Why the OECD Arrangement Works (even though it is only soft law)

David Drysdale's column represents the eighth chapter for Global Policy’s e-book, 'The Future of Foreign Trade Support – Setting Global Standards for Export Credit and Political Risk Insurance'. Contributions from academics and practitioners will be serialised on Global Policy until the e-book’s release in the second quarter of 2015. Find out more here.

Summary

In summary, there are three components to the success of the OECD soft law on officially supported export credits. The Arrangement contains comprehensive rules, ensures real time transparency, and provides for the ongoing evolution of the rules to meet the needs of both the Participants and the markets.

The OECD as a Forum for Cooperation and Rule-Making

When it comes to making rules and adopting common policies on government-backed financing for exports, the OECD provides like-minded governments with an effective and flexible forum where international disciplines on officially supported export credits are agreed, implemented and monitored.

The OECD’s work on export credits is undertaken by two groups. The Working Party on Export Credits and Credit Guarantees (ECG) is an official OECD committee that was created in 1963; this group serves as a forum for the exchange of information on export credits programmes and policies. The Participants to the Arrangement on Officially Supported Export Credits came into being in 1978 when the first financial disciplines in the “Consensus” (subsequently, known as the “Arrangement”) were agreed. Although these two groups operate in parallel for practical reasons, they are ultimately independent from each other; this means that a country may decide to participate in the ECG, the Participants or in both groups, and is only obliged to apply the export credits disciplines of the group in which it participates.

The ECG is a formal OECD Body that operates under the OECD rules and procedures and all OECD members except Chile and Iceland belong to this group. The work of the ECG covers a wide variety of issues including sharing information on members’ products and services. This being said, the most important issues addressed by the ECG are related to good governance and it is in this forum that the two official OECD instruments on export credits (environmental and social due diligence processes, anti-bribery measures) were agreed. ECG agreements on these topics as well as sustainable lending policies reflect members’ desire for coherence between their national export credits policies, their international policies, and their commitments under relevant international agreements and conventions.

The Participants to the Arrangement is not a formal OECD Body; however, since “the Consensus” was originally agreed under the auspices of the OECD in view of the large overlap between its membership and that of the ECG, the Participants choose to follow OECD rules and procedures. There are at present nine Participants (Australia, Canada, the European Union, Japan, Korea, New Zealand, Norway, Switzerland and the United States) and two regular observers (Turkey and Israel). In addition, Brazil is a Participant to the Aircraft Sector Understanding (ASU) since 2007. The focus of the Participants’ work is the financial disciplines contained within the Arrangement.

The Arrangement sets out the most favourable financial terms and conditions that can be provided for official export credits, whether through direct financing, insurance, guarantees or interest rate support measures. It also contains disciplines on the provision of trade-related aid, principally with regard to tied aid. The text of the Arrangement, including its specific sectoral agreements, is regularly reviewed in the context of market developments and the evolution of broader public policy debates.

The purpose of the Arrangement’s is to foster a level playing field in order to encourage competition among exporters based on the quality and price of their goods and services exported rather than who can provide the most favourable financial terms and conditions.

Why the OECD?

Why did this all happen at the OECD? This is due to (1) the initial composition of the OECD, which included the main competitors in the provision of official export credits support, (2) the scope and type of such disciplines needed in various sectors, (3) the absence of any other international regulation (the WTO disciplines on export subsidies only became multilateral as of 1995), and (4) the available infrastructure to support this work.

From the beginning, the ECG was tasked with evaluating members’ policies regarding export credits, resolving any problems identified and promoting policy coherence, with the aim of developing common guiding principles and improving co-operation between export credits providers. Against the background of the 1970s financial crisis, this work evolved into discussing ways to limit subsidies in export credits by developing some financial disciplines: the result of these discussions was the 1978 Consensus.

Since then, these financial disciplines have continued to offer a unique framework in which close cooperation between governments has led to concrete results:

• In sharing information on export credits policies and practices among export credit agencies (ECAs) and governments;
• In developing and implementing various financial and procedural disciplines to govern the use of officially supported export credits, in a flexible manner, with a view to establishing a level playing field while eliminating financing subsidies; and
• In solving potential disputes in real time, allowing transactions to go forward in a timeframe commensurate with business needs.

The Arrangement, however, is a “gentlemen’s agreement” and, therefore contains no formal enforcement mechanisms. So why has it been so successful and why are non-members increasingly interested in OECD export credits work?

Reasons for Success

There are three aspects of the OECD export credit work on financial disciplines that makes it successful: comprehensive rules, real time transparency, and an ongoing evolution of the rules to meet the needs of both the Participants and the markets.

First, the Arrangement rules are comprehensive. They not only set the most generous repayment terms (tenor, repayment structure, cash payment), they also provide pricing rules, both for minimum premium (risk fees) and interest rates. These rules promote a level playing field among the Participants by ensuring that all aspects of the financing are covered, thereby neutralizing the competitive dimension of the financing. In addition, they ensure predictability on export credit policies and practices: everyone knows what the best terms available are, so no one worries about what terms competing governments might offer. Moreover, the terms are designed to meet the two key WTO obligations of charging risk fees that cover losses and administrative costs over the long term (the “breakeven test”), and not lending below the government’s costs of funds. Thus, in endeavoring to make these administrative rules as market-oriented as possible, the Participants have succeeded in minimizing subsidies, and thereby trade distortions, as well as costs to governments.

Second, the system provides for real time transparency. This transparency includes real time access to transaction based data, a forum in which confidential information can be exchanged, and a process for resolving disagreements before financial commitment in a transaction. There are no secret financing terms and, thus, no competitive advantages to be gained from deviating from the rules. Real time transparency is effectively a regulatory regime that provides confidence to all competitors that everyone follows the rules. Even if there is a disagreement on interpretation, it is transparent, thereby allowing everyone to know what the options are, so no competitive advantage is gained.

Finally, the rules are constantly evolving, adapting to changing needs of the users and the market. Over the last decade alone, the Participants have negotiated regular updates and upgrades to the Arrangement, including two successive aircraft sector understandings (2007 and 2011), a revised sector understanding (SU) for nuclear power plants (2009), a new SU for renewable energies and water projects (2009), which was then extended to include both climate change mitigation (2012) and climate change adaptation projects (2014), and a new SU on rail infrastructure projects (2014). In addition, the Participants have integrated rules for project finance transactions into the Arrangement, modified the provisions for supporting local costs and introduced a common framework for risk based pricing of both buyer and country credit risk. In the same period, the good governance disciplines have also evolved with ECG agreement to new instruments on anti-bribery measures and on environmental and social due diligence, as well as guidelines for sustainable lending that support the IMF and World Bank Debt Sustainability Framework for Low-Income Countries.

These elements have a proven capacity to resolve divergences: in 40 years, there has been only one dispute in the WTO on export credits among OECD Members (EU versus Korea on ships), and that was because, unlike the rest of the Arrangement rules, the SU for ships lacks the precision and depth of Arrangement disciplines, with, for example, no pricing rules. Another major export credit dispute at the WTO on aircraft (Brazil versus Canada) was finally resolved by the negotiation of the 2007 OECD ASU which brought all of the major aircraft producing countries, including non-member Brazil, to the table.

Importantly, despite the deep degree of coordination of export credit policies and practices at the OECD, the disciplines have constantly preserved national cover policies, individual underwriting decisions and portfolio management policies, all of which remain sovereign decisions. Each country bears the ultimate financial responsibility of its own export credit decisions while maintaining a level playing field on the financing terms.

The Future

Given the long term success of the OECD export credits work, what might the future hold? Today the main issue is the emergence of official export credit agencies in non-OECD countries, such as the BRICS. Should they remain outside of any rule setting system, join in the OECD work, or set up their own financial disciplines?

For countries deciding to stay outside of any rule setting system, the risks are clear: ultimately, there are the WTO anti-subsidy rules in the Agreement on Subsidies and Countervailing Measures (ASCM), including with regard to export credits; however, the ASCM also includes a safe harbor provision for those governments that follow the financial disciplines set out in the Arrangement. So any country, whether a Participant or not, may follow the Arrangement rules and benefit from this safe haven.

That being said, as mentioned earlier, the Arrangement is constantly evolving and adapting to the changing needs of the Participants and the market. So, why chose to follow a set of rules without having a say in how they might evolve over time? By participating in the OECD export credits work, any country can influence the future direction of the rules: a seat at the table allows a country to have a say in these changes. Brazil has seized this opportunity in the aircraft sector. And let there be no doubt, Brazil has been a major contributor to the aircraft rules, bringing a strong commitment to the technical work that underpins the results of these negotiations.

If the goal is to achieve a new set of disciplines outside of the OECD, in order to be successful, these disciplines would need to comprise the elements mentioned above: comprehensive rules, real time transparency, and the ability to evolve over time. Anything short of this would probably result in an un-level playing field, a lack of trust in compliance, and rules which will lose their relevance over time.

David Drysdale is the Head of the Export Credits Division of the Trade and Agriculture Directorate of the OECD. He has worked in the field of export credits since 1994, first at Export-Import Bank of the United States and later from 2001 until 2013 at the U.S. Department of the Treasury in the Office of Trade Finance and Investment Negotiations.