CIRR: Analysing its contemporary importance

Minimum fixed interest rates are as old as the OECD Arrangement on officially supported export credits. Then the system was finetuned in 1983 and these fixed rates were called CIRR (commercial interest rate of reference). Some ECAs offer these kind of fixed rates, directly or through other public agencies, while other ECAs do not offer these rates to their exporters. A few ECAs that offered it 10 or 20 years ago stopped, generally for budgetary reasons. Interestingly, the British scheme which was scaled-down in 2005 and closed in 2011 for budgetary reasons, was relaunched in 2014 by UKEF in order to better support exporters. As current fixed rates are very low and most experts expect, and sometimes also hope, for an increase, guardian authorities of the ECAs face an interesting challenge: does the support to exporters justify a scheme which might be costly for the taxpayer?

1. Brief description

CIRR are fixed rates used for export credits and supported by public authorities. The OECD Arrangement defines some rules regarding CIRR. It is now constructed as the sum of Treasury Bonds (with a duration close to the average repayment period of the export credit) plus a margin of 100bp, and if the export credit benefits from an official funding with a fixed rate, the CIRR is the minimum applicable fixed rate.

While commercial loans with fixed rates made available to corporates are usually used with a unique drawing and a rate determined on the date of the drawing, CIRRs are fixed rates which are not offered by the market as they include three options:

• The first option is that the interest rate is determined before the signing of the export credit; it can be fixed on the date of signing of the commercial contract (so the parties are granted a delay of a few months to sign an export credit, without being subject to variations of fixed rates over this period). This option is free.
• The second option is that the rate can be fixed on the date of the commercial offer of the exporter (so a few months ahead of the signing of a possible contract). The price of this option is a surcharge of 20bp on the interest rate if the credit is signed. There is no fee charged if the commercial offer fails or if the export credit is not signed.
• The third option is that the loan is not used at once on the day upon which the rate is determined; it can be used through one or multiple drawings for years after the signing of the export credit, without any previous commitments on the dates of drawings which are only made according to the execution of the underlying commercial contract (and not predefined). This option is free.

Some rules regarding the delays of validity of these options (and renewals) are mentioned in the Arrangement but interpretations differ from one country to the other.

CIRR can be extended through three different channels:

• Some ECAS can act as direct lenders and offer CIRR, using funds usually brought by their Treasury with fixed rates.
• For loans granted under a pure cover scheme, commercial banks can, according to the ECA,

  – Ask for an ad-hoc refinancing to public institutions (such as KfW Ipex in Germany or ExportKreditt in Norway)

  – Use their own funding and enter in an Interest Make-Up (IMU) agreement with a public institution (which will exchange interests calculated with the CIRR against interests calculated on a floating basis). This exists in Belgium, France, Italy, and Spain, for example.

2. Why does it make sense to use CIRR?

There are several reasons why CIRR are used in export finance:

• The need for a fixed rate, linked to:

  – A request of the borrower, especially if it is a Sovereign entity used to borrow only with fixed interest rates

  – The need for a fixed rate to discount a supplier’s credit

• The flexibility of CIRR vs traditional fixed rates during the drawing period, as drawings are only made according the execution of the commercial contract with no financial constraints linked to a financial timetable. The borrower is not exposed to replacements costs which would appear with a loan fully drawn at the beginning, or it does not take the risk of future fixed rates (at the end of the construction period).

In addition, it is often the only way to get an export credit with a fixed rate. Most banks do not offer loans with fixed rates and do not propose either Interest Rate Swaps (IRS) attached to an export credit signed with a floating rate as breakage costs are often not covered by ECAs. In addition, regulatory costs are expensive if the borrower is poorly rated and the IRS has a large duration.

Some borrowers have also realised its financial advantages:

• Two options (delay for the signing of the export credit and drawings during the construction period) are free options and in some cases the choice between the floating rate and the fixed rate has only to be made upon the date of the first drawing. With a unique drawing, the choice might then be delayed for years. If rates are declining, the borrower can renounce to the option at no cost without infringing the Arrangement
• As CIRR are constructed according to the duration of the repayment period, for loans with very long construction periods, some borrowers are asking for very short repayment periods and able to get cheap rates, based on two-year T bonds, for sixyear credits.

Finally, for some ECAs, the recourse to CIRR, with prevailing rates, might also be a way to limit credit risks, if floating rates (and then interests calculated on these basis) were to increase substantially in the next five to ten years.

3. Are there other ways to get fixed rates?

The rules prevailing on capital markets (with bond issuances) also prevent the recourse to flexible solutions, included in the CIRR, unless there is one unique drawing.

Long-term fund providers such as pension funds are looking for long-term investments with fixed rates but today their capacities to manage export credit policies and a calendar with uncertain dates of drawings are limited.

4. Can ECAs afford CIRR ?

Some borrowers are reluctant to use fixed rates as they might be lower a few years later. This was probably more accurate in 1995 when US dollar CIRR rates at 8.5 years were at 8.8% but with prevailing rates (2.33% on 1-9-2016) this risk is probably remote.

More importantly, the CIRR exposes guardian authorities to financial risks and attached costs.

The first risk is linked to the funding of the loan.

• a) if the CIRR loan is funded by the ECA or a public authority through a refinancing, this entity will have to use its financial resources at fixed rates, taking a risk of replacement or a risk of a future increase in fixed rates.
• b) if the CIRR loan is funded by a banks using an IMU, the public entity is taking the risks of increased floating rates in the future.

In both cases, these risks could be covered by appropriate financial instruments which can be paid using the 100bp margin added to T-bonds. This would probably be better done if the durations used as reference for the CIRR rates were aligned on the average durations of the export credits including their drawing period. In addition, CIRR would increase with the inclusion of the drawing period in the average duration.

With an IMU, the public entity is also taking the risk of a widening gap between the CIRR (based on T Bonds) and the index used for floating rates (based on interbanks’ lending). This difference measured by mid-swap rates measures somehow the differences between the creditworthiness of Sovereign entities and banks. We are now coming again to the situation which prevailed 10 years ago and the high spreads registered in 2011 were for the benefit of the CIRR managers.

A second risk is linked to an early repayment of the loan. If it is a voluntary prepayment, the Arrangement mentions the need to ask for breakage costs so the financial risk for the public entity is a remote one. If the early repayment of the loan originates in an event of default, the financial risk created by the CIRR will only appear if the ECA decides to indemnify the bank at once and not according to the original repayment-schedule. In the second case, the risk remains the original credit risk accepted at the inception of the operation, as it would have appeared with a loan with a floating rate. And the choice of an early indemnification remains the choice of the ECA, except if there is a repossession of the financed asset (which might only happen for aircraft and ships). The rules applying to aircraft limits the usage of CIRR. Hence the major risks from a CIRR angle might appear in shipping and do not really exist for other goods. If market solutions are considered, the need for a cover of breakage costs also exits.

A third risk is linked to the options embedded in the CIRR. These options might be very costly and are often offered at no cost.

Some countries do not use all the flexibilities provided by the Arrangement while others do. And some delays, especially in the case of renewals, are not clearly defined, if they are.

Some delays (expressed in months) are often required for the formalisation of export credits and the risk of delays in the drawings will always remain. They can be probably covered by the 100bp margin embedded in the CIRR.

While it is probably difficult to ask an exporter or a bank involved in a bidding process to pay for offering a CIRR, it should be possible to ask borrowers to pay for some options, once a project is awarded, or to commit upon the signing of the export credit on the recourse to the CIRR without waiting for the end of the drawing period.

This might create a need for some clarifications in the Arrangement to prevent competitions among ECAs (or providers) on the extension of the CIRR.

While some countries stopped to offer CIRR for losses incurred through this system, other countries claim for positive results thanks to appropriate financial covers.

Conclusion

The possibility of offering export credits with CIRR rates is a good tool to support exportation contracts as it allows to combine the need for fixed rates and the need for some flexibility which does not exist on financial markets. Alternatives through markets do not really exist for the time being. The financial costs linked to their management can be probably covered in most cases when loans are drawn; they require adapted cover policies of interest rates.

The recourse to the appropriate durations (including drawing periods) used as references for the establishment of CIRR rates and the billing of some options (such as the possibility to wait for the end of the drawing period to make a decision on the recourse to the CIRR) used by clever borrowers are tools which might limit some financial risks assumed by public entities. And some clarifications in the OECD Arrangement might be required to prevent unnecessary competition.

Henri d'Ambrières

HDA Conseil