OECD Reform: Too much talk – too little action
With development of the EU Strategy on Export Credits underway, and longstanding debate over OECD Arrangement reform deserving of the label inert gas, are the OECD’s rules of ECA engagement in danger of becoming an irrelevance?
The OECD Arrangement on Officially Supported Export Credits: has there ever been a more innocuous document to cause so much trouble for a venerable economic institution? Reams have been devoted to its design, its flaws, and its future, not least in these pages, but there are signs that change may be on its way. At the very least, industry sentiment has broadly concluded that this situation cannot be suffered for much longer.
OECD exporters face an unparalleled cocktail of challenges, some of which are unavoidable, but many of which are simple own goals caused by a rigid commitment to the status quo. Momentum is building, but there is nothing inevitable about a reform process; it requires persistent engagement from all stakeholders. Without a transformational modernisation package, the OECD must consider the real possibility that its export strategy will be left behind for good.
For the uninitiated, the Arrangement is a gentleman’s agreement between its participants (Australia, Canada, the EU, Japan, Korea, New Zealand, Norway, Switzerland, Turkey, the UK, and the US). Established in 1978, its purpose, according to the OECD website, is to “(foster) a level playing field in order to encourage competition among exporters based on quality and prices of goods and services exported rather than on the most favourable officially supported export credits”. In other words, it states that a country’s relative economic power should not hinder or help its ability to compete for exports. To this end, it asks participant ECAs to place limits on the products they offer, with regulation on tenors, premiums, due diligence, down payment financing, and more besides.
Fit for purpose?
The fundamental ideal of the Arrangement is admirable, and it reflects a commitment to a collaborative, rules-based international order. There is no legal obligation that forces ECAs to adhere to this principle. In light of recent geopolitical events, it is not surprising that many industry participants are so keen to preserve it. However, the gloomy reality is that the Arrangement is not functioning as intended. Exporters find themselves caught between a brutal macroeconomic storm and the stringent demands made by their ECA-backers.
The term ‘permacrisis’ has been widely shared to describe the black swan events that have undermined global prosperity in the years since 2020. It suggests that countries are still playing catch-up after the cumulative effects of the pandemic and Russia’s war in Ukraine; rather than establishing safeguards for the future, they are firefighters in the present. When the appetite for risk dries up, exporters are often left to weather their problems alone. Prices for raw materials continue to climb, and financing for export contracts is harder to acquire as interest rates rise.
Makiber is a Spanish construction firm with a portfolio of social infrastructure projects in both the developed and developing worlds. According to Ramón Villagrasa, a member of Makiber’s finance department, there is little incentive for banks to provide favourable funding for social projects in Africa under the present conditions: “When interest rates are at a low level in Europe or America, more banks are willing to finance projects in Africa and Latin America because they are looking for profit. But as soon as America and Europe become more profitable for banks, they tend to go back to their homes”. Building a hospital in a low-income country is a complex, long-term procedure, but the best efforts of an exporter can be easily undermined by forces beyond their control.
On top of these financing concerns, exporters are facing volatility in the prices of materials. For a construction firm, volatility makes the task of setting an accurate project budget virtually impossible. Yet rather than spreading the risk of inflation, Villagrasa says that exporters are often left to deal with price volatility alone. Once the contract has been agreed, there is little room for further negotiation regardless of the risks posed by inflation.
In the context of global supply chain pressures, all industry participants will face serious challenges. However, questions are raised when ECAs fail to offer their exporters flexible products in times of crisis. One notable example in recent years was the debate over local content rules in the Arrangement. As Villagrasa says: “If logistics are a problem, we could look for an alternative solution in the local market. But we also have to follow what ECAs request for from us. If we said to the ECAs, this project is going to be 70% exported from Europe, we cannot then say that exporting from Europe became too expensive due to logistics costs, for example”. The Arrangement mandated that local costs could only form up to 30% of an ECA export contract.
Improvements were made in 2021, when this limit was increased to 40% for buyers in high-income countries and 50% in low-income countries. The adjustment reflected the fact that modern export contracts are multinational in scope, rather than simple exchanges between two participants. While some may have hoped that this case would lead to further reform, the story since then has been one of inertia.
Market sentiment on reform
The key issues that surround the question of OECD reform are many. TXF’s industry survey, conducted earlier this year, provides a comprehensive view of market sentiment: the most popular potential changes included lower minimum premium pricing for ESG projects, longer tenors for social infrastructure, 100% cover when commercial insurance for the down payment is unavailable, and integration of the Paris Climate Agreement into the OECD. Much like the change to local content rules, the guiding spirit for many of these reforms is modernisation. The OECD Arrangement was constructed in the 1970s, and its age has never been more apparent.
As the reforms listed above suggest, the Arrangement limits the flexibility available to exporters, banks and ECAs when designing contracts. ECAs could, until recently, only cover 85% of a contract. The tenors they can offer are frustratingly short-term in the world of project finance. And the OECD’s premium curve disincentivises investment in non-commercial infrastructure, particularly in those countries that are deemed riskier. As a result, the product offered by OECD exporters is often inadequate when compared with the most prolific non-OECD countries.
None of this will come as a surprise to the export finance community. Of greater interest is the fact that a reform package is reportedly close to being revealed. It was revealed in November that the Common Line agreement, which temporarily reduced the down payment requirement on an ECA contract from 15% to 5% during the COVID-19 pandemic, has been extended for another year. In many ways, this was a strange announcement. It undoubtedly came as good news to many exporters, since it offers greater access to cheap ECA debt. However, it is a move that has riled many private insurers looking to cover the spare 15% and is seen as a further encroachment by ECAs on their business.
What might reform look like?
As an extension of a temporary measure, it might indicate that the OECD is keen to do something rather than nothing, even if the Common Line is nowhere near a comprehensive solution. Ongoing discussions have been bolstered by the publication of a letter sent by the International Chamber of Commerce (ICC) to the OECD. In this document, the ICC, with the support of 16 leading export finance banks, has put its weight behind a wholesale transformation of the Arrangement. It sets out the reforms that are reportedly under discussion at the OECD, including an expansion of the sector agreement relating to renewable energy and climate mitigation (the CCSU), a flattening of the premium curve, an extension of repayment terms for normal ECA projects from 10 years to 15 years, and an easing of regulations that will allow for more sculpted loans.
On top of these, the ICC has called for longer tenors on social infrastructure projects and financial mechanisms that incentivise environmentally sustainable projects. The OECD has drawn sharp criticism from those who argue that export financiers do not take the “social” as seriously as the “environmental” in their ESG profiles. While many green projects now offer attractive future returns for investors, little has been done to incentivise financing for essential infrastructure projects that do not offer commercial revenue. At present, it appears that this issue is not a part of the reform discussions, although the scope of the CCSU reforms have not been agreed yet.
Hussein Sefian, the CEO of Acre Impact Capital and a member of the ICC’s Sustainability Working Group, has argued that these changes would represent a far more substantive commitment from the OECD: “if the driving objective of the Common Line is to improve affordability for the types of borrowers that are being targeted, then some of the broader reforms of the OECD Arrangement and some of the policy recommendations that the ICC has been calling for since the White Paper, in our view, would be more appropriate policy steps”.
The OECD could rightly point to the complexities of the talks at hand, as well as the challenges of meeting the demands of all of its ECA participants. These reforms require significant technical detail. Yet the risk of a lengthy consultation process is that the Arrangement is left behind. Already, it seems clear that ECAs are embracing a mandate that goes beyond export credits. Activities that fall outside of the bounds of the Arrangement are increasing, not least in the form of untied loans. Euler Hermes has closed two deals of this type with Trafigura, the commodities trader, in recent months. An $800 million facility for the supply of metals was secured in October, and this was swiftly followed in December by a $3 billion deal for natural gas. In both cases, no export contract was involved.
Of course, the untied facility does not represent a death knell for the Arrangement, and many ECAs have always had remits that go beyond pure export contracts. More concerning for the OECD should be the notion that its members are now too diverse in their approaches to agree on a mutually beneficial set of reforms. Take the issue of local content; the US demands significant American content across all of its products because it wants to generate business in the US. By contrast, Switzerland has a small manufacturing base, and would prefer to see an Arrangement that supports its position as a re-exporter of goods. How can these issues be reconciled in the long-term? There is no obvious solution.
The TXF perspective
As these debates proceed within the OECD, the spectre of an EU Strategy on Export Credits looms large. Feasibility studies have begun, and the EU has conducted surveys among banks, exporters, and ECAs to garner ideas. The conclusion of a recent workshop held with the private sector was that EU exports are declining in the face of steep global competition. Given this context, all options are up for discussion, including the possibility of a new pan-European ECA body. There is real optimism here; one source close to the talks told TXF that, “this is somehow better prepared than almost everything else I have ever seen in the past from the EU with regards to trade and export finance, because it's not a major topic historically for them. Therefore, it's good that this has changed… this is something which is now, from my perspective, starting and everybody should feel encouraged to contribute to that initiative”.
While an EU Strategy would not necessarily compete with the OECD Arrangement, the potential for tension is obvious. The danger for the OECD is that its provisions no longer match the reality of export finance in the 21st century. As long as major exporters like China continue to offer more attractive products, OECD members cannot pretend that the level playing field exists. It may be a forlorn hope, but a truly comprehensive agreement would incentivise the participation of all exporting nations. At present, there is little reason for China to limit its export policy with the OECD’s outdated rules. The first step will surely come when OECD members show that they can unite among themselves.