting to use their liquidity to invest in trade finance instruments as a new area of business.”