Case Study #2: Trade Finance and Risk
Risk and opportunity – together as always!
Engineering Tech (ET) is a large national engineering partnership in Australia,
with expertise in large-scale infrastructure projects, including public-private
partnership (PPP) projects involving government departments and agencies. ET
has been a major player in various parts of Australia, and has ventured into
consulting activities in Japan and parts of Asia.
A senior partner of the firm was approached recently about executing a major
infrastructure project in Addis Ababa, Ethiopia near the Bolé Road airport. The
country that was once referred to as the ‘Breadbasket of Africa’, and remains the
only country on the continent never to be colonized, has experienced war,
drought and starvation, and continues to face extreme poverty.
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Those harsh realities aside, the country has benefited from some foreign aid and
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some investment, and the partner at Engineering Tech perceives an opportunity
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to do some good, as well as to take on a complicated, profitable project in a
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region considered too risky by the firm’s competitors.
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Engineering Tech has an excellent relationship with EFIC, Australia’s Export
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Finance and Insurance Corporation. The national export credit agency Down
Under is viewed by many as a very progressive, dynamic and innovative export
credit agency that will go to great lengths to promote the success of Australian
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exports – even taking in significant country and bank risk to do so when
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warranted.
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While the several partners at Engineering Tech are intrigued and willing to invest
time to put a bid together, the company Board is concerned: how will the firm
succeed in a country that faces so many challenges? How, they wonder, will
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Engineering Tech protect its interests and ensure excellent results in a place
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where a major national language, Amharic, is spoken nowhere else in the world?
The challenge
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Several partners of Engineering Tech have been to Africa – including Nigeria,
Ghana and Kenya, but none have traveled to Ethiopia, and previous projects
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involved a consortium of partners to share both the project execution and the
risks. This time, Engineering Tech is the lead executing firm under a World Bank
development program, facilitated partially through the World Bank/IFC
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(International Finance Corporation) Trade Finance Program. Engineering Tech
will be the prime contractor, and must adequately provision for the risk.
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The partners supporting involvement in this project – now known at Engineering
Tech as the “Acacia Crew”, in reference to the tree that often frames sunsets
outside of Addis – have engaged you to identify some risks and their mitigation
options. You have been able to outline some preliminary risks to consider, and
must now present viable risk management options.
The Risks
A complex infrastructure/engineering project in an LDC (Least-Developed
Country) environment automatically brings with it a complex set of risks, from the
possibility of revolution (as was the case in Ethiopia in 1974), through to the risk
of outright expropriation of the completed project, if its ownership lies elsewhere
than with the government of the day, even temporarily. In the event that a project
is only partially funded through development monies, assets associated to the
project may not be usable to secure financing, due to the in-market risk to those
assets.
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Shortage of resources, staff and materials can cause significant delays and
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generate significant cost overruns; questionable business practices and outright
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corruption can be a serious risk, as can eruptions of violence caused by political
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unrest.
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Environmental impact concerns are increasingly critical in projects of this type,
and any government agency which might be engaged to support in this project –
including EFIC – has committed to conduct environmental impact assessments
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on any projects funded. This includes assessment of impact on local populations.
The World Bank has also published standards related to sustainability and
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environmental issues. Non-governmental organizations (NGO’s) actively monitor
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and report on projects such as this one, and Engineering Tech has no desire to
be dragged into a public relations nightmare.
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Even in the ideal situation, there remains the risk of disagreement between
Engineering Tech and the funding agencies, including the World Bank and the
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IFC. Such disagreements can occur and can be time-consuming to resolve.
Projects funded through multilateral agencies are subject to significant due
diligence and verification – even (potentially) stringent audit processes – all of
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which imply risk and added cost (both net new costs, and cost of funds on
delayed payments) to Engineering Tech.
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Your general impression after having studied the proposed project is that nearly
every business risk imaginable is represented, to some degree, in this
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opportunity.
Risk Mitigation Considerations
The “Acacia Crew” are experienced consultants and engineers with successes in
numerous high-risk markets, and understand that – inevitably – things will ‘go
wrong’, but that some foresight, coupled with effective planning, will maximize the
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likelihood of a successful outcome. The Engineering Tech Board members are
somewhat less schooled in the nature of developing market projects, and will
require comprehensive assessments and significant reassurance.
Your assessment indicates that this opportunity is primarily about risk
management and ensuring adequate financing and cashflow over the term of the
project. Engineering Tech and its Board must take a holistic view of the situation
and determine whether they have access to the necessary risk mitigation tools,
and whether the firm has the financial wherewithal to see the project through.
Case Study Discussion Questions
1. How can Engineering Tech begin to organize an approach around risk
mitigation with so many factors at play? What are some of the resources
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and techniques that can be explored as possible risk mitigation solutions
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in the context of a project such as this one?
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2. Do any of the basic or ‘vanilla’ trade finance products or services apply in
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complex and high-risk scenarios such as this one?
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3. The risks in the transaction seem to be very broad and encompassing. Can
Engineering Tech effectively protect its interests and assure payment?
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4. What assurances can the “Acacia Crew” offer to the Engineering Tech
Board?
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1a) The above assessments of the risks of executing this major
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infrastructural project in Ethiopia, highlights complex set of risks, like
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country risk, business risk, finance risk and counterparty risks etc.
However, Engineering Tech (ET) must approach risk mitigation with a
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broad, holistic and all encompassing approach that essentially ensures
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that all potential risks to the infrastructural project is fully mitigated by
the necessary and appropriate mitigation tools and techniques.
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1b) Some of the resources available to Engineering Tech in this
infrastructural project are its key partners: its excellent relationship
with EFIC, Australia’s Export Finance and Insurance Corporation and
the Acacia Crew.
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The EFIC has a broad range of financial solutions that will ultimately
ensure the overall success of Engineering Tech in a country with
complicated risks like Ethiopia. EFIC has also committed to
environmental impact assessment of any projects it funds.
Acacia Crew’s expertise as experienced consultants and engineers with
successes in numerous high risk markets is a major resource for
Engineering Tech if properly harnessed.
Some risk mitigation techniques are listed below;
Documentary credit guarantees
Bonds
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Working capital guarantees
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Foreign exchange guarantees
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Political risk insurance
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Medium export payment insurance
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2) From the overview of the risks associated with the infrastructural
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project in Ethiopia, basic trade finance product and services will apply
to help maximize the likelihood of a successful outcome.
Basic trade finance products and services like
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a) Country analysis: country analysis is an important decision to
foreign investors to help ascertain the level of risk within the target
country.
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b) Documentary Credit guarantees: rather than rely on ET’s foreign
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partner’s banks overseas, a documentary credit guarantee can help
project activity. A documentary credit guarantee can help protect
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Engineering Tech’s contract payments. It gives increased confidence
that if Engineering Tech provides its bank with the documents required
by the documentary credit, ET will receive payment. This also enables
the bank to advance working capital to Engineering Tech.
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c) Foreign exchange guarantees: Adverse movements in exchange rates
are inherent risk of doing business internationally. For example if
Engineering Tech pay suppliers in Australian dollars, wages/salaries
and utilities in Ethiopian currency but receives payments in US dollars,
unfavorable shifts in the exchange rate of the currencies may affect
Engineering Tech’s profit margin. A foreign exchange guarantee facility
can help ET protect its profit from exchange rate fluctuations by
locking in exchange rate and allowing ET to hedge its currency
exposure. The more of foreign exchange it can hedge, the greater the
control over foreign exchange risks.
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d) Political Risk Insurance: Political risk insurance is critical in this
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project because it involves commercial risks and it’s a project in a least
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developed country, with an uncertain political environment. E.g. if the
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project is damaged in civil war or political violence or the project is
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taken over by the government of the host country, Engineering Tech
will suffer substantial financial loss. Political risk insurance from EFIC
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can help protect Engineering Tech from financial loss due to certain
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political events and this ultimately gives greater confidence to ET.
e) Medium term export payment insurance: in general, the longer the
payment period in project contracts, the higher the risks of non-
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payment and the greater the pressure on ET’s working capital. Export
payments insurance from EFIC can protect ET against the risks of non-
payment due to defined commercial and political events.
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Other important products and services include bonds and working
capital guarantees.
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These products and services essentially help mitigate risks and
maximize the overall bottom line of the project.
3) Yes Engineering Tech can effectively protect its interest and assure
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payments.
Some major interests of ET in this project are their profits in the
venture, their assets and their brand image or corporate identity. To
ensure that ET’s profits are secure and not eroded, ET should get an
advance payment, documentary credit guarantees and insurance, these
ensure that Engineering Techs interest are secured a that their profit are
secure.
ET must also ensure that their assets are not used as loan collaterals that
cannot be redeemed or financed. Also, ET must ensure that all their
assets are insured, this ultimately secures ET’s assets.
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4) Overall, the Acacia crew can offer assurance that ET will have a
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potentially successful outcome in executing this project if the board of
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ET plans effectively, mitigates its identifiable risks, ensures adequate
financing and cash flow over the term of the project.
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The “Acacia crew” are well-experienced consultants and engineers
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with successes in numerous high-risk markets and they understand the
dynamics of executing project like this unlike the ET board and
partners.
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Experiences like these are invaluable and ET can leverage on these
experiences and ultimately be successful irrespective of the perceived
risks.
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