Practice supervisor, Partner
Today, over 80 % of foreign trade transactions in the world are executed through trade financing mechanisms. However, the banking sector is still unable to reach unanimity on the question, what is trade financing. And that, in particular, was confirmed at the conference “Real problems of trade financing” held in September 2012, organized by the Russian National Committee of the International Chamber of Commerce - the World Business Organization (ICC Russia).
The trade financing is most commonly defined as a set of financing tools, methods and mechanisms of foreign trade transactions through local banks using the resources from the international financial markets.
In this article, we shall describe about one of the tools of trade financing – Associated financing under the cover of Export Credit Agency (ECA), which is the funding provided by a foreign bank to implement a pre-determined foreign economic contract under the guarantee of agency (Presence of a signed contract is a prerequisite for lending).
So, what is ECA? And how does the mechanism of associated financing function?
ECA is a public tool to promote national exports, aimed at stimulating employment and supporting the strategic sectors of the country, as well as a tool to strengthen the position of national economies in foreign markets.
A little history
The first agency was created in 1919 in the UK (ECGD), and presently ECA is already operating in many countries, such as: EGAP (Czech Republic), Hermes (Germany), CESCE (Spain), COFACE (France) , MEHIB (Hungary), KUKE (Poland), US Ex-Im Bank (USA), SACE (Italy), EXIAR (Export Insurance Agency of Russia) (Russia), etc.
Legal regulations of the ECA in different countries have both common features, as well as their national peculiarities. National peculiarities are regulated through a national legislation of the country, where the ECA has been established. The general features are determined by international agreements of the OECD, the European Union and the Berne Union.
The first attempt to unify the rules of export credits was the creation of the Berne Union (the official name of the "International Union of Credit and Investment Insurers") in 1934, which is an informal association of insurance companies and organizations (including governmental) involved in export credit insurance and investment. To date, the Union brings together some 50 organizations from 41 countries. The Objective of the Union - the application of agreed credit terms of international trade and long-term export credit insurance, the exchange of experience and information on major economic trends, patterns of export credit insurance, administrative changes, borrowers etc.
In 1978, 22 countries - members of the OECD have signed the International Agreement on Export Credits, also called the Consensus. Parties to the agreement are: the EU, Australia, Canada, USA, Japan, New Zealand, Norway, South Korea, and Switzerland. Key aspects, defined by the Consensus on export credits are: the minimum advance payment, the financing of local costs, the maximum loan term, repayment terms, the commercial interest reference rates (CIRR), the minimum size of bonus, including in case of political risk insurance, the project financing, related assistance and the country risk classification (7 categories in all).
Essence of the associated financing model under the cover of the ECA
The essence of the model can be briefly presented through an example, a recent project YUYDI, under which we raised associated financing of the Czech Bank through the Russian Agricultural Bank in the amount of EUR 186 million under the insurance coverage of the Czech Export Credit Agency (EGAP). As part of the project, we had to procure, the Czech and European equipment and services. Funds for their procurement were released by the Czech bank (the so-called - "Financing bank") through the Russian Agricultural Bank JSC under the insurance coverage of the Czech Export Credit Agency.
Features of the associated financing model
The credit agreement is concluded between a Russian borrower and a Russian bank*, which, in turn, has entered into a loan agreement with the financing bank.
*The Russian bank must meet certain formal requirements including such as - a good credit rating, the scope of credit limits opened by foreign banks, etc.
The amount of credit provided by the Czech bank to the Russian bank may not be more than 85% of the contract value, which is financed through a loan.
The collateral for the loan contract, concluded between two banks is the insurance of Czech ECA **;
**Provision of export credits is directly related not only to commercial, but also to political risks. The ECA cover both types of risks.
Benefits of the associated financing to the borrower
Of course, the main advantages of the model include lesser interest rate than the "traditional" loans from the Russian banks for the Russian borrowers - the rate of LIBOR / EURIBOR + 1 to 2% (margin of the "financing bank") + 3 to 4% (margin of the Russian Bank), which constitutes the final rate of 6 to 8% per annum (compared to 13 to 16% per annum in the "traditional" loans).
This also possesses the ability to attract "long-term money". In some cases, the financing terms are up to 10 years and above.
And of course, there is access to international financial markets, increase in the credit rating of the borrower.
And the attraction of trade financing in the agricultural sector projects - also there exists the possibility of subsidizing the entire interest rate on the loan.
Financing under the above model is possible not only for supply of equipment, but also for construction and installation, commissioning, and many other types of work (of course, subject to all the requirements of the ECA). Accordingly, we are talking about the tools of financing investment projects, not just deliveries. It is for the financing of the investment project and the funds were mobilized from the Czech bank in the example above.
Trade financing is growing in popularity year after year. According to the Berne Union (www.berneunion.org), the volume of export credits and foreign direct investments, insured by the members of the Union in 2011, has grown by 17%. As a result, transactions were insured for a record amount of $ 1.8 trillion in the history of the union, which is more than 10% of all international trade.