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What is Export Finance and How Does It Work?
Definition of Export Finance and the Role of Export Credit Agencies
Typically, Export finance is structured around the involvement of Export Credit Agencies (ECAs) – government-backed institution that provide guarantees, insurance with the overarching goal of supporting national exports. The primary function of ECAs is to help domestic businesses mitigate the risks associated with international trade, particularly in unstable or emerging markets. ECAs greatly facilitate exports by offering cover to protect against commercial risks (i.e. non-payment) or political risk in foreign countries (e.g. embargo, war, conversion and transfer risks). By filling the financing gap that private lenders may not be willing to cover, ECAs enable businesses to confidently engage in high-risk markets.
The Role of Export Finance in Global Trade
Export finance plays a critical role in facilitating global trade by 1. enabling buyers – ranging from corporate to sovereign entities- to access competitive financing solutions tailored to specific requirements and 2. by reducing payment risk for exporting companies in economically or politically challenging regions.
Export finance can help businesses expand their reach into global markets while managing the financial and political risks inherent in international trade.
How Export Finance Operates in Practice
Securing export financing involves several steps, and businesses can access it through banks, export credit agencies, or selling/exporting companies. To begin, businesses must assess their financing needs, gather documentation and choose the most suitable financing partner.
Key parties in export finance transactions include the importer, the exporter, both signing the commercial contract, and the financing bank. Depending on the characteristics of the underlying project and the risk profile of the transaction local banks or sovereign institutions can also be involved. Export credit agencies also play a key role in providing cover, hence mitigating risks for both the exporter and the financing bank.
A typical transaction begins with an industrial project that is discussed or already agreed between the importer and exporter. Early in the process, one of the parties contacts a financial institution to request an offer for an ECA-backed financing. After having determined whether the export transaction qualifies for ECA support, a non-binding, indicative proposal is submitted. Once the financial institution is officially mandated, the credit and the ECA application processes start. After credit approval the loan documentation will be developed, negotiated and agreed. Upon all fulfillment of the conditions precedent set in the documentation, the loan is usually disbursed to the exporter after the delivery of the contractually stipulated payment documents that evidence that deliveries have effectively been made and/or services have been rendered. Not later than six months after the starting point of credit defined in the loan agreement, the borrower will start repaying the loan.
Key Facts of ECA-covered Financing
- In general, tied to particular industrial or infrastructure project that includes cross-border supplies and services
- The underlying project has to be eligible for ECA support
- This depends on the policy of the respective ECA requiring min. national content or min. national footprint
- Availability and pricing of ECA finance depends on
- The rules of the OECD Arrangement on Officially Supported Export Credits apply
- A maximum of 85 % of the export contract value can be financed under an ECA loan
- A minimum of 15 % of the export contract value is required as down payment.
- A guarantee premium, determined by country & borrower’s risk, needs to be paid to the ECA
- The loan is usually disbursed to the exporter directly pro rata its deliveries and services.
Key Forms of medium/long-term Export Finance
Buyer credit involves the importer receiving a loan from a financial institution to pay the exporter. The Buyer Credit is granted to a foreign client (private or public company, sovereign entity or local bank) for the purpose of financing the purchase of equipment, infrastructures and related services supplied by exporters. By far, the most important form of export financing.
With a Supplier credit suppliers provide medium/long-term payment terms to the importer. This credit is granted by supplier directly to its foreign buyer in order to finance a purchase of equipment, infrastructures, and related services.
Sales of receivables/Forfaiting: Purchase of receivables excluding recourse to the supplier in the event of non-payment by the foreign purchaser.
These forms of export finance are tied loans as the credit is used solely to finance a specific export transaction.
Untied loans are granted to specific projects abroad and do not require to be tied to the export of goods and services. These loans usually provide support to projects related to the supply of key raw materials or energy security.
Essential ECA Financing Structures
Export finance can follow different structural models:
Direct loan involves a loan from a financing institution directly to the buyer (also acting as borrower). This structure is only applicable for companies with a strong credit worthiness.
Bank-to-bank loan involves a local bank acting as direct borrower under a loan contract with an international financial institution. The same local bank on-lends the funds to the importer, i.e. ultimate borrower.
A sovereign counterparty, e.g. the Ministry of Finance or a state-owned enterprises of a foreign country acting as borrower or guarantorunder an ECA loan for critical infrastructure and key strategic projects.
Project finance enables large-scale infrastructure or capital goods exports by which the debt service to repay the loan is generated from the project cash flows. In this structure, a newly created special purpose vehicle acts as borrower without or only with limited recourse to the sponsor.
Advantages of Export Financing for Businesses
Export finance offers many benefits that enhance a business’s ability to compete internationally. It enables companies to offer more attractive payment terms to their international clients by providing access to medium/long-term capital in hard currency. Additionally, businesses can maintain liquidity and manage operational expenses without financial strain during exporting.
Export finance allows businesses to offer better payment terms, making their products more attractive to international buyers. This flexibility helps expand the customer base and increases market share by enabling exporters to meet global clients’ diverse financial needs and preferences. It mitigates political and commercial risks protecting both exporters and lenders from defaults or geopolitical issues. Exporters benefit from improved cash-flow, as they are paid in cash or short-term while the borrower repays over time.
The Risks and Challenges in Export Finance
Export finance presents several business risks and challenges, ranging from credit risks to political and regulatory hurdles. These factors can complicate transactions, making it important for companies to manage risks effectively and remain compliant with regulations.
Businesses and borrowers must meet specific credit standards set by lenders. This includes having a strong credit history, sufficient collateral as the case may be and proven financial stability. Failing to meet these requirements can result in denied applications, limiting a company’s ability to access necessary financing.
Political instability, economic downturns, or changes in international trade policies can impact transactions, making it harder for businesses to complete international deals or receive payments on time.
Businesses involved in export finance must comply with international regulations, such as anti-money laundering (AML) and Know Your Customer (KYC) policies. Non-compliance can lead to legal penalties and disruptions in trade activities.
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