The Project Finance Law Review: Export Credit Agencies and Insurers
I EXPORT CREDIT AGENCIES – GENERAL
Export credit agencies (ECAs) are national government-owned or affiliated entities that support exports of goods and services from their own countries by providing financing to foreign purchasers of those goods and services. The fundamental purpose of ECAs is to increase the volume of exports from domestic producers of goods and services by opening up overseas markets for such products through the provision of financing and other financial risk-reducing products. ECA-supported goods and services range from large capital goods, such as aircraft, satellites or locomotives, to finished industrial products, such as solar panels, wind turbines, pumps and engines, to 'soft' exports, such as legal, engineering, technical and other services. In a nutshell, ECAs support the expansion of foreign trade by their national exporters and service providers. In doing so, of course, they also support domestic employment.
ECAs have a long history that is intertwined with the expansion of economies and government policies to promote national exports. The first official ECA, the English Credit Guarantee Department, was established in the United Kingdom in 1919. The predecessor to the present German ECA was established in 1917 and US Ex-Im Bank was established in 1934. Many ECAs were established in the post-war period, such as in Austria in 1946 and Japan in 1951, and others in the period from 1970 to 2000, including Iran in 1973, Korea in 1976, India in 1983, Egypt in 1992 and China in 1994. More recently, new or smaller countries have established their ECAs, such as Serbia and Sudan in 2005, Estonia in 2009 and Armenia in 2013.
Today, there are almost 80 countries that have established ECAs or some variation of national export support agencies.
II ECA RISK MITIGATION
The principal benefit ECAs generally provide is the mitigation of risk associated with international trade transactions. Cross-border trade in goods and services has always included various risks imposed on buyers and sellers, such as credit risks related to payment for goods, and political risks related to transit and delivery of goods across borders, often at great distances. Ancient Roman traders faced the same fundamental question as modern-day Asian traders: when does the risk associated with a given transaction outweigh its desirability? Further, the entities to whom exporters and traders might turn to assist them – banks and insurers – also might find the associated risks of a given transaction too high. In such a high-risk environment, trade and exports suffer as transactions are deferred or avoided altogether owing to risk concerns.2
ECAs mitigate political and payment risk and thus enhance the ability of market participants to transact – whether they are sellers, buyers or financiers. ECA programmes provide direct finance or guarantees of bank finance, actual political risk insurance or an implicit political risk umbrella owing to their presence in the transaction.
As project finance structures are fundamentally designed around the principles of risk identification, allocation and mitigation, ECAs play a key role in the risk-reduction goals of the participants.
III PRODUCTS AND SERVICES3
Although there are variations in the products offered by ECAs, they typically offer direct loans, loan guarantees and export credit insurance.4
In addition, ECA products can be offered as either a supplier's credit or buyer's credit. In a supplier's credit, the ECA loan or guarantee is made to or benefits the domestic exporter (the supplier of the goods or services) and the supplier is then able to include financing terms to the foreign buyer, assisting their purchase of the supplier's goods or services. In a buyer's credit, the ECA loan or guarantee is made to or benefits the foreign buyer, allowing the buyer to finance its purchase of the domestic exporter's goods or services.
Typical financing periods for ECA products are short-term (less than two years), medium (two to five years) and long-term (over five and usually 12 to 15 years).
IV TYPICAL STRUCTURES
ECA participation in major project financing transactions generally use buyer's credit structures and are on a long-term basis (10 to 15 years). In this way, the project company or borrower established for the project financing transaction can borrow the ECA loan (or borrow from banks guaranteed by the ECA), and can pair the ECA-supported financing with other project debt borrowed by the project company, thereby assembling a complete financing package for the project with long repayment terms, enhancing project and sponsor return. The most commonly used ECA structures in project financing are discussed below.
i ECA direct loan structure
In this structure, the ECA makes a direct loan to the foreign project company to support the purchase by the project company of the exports supplied under the goods and services supply agreement between the project company and the domestic exporters.
ii ECA guaranteed loan structure
This structure is very similar to the previous one, except that the ECA provides a guarantee of loans made by a bank or banks to the project company for its purchase of the exports supplied by the domestic exporters.
V COVERAGE ISSUES
i ECA country content
Given that ECAs have the purpose of supporting their own national exports, generally there are domestic content requirements that must be satisfied for an ECA to provide a loan or guarantee. In project finance, usually the borrower or project company works with the EPC contractors and other suppliers to ensure that domestic content rules are followed. It is often the case that there will be products available from a variety of sources; for example, a Moroccan project company using a German contractor may obtain support from the ECAs of the US, Germany, Italy and Korea if the German contractor sources equipment from manufacturers in each country.
ii Local cost
Project financing always results in certain costs being incurred in the host country. For example, site preparation, concrete and steel installation, and other such activities will require local labour, equipment and supplies. Such project-related costs incurred in the project borrower's country are referred to as 'local costs' and ECAs will often provide credit support for a fixed percentage of the local costs in addition to the national export costs they are financing. This provides project borrowers with an ability to obtain credit from ECAs for a larger portion of the overall project financing needs and assists project economics by wrapping more of the total project debt into the ECA facilities.
iii Coverage percentages and types
'Cover' is the credit exposure percentage of the eligible goods and services that an ECA agrees to provide through its loan or guarantee to the project company borrower. Such percentages range from 80 to 100 per cent depending upon the ECA and the type of ECA programme being employed in the specific transaction. In addition, ECA programmes can offer comprehensive cover (meaning both commercial and political risks are covered), commercial cover (which excludes political risks) or political risk cover (which excludes commercial risks). The optimal goal for most projects is to maximise the comprehensive cover percentage from the ECAs.
ECA pricing generally has multiple components:
- Interest rates – these will vary according to whether the ECA credit is a guarantee of commercial bank debt or a direct loan by the ECA itself and whether the loan is on a fixed or floating-rate basis.
- Commitment fees – expressed as a percentage of the total loan or credit exposure charged to compensate the ECA for reserving or committing its funds or credit exposure to the relevant transaction for the requested tenor of the loan or support.
- Exposure fees – expressed as a percentage assessed on each disbursement of the loan or credit exposure event, which compensates the ECA for the assessed risk associated with the transaction. Exposure fee calculation components will generally include consideration of the host country of the borrower, the nature of the transaction, the tenor of the loan or guarantee and other risk features of the proposed transaction.
In addition, the Organisation for Economic Co-operation and Development (OECD) (discussed below) has established minimum premium benchmarks that act to constrain overall fee rates charged by ECAs, by establishing a floor for such fee rates that can only be derogated from in specified circumstances.
VII OTHER IMPORTANT POLICIES
ECAs typically require adherence to various policies by the project, the contractors and suppliers, and the project company and its shareholders. This requirement reflects the fact that ECAs are government entities and are also subject to significant attention by non-governmental organisations that monitor their compliance with various codes and standards related to aspects of foreign direct investment in emerging markets. These policies can have significant impact on project design, construction and operation, as well as on the business practices of the project company. Policies can vary from ECA to ECA, and therefore project companies may often need to comply with a variety of such policies covering for example:
- anti-bribery, anti-corruption and anti-money laundering;
- environmental, social and corporate responsibility;
- gender equality and empowerment;
- UN and international economic and political sanctions;
- high carbon-intensity projects; and
- military, security and dual-use equipment.
VIII GOVERNING AND COORDINATING INTERNATIONAL ORGANISATIONS
i The OECD
In the same way that producers of goods compete against each other – Airbus versus Boeing or Caterpillar versus Komatsu – ECAs compete against each other to provide favourable credit terms to allow their respective national exporters to secure sales and expand their foreign trade. Because the ECA-supported exports in most project financing arrangements are quite sizeable, the impact of the ECA fee and financing costs can also have a material impact on project economics, and ultimately on sponsor return. The obvious potential downward spiral of increasingly competitive ECA support packages would result in unfair competitive advantage benefitting the national exporters whose ECA was willing to offer the most concessional terms, resulting in a negative impact on buyer (i.e., project company or sponsor) choices. In this way, there is potential scope for countries to use their ECAs to unfairly subsidise their own exports through ECA credit terms (such as offering longer debt tenors, lower interest rates or other concessional terms). The resulting effects would be to skew the market towards all-in price competition (i.e., goods and financing costs) and away from comparative values of the actual goods produced by differing national producers.
To address these concerns and, more generally, to introduce transparency into the ECA market, various countries, including the vast majority of the developed economies whose ECAs have a very large combined market share in ECA-supported project financing, are participants in two international organisations that focus on ECA-related issues: the OECD and the Berne Union.
The OECD was established in Paris in 1961 by 18 European countries, the US and Canada. Today it has a membership of 36 countries, including a number of leading emerging market countries, such as Mexico and Turkey. The stated mission of the OECD is to provide a forum for governments to develop common economic policies on various issues, to establish international standards on various goods, and to be a clearinghouse for reliable data on global and members' trade and investment volumes, GNP, GDP, productivity and other economic metrics.
Since 1978, the OECD has administered the Arrangement on Officially Supported Export Credits,5 which seeks to level the playing field and eliminate (or severely limit) financial subsidies and potential trade distortions. The Arrangement thus sets forth the most generous export credit terms and conditions that may be supported by its participants.6 It is a 'gentlemen's agreement' among its participants who represent most OECD member governments7 and, thus, it is voluntary and not legally enforceable by its members. Ultimately, the purpose of the Arrangement is to maintain a global trade system where exporters compete on the basis of the price and quality of their products rather than the financial terms provided by their ECA, thus eliminating trade distortions and subsidies.
Supplementing the Arrangement are six Sector Understandings that cover export credits in the area of ships, nuclear power plants, civil aircraft, renewable energy, climate change mitigation and adaptation, water projects, rail infrastructure, and coal-fired electricity generation projects. These sectors have special technical, financial and national policy characteristics that warrant different treatment from other exports of goods and services addressed by the arrangement.
In general, the Arrangement and the Sector Understandings are considered by the ECA itself in connection with its consideration of a requested loan or guarantee for a particular project and the establishment of the various financial terms that will apply to its offered financing to the project company or sponsor.
ii The Berne Union
Unlike the OECD, which was formed by national governments and whose members are all states, the Berne Union is an international not-for-profit trade association, representing the global export credit and investment insurance industry.8 The Berne Union9 has 85 members that include 70 ECAs, private credit and political risk insurers, and multilateral institutions that provide differing types of financial and insurance support of cross-border trade.
Berne Union members have significant impact – according to their 2018 statistics, members supported 13 per cent of global cross-border trade under the equivalent of US$2.5 trillion of trade financing and insurance support.10 Of this total, US$193 billion consisted of medium-to-long-term credits from ECAs.
Although the Berne Union is a private trade association and not a regulatory or government organisation, it provides a forum for ECAs and trade insurers to discuss policies and issues that affect their various products. As a result, the Berne Union has an important role in the shaping of ECA policies that are implemented in the support of project finance transactions.
IX POLITICAL RISK INSURERS
Project and infrastructure development and financing transactions face a multitude of risks. Some of these risks can be addressed by due diligence, contract terms or credit support. However, particularly in emerging markets, risks related to political actors or occurrences can be very difficult to mitigate through those conventional approaches. In these cases, both equity investors and debt providers can use political risk guarantees or political risk insurance to wholly or partially mitigate such risks and cover losses arising from those events. In the words of the World Bank's political risk agency, the Multilateral Investment Guarantee Agency (MIGA): 'Political risk insurance (PRI) is a tool for businesses to mitigate and manage risks arising from the adverse actions – or inactions – of governments.'11
Political risk mitigation products are offered by many entities. In general, the market consists of public agencies and private providers. The public providers include multilateral agencies (such as MIGA), many ECAs, and bilateral agencies or development finance institutions (DFIs). These DFIs, such as the US International Development Finance Corporation (DFC),12 are government agencies whose purpose is to promote developmental objectives in emerging markets.
On the private side of the market, major political risk providers include a variety of insurance companies and associations, including AIG, AXA XL, Chubb, Lloyd's of London, Sovereign Rick Insurance Ltd and Zurich Insurance Group.
Although there are many public and private entities providing PRI, in emerging market project finance transactions the most significant providers are MIGA, the ECAs and the DFIs.
ii PRI Form
Typically, ECA political risk products are called political risk guarantees, whereas the products offered by MIGA, DFC, other DFIs and the private market are called political risk insurance. While there are legal distinctions between these two forms of coverage and the associated mechanics for claim and payment, these distinctions are not relevant for this chapter. As a result, the term 'PRI' will be used here to refer to all forms of this coverage, whether guarantee or insurance.
iii PRI risk coverage13
PRI cover can be obtained to address the following types of risks that are of common concern in project finance transactions:
- expropriation: losses arising from actions or inactions of the host government that eliminate, deprive or reduce ownership or control (or both) over project assets or the project investment, including physical assets and shares in the project company;
- currency inconvertibility and transfer restrictions: losses arising from the inability or restriction of conversion of local (host country) currency into foreign currency or on the transfer of foreign exchange outside the host country;
- war and civil disturbance: losses arising from destruction or damage to project assets caused by politically motivated acts of war or civil disturbance in the host country;
- breach of contract: losses arising from a host country's breach or repudiation of a contract with the project; and
- award frustration: losses arising from a host government's non-payment of a binding arbitral or judicial decision.
iv Typical structures
PRI can be obtained by either the equity investors (sponsors) of a project or by the lenders. In general, equity coverage will focus on risks that deprive the investors of their ownership interests, value of the project assets or ability to repatriate dividends or profits (or both). Lenders, who are not project owners and are fundamentally interested in recovery of their debt (principal and interest), will focus on coverage that provides timely repayment of their loans and financial exposure.
In addition, a significant volume of PRI has been taken out to support capital markets issuances (bonds), especially in circumstances where the rating of the bonds would be limited by country risk concerns. In these circumstances, PRI can be used to help bond issuers to 'pierce the sovereign ceiling' and achieve an investment grade rating not otherwise achievable owing to political risk.
v Coverage issues
ECAs that provide PRI generally have coverage requirements and limitations that track those found in their guarantee programmes discussed above. PRI providers that provide insurance products typically have limitations of the following types:
- criteria regarding the eligibility of the investment (specific asset or equity interest) to be insured;
- tenor of policy – most often from one to 20 years;
- percentage of eligible investment that the policy will cover – generally, the policyholder is required to risk-share with the PRI provider by retaining some percentage of the risk of loss (for example, DFC can insure up to 90 per cent of an eligible investment, with the investor retaining a 10 per cent risk share); and
- specific claims procedures requiring submission of documentation in specified time frames, exclusions to cover and, as a condition of payment, transfer or subrogation (or both) to the insurer of the insured's covered investment.
PRI is priced on a premium basis, with premium calculations dependent on factors specific to the relevant investment, including country, sector, transaction type, nature of covered risks and coverage tenor.
vii Governing and coordinating international organisations
ECAs that provide PRI are subject to the OECD Arrangement's terms, discussed above. Moreover, also as discussed above, the Berne Union plays a prominent role in the dialogue among public and private PRI providers, and has more than 80 members actively supporting international trade and investment transactions, many of which are PRI providers. According to its recent statistics, in the first half of 2018, Berne Union members paid US$2.65 billion of total claims, with 53 per cent of such claims relating to medium or long-term export transactions for capital goods and infrastructure.14