Rethinking the rules of development financing

The question of the level playing field in relation to the provision of financing within export credit agency-backed (ECA-backed) transactions is a particularly thorny one. Many corporates and financiers working with ECAs bound by the OECD consensus have been particularly vociferous about some of the practices of certain ECAs and other institutions not bound by the OECD and the issue of unfair competition.

This whole debate transcends well beyond this of course into the provision of aid, investment and development financing with emerging economies, how business is being won and lost, as well as the end of the line debt repayment process and the problems this can produce.

Given the parameters that many institutions have to operate within today, and given that the rules governing some of development financing practices date back up to 60 years in many cases, the big question is not: do we need to revise these rules of engagement, but when will we revise them?

These issues have been talked about for a long time. Now, a new report entitled: “Official Finance Practices of the PR China: Distortion of competition, OECD responses and the threat to the Multilateral Official Finance System” has been published last week on the website of the European International Contractors (EIC), a large European association of leading EU construction companies. The report is intended to act as a draft lobby paper for the EIC. It also raises many points that allow us to look at this whole issue holistically.

The report is a hefty tome of 90 pages, immensely comprehensive with detailed research, data and appendices. Importantly, the report in its conclusions lists six steps or recommendations as a necessary process ‘towards a level playing field for OECD construction companies and an enhanced global official finance framework’ (see below). In addition, while a new official framework/arrangement is being worked out by policy makers, the author also suggests eight measures which could be adopted in a transition period.

It should be noted that the views expressed in the study are those of the author, Paul Mudde of Sustainable Finance and Insurance, and do not necessarily reflect the official policy or position of the EIC. That said, on the 12 November the EIC issued a press release entitled: ‘Correcting the unlevel Playing-Field’ which refers back to a March 2018 meeting in Brussels where the EIC called upon European policy-makers to recalibrate the competitive framework for European international contractors.

That EIC press release states: ‘The EIC calls upon European policy-makers to realise that China, more than other trade partners, takes advantage of the existing imbalance in the international trade law and that the resulting asymmetric obligations for European and Chinese international contractors, and notably the European and Chinese development and export finance institutions, is distorting the international level playing. The leading Chinese international contractors are large state-owned conglomerates which are nurtured by Chinese state development banks providing tied aid and loans disbursed directly to Chinese construction enterprises’.

And, as the report also points out: ‘Unlike OECD countries, China does not make a clear distinction between (i) official development finance, which includes concessional official development assistance (ODA) and other forms of multilateral and bilateral development finance and (ii) officially supported export credits. Moreover, even in the OECD world there are certain financing modalities that cannot be characterised as development finance or export credits. This concerns so-called untied investment loans or guarantees that are provided by official ECAs or specialised official investment lenders or guarantors.’

One of the key findings of the study is that the rules-based multilateral official finance system, which is based on seven key pillars and built during a period of 40-60 years is currently seriously at risk.

In essence this is caused, the report notes, by two interlinked forces, namely: (i) The distortive official finance practices of China, which it is able to conduct because it is not a member of the OECD DAC (Development Assistance Committee), The Paris Club and OECD Arrangement of officially supported export credits. (ii) The responses to Chinese competition of some OECD governments, which has led to an increase of non-Arrangement business, tied aid and problematic untied aid practices and the work of the International Working Group (IWG).

The report explains what is at stake, and also provides other important arguments to come to a global comprehensive framework for official finance and what actions should/could be undertaken to stop a further erosion of the multilateral official finance system.

The increasing role of China in Africa is of course one of the major focus points in the report. It was noted that: ‘The annual gross revenues of Chinese construction companies in Africa in 2016 reached an amount of $50.27 billion, which is more than three times the gross revenues of European contractors in 2017 ($16 billion).’ And that: ‘The vast majority of the Chinese official finance is used to finance public sector infrastructure projects in Africa.’

But as the author of the report has informed me, the whole issue is not just about China, the whole system of development financing is at risk and there is a real need to change the OECD consensus. He asserts that these issues cannot be solved at the level of agencies, and that they need to be addressed by governments at the policy level. By so doing, development financing can be done differently and better in the interests of developing countries.

Looking at the issue of China in more detail, the report notes: ‘The massive official finance practices of China in Africa (and other developing countries) cause severe distortions in international trade. Chinese official finance support is completely unregulated, which creates great advantages for the four Chinese policy institutions [China Exim, China Development Bank, Sinosure and the Agricultural Bank of China] and their national construction companies. 

‘The main issues of concern are the following: a) Unfair competition between OECD private construction companies and Chinese state-owned enterprises, and: Chinese official support is not governed by international regulations on officially supported export credits and development finance, which further deepens the unlevel playing field for EU construction companies.’

The report then lists some 10 key official finance issues that cause a severe distortion of competition. I won’t go into all of these here, but they range from: minimum risk/market-based premiums; tied aid standards and procedures; managing environmental, social and governance risks; threats to debt sustainability; to lack of transparency with development loans.

In response to this type of activity, the report says that many OECD countries have adopted their own counter-measures. One of these is the substantial increase in non-Arrangement business. The report states: ‘In the period 2013 – 2017 OECD Arrangement business decreased from $107 billion to $63 billion. Non-Arrangement business increased from $135 billion in 2013 to $157 billion in 2014 and decreased again to $148 billion in 2017. The OECD Arrangement has become substantially less relevant during the past five years.’

In particular, the report highlighted: ‘Japan, but also Korea have responded with a substantial increase of non-Arrangement official finance to the Chinese official finance competition.’

Other OECD related developments that the report also pointed out included: tied aid provided by certain OECD governments has increased substantially; Untied aid is de facto tied aid; and, the International Working Group (IWG) for officially supported export has made no or limited progress.

As the author has informed TXF: “In my view there is, however, much more at stake than the OECD Arrangement. The entire multilateral official finance system is at risk, but not many people involved in the various pillars of the multilateral official finance system seem to be aware of this, which partially explains the lack of action thus far.”  

He notes that concerted action of OECD (and non-OECD) governments, multilateral development banks, bilateral development finance institutions, ODA aid agencies, ECAs and Exim banks and the ‘guardian authorities’ behind these official finance agencies (e.g. ministries of finance, trade & industry, development cooperation/foreign affairs) is urgently needed to create a global level playing field for internationally operating construction companies.

Important other arguments for a joint action plan cover among others: (i) improving debt sustainability & IMF/WB Debt sustainability Framework, (ii) achievement of the UN SDGs [sustainable development goals], (iii) protection of the preferred creditor status of IMF and multilateral development banks so that they can continue to act as ‘lenders in last resort’, (iv) better alignment of various forms of official finance to develop successful strategies for the mobilisation of private capital for the UN SDGs and improve aid efficiency and effectiveness.

Priority issues, the report concludes, for a global framework for official finance should be:

• Common regulations on all forms of tied aid and (partially) untied aid (e.g. ODA and multilateral or bilateral development finance), including an additionality ranking of all forms of official finance;
• Common risk-based pricing system for all forms of cross border trade- or investment-related official finance / guarantees;
• Minimum interest rates for all forms of cross border trade- or investment-related official finance / guarantees;
• China should be strongly encouraged to become a permanent member of the Paris Club and to fully adhere to the IMF/WB DSF [debt sustainability framework] and OECD guidelines on sustainable lending to developing countries;
• Common terms and conditions on maximum repayment periods, maximum grace periods, repayment profiles, minimum officially supported interest rates & premiums, maximum amounts for official support for all forms of cross border trade – and investment-related official finance/ guarantees;
• Adequate and verifiable transparency on all forms of official finance with priority to (i) tied aid, (ii) export credits, (iii) untied development finance (multilateral and bilateral ODA and non-ODA), (iv) untied investment loans and guarantees and (v) other forms of official finance (eg. equity investments).

TXF will run a much more detailed article on the report by Paul Mudde in the very near future. Please keep your eyes peeled!

Asian ECAs strike unique collaboration pact
In an unusual display of cooperation between East Asian export credit agencies (ECAs) – the Export-Import Bank of Korea (Korea Eximbank), the Export-Import Bank of China (China Exim) and the Japan Bank for International Cooperation (JBIC) have formed a consultative body with the goal of promoting financial cooperation among the three countries.

The agreement was struck at a meeting of Asian ECAs last week in Phuket, Thailand. Not much has been released on this pact so far, but it is expected that the three ECAs will focus their efforts on the global infrastructure market. The first formal meeting of the consultative body will be held in South Korea, but as yet no date has been announced.

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