Is the OECD Consensus too inflexible for emerging markets?

Finalised in 1978, the OECD Consensus, known officially as the ‘Arrangement on Officially Supported Export Credits’, is a “gentlemen's agreement” that was established as a framework to stop OECD member countries gaining advantage over each other on the price of export credits. In short, the Consensus aimed to level the playing field and encourage competition among the top exporting countries in the world - but this was over forty years ago now.

The establishment of the Consensus also happened to coincide with the rise to power of Deng Xiaoping in China, who set in motion a number of market reforms that would one day lead to China, a non-OECD country, becoming the world's largest exporter. The modern reality of China and other non-OECD nations as large exporters underlines just how old the Consensus is, as well as the dramatic shift in the global economy that has taken place over the last four decades.

While the consensus has been continuously updated since its inception to keep pace with these changes, its relevance remains a hotly debated topic. A 2019 Business at OECD (BIAC) paper outlined a vision for the future of the OECD Consensus; where alongside the ICC and the European Banking Federation (EBF), the agreement was labelled “no longer fit for purpose”.

The desire for flexibility

“When you take all the items of the consensus as of today they probably deserve some reflection on their flexibility in today's world,” said Bruno Cloquet, global head of exporters and ECAs origination at BNP Paribas, while speaking at the TXF Africa Virtual conference last month.

This lack of flexibility has two notable consequences, first is the potential risk that a borrower, particularly in an emerging country with an aggressive risk profile, may be unable to afford the down payment, leading to the cessation of the project. The second is an ever widening gap between non-OECD and OECD countries, with the former able to offer far more flexibility for borrowers.

Cloquet’s main concern is that the decision to go with either an OECD ECA or non-OECD ECA rests solely on the basis of the flexibility of the financing, with transfers of technology and the development of countries playing no part in the final decision.

Cloquet’s view of the consensus as inflexible is widely shared, with TXF Research’s focused look at the ECA landscape indicating that dissatisfaction with the consensus is commonplace. Unsurprisingly, the flexibility of non-OECD ECA’s is what most clients want, especially for projects that, on paper, do not seem viable because of the associated risk. Non-OECD member ECAs are able to offer longer tenors, are able to support larger ticket projects with more favourable pricing with speedy due diligence processes, principally because they are not constrained by the OECD guidelines.

This has led to a growing turn towards non-OECD ECA support. TXF Research findings show that 43% of exporters and buyers have accessed non-OECD financing. However, it is important to point out that many exporters do not get the choice to use a non-OECD ECA. Exporters typically only have access to the ECA of the country they are located in, or ECAs in other countries where they have registered subsidiaries or manufacturing hubs.

Are the problems with the Consensus overstated?

“The question around the OECD common arrangement and whether it is fit for purpose has to be viewed through the lens of a wider framework that draws its strengths from the common goals, common rules that are meant to ensure the orderly function of international markets,” said Steven Gray, head of export finance - West Africa at UKEF, who also spoke at the TXF Africa Virtual conference.

Amid rising trade tensions, increased protectionism and turbulent digital transformation, effective multilateralism is both more important than ever and also increasingly harder to achieve. While the Consensus is far from perfect, it remains an important and relevant framework in this regard, providing a good basis for international competition and the promotion of a global level playing field in trade finance.

In fact the current rules may actually promote inter-regional trade in regions like Africa where companies may choose to buy products from neighbouring countries if they are unable to buy them from the domestic country that is doing the building.

Having said that, it is also important to remember that in recent years the treatment of local costs does not reflect the realities of the market and that this is especially problematic for large-scale turnkey projects, where localisation requirements have outgrown the OECD limit. (Historically, ECAs could only cover local content to a maximum of 30% of the export contract value).

Gray cautioned that “we must not lose sight of the potential for increasing risks around long-term currency risk and this is where perhaps borrowers and exporters should also look at structuring contracts to recognise the split between local and foreign costs on the larger medium- to long-term transactions.”

However, changes are being made. Last month, the OECD announced that it would raise the limit on the amount of local content in a project that may be covered by ECAs. The much welcomed amendment states that the proportion of products and services produced outside the buyer’s country which can be covered by an ECA is being increased to 40% if the buyer is located in a high-income country, and 50% if they are located in a low-to-medium income nation.

The Consensus in an emerging market context

Many have been pushing for such change for some time, suggesting that the OECD have recognised how exports and trade flows have changed over the past few years. None more so than those highly involved in emerging markets which are typically less capable of sourcing content and financing requirements locally.

“I’m not saying that the OECD Consensus is not relevant, because it still has relevance, particularly in the framework of multilateralism,” said Inal Henry, ECA head at Rand Merchant Bank.

“But there are some rules that are just too stoic and do not make sense in an ever evolving dynamic market economies such as the economies in Sub Saharan Africa, where a borrower would actually require 100% financing as opposed to the 85% financing.”

Henry highlights the need to understand the challenges of emerging markets, making clear that large projects are accompanied with complex legal and financial structures which, in an African context, causes huge strain on the part of the sovereign under the current rules of the Consensus.

What is most needed is the flexibility to build up projects from ground up, so that they are viable both from a risk point of view, but also from a commercial reality point of view. This is vital to avoid bankrupting African sovereigns, which have a huge task at hand in terms of balancing infrastructure, core infrastructure, critical infrastructure, and the cost of that infrastructure.

Henry points out that the cost associated with said infrastructure is normally in hard currency, and that while local currency borrowing should be encouraged, local markets are simply not deep enough and lack sufficient volumes of liquidity to support any large-scale borrowing, underlining the need for 100% cover.

This is not the only shortcoming of the Consensus in Henry’s view, she offers her views on the Country Risk Classifications, noting that while these ratings may contain useful market data and reference points, it prevents countries from using dynamic pricing.

The classification marks countries from one to seven, with a score of seven representing the most risky. The higher the score, the higher the premium. This can hit projects where the actual risk of default is low. For example, a low risk project in South Africa, currently classified as a four, will have higher pricing than a project with equal risk in a country classified as a three.

Stepping back and looking at the Consensus as a whole she states that while the rules create a level playing field for European nations looking to promote European exports, ultimately the framework serves developing markets poorly. However, China and India were not major exporters when the Consensus was established. But now these respective non-OECD ECAs and their contractors are throwing money at the export and project finance table and winning deals from European competitors, the need for further revision to the framework is greater than ever.

“We have to be real about the situation, we have to look at what is practicable, and what works for all parties concerned. At the end of the day, we need to do good business in Africa, and we only do that by being flexible and dynamic,” Henry added.

Untied lending

A consequence of the sluggish pace of modernisation has been the development of parallel product offerings, such as untied lending by OECD ECAs, a financial instrument to circumvent the barriers put in place by the Consensus. United lending does not require a buyer to purchase products from the country the ECA is located in.

Untied programmes, such as “push” and “pull” schemes, have become an increasing focus of some European ECAs’ strategic efforts, according to a 2019 US Exim report. The report reveals that in 2019, Canada’s “pull” programme included $4.7 billion, while Italy’s “Push Strategy” had just under $700 million. An example of a deal in this space would be SACE’s untied $500 million loan to Reliance Industries, signed in 2018, which was based on future export contracts with Italian exporters.

The report also shows that Japanese and Korean ECAs are particularly active in this area, largely in an attempt to compete with Chinese ECAs. US Exim data shows that in 2019 Korea’s untied activity stood at $5 billion with Japan reaching $2 billion.

While the volume of OECD ECA untied lending is significant, it remains comparatively small to consensus compliant lending. TXF data shows that in 2020, JBIC financed $36.5 billion worth of untied lending, followed by SACE (over $30 billion) and KSURE ($20 billion).

The geopolitical angle

Untied OECD lending or investment financing is not the only consequence of uncompetitive Consensus rules. China does not need to follow the Consensus, although it can choose to, and poses serious competition. In recent years it has entered markets where OECD ECAs have feared to tread, offering longer term and cheaper debt.

To combat this Chinese influence, protectionist measures, particularly by the US, have resulted in the revival of US Exim and a new mandate to directly counter China’s two ECAs: Sinosure and China Exim.

The mandate given to US Exim titled ‘Program on China and Transformational Exports’ charged US Exim with reserving no less than 20% of the agency’s total financing authority ($27 billion out of a total of $135 billion) with the aim of neutralising Chinese export subsidies.

So far US Exim has been involved with three deals in Africa, the most significant being the Mozambique LNG project. This deal was the largest direct loan in the history of US Exim, a $4.7 billion loan focused on export of US goods and services to construct an LNG facility in Mozambique.

To protect the longevity and the viability of the Consensus, especially in emerging markets, it is clear that changes need to be made and that the pace of change needs to increase.

The IWG: dead on the vine?

Indeed, the need to modernise the Consensus has been recognised for almost a decade. The International Working Group (IWG) - an Obama administration-led initiative set up in 2012, was established with the intention of crafting new international rules on the use of ECAs, that would be followed by OECD countries as well as non OECD countries such as China, India and Brazil. Questions were abound in response to the IWG, will it replace the Consensus or run alongside it? Might it be legally binding rather than a ‘gentlemen's agreement’?

These questions have never been formally answered and in November 2020, IWG technical talks were suspended for a year by 11 of the 18 countries (including the EU), citing divergent positions and troubles with transparency.

Crafted over decades by professional export credit negotiators as a compromise between OECD nations, the Consensus now stands at almost 150 pages of dense technical writing. Any attempt to impose a similar rule set for both OECD exporting nations and their on-OECD competitors was always going to require many rounds of intense negotiation.

The Consensus has its inadequacies and there is plenty of room for improvement, however, as last month's increase to the local content requirement limit demonstrated, the OECD is responsive to calls for change - even if that response is a slow one. With the IWG seemingly dead on the vine, the Consensus remains the only game in town, for the moment at least.