The Norton Rose Third Transport Survey highlighted that poor bank liquidity is a major issue for shipping companies with 61 per cent of respondents reporting that this was the issue which was mostly restricting the availability of funding for them. Lack of finance was considered by 42 per cent of respondents in the shipping industry to be the greatest threat of stability to their business.
Whilst not necessarily an available solution in every case, export credit financing can be one way of overcoming the issues currently being experienced with the traditional financing model.
What is export credit financing?
Export credit financing is a government-driven technique for encouraging manufacturing, industry and employment in its country. The criteria applied by an export credit agency (ECA) in deciding whether to be involved in the financing of a ship being built in that country may therefore be coloured by that policy perspective and vary from country to country. However, while they have a public policy function in promoting local industry, ECAs also have a commercial function in seeking to ensure that the export credit scheme does not lose money and a balance between the two must be sought.
ECA financing is a form of state aid to shipbuilding and can take various forms. Countries which are members of the Organisation for Economic Co-operation and Development (OECD) have sought to control and regulate ECA financing by joint agreements to try and achieve a level playing field between those OECD members who wish to provide state aid to their shipbuilding industry in this way.
The OECD Guidelines (known as the Consensus Arrangement) provide a framework for the orderly use of officially supported export credits under a "gentlemen's agreement" between parties. The participants to the Consensus Arrangement are Australia, Canada, the EU, Japan, South Korea, New Zealand, Norway, Switzerland and the United States. The principal provisions of the Consensus Arrangement relating to ships are outlined in the Sector Understanding on Export Credits for Ships (also known as the "shipping protocol").
The shipping protocol:
- 12 years maximum repayment term
- minimum 20 per cent cash paid by purchaser no later than delivery date
- repayments of the loan to be in equal instalments at regular intervals
- interest periods to be at least 6 months, maximum 12 months
- ECA premium to be adjusted to reflect credit risk of export country and political risk
Other criteria can also be set by the relevant ECA.
What types of support are available?
The ECA support can take various forms and can vary according to the country and will be influenced by the parties involved and the reason for the required support. That said, the following key ingredients in an export credit financing will be found, to a greater or lesser extent, in all structures:
- Credit Support - the ECA assumes the risk of borrower default - this may take the form of an "insurance policy", "buyer credit guarantee" or "export credit loan" (if given directly by the ECA itself).
- Interest subsidy - the ECA takes risk on the interest rate for the funding either by subsidising rates or offering a long term low fixed rate. The Commercial Interest Reference Rate (CIRR) is the official fixed lending rate and is calculated by reference to the preceding month's average rates for the relevant currency. ECAs allow the CIRR to be "locked-in" whilst transaction documentation negotiations take place.
Whatever the type of support being offered, ultimately it is the ECA that takes some or all of the risk and often more than a commercial bank would be willing to take, especially in the current market conditions. One or more ECAs in the same country may also be involved to make up the component parts of the relevant support; for example one may provide an insurance policy and other may provide interest support.
What are the advantages for a shipowner?
ECA financing may provide the shipowner with access to finance which would not otherwise be available. Further, it may also allow a greater spread of finance sources for banks as the ECA support may reduce the impact of bank limits in relation to a particular company or group of companies and also country (see Basel III below). The cost of ECA financing is often lower than would be the case with a commercial bank, particularly where fixed interest rate support is available. An ECA will typically charge a premium or fee for the support which will need to be factored into the cost although many banks will allow this to be funded by the commercial loan.
What about Basel III?
Under the new Basel III proposals, ECA backed loans will no longer have a zero-risk weighting. This will therefore need to be taken into account by banks because pre-Basel III, ECA backed loans would be zero weighted and thus would not affect a banks' capital adequacy requirements. This is likely to increase the cost of ECA funding but it is hoped will not restrict its continued availability.
In addition to the ECAs which are members of the OECD listed above, ECA activity is also regularly seen in other jurisdictions. For example, recent reports show that CEXIM (China) is increasing ECA support for its own shipowners and is also planning to offer funding support to overseas shipowners acquiring Chinese built ships.
Although perhaps most commonly seen in relation to newly built ships, ECA financing can also be sought in relation to ship conversions thereby enlarging the range of countries providing the export and, thus, the export credit.
Export credit financing, of varying forms, continues to play a major part in the strategic approach of many in the shipping industry, relied on by both shipowners and builders alike to maintain the order book and bring new ships on to the seas. It can be a highly attractive form of financing and potentially for some, the only form of fundamental financing for current projects.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.