This is my third time in Dubai and each time I marvel at the explosive building and development that has taken place – a great deal of which has been financed through some form of trade finance.
This is not the audience to talk about the fundamentals of trade finance. In Dubai you don’t build an airport, in fact the world’s busiest airport, without trade finance, you don’t create a metro system without trade finance, you don’t build the facilities to attract tourism without trade finance. And the list goes on.
Some form of trade finance has been around since the beginning of time starting with cash in advance – this has to be the exporter’s favorite choice but it is rarely available. As economies developed, so did the demand for more structured terms and the letter of credit was created which gave comfort to the exporter that he will be paid by replacing the credit of the buyer with the credit of a bank and gave comfort to the buyer that goods were on their way.
So while the short term risks tended to be covered, demand for term financing began to grow bringing with it a broader range of risks that had to be addressed ranging from an assessment of country condition over an extended period of time to FX risks along with the risks of any term credit – interest rate risk, performance risk, rule of law, the perfection of liens, the potential changes in economic conditions, etc.
Clearly as the term is extended and the risks increase, there is need for a more sophisticated financing structure with the flexibility to mitigate the issues of more complex transactions.
Enter the export credit agency or ECA.
ECA’s have been playing a critical role in trade finance for many years. In the case of the U.S. Ex-Im Bank, it was founded in 1934, and it is the official export credit agency of the United States Government.
Today most countries have an ECA, and many are members of the Organization for Economic Cooperation and Development or as it is known, the OECD. The OECD members agree to support the pricing, structure and minimum ratings established by the OECD resulting in a level playing field for all participants. In addition, at Ex-Im Bank each country is rated again primarily based on an assessment of both ability to pay and willingness to pay, and fees are adjusted accordingly but not below the OECD minimum. While the system works and has integrity it is noted that none of the BRICs (Brazil, Russia, India and China) are members of the Arrangement, the agreement among the ECA members of the OECD. If a BRIC is proposing non-compliant conditions, member ECA’s can match them even if they are below the OECD minimum.
The role of the ECA is multi-faceted:
- The principle role of an ECA is to support its country’s exports through the issuance of guarantees and insurance;
- In the case of U.S. Ex-Im Bank, their mission is to create and maintain jobs in the US. Each year a report is submitted to Congress regarding jobs and the level of support provided to SME’s.
- Another important role for ECA’s is to fill a void when conditions warrant such as providing direct credit in the midst of a financial crisis. For example during the most recent crisis Ex-Im Bank’s annual commitments rose from $10 billion to $35 billion in 2012. Closer to here, portfolio exposure to the UAE and Saudi over a similar time frame rose from $1.6 and $1.4 billion respectively to $7.3 and $8.1 billion respectfully in 2012;
- Another aspect for members of the OECD is that the ECA’s agree to comply with the OECD’s position on environmental issues as well as special conditions that support an important Sector such as the Aircraft Sector Understanding (ASU)
So what is happening in the trade finance market today? The simple answer is that there is increasing demand. Here are a couple of points to consider:
- According to the IMF, for the first time ever, the combined GDP of emerging and developing markets has eclipsed the combined measure of advanced economies. In other words, poor countries are declining in number and the developing world is growing in wealth and will be improving their infrastructure. This could have the effect of increasing the demand for trade finance while potentially increasing the cost associated with trade finance;
- In addition to global economies improving, to the extent that US Ex-Im Bank reflects the market, there has been a shift in the funding of exports. In the years leading up to the ’08 Crisis, 93% of the Ex-Im Bank guaranteed transactions were funded by banks. Today it is closer to 25% resulting in a financing gap. This is giving rise to non-bank finance companies, like ExWorks, participating to a greater extent in the trade finance market.
There are several additional factors contributing to this shift including:
- One is Basel III. Basel III established criteria to support the soundness of the global banking system by requiring certain levels of capital and liquidity. This has reduced the appetite of banks to lend generally and to trade finance in particularly because of its complexities and cost;
- Another factor contributing to the shift in financing is that the size of projects is increasing which is stretching the banks’ capacity to finance them. For example, it was not that many years ago when a large project financing was in the $100’s of millions – a billion dollars was a rare exception. Today multi-billion dollar transactions are not uncommon;
So what can be done to avoid gridlock for export finance? Our panel will have some ideas to share but let me leave you with a couple of thoughts:
- ECA’s should identify the markets that they consider high priority and focus their limited resources on those markets; and
- Another suggestion is that exporters and Importers should anticipate financing challenges and consider alternatives early in the process.
Let me share with you steps that Ex-Im Bank has taken in the direction of these strategies:
- Regarding identifying the markets that are considered to be high priority, Ex-Im Bank named nine high priority markets in 2010 and has augmented that list since then through strategic alliances including here in Dubai where an MOU of $5 Billion was signed last April.
- With regard to developing alternative sources of funding, Ex-Im Bank has identified capital markets to be at least one of those alternatives. Capital markets provide a deeper funding source than the banks at competitive pricing, and capital markets transactions are not subject to Basil 3. Ex-Im Bank has successfully brought transactions to the capital markets, the first one being $400 million for Emirates Air.
- Finally, you are all encouraged to be open to new entries in the trade finance space such as ExWorks that not only have resources to fund transactions but are bringing new products and ideas to the market place such as securitization alternatives and solutions that may include unique structures such as a trading company or some other vehicle.
With that small advertisement, I thank you for your attention and time and I turn the floor over to Alan Beard