UK: WHERE GOVERNMENT CAN DAMAGE OUR HEALTH - EXPORT CREDIT COVER. - UK firms hoping to sell in distant markets are suffering the chaos of credit cover uncertainty.

by Peter Wilsher.
Last Updated: 31 Aug 2010

UK firms hoping to sell in distant markets are suffering the chaos of credit cover uncertainty.

Britain still sells more than £100 billion-worth of goods and services abroad every year. That represents nearly one third of national income - and almost twice as much per head of population as the supposedly all-conquering Japanese. The Government claims to admire and foster this activity, and is perpetually trumpeting new initiatives to promote it, support it, and help rebuild the UK's long declining share of world trade. Yet everywhere there is acute scepticism about the true scale of this commitment. Where it really counts - in the marketplace and the profit-and-loss account - the nation's exporters feel short-changed and unloved.

The most vociferous complaints at the moment focus on the little understood but often crucial area of export credit insurance. This provides those enterprising firms always ready to pursue far-flung and often risky business opportunities with some guarantee that they will ultimately get paid. But this market is currently in conceptual and financial chaos. Many critics, and not only those with a direct financial axe to grind, feel that Britain is facing a severe competitive disadvantage here, which can only get worse unless an unsympathetic Treasury can be persuaded to change tack.

That, however, is only the most immediately pressing concern. Almost equally worrying is the growing reluctance of the commercial banks to support activity overseas. This is beginning to have serious disincentive effects at both ends of the commercial spectrum: not only for tiny, untested companies seeking to stick a toe into promising distant markets, but even for the giants when they find themselves frostily refused the loan backing needed to underpin a big international bid.

Beyond these major problem areas, there are further headaches arising from the near-collapse of the Exchange Rate Mechanism and the costs of meeting the European single market's new VAT and statistics collecting requirements. I recently came across a relatively modest exporter whose finance director says he now has 16 people monitoring currency fluctuations; and one estimate suggests that the tax reporting burden can easily reach the equivalent of 2% of turnover. It is not hard to understand why barely one in seven of Britain's 85,000 manufacturers is prepared to treat exports very seriously (normally defined as accounting for more than 10% of sales).

In his March Budget the Chancellor of the Exchequer acknowledged that many British firms are 'sometimes at a disadvantage when seeking business overseas'. Much of this, he insisted, was the result of the unfair and trade-distorting subsidies (see The Uneven Playing Field, p52) made available by many (indeed, probably most) foreign governments. Though he stated that the Government was negotiating hard for these aid levels to be reduced, he was not able to report much immediate success. In the meantime, he was prepared to offer two kinds of temporary help. First, there would be a further drop of 7.5% in the premiums charged by Britain's state-financed Credits Guarantee Department (ECGD). This is intended to reinforce the 20% cut announced last year and bring these costs down on average to the same level as those charged by our main competitors. Secondly, an additional £1.3 billion of export-credit cover would be made available (on top of the £700 million promised in last year's Autumn Statement), with the hope of winning an equivalent of new big-ticket business for the country's major overseas contractors in the next three years.

These offers were fairly cautiously welcomed by industry. As Neil Johnson, director-general of the Engineering Federation put it: 'If what he says is borne out in practice ... it is good news.' Others, closer to the firing line, were even less overwhelmed. Alan Gormley, chief executive of Trafalgar House, with its worldwide civil construction interests, spoke for most of his colleagues when he said: 'The previous regime was ridiculous. It clearly penalised UK exporters against the competition. What we have seen in the past two years is the UK moving closer to the middle ground. They're not there yet.'

Moreover, it is important to appreciate that the Chancellor's assurances only applied to one particular class of credit insurance: the important but limited variety that is still handled by the ECGD's Projects Group. This essentially means major medium-to long-term projects. It no longer extends to the much more common short-term type of business (normally goods and services sold on up to six months' credit) which accounts for the great majority - around 90% - of all Britain's overseas trade.

From 1931 (when the UK went off the Gold Standard) until 1990, this, too, was an official, state-sponsored ECGD responsibility, managed by a body called the Insurance Services Group (ISG). This is the pattern followed by most other EC countries - France's Coface, Germany's Hermes, Italy's SACE - where the government continues to provide an ultimate financial guarantee. Even in the US, where the equivalent, the FCIA, has been similarly allowed to 'go private', there have been second thoughts, and a commerce department-backed 'Mark 2' version has been set up to ensure that, in an emergency, Treasury support can still be mobilised.

However, at the start of the 1990s, Britain decided to go the full privatisation hog. The ISG was finally sold off (for a nominal £70 million, which reduced, after various adjustments, to a net realisation of only £7 million) to the Dutch insurance conglomerate NCM. At home in Holland NCM enjoys very considerable state backing in the terms it can offer its customers. But in Britain it is required - with one important, but transitional exception - to operate on strictly commercial lines.

Other things being equal, a credit insurer has two strategic choices: either he can raise his premiums and select the risks he is prepared to cover carefully enough to remain solvent and make an occasional profit; or he can shave his prices, be less selective and face the possibility of soaring costs - especially at a time of global recession, when defaults, late payments and customer failures are all spiralling skywards.

Britain is certainly not alone in considering the privatisation alternative. Denmark, Spain, Portugal and Italy are all exploring similar moves, while even subsidy-prone Germany, which for the moment remains wedded to the old ways, is increasingly appalled by the resulting deficit, already standing at over DM 12 billion (£5 billion). It is reckoned that export insurance subsidies throughout the EC currently account for around 10% of all state-aid to industry. Brussels, as well as our own Foreign Office, is pressing hard to level this costly corner of the competitive playing field. So far, though, they have had only very limited success, as the Chancellor pointed out. Unfortunately, so long as other member states are willing to absorb our profligate competitors' mounting losses, the prudent, and those who depend on them, are caught in an increasingly nasty double bind. They often have to pay significantly more than their competitors for the insurance cover they are able to get, and for certain classes of business they find it difficult, and sometimes almost impossible, to get cover at all.

The real sticking-point has turned out to be not so much the level of premiums as the cost and availability of the reinsurance which provides a backstop when things go really wrong. This applies particularly to what the market calls 'political risk', where a currency crisis (Kenya last year), or a war (Kuwait during the Gulf conflict), or the collapse of some major state department or agency (India in 1987, Italy this year), leaves a whole country unable to meet its contractual commitments.

Whitehall recognised there might be a problem, and agreed, as part of the sale arrangements with NCM, that it would offer some transitional 'top-up' support for three years (ie, till the end of 1994) while the private sector reinsurers built up sufficient capacity to handle the newly-available business. The Government also undertook to provide backing, for an indefinite period, in those particularly risky (or 'non-vested') markets that commercial reinsurers refuse to touch, such as India, China, the former Soviet Union, and large parts of Asia, the Middle East and Latin America.

These reluctant compromises have left nobody very happy. The Treasury, fearing a new cascade of defaults, imposes tightly-restrictive rules and is notoriously slow to make definitive decisions. NCM, which handles the bulk, but not all of the short-term business (around £14 billion-worth each year), complains that it is often hamstrung and forced to turn down perfectly good propositions - to the point where its MD, Colin Foxhall, reckons that more than £1 billion-worth of potentially valuable exports have been lost due to lack of credit cover this year. Trade Indemnity, NCM's main rival, which underwrites another £4 billion-worth of annual contracts, is bitterly aggrieved that it is excluded from even the flawed and inadequate backing that the Exchequer extends to NCM. And the customers who are actually trying to get out into distant markets and sell find themselves floundering in a morass of expensive uncertainty.

Probably the single most aggravating aspect of all this revolves round the notion of 'country exposure'. Both the state and the commercial reinsurers set strict cash limits on the amount they are prepared to commit to each market. The paradoxical effect of this is that when an area takes off (as Indonesia is doing) and orders and opportunities start to proliferate, a point is quickly reached where there is no more reinsurance capacity, and the exporter either has to back away or carry the risk on his own.

Foxhall reckons that capacity is so tight that his agency could be forced to turn down as many as one in five of this year's cover requests. After he had expressed that view, forcibly and publicly, at a recent meeting of the Institute of Export, Richard Needham, the trade minister, was jolted into promising urgent consultation with his own and Treasury officials to see how quickly these bottle-necks could be cleared. However, there is little indication yet of how much cash help he will be allowed to release.

The worst example of this dilemma is China, rated by most people as the world's most promising emergent market. Britain has dispatched no fewer than three major official trade delegations there in recent months but, thanks to Treasury dithering, it is still failing to provide any effective insurance cover.

The best-documented victim, Siemens Plessey, with a £10-million radar contract in the bag, spent months trying to protect itself against non-payment, and could have lost the order altogether if a fellow subsidiary had not been able to make alternative arrangements in France (where the decision came within 48 hours). And, as one of the company's directors, Keith Johnson, tersely comments: 'We are anything but alone in this.'

The privatisation snarl-up has had significant knock-on effects, too, in the related area of bank finance. Before NCM took over, the government-backed Central Bank Guarantee scheme, launched in the 1960s, allowed insurance-worthy exporters to borrow at very favourable rates - typically 0.6% above base - and the commercial banks, who were then in a virtually risk-free position, were only too happy to lend. Until 1991, when the position dramatically changed, there were 13 of them bidding for the business. But since the guarantee ended, five of those players have withdrawn altogether, one, Exfinco, has failed, and most of the rest have curtailed their activities. As Ann Newson, speaking for the Royal Bank of Scotland, puts it: 'We have been in the business of supporting exporters for many years and we will continue to do so. But our support is constrained by commercial reality. Ultimately, decisions will be made on a commercial basis.'[QQ) None of this, of course, inhibits the truly dedicated. I talked to four winners of last year's Small Business Export Awards: Designers Guild (the London-based fabric and wallpaper specialists), the Technology Partnership in Royston, Herts (which has developed a lucrative niche in pharmaceutical equipment), Charles W Taylor and Son in South Shields (world leaders in high-quality castings), and R A Davies and Partners in Colwyn Bay (which, amazingly, now sells 45% of its output of barbecue firelighters in Europe and North America); all claim to be largely unaffected by the recent financing vicissitudes.

But that is largely because they are able to by-pass them, dealing directly with large or long-standing customers where there is no real question about the bills being met. Where they now feel inhibited is in attempting to develop new markets. Typically, they will start by going through an untested agent or distributor and relatively large sums will initially be at risk. This is exactly the kind of business which is hard and expensive to insure.So they tend not to bother. And that is probably the most telling indictment of current policy - it tends to make people with potentially world-beating products opt instead for the easy, unthreatened life. Which is hardly good news for Britain's future economic health.

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