Export finance – looking back at some of the best crystal ball gazers in the business
Back in 2014 TXF hosted an export finance filmed webinar with participants assessing both the state of the industry then and how it might be in 2019. Jonathan Bell examines what was said about the industry then and how the predictions stack up in today’s landscape.
One of the most difficult things to do is crystal ball gazing. But journalists will inevitably push for this – whether in a written interview or on a conference stage – by putting industry practitioners on the spot. Sometimes it’s cruel I know, but we take our hats off to those prepared to make a good thrust at this with considered forecasts.
So, back in September 2014 in one of TXF’s first filmed webinars in its new London offices I held court with four export finance practitioners on some of the key issues impacting the market back then and what the future of the export credit sector might look like in 2019. The title of the webinar was ‘Export Finance in 2019 and beyond’. Five years on it seems reasonable to revisit what was said then and how it matches up with the export finance landscape today.
Sitting with me that day was David Godfrey, the then chief executive officer of UK Export Finance; Simon Sayer, managing director and head of structured export finance, EMEA, at Deutsche Bank; Alex Taylor, managing director, head of export and agency finance, EMEA at Citi; and, Kai Preugschat, then the secretary general of the Berne Union. Hats off to these fine gentlemen for agreeing to be part of our crystal ball gazing exercise.
To see exactly what was said, do have a look at the 75 minute webinar video on YouTube.
And in the true spirit of the export finance sector, one of the participants at the outset had this to say: “The really exciting part of our of our debate is what's the business going to look like in five years time, and for a very mature business it's actually been incredibly dynamic over the last few years and there's every prospect of that continuing to be the case with continued change.”
But five years in the world of trade can be a lifetime and much can happen to throw even the most considered predictions out the window. For instance, who could have predicted then that US Ex-Im would have had its hands tied for virtually five years, or that the Russia market would be strangled by sanctions, or that we would be in one of the most damaging global trade wars that we have seen in generations.
The 2014 webinar discussion was limited to some of the key issues influencing the market then, and into the future, including: the impact of Basel 3 on export finance pricing and provision; the role for the capital markets; innovations within export finance; export finance as a product for category zero borrowers; how to improve the export finance experience for end-users; and, the crisis in Russia, the global shortfall in large projects, and the pipeline for ECA deals. A few examples are lightly fleshed out below.
Basel 3 - export finance pricing and provision: The initial punt was to ask the bankers if Basel 3 was being priced into export finance transactions already or is it something that's yet to come. Simon had this to say: “No it's not in the pricing at the current time. But 2015 will be a watershed year as institutions adopt the different leverage capital liquidity ratios. So next year will be the year when pricing does start to edge up.”
Alex largely concurred with this, adding: “From a capital perspective I think banks are taking into account Basel 3 and actually going out and securitising some of the deals in order to raise money. The part that we haven't seen evidence of being priced in is really the leverage ratio and the impact it has on the balance sheet and a lot of banks don't seem to be considering that a huge amount. My expectation would be for prices to adjust. But we've just seen as a wall of liquidity coming to the market and it's pushing pricing right down.”
Taking this on and looking at other investors into the sector, Simon had this to say: “Once people realise what a low risk sector this is it becomes a very viable alternative for all sorts of investment classes. You can have rated vehicles, you can have pools of liquidity coming in on a sort of fund of funds basis and I think the whole provision of funding to the industry will be what marks the major change between now and 2019.”
Mention was also made as to how banks have provided much of the liquidity in the export finance sector to date. But the trend was to a more diverse pool of investors, with ECAs providing direct lending, or greater amounts of funds on that basis, institutional investors also coming in including hedge funds and pension funds and potentially even high net worth individuals.
From an ECA perspective David said there was much that the ECAs could to do to help, such as ensuring that their guarantees were transferable into the capital markets. He also said there will be far broader pools of liquidity coming in each with different risk profiles, different risk demands and parameters. But he also warned that the regulators could put obstacles in the way of insurance companies holding some of the assets they want to hold. “So I think from a capital point of view, regulation is going to play a big part in how this market develops over the next five years,” he noted.
Kai also suggested that so far the regulators had been fairly kind to export and trade finance because Basel 2 had provided fact-based empirical multi-bank evidence about the specific risk profiles of individual products allowing the regulators to consider the merits of the business and to provide special treatment. He also brought up the influence of the ICC with the introduction of the ICC Trade Register following the global financial crisis.
This also introduced to the discussion the June 2014 ICC Export Finance Trade Register meeting where I mentioned that 14 global heads of export finance had debated what could be done both to promote the sector and further influence regulators. However, then it was very much early days for this export finance working group, and today much more is being done to both further the progress of the register, work with the ICC to educate and influence regulators and to promote the industry overall.
Overall, today the issue of pricing on both capital and transactions inevitably remains a hot topic. Banks are intensifying their focus on yield, and continuing a balance sheet optimisation trend catalysed by Basel regulation. Some long-term loans in the market from a few years ago where banks did not take this into account are consequently returning virtually nothing. Margins on transactions continue to be squeezed in most areas of the industry.
On the subject of alternative lenders coming into export finance, this is still something that the sector needs despite the overall abundance of liquidity in the market today. This is particularly the case in the greenfield project space as banks are now less willing to tie-up cash in long-term low-yield deals. And let’s not forget, somewhere between 60%-70% of project financings now also involve ECA support of one form or another.
Capital markets tools: Back in 2014, given the high level of liquidity that was being seen in the market, there was a feeling that capital markets funding for export finance transactions had been reduced. The feeling was that the liquidity climate had lulled many banks into a false sense of security and more effort was needed to ensure the capital markets were brought in where possible.
Alex also pointed out that most of the capital markets activity to date related to aircraft financing transactions. But he also mentioned that there was now more relevance for such activity in shipping finance transactions, which was an area being explored with the Korean agencies.
David also pointed out that UKEF had done several key capital markets aviation deals. He noted that the US market was far more developed on this front than anywhere else, although he was keen to point out that institutional investors really dislike drawdowns. He stated: “We have supported eight aircraft financings into the capital markets. A lot less than Exim, but we believe very strongly in the importance of capital markets funding throughout the cycle.” Given the way the banks operated and the route other investors were looking at, he added: “I think the combination of bank funding and capital markets is to me potentially a winning combination.”
Kai pointed out that what was needed was greater standardisation to help draw in investors. But also the other big issue was pricing. He noted: “When I started in this business in trade finance the definition of a structured deal was anything that yielded 100 basis points or more. And funnily enough that was exactly the sort of benchmark that investors were looking for in the capital market securitisations. Yield will determine just how interested investors are in the product as well not just the structures.”
Of course one of the big changes today in the EF market is that there are much fewer aircraft financing transactions backed by ECAs taking place than back in 2014. This is largely due to the demise of US Ex-Im which is operating without a quorum and is unable to finance new deals beyond $10 million. UKEF has though managed to support some Boeing transactions where the aircraft involve UK-built Rolls Royce engines.
ECA innovations: The panel took time to look at some of the recent innovations that had taken place by some of the ECAs – and this was very much a period when the agencies were re-inventing themselves so new ways of operating were quite prevalent. David pointed out that most ECAs had moved on from simply being lenders of last resort.
He said: “One of the things that we have learned is we need to be in partnership. We shouldn't be competing with the private sector because perhaps the private sector tends to do things better than we do. But there are times when the private sector isn't functioning properly, it hasn't got the liquidity or hasn't got the risk appetite. We should be there as a complement to that so that we can react quickly.” He also noted that the UKEF refinancing facility was one way in which the agency could help the banks with some of the capital requirements particularly with very long dated loans which had punitive capital requirements.
On the UK front Alex noted that: “The direct lending scheme of UKEF will be a big success. I think we're all agreed on that and the refinancing facility has the potential to be a success as well. In terms of other areas, some of the things we've seen the UK and other ECAs do is to adopt flexible content rules on national content, and these have been hugely successful.”
On the overall subject of direct lending globally, Simon said: “I think it's hugely beneficial and I welcome it with open arms. There’s plenty of room for direct lending in the market. This is a big market and I don't think it's taking financing away from us particularly in an environment where as we know the regulation is moving away from us a little bit in terms of what we can keep on the balance sheet longer term.” However, he did sound this warning: “There is a danger that if direct lenders set themselves up to do everything without the involvement of the banks then exporters will find when they need a bank that there's just nobody there because the shops have been shut.”
Kai pointed out that he was a big fan of the German system where there was always support for the smaller deals in the market, and where deals can be pooled to get favourable financing. Kai also brought up the issue of local currency financing. And looking ahead five years, Kai said: “I think local currency will not go away if it makes sense. If it's really mitigating then we need to have a very open mind to what can we do better to promote local capital markets with local currency solutions.”
On a controversial topic and one that certainly resonates today, David brought up the subject of ECA direct competition. He said: “Certainly we're not really supposed to talk about ECAs competing with each other, but they have had to do that in order to help national interest. And there's been a very very fertile period for new products. And I expect we'll see more of the same.”
So, how is the ECA market today with real innovations? Few are really pulling out the stops compared to some of the big changes that took place in the aftermath of the global financial crisis. And the whole issue of ECA ‘innovative’ activity is one in which the US Treasury has voiced its displeasure with – stating that it creates an uneven playing field. Others see this as simply ‘sour grapes’ while the US effectively doesn’t have a fully active ECA.
UKEF is one agency that continues to innovate – and its recent developments with furthering local currency financing is a case in point. Certainly today we see more competition between ECAs as national interest issues come to the fore. This could intensify further depending on how some of the global trade wars pan out.
As to direct lending – as deals and projects have got bigger so have the amounts coming from some of the ECAs on a direct lending basis accordingly. Back in 2014/15 there were a number of large ECA-backed oil/gas development projects with serious direct lending components. Despite the market rollercoaster on the crude oil price in recent times, the same is taking place with major gas projects today. One thing that appears to be creeping in a bit more though is the aspect of tied loans from certain agencies as they compete in key regions such as Africa and the Middle East.
The webinar looked closely at the development of the ECA product in Africa in particular. The participants were very much on point when it came to their assessment of the spread of ECA activity across key African countries, and also pointed out that some of that activity was making up for the lack of deals in the Russian market.
In wrapping up the discussions, Kai had this to say: “I think the export finance business policy is one of the greatest success stories for private public partnerships. We need to develop certain products as the market demands. Many of them we don't know yet. But it certainly will be around capital market facilitation and around SME solutions. We must provide enough evidence to regulators that we have one of the greatest low risk products that there is in banking.”
David concluded: “I've always been a glass half full man so starting with the half full perspective I think the outlook over the next two to five years is very positive. I think there will be product refinements and enhancements. I also think the one dark cloud on the horizon is that we have a lot of influential ECAs who are not part of the OECD and who are not part of the club.”
Simon stated: “This is no longer just about transactions it's about servicing clients providing debt and liquidity to our clients and not just our clients but our clients clients. And once you change that mindset then the export finance business is a huge hugely beneficial product in that armoury that you offer to the bank's clients. So, I think there's a very positive trend in that we'll see an increased level of business which has come out of that anti-cyclical cycle which will be maintained because of the client focus that institutions are now providing in terms of how they allocate their resources.”
To see exactly what was said, do have a look at the 75 minute webinar video on YouTube.
Further entertaining insight into recent trends in the industry can also be seen in the TXF 15 Trends in Export Finance video on YouTube which we shot last year. Check this out as it provides more issues affecting the sector than we highlight here.
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