Crossing borders with trade credit insurance

Until recently, exporters to emerging markets had only stopgap measures on which they could rely, They could buy traditional credit insurance, which is used by exporters to developed markets to protect themselves against commercial risks. However, a separate political risk policy had to be added to protect against the risks of expropriation, nationalization or currency inconvertibility.

Assessing the risk of foreign markets can be tricky. Bewildering regulations, unreliable and fragmented financial information, a maze of languages and enigmatic cultural traditions place considerable roadblocks in the path of companies that have set their sights on many emerging markets. With political risks such as currency inconvertibility or creeping expropriation added, some emerging markets present truly formidable barriers.

But the prospect of handsome returns can easily outweigh the potential hazards. In some regions like East Asia and the Pacific, economic growth for developing countries is estimated to approach seven percent in 2004 and 2005--nearly three times the rate of developed countries.

These forecasts reflect the speed and momentum at which the global market is changing. Exporting to emerging markets generates more than $2.1 trillion annually for businesses. As foreign trade increasingly contributes to companies' revenues, the importance of managing trade credit and political risks will increase as well.

Until recently, exporters to emerging markets had only stopgap measures on which they could rely. They could buy traditional credit insurance, which is used by exporters to developed markets to protect themselves against commercial risks. However, a separate political risk policy had to be added to protect against the risks of expropriation, nationalization or currency inconvertibility.

This approach produced varying results. Tenures for traditional short-term trade credit were frequently shorter than those needed in many cases by exporters to emerging markets. Additionally, finding the joint specialty to expertly underwrite both political risk and credit risk under one insurance roof is rare.

AN INTEGRATED APPROACH TO CREDIT RISK

Over the past six years, an integrated approach to managing credit risk in developing countries has emerged in the form of medium- to long-term trade credit insurance, which extends political risk insurance to cover commercial credit risk. Tenures can be as long as seven years, a timeframe that is more in sync with growth opportunities in many emerging markets. The coverage also responds to the special risks of emerging markets where economic turmoil can jeopardize an importer's ability to make payments even where governments haven't imposed currency restrictions.

The most flexible approaches to managing trade credit risk allow exporters to transfer the risk of payment default for single-buyer contracts. Coverage is designed to respond to a specific transaction as opposed to traditional approaches that cover turnover sales for comparatively low policy limits.

For lenders, the availability of medium-term trade credit insurance provides an alternative to syndicating loans when they come up against their country or customer limits. By sharing the risk, trade credit insurers can provide additional capacity to lenders without compromising the financial institutions' long-term customer relationships, which might be exposed to competitors under loan syndication scenarios.

Yet managing trade credit risk is not a simple matter of purchasing an off-the-shelf insurance policy. In most cases, the value of this protection is derived as much from the risk-mitigation techniques of an insurer as from policy language. Negotiation and diplomacy are the tools of effective credit find political risk mitigation, and those entities that have pursued long-term partnerships and developed a reputation in the market are most able to deploy these tools effectively.

BORN FROM NECESSITY

One of the most successful partnerships to surface in recent years is the one formed between public agencies and private insurers. Born from necessity in the late 1990s when increased activity in developing economies called for increased capacity, these arrangements have promoted product innovation in the trade credit and political risk insurance markets and averted loss during times of financial crisis.

A good example of this type of arrangement is the risk-sharing facility established between the International Finance Corporation, the private arm of the World Bank Group, and Zurich Emerging Markets Solution, the political risk and credit insurance unit of Zurich North America. Established to encourage the deferred payment sale of capital goods and services to emerging markets, the facility helps to promote medium-term trade credit opportunities for financial institutions.

Collaborations of this kind tend to be successful because they are built on the combined strengths of the stakeholders. Public agencies can guide insurance buyers through the morass of confusing and piecemeal data that distance and inexperience create. This compliments the speed-to-market efficiencies and underwriting expertise of private specialty insurers. These collective talents have improved the effectiveness of insurance to manage trade credit risk.

During economic crisis, for example, public agencies and private insurers have used their cumulative clout to avert losses by gaining exemptions from currency restrictions. Their ability to convince host governments of the importance of maintaining favorable trade relations has bolstered the protections of credit products and services, and given indisputable evidence of the need for and effectiveness of partnership arrangements.

As companies increasingly rely on new, unfamiliar markets as sources of revenue, the need to manage trade credit risk also rises. Effectively managing trade credit risk requires the skills of all stakeholders--risk managers, brokers, insurers and public agencies--to evaluate the level of risk and determine the appropriate risk mitigation techniques that need to be employed.

Dan Riordan is executive vice president and managing director of Zurich Emerging Markets Solutions.

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