The demand for export credit and investment guarantees has increased dramatically in the wake of the Arab Spring and the signs are this trend will continue in the foreseeable future. MUSHTAK PARKER casts an eye over the financial landscape
“sovereign guarantees – no-one takes them seriously these days. They don’t mean much, especially in the wake of what has been happening in the eurozone countries. They are worthless these days,” emphasised a seasoned International Monetary Fund (IMF) official.
Whether he was jesting, or merely being cynical in these stressful and trying times, is a moot point. But there may be an element of truth in what he was saying, albeit with caveats. For instance, in the bond market in Saudi Arabia, the recent SR15bn Sukuk (Islamic Trust Certificates) offering by the General Authority of Civil Aviation (GACA), effectively a quasi-sovereign issuance was guaranteed by the Ministry of Finance of Saudi Arabia. The issuance was three times oversubscribed.
Another utility, Saudi Electricity Company (SEC), which is largely state-owned, similarly went to the market in May to raise $1.75bn in the international market through a Sukuk issuance – the first US dollar-based Sukuk by a Saudi utility. Because of the state ownership of the utility (some 78 per cent), investors regarded the issuance as guaranteed by the Saudi state. As such, in a spectacular endorsement of Saudi sovereign risk, investors oversubscribed the issuance by a thousand times with the order book reaching $17.5bn.
While petrodollar rich countries such as Saudi Arabia may be the exception, many other markets may find it difficult to raise similar funds readily and at the same pricing and yields, irrespective of whether they have sovereign guarantees or not.
For corporates of course, unless they are government-linked companies (GLCs) or companies involved in strategic activities, the recourse to sovereign guarantees is not an option. They have to rely on collateral, which they often do not have in adequate volumes, or on national or multilateral or private sector export and investment guarantee agencies such as Dhaman; Turk Eximbank (Turkey); the World Bank’s Multilateral Investment Guarantee Agency (MIGA); and the Jeddah-based Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC), the standalone multilateral Export Credit Agency (ECA) of the IDB Group.
Indeed, in the wake of the Arab Spring, the demand for export credit and investment guarantees has dramatically increased and all the signs are that this trend will continue in the foreseeable future, says Fahad Al Ibrahim, director general of the Kuwait-based Arab Investment and Export Credit Guarantee Corporation, commonly known by its Arabic acronym, Dhaman.
“I believe that the demand is good for export credit and investment guarantees,” he explained in an interview with Cash&Trade during a visit to London in June 2012. “In 2003, the volume of our underwriting business in the above respect was $350m. By the end of 2011, this volume had increased to $1.4bn. This means that there is a huge pent-up demand for export credit insurance (ECI) and political risk insurance (PRI).
In the wake of the transition in the Arab Spring countries, I think there are two emerging elements: first, there is huge demand for investment and political risk insurance because there is instability in this area – so many investors are asking us about our product offerings; secondly, we amended our Articles of Association in 2011. Where previously we accepted only new investment, we can now also consider extending guarantees for existing and on-going projects.
“Not surprisingly, demand for ECI and PRI has concomitantly increased especially from investors who have existing investments and projects in the Arab Spring countries.
“In the process, we are also educating the market on the necessity, desirability and efficacy of ECI and PRI. I believe that investors and companies will avail themselves even more of the services of agencies such as Dhaman and ICIEC.”
Indeed, MIGA in its 2011 World Investment and Political Risk Report concurred that demand for political risk insurance (PRI) has increased to unprecedented levels, with PRI supply by members of the Berne Union, the international body of ECAs, remaining robust and pricing reflecting a buyer’s market. Like any other product, the pricing of PRI is determined, by and large, by the demand and supply of PRI in the market. Dhaman concurs that its pricing for its PRI is competitive, albeit it does depend on the demand and supply dynamics.
Dhaman was established in 1974 as a supranational export credit and investment (political risk) insurance agency by the 21 Arab countries and four Pan-Arab organisations, including the Arab Fund for Economic and Social Development, the Arab Monetary Fund, the Arab Bank for Economic Development in Africa and the Arab Authority for Agricultural Investment and Development.
It is mandated with promoting the flow of foreign direct investments (FDI) into Arab countries through the provision of ECI and PRI to both Arab and non-Arab investors and lenders; enhancing the exports of member countries through the provision of political and commercial risk insurance to Arab exporters; supporting domestic Arab trade through providing commercial risk insurance for business-to-business sales; and supporting economic growth in member countries by providing political and commercial risk insurance to non-Arab exporters and financial institutions involved in the sale of commodities, raw materials, equipment and other development-linked goods and services to Arab countries.
However, Dhaman, which is rated AA with a stable outlook by international rating agency, Standard & Poor’s, reflects the under-developed export credit and investment insurance culture in Arab countries. Its total equity in 2011 was $317.5m of which the paid-up capital is $199.3m. This severely constrains the underwriting capacity of the Corporation and gives it little room for expansion. According to director general Fahad Al-Ibrahim, there are no current plans to increase the capital of the corporation.
This is in contrast to peer institutions such as ICIEC, which last year increased its capital from $240m to $640m. According to CEO Dr Abdul Rahman Al Taha this “will significantly enhance the insurance capacity of the Corporation and enable it to meet the huge demand for ICIEC’s credit and country risk insurance services from exporters and investors in its member countries”.
Standard & Poor’s in April 2012 reaffirmed Dhaman’s AA counterparty credit and insurer financial strength rating and revised its outlook to stable from negative. “The outlook revision,” stressed Standard & Poor’s in its rating rationale, “reflects Dhaman’s demonstrable control of its exposures, resulting in the absence of significant losses from the recent and continuing political upheavals in some of its key Arab markets and member states.”
The ratings also reflect the company’s “very strong capitalisation. In our opinion, the company also benefits from its organisation as a multilateral institution owned by governments of the Arab region. Dhaman benefits from strong financial flexibility afforded through its membership convention, particularly for recoveries for investment risk losses from relevant governments”.
Dhaman’s Guarantee Contracts Portfolio increased from $1.198bn in 2010 to $1.441bn in 2011, which given the huge export and import trade of the 21 Arab League Countries is very modest. This suggests that the latent demand for Dhaman ECI and PRI underwriting is potentially huge given its current modest market penetration. The Corporation’s other financial indicators support this – in 2011 total assets amounted to $341.2m; revenues touched $14.7m and net profit was $5.8m.
Since its inception, accumulated guarantee contracts have totalled $7.8bn over 38 years.
Demand for export credit and investment insurance in the MENA region is set to increase sharply over the next few years partly also due to the increase in intra-Arab, intra-OIC and trade with other regions; and partly due to the economic impact of the Arab Spring.
In this respect, Dhaman is following in the footsteps of MIGA and ICIEC in stating the case for ECI and PRI. The corporation, in fact, at the end of June 2012 came to London on a Roadshow at the invitation of the Lord Mayor of the City of London Corporation, Alderman David Wootton and The CityUK, the London-based professional body that champions the international competitiveness of the nationwide British financial and professional services industry; supports and promotes UK financial and professional services at home and overseas; and plays an active role in the regulatory and trade policy debate.
But what was supposed to be a showcase for Dhaman was hardly flattering given the meagre attendance of about 25 people. Privately, the guests from the Kuwait-based institution rued the fact that the UK Trade and Investment and The CityUK “did not adequately nor creatively promote the event”, which, according to them, is a lost opportunity given the keenness of British exporters to do business with the Arab region.
Indeed, export credit and political risk insurance are more than just hedging against credit and commercial risk and political instability and transformation. They are also key tools to encourage intra-Arab, intra-Islamic and intra-MENA trade.
Dhaman director general Fahad Al-Ibrahim agrees that in terms of the various ratios for instance premium income to GDP, market penetration of ECI and PRI when compared to other regions (especially in the developed and emerging countries) remains low. The corporation, however, does publish regular articles and reports relating to the demand drivers for its products and services in an effort to encourage corporates and banks to use these products and services.
He believes that the corporation is adequately resourced to meet the challenge of projected increased market demand for ECI and PRI.
Dhaman claims that it is in a unique position because of its privileged incorporation status, which it is not hesitant to leverage in any difficult situation. “For investment guarantees, we don’t have a commercial risk, it’s only political risk, and we have an agreement between Dhaman and all the member countries.
“We are not giving guarantees to any investor unless we have the approval from the relevant country. So there is only political risk and this is signed between Dhaman and the particular Arab country. That’s why we don’t have any problems relating to default. For political risk, the main issue is transfer of assets and profits in the case of war. Every investor wants to be sure that they are covered for that eventuality,” explained Al-Ibrahim.
As far as LC confirmations are concerned, Dhaman has expanded this underwriting activity over the last two years, and is dealing with the banks in the region through their respective central banks. “We are not afraid if there is any payment delay. This is okay, because we know that this will sooner than later be settled. We have never had any claims in LC confirmations since we started the Confirmed LC Insurance Policy for banks and Unconfirmed LC Insurance Policy for exporters.
“Unlike other ECAs, Dhaman does not deal with insuring sovereign debt risk. Under its constitution it covers only export credit and political risk insurance. “We are not involved with sovereign debt and we will not give guarantees against such risks. And that is good for us.”
The corporation is essentially a conventional insurer, but as Fahad Al-Ibrahim explains, given the proliferation of Islamic finance in the Arab countries, especially those that make up the Gulf Cooperation Council (GCC) countries and Jordan and Sudan, where Islamic finance commands a market share of the banking sector of between 30 per cent to 40 per cent, it has introduced several lines of Islamic insurance products (Takaful) where any exporter, investor or financial institution prefers them to conventional products.
“We accept such demands and we are dealing with them on a Shariah-compliant basis. We don’t have any institutional obstacles to offering Shariah-compliant underwriting. It is now part and parcel of our offerings but it depends on the demand of the investor or the exporters.”
In terms of Dhaman’s current business balance sheet, it is difficult to differentiate what percentage is conventional and what percentage is Shariah-compliant, albeit that the former is dominant by far. Al-Ibrahim agrees though that if more opportunities arise and more investors and exporters want to use Shariah-compliant ECI and PRI products, Dhaman will have no hesitation in increasing its underwriting in this respect.
He revealed that Dhaman’s Investment Committee is currently reviewing its Shariah-compliant product offerings and strategy. The corporation’s main policies in this space deals with Ijara (leasing) and Murabaha (cost-plus finance) for vanilla trade finance contracts based on mark-up.
In fact, Ijara accounts for half of Dhaman’s Islamic commercial risk insurance offerings, followed by Murabaha, which still constitutes some 50 to 60 per cent of the balance sheets of most Islamic financial institutions, and which have been “very successful lines and good business for us. We are also eying Shariah-compliant investment opportunities. As I mentioned, we are now trying to take on some of the new activities but we are not succeeding because of the current situation in Syria with the war going on. We should wait for another three months or so. There is a huge demand for Islamic credit and investment risk insurance tools”.
Al-Ibrahim concedes that the potential for commercial and credit risk insurance is huge given that the total trade of the 56 OIC member countries is $2.5 trillion and the local, regional and indigenous multilateral ECAs have not made huge inroads into the sector.
The reasons for this, according to him, are two-fold. First, foreign export credit agencies (ECAs) are dominant in the market in the Arab and Islamic countries. For example, COFACE, the French ECA, is a well-established agency with a long tradition and a strong suite of products and services.
In contrast, “we,” says Al-Ibrahim, “are weak in our organisation and operations, whether for conventional or for Islamic ECI and PRI. Given that demand for such products is increasing, Dhaman, ICIEC, Turk Eximbank and Eximbank of Malaysia are the drivers behind the establishment of the AMAN Union, which is the professional organisation of the Arab and Muslim export credit agencies and which is headquartered in Lebanon.
“It is a major responsibility for us to create this organisation, because we want to co-operate closely to leverage the opportunities in our countries especially in trade finance, FDI and other investments. Otherwise we will still suffer. I don’t believe Western agencies such as Coface and Hermes will come and give us their know-how”.
ECAs such as Coface may have a first-mover advantage, but it is not necessarily because their terms and pricing are more competitive. According to Fahad Al-Ibrahim, the obstacles in establishing these kind of ECAs are much bigger in the Arab countries, especially from a legal and regulatory point of view. Such ECAs also need strong support from their respective governments. For example, Coface has very strong support from the French Government, and, in fact, is a pioneer in export credit and investment risk insurance.
It has operated in the Arab and Islamic world well before Dhaman and ICIEC were established and has strong relations in these countries. Coface, like the US Eximbank and Hermes, tie their ECI and PRI to their own companies that won projects or contracts in the Arab and Islamic world.
In fact, one of the reasons why the AMAN Union was established was to counter the expansion of ECAs from developed countries, including Coface, Hermes, US Eximbank and Jeximbank into the Arab and Islamic world. The establishment of the AMAN Union “did not amuse those ECAs”, which, in fact, attacked the very existence of the union, which according to Fahad Al-Ibrahim, is making good progress in countering the very influence of the developed ECAs by developing the professionalism and products and services of the likes of Dhaman, ICIEC, Turk Eximbank and Eximbank of Malaysia.
He agrees that the proliferation of the Sukuk market in the Middle East and Asia – with some $200bn of Sukuk outstanding – presents exciting new potential business lines especially in Sukuk Takaful and perhaps more importantly in third-party guarantees for Sukuk for credit enhancement for Musharaka and Mudarabah Sukuk where the principal cannot be guaranteed by the issuer or related obligor. As such a third-party guarantor through an independent underwriter, which is eminently Shariah-compliant, would be in great demand.
“I think ICIEC should pioneer and lead the introduction of such products because their business is dedicated Islamic underwriting and ECI and PRI. For us, it is different, but we will support any such initiatives. Of course our member countries are big players in Sukuk issuance and we are keen to cooperate with ICIEC to encourage the proliferation of the Sukuk market. We have very good relations with ICIEC and, in fact, signed a new Memorandum of Understanding with the Corporation to expand our exposures.”
The other side of the ECI and PRI coin is reinsurance, which continues to be dominated by the London Market through Lloyds and other players such as Hanover Re, Swiss Re and so on. However, it is difficult, if not impossible, to get reinsurance for underwriting business for some countries because of political problems.
For instance, this currently applies to Sudan and for Arab exports to Iran, and equally to other countries that are perceived as being “politically unstable”. Dhaman, says Al-Ibrahim, “has the responsibility to come in and give support to these countries. We do some reinsurance business by taking a portion of the reinsurance risk.” However, he believes that Dhaman and ICIEC should cooperate and expand their reinsurance capacity.
Dhaman’s priorities for the next few years, he explained, are to consolidate its LC confirmation and leasing business lines, which are essential for transitional countries suffering from rising commodity prices for oil, gas, petroleum products. Dhaman similarly has strong links with ICD (the Islamic Corporation for the Development of the Private Sector), the private sector funding arm of the IDB Group, which is building up a strong portfolio of Ijara joint ventures in Arab and OIC countries, the latest one which is in Algeria.
Under Dhaman’s 2007-2014 Strategy, the corporation covers a range of risks including commercial risks; political risks; short-term and medium-to-long-term credit insurance and unconfirmed letter of credit insurance for exporters; investment insurance and contractors’ equipment insurance for investors; confirmed letter of credit insurance and buyer credit insurance in trade finance and loan insurance in project finance for banks; and factoring insurance and leasing insurance for factors and lessors.
A major development has been the underwriting of domestic business in member countries. Previously, the corporation was not allowed to underwrite domestic business under its mandate, but over the last two years since the introduction of domestic policies, the corporation has underwritten $400m worth of domestic business, which it believes will continue to expand and help exporters and investors of member countries.
Another new line for Dhaman is underwriting the business of expatriate investors in member countries and elsewhere who wish to invest in their home countries.
One of the demands from protestors during the Arab Spring demonstrations was employment generation especially for the youth, with the result that governments, the financial sector, the development agencies and the corporate sector have all been urged to gear their policies and financing towards supporting projects and initiatives that contribute to creating jobs, GDP growth and real economy activities.
Dhaman similarly sees this as part of its agenda, but its message is clear and present – what it requires from the countries in transition is political stability, at least for a minimum of one year. Stability will also help the tourism industry and inward investment into the transitional Arab countries, and this is what is needed because it would further boost confidence.
Employment generation financing and policies are similarly important because if countries do not improve, especially where youth employment is concerned, then the chances are this could turn out to be very dangerous for them.