Trade Finance in Africa

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Trade Finance in Africa: Understanding Political & Commercial Risk

and the Role of Credit Insurance

Diana Smallridge, PresidentInternational Financial Consulting Ltd.

March 15th, 2006Nairobi, Kenya

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Outline1. Trade Finance & Risk

Risks associated with TF Political Risk Bank Risk Commercial Risk

2. Export Credit AgenciesThe roleThe business models

3. Trade Credit InsuranceExport creditTrade credit insurance

4. Financial Requirements throughout the Export ChainExport Credit Facilities Facilities for ExportersFacilities for Banks How the facilities can work

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Trade Finance and Risk

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Trade-Related Risk

Importer(Buyer/Applicant)

Exporter(Seller/Beneficiary)

Advising Bank (Confirming Bank)

Issuing Bank

Political/Country Risk

Bank Risk

Commercial Risk

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Political/Country Risk

Risk associated with the countries involved in the transaction, most commonly the importers’ & exporters’countries of residencethe inability of the buyer to transfer foreign currency; or actions by the government of the buying country to prevent import or payment or to the destruction of the goods etc.the imposition of export licensing or import licensing in either the buying or importing country.

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Bank Risk

Banks may assess their interest in a transaction based upon the stature of their counterpart institution in the other marketConfirmations under L/C’s are provided based on assessment of Bank Risk (and Country Risk) by the Confirming institutionFinancial standing, trade expertise, nature of Correspondent relationship are all factors. Probability of default on payment obligation also considered

Advising Bank (Confirming Bank)

Issuing Bank

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Commercial Risk



Risk associated with non-payment or non-performance by buyer or sellerthe cancellation of an order; the deterioration of the financial position of the buyer or his country so as to make it imprudent for the exporter to ship

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A Philosophy of Risk

Risk can be avoided, minimized, mitigated, optimized, or accepted fatalistically Avoiding risk equates to foregoing businessMinimizing risk generates modest returnsMitigating risk suggests measured, conservative approachFull acceptance of risk is not a viable option in trade

We advocate a view based upon Risk Optimization…

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A Working Definition of Risk

Optimization – informed, expert assessment of risk/reward, including risk profile Seeks to achieve a commensurate returnRisk as a reality and a cost of doing business, perceptions are criticalTrade Finance tools & techniques exist to help strike the desired risk/cost/reward balance

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Understanding Risk

O/R: Optimized Risk

MitigationCost

RiskLevel

$

Low Medium High

O/ROptimized with reference to:

Risk Tolerance

Expected/Target Return

Acceptable Mitigation Costs

Understanding risk means the ability to act effectively in the face of risk

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Risk Mitigation/OptimizationPolitical Risk Bank Risk Commercial Risk

Political Risk Insurance (ECA or private sector)L/C ConfirmationIFI/DFI Guarantee

L/C Confirmation Credit InsuranceStandby Credit or Guarantee

Education & Information

Transaction-Level Mitigation

1.

2.

Information about a market, institution or company can mitigate perceived risk.

Payment Timing3.

Payment at “Sight”, discounting of term items without recourse can assist in risk mitigation

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Role of an Export Credit Agency

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The Role of an ECA

• All OECD and most developing countries have ECAs.• There is no single model for an ECAs; they come in

different shapes and sizes.• ECAs support and encourage exports and outward

investment• ECAs provide credit and political risk insurance,

guarantees, and sometimes, direct finance.• Most ECAs do not lend directly to exporters• The basic common function of an ECA is to take (or

provide cover for) political and commercial risks of foreign buyers/borrowers.

Export Credit Agencies (ECAs) play an important role in international trade and investment flows.

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ECA Business Models

While the mandates and roles of all ECAs are broadly similar, there is no such thing as a “typical” ECA.

ECA business models, status, objectives, institutional arrangements, and government involvement vary widely from country to country.

These differences reflect unique national circumstances

and histories.

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ECA Business Models

There is no single, perfect model for an ECAVariety of forms, structures, products, delivery mechanisms existEach must be tailored to individual national or regional circumstances

Some ECAs underwrite business on their own account as well as the government’s. Some do only short-term (ST) business; some only medium/long-term (MLT), and some do both. Some only insure or issue guarantees. Some only lend, and some do both. Some are called insurers and some export/import banks.Some only insure exports, while another institution insures investments.

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Main ECA Business ModelsModel Description Countries Private Company acting as an Agent

• Government has an exclusive arrangement with a private company that issues policies as agent for the Government.

• Separate department of the government operating under the authority of a government minister, secretary etc.

• Autonomous institution owned by the government (or governments if regional)

• Government is only involved in the risk taking and decision-making. No underwriting expertise or “bricks and mortar” institution exists

• Government will not underwrite ST business directly, but will provide reinsurance to insurers

FranceNetherlands

Germany

Government department/facility

UKSwitzerland

State-owned Agency

Canada, US,Turkey,

Africa

Virtual ECA New Zealand

Government Provider of Reinsurance

UKAustralia*

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What is Export Credit?Risk is inevitably associated with international trade transactions, arising regardless of whether or not goods are sold on credit.As soon as an exporter or seller begins to produce goods or services to sell to someone else, there is the risk that:

they may be unable to ship the goods or deliver the services orif they can do so, they may not be paid.

These issues are particularly acute for Small and Medium Enterprises (SMEs), for whom access to finance is crucial.

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What is Credit Insurance? Credit insurance protects the insured party (normally the seller/exporter), in exchange for a premium, against a range of risks that result in nonpayment by the buyer.

It is also called accounts receivable insurance.

In export credit cover, both commercial and political risks are normally involved.

Normally, pre-credit and post-credit periods are covered.

The traditional product is an umbrella policy (or whole turnover policy) covering an agreed part of exports of insured party. Single transaction cover is less often offered by insurers due to adverse selection.

19Financial Requirements of Exporters throughout the Export Chain

Exporters have different financial requirements throughout the export chain.

Local Currency

Loan:

Short term –under 6 months

Phase 4

Buyer receives goods

Export Chain

Phase 1

Exporter purchases imported equipment/machinery

Phase 2A

Exporter purchases raw materials from domestic suppliers

Phase 3

Exporter packages and ships product

Phase 2B

Exporter produces goods for export

Foreign Currency

Term Loan:

6 months to 5 years

Working Capital Loan

-- Receivables Finance

Exporter’s Financial Requirements:

PrePre--ProductionProduction ProductionProduction Credit PeriodCredit Period

Phase 5

Buyer makes payment

PaymentPayment

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Export Credit Facilities

Phase 4

Buyer receives goods

Export Chain

Phase 1

Exporter purchases imported equipment/machinery

Phase 2A

Exporter purchases raw materials from domestic suppliers

Phase 3

Exporter packages and ships product

Phase 2B

Exporter produces goods for export

PrePre--ProductionProduction ProductionProduction Credit PeriodCredit Period

Phase 5

Buyer makes payment

PaymentPayment

Domestic Credit

InsuranceExport

Performance Guarantee

(Import Duty)

Export Credit Insurance: pre- and post-credit risks

For Banks:

For Exporters / Suppliers:

Pre-Shipment Working Capital

Guarantee

Export Finance Post-

Shipment Guarantee

ECA Facilities:

ECAs can play a significant and important role throughout the export chain providing facilities to both exporters and banks.

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Facilities for Exporters

1. Credit InsuranceInsurance against a range of risks that result in non-payment by the buyerProtecting the insured party in exchange for a premiumTypically a framework or umbrella policy which will embrace all or an agreed part of the exports of the insured party over an agreed period (normally one year)

There are two basic mechanisms that are useful for both SME and larger companies:

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Facilities for Banks

ECAs normally are not directly involved in providing working capital ECA credit insurance policies can sometimes be used as security by exporters to obtain working capital from their banksWorking capital facilities can also be issued direct to banks and other financial institutions that are providing working capital loans Normally, the provision of working capital to exporters or working capital facilities to financing banks would be done in respect of a specific export transaction

2. Working Capital Guarantees

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23How Export Credit Facilities can Work

The range of export credit facilities offered by a typical ECA provide many advantages to SMEs and other exporters:

Risk mitigation;Increased sales through more competitive payment terms; Management of foreign receivables;Access to buyer information and buyer country information of all kinds.

Different buyers/sellers, and different market conditions call for a range of international trade transactions with associated facilities.

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International Trade Transactions

A Simple International Trade Transaction

1. Receive export order

2. Goods & services shipped

3. Payment received from importer

Goods & Services

Money

Exporter

Exporting Country Importing Country

Importer1

2

3

3

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Goods & Services

Money

Exporter


Importer

Bank BankMoney Money

A Trade Transaction with Payment Through Banks

41. Receive Export Order

2. Goods & services shipped

3. Payment received by foreign bank

4. Payment received by domestic bank / exporter

1

2

3

3

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Goods & Services

Money

Exporter


Importer

Bank A Bank B

Money MoneyFulfillment of Conditions

Title and other documents

Letter of Credit

Documents

A Letter of Credit Transaction4

5

6

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2. Bank B opens Letter of Credit

3. L/C is passed to Bank A

4. Exporter produces / ships goods and services – and otherwise fulfills L/C conditions.

1

2

3

5. Exporter submits documentation to Bank A, who in turn sends documentation to Bank B

6. Bank B remits funds to Bank A, who in turn pays the exporter

7. Importer remits funds to Bank B

3

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Export Credit Insurance

Money

Goods & ServicesExporter


Importer

Export Credit Agency

Insurance

Premium

4

5

6


2. Exporter submits application to ECA

3. ECA calls for / receives status report on buyer / importer from ECA alliance

1

2

3

4. ECA provides insurance to exporter in exchange for premium

5. Exporter produces / ships goods & services

6. Exporter receives payment from importer

3

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Domestic Credit Insurance

Sub-Supplier

Exporting Country

Exporter

Export Credit Agency

Insurance

Premium

Goods & Services

Money

4

5

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2. Domestic sub-supplier receives order from exporter

3. ECA provides insurance to sub-supplier in exchange for premium

4. Sub-supplier produces/ delivers goods to exporter

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3

5. Exporter produces/ships goods to importer


7. Sub-supplier receives payment from exporter

3

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Goods & Services

Money

Exporter


Importer

Export Credit

Agency

Insurance

Premium

Bank

MoneyRepay-ments

Export Credit Insurance with Assignment to a Bank

4

5 6

2

3

1


2. Exporter submits application to ECA

3. ECA calls for / receives status report on buyer / importer from ECA alliance

4. ECA assigns policy to bank

5. Bank provides credit to exporter with insurance policy as collateral

6. Exporter produces / ships goods & services

7. Exporter receives payment from importer and repays bank

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3

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Direct Bank Purchase of Export Credit Insurance


2. Bank B opens Letter of Credit, L/C passed to Bank A

3. ECA provides insurance to Bank A in exchange for premium

4. Exporter produces / ships goods and services – and otherwise fulfills L/C conditions.

5. Exporter submits documentation to Bank A, who in turn sends documentation to Bank B

6. Bank B remits funds to Bank A, who in turn pays the exporter

7. Importer remits funds to Bank B

Exporter


Importer

Export Credit

AgencyInsurance

PremiumBank A

Money

Bank B

Money

Title and other documents

Goods & Services

Money

Letter of Credit

Documents

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6

7

1

2

3

3

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Exporter


Importer

Export Credit

AgencyGuarantee

Premium Bank

Money

Goods & Services

Money

Working Capital Guarantee4

5


2. Exporter applies for working capital loan from Bank

3. As condition for providing working capital, bank requires (and arranges) guarantee from ECA

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4. Exporter produces / ships goods to importer


6. Exporter repays bank

3

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Short-Term Credit Insurance

In practice, most ST business is less than 180 daysTraditional mainstay of export credit insurance Normally, both political and commercial risks are coveredIn this area, private sector activity has been very significant

Private-sector activities have grown substantially and there is significant private reinsurance capacityPrivatization and consolidation have given rise to three large global insurers with extensive alliances (e.g., Euler-Hermes, Coface, Atradius)Large global players have massive databases of buyer information

The product has expanded beyond the traditional credit insurance (i.e. risk transfer) to include risk assessment, underwriting decision and credit information

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Working Capital

Working capital loans are normally not provided directly by the ECA, but the exporter can obtain working capital from its bank by using the credit insurance policy as security

Where the bank sector has difficulty assessing or taking the direct risk of the exporter, the ECA can provide a working capital guarantee

In some cases. ECAs will provide loans directly to the exporters for working capital with or without bank guarantees

In OECD countries, traditionally ECAs have not been actively involved in this segment. The support is generally directed at SMEs which often have limited access to financing

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Bonding and Letters of Guarantee

Normally, the ECA provides cover to a bank that issues a bond or letter of guarantee to a buyer on behalf of an exporter. A wrongful call on the bond results in a claim against the ECA.

Bonds can be advance, bid/tender, performance, warranty

ECAs do not normally issue bonds direct.

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Parties to a Trade Transaction

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Overseas Bank(s)Domestic Bank

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Use of Insurance/Risk Mitigants



Overseas Bank(s)Domestic Bank

ECA insurance: Open account

ECA insurance: Letter of Credit

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Parties to a Transaction: Underwriters

Risk Mitigation/Optimization is a critical value-add of Trade FinanceProvided by banks to a limited degree, especially in Developing/Emerging MarketsExport Credit Agencies & Risk Insurers frequently work with Banks on trade transactionsPrivate insurers (COFACE, Atradius, Euler, AIG & others) are increasingly active in underwriting trade risk

Trade Finance in Africa

Documents

Transcript of Trade Finance in Africa