German exporters again achieved record sales abroad in 2018. With growing uncertainty in international business, demand for so-called ECA and/or German-funded financing rose again, said Deutsche Bank’s Head of Structured Trade & Export Finance Germany, Werner Schmidt, in an interview with Dolly Varden.
The political risks are back. How do you experience the changed risk situation in export financing?
Political uncertainties are much more important to our clients ‘and banks’ businesses than they were in the previous decade. Some political decisions have led to uncertainty in the markets and in the export economy. This delays investment decisions, increases the analysis effort in terms of project risks and feasibility, and thus extends the lead times for our businesses. While larger financings used to be done in six to twelve months, today they sometimes take two or three years to complete.
How do you react to that?
The financing covered by an Export Credit Agency (ECA) is intended for precisely these situations. It provides security and stability. Already during the financial crisis it became apparent that export financing was one of the few long-term instruments available even in this crisis situation. During this period, the highest level of export financing was achieved. Export credit insurance has also supported significantly higher volumes than in “normal” times.
What do you need to look out for in the risk assessment?
Export finance supports investments abroad and enables exports of German products abroad. These include major infrastructure projects and investments in machinery predominantly in developing countries, but also selectively in the so-called “high-income countries”. There are political as well as commercial risks that affect the economic viability of the projects and need to be hedged. Among other things, these depend on the political and economic conditions in the countries. Increasing uncertainties are affecting export business and influencing demand for financing. But in difficult times, as has been said, the demand for export finance is usually higher than for other financing options.
That is, export financing is chosen more from a risk perspective? In normal times, other forms of financing are more likely to be considered?
There is still a lot of liquidity in the financial markets. This is partly due to the low interest rate policy of the central banks. There is strong competition for investment opportunities and numerous offers beyond export financing. Business is financed through the capital market or through traditional loans without Hermes coverage. But in the current environment there is heightened uncertainty and thus a higher need for hedging. There are two categories: hedging the economic risk and hedging the political risk. In addition to securing these political risks, government export credit insurance also provides for a certain amount of support, depending on the nature of the restructuring and loss event, including at the ministerial level.
Is there a shift in coverage volumes from countries like Russia and Turkey to other countries due to higher political risks?
Although the number of transactions has declined in recent years, transaction volumes in export financing have increased. The business has therefore become more volatile. A clear and sustained reduction of cover in Russia and Turkey can not be determined and the volume remains high. But countries have been added, for example Egypt, Iraq, some countries in Latin America and Africa. The regional distribution of the business has become more diverse. However, there are still focus countries, including Russia and Turkey.
How do the lower number of transactions and the rising volumes affect margins?
I can only speak for medium and long-term financing, but developments in short-term trade finance business are likely to be similar. Export finance is a business that is very customer-oriented, very transparent, and that the banks are very happy to operate. Therefore, there is a lot of competition and it is still increasing. Although the number of transactions is currently rising again, it has fallen in recent years. Due to the good liquidity situation, other financing products such as capital market solutions, bonds or classic loan financing compete with export finance. For example, companies in Russia were able to finance their investments in foreign currency with terms of five to seven years in the local market, without the need for export finance.
What significance do classical country risks have in this analysis?
Export financing performance is very good compared to other types of loans. The International Chamber of Commerce (ICC), which strives for more transparency with regard to the default history, has rather low claims rates. The country risk usually does not lead directly to the event of damage. But political decisions have an influence on the individual projects, as, for example, the creditworthiness of companies can be influenced by exchange rate movements. There we potentially see a risk increase, which will only show over time. Compared to the past, this is more likely to be the failure of individual businesses than of states.
How do you deal with non-financial risks?
Non-financial risks such as reputational or money laundering risks have become more important in the due diligence process. This affects the feasibility of projects, and you have to look hard at what risks are relevant and you are ready to take on as a lender. This requires significantly more transparency and evidence regarding the feasibility of the business. Regarding the discussion about sanctions of third countries, especially the USA, foreign regulations should not be considered in the context of the boycott ban. However, the reform of Article 7 of the AWV seems to allow for the possibility of taking into account sanctions by third countries that are not congruent with EU sanctions. This, for example, facilitates covered banking in Russia. So far, businesses and banks have been in a dilemma with regard to Russia’s business, given differences in US and EU regulation.
How does the increase in regulation affect your business and transaction thresholds?
There are two major topics: regulation, which addresses equity requirements and the valuation of balance sheet items, as well as the deduction of collateral in the export finance business. The other issue concerns the non-financial risks already mentioned [money laundering, know your customer (KYC), etc.]. These are regulations, which incidentally also include environmental audits and social standards, which we certainly welcome. But they also change transaction costs, affect profitability, and thus increase transaction thresholds.
Small ticket solutions that fall below these thresholds therefore require simplified and standardized processes. This also makes a digitization of processes possible. Export financing, as we do today, is very individual. A desirable standard export contract, simplified Hermes’ click & cover expiry, banking standardization and digitization could depress the thresholds. AKA Bank has already taken the initiative, which we strongly support as a large shareholder. Ultimately, however, all partners must pull together.
Is there a technological development that will change the market?
I do not currently see the disruption in export finance. There is no platform solution – even by Fintechs – that could fully reflect the complexity and variety of risks. In the short and medium term, it is more likely to increase the efficiency of the processes.