Massimo Falcioni, Head of Middle East Countries at Coface, explains the strengths of credit insurance and lessons learned from the 2008 crisis, explaining credit insurance addresses key challenges of SMEs’ growth, such as protection against non-payments, risk assessment and monitoring, and better access to funds.
At the Global Trade Development Week, you said: “The delivery of timely in-depth insights, especially in risk monitoring, is of crucial importance for all companies operating in international trade.” What is your viewpoint regarding the diversification and stability of the UAE’s economy?
The economic diversification model established in the UAE is a reference not only for the entire region, but also in general for all oil exporters worldwide. In the UAE, dependency on oil was reduced from 90% down to 30%. I would like to quote His Excellency Eng. Sultan Bin Saeed Al Mansouri on this, who said that in line with Vision 2021 dependency should further be reduced to 10% in the next 15 years.
The UAE is a reference model because if you see what is happening at the moment with the fall in oil prices, all the non-diversified economies are suffering. Many African countries and also some Arab countries have the same problem. Economic diversification promotes sustainability when oil prices become particularly volatile.
In 2015, Coface expects world growth to be below 3%. The recent geo-political situation worldwide is causing some uncertainties which impact global demand and financial liquidity.
Dubai leveraged on its strategic position to attract foreign direct investment and create a real re-export hub for three major destinations: the Arab world, Asia and most recently, Africa.
In addition, in line with the UAE Vision 2021 National Agenda inspired by Sheikh Khalifa bin Zayed bin Sultan Al Nahyan, the President of the UAE, other services were developed in the financial sector, tourism, food, heavy industries, real estate, ICT, and electronics aimed at improving the quality of life of UAE citizens thereby creating a perfect balance between economic and social development.
Regarding risk monitoring, to be a real re-export hub you need to have entrepreneurs ready to know exactly how to competitively trade in the destination countries. The global environment is very competitive. Entrepreneurs need to know the creditworthiness of their customers, if they want to sell on credit and establish a consolidated partnership. One of the major requirements is to sell on open account credit. The relationship between a seller and a buyer – especially if the buyer is not in the country where the goods are stocked or manufactured or re-imported to then be re-exported – is key in order to make this kind of flow constant and sustainable.
The first mechanism between a buyer and a seller is to anticipate the payment. However, when the partnership is not there yet, there is the advanced payment approach, which protects the seller against the non-payment and the logistic cost to re-export the goods. When trust arises, after some transactions, another mechanism is the partial anticipated payment. But, all of these are mechanisms that rely heavily on liquidity, which in turn slows down trade flows.
To be sustainable and more rapid, trade flows need some levers. That’s why banks and credit insurers might help. Banks can create such kind of links with a letter of credit, confirming the trade between the seller and the buyer. Still the mechanism banks use to do this is based on guarantees: the bank provides the guarantee if there is another guarantee in place. And traditionally it’s transaction by transaction.
Another mechanism, which comes after this, is to trade on open account, according a credit limit underwritten by a credit insurer: a seller agrees that a buyer can buy up to a certain credit limit while the transactions are protected against non-payments by the credit insurers. When a seller is doing this, he’s acting like a bank.
Why are information and risk monitoring is important?
Because when credit insurers are doing this, it’s because there is plenty of information available; they monitor payment behavior of companies worldwide, they know exactly the country risk, sector risk, product-cycle risk, risk of insolvency and credit worthiness of the buyer and many other things. At Coface, we strongly believe that in-depth information on buyers and constant monitoring on site by sector and country experts are key to assess correctly a risk of default or non-payment, and assist through our wide risk management service offer companies of all size to trade and export safely.
Asymmetric information is one of the key problems in making these kinds of transactions. How feasible is it for SMEs to create those kinds of information structures?
Asymmetric information is indeed a key factor. An entrepreneur or an SME obviously cannot invest in such IT, skilled people, or information set. An SME has a fragile financial structure, especially if it’s an exporter. In this case, SMEs don’t have assets traded specifically; they take their small margins over the service they provide and based on the volume of trade.
For SMEs cost control is vital as well as profiling a healthy customer portfolio. In this case, SMEs don’t need to set up risk monitoring or risk management structures; they can easily outsource the services to external providers and mitigate their commercial risks through credit insurance solutions.
To conclude: what SMEs need is access to information, to sell on credit, possibly on open account. Entrepreneurs need to know the risk they are taking in order to decide which kind of measure they want to take.
How can trade credit insurance play a vital role in supporting SMEs’ cash flow and capital if we compare it to the conventional banking system, for instance?
The credit insurance sector in the GCC region is still in its infancy stage. Coface estimates around 500 companies insured against the risk of non-payment, the total industry premium wallet for $70 million. If you compare the revenue stemming from this sector compared to the GDP, you will see that the penetration of such kind of instrument in the region is very under-developed, at around 0.0047%. If we exclude from the GDP the oil component, the GCC region remains underpenetrated at around 0.005%, which is six times lower than the average of several developed economies.
The reason for this is mostly because there is a lack of proper education on such kinds of solution and risk consciousness. It seems to be a new solution for the region, but it’s not very new at all in many other countries in the world, for instance the US and Europe.
Credit insurance helps entrepreneurs to facilitate their business in a simple way. A credit insurer has to have clear risk assessment and monitoring capabilities on site. So there should be a credit analyst and a financial analyst who can provide credit opinions and can do risk assessment.
In many countries there is little access to or information on companies’ financial affairs. Therefore, the only way for credit insurance companies to efficiently underwrite the risk and to protect against non-payments is to have all their people in the field; to have their information entities that can visit entrepreneurs and customers; and understand based on their country and sector experience, what is the potential opportunity, credit worthiness, and credit merit of the companies.
Secondly, credit insurers interact with the banks, exchanging information about risk assessment, for instance on liquidity trends, information on economic sectors or also specific projects. Credit insurers combine these two sets of information with the most important one that comes directly from the customers of the credit insurance, which is the payment behavior of the buyers.
For instance, Coface through its local partners in the GCC region, currently has an exposure of approximately €7 billion. You have to multiply this amount by 3 to understand how much trade; domestic and export-oriented regional transactions are currently protected and guaranteed. So, €21 billion is a remarkable figure. But what is much more relevant is the number of buyers which are constantly monitored by Coface Emirates Services, which is the Dubai-based enhanced information service company, established by Coface in 2007, which is monitoring approximately 33,000 local companies in the GCC.
33,000 companies monitored, on a daily basis, on their payment behavior: if they pay, if they have a delay in payment, if there are protracted defaults, if there is any incident of payment. This is done by sector, company size, trade size, and country of destination in the region, and it gives you an immediate flavor and understanding, long before any economic reports. Through its network of 46 enhanced information centers worldwide, Coface monitors approximately 65 million companies worldwide. Coface offers risk management solutions to companies in 99 countries and guarantees in nearly 200 countries.
One of the characteristics of this part of the world is its speed: speed of the economy and transactions. So you cannot wait for a quarterly report; you really have to monitor this on a daily basis, like currencies.
Credit insurers translate their financial stability on the risk they protect. Companies, whose trade receivables are protected against payment default by a credit insurer automatically benefit from the rating of the insurer. Banks and factoring companies consider the trade credit insurers’ rating and not the buyers’ probability of default. As a consequence, credit insurers also facilitate access to funding from financial institutions.
For instance, if you look at Coface, it’s rated by two rating agencies such as Moody’s and Fitch with AA- and A2, both with stable outlook.
Trade credit insurance, however, has also been criticized because during the 2008 crisis many of these insurers have withdrawn their services because they had foreseen large losses had they continued to underwrite sales of failing businesses. At the end of the day, can SMEs really rely on those kinds of services when they’re needed the most? How can this challenge be overcome in the sector?
Thank you for this question. This criticism is leveled at this industry most of the time, especially for its behavior in 2008.
All credit insurers learned a big lesson from that crisis. The big education was firstly that no credit insurer anticipated the crisis, which is very bad, because whoever is involved in risk and is managing it must of course be able to predict it. Insurers have now improved the risk management tools and algorithms they were using, which in the past were mostly based on historical and statistical elements. The crisis in 2008 showed that something had to be changed: the statistical series were not capable of predicting.
The model had to be changed, and all the insurers changed their predictive models. Today most of the insurers use to have the “fuzzy logic methodology”, but all of this methodology has been further enhanced through probabilistic and econometric models, in order to anticipate the evolution of the defaults. So, the first lesson learned was to enhance the predictive risk management models with the ability to provide so called “early warnings” rapidly.
Second, in a situation of economic slowdown, the value of the information on which an entrepreneur can set his own strategy becomes much more important than one dollar granted for exposure. So insurers started to change the paradigm, based on the provision of state-of-the-art additional tools to monitor risk in order to anticipate and enhance prevention. Since this crisis the priority of credit insurers became not only to provide protection but to prevent such incidents. At Coface, any entrepreneurs, corporate companies or banks can immediately have access to information regarding the level of risk concentration, by sector, country, or single element; the dynamics and the trends, so you can take actions immediately.
Third lesson learned: reaction was too slow. Insurers learned also that IT investment in infrastructure was very important because decisions have to be taken fast. There was another component which was unbalanced during the crisis: the cost ratio for such prevention/protection was too low. Economies worldwide came from 10 years of a growing economy, where the premium rates were going down due to a declining claim trend and fierce competition in the sector, while the exposure was going up at a level never recorded in the sector. Insurers were not prepared for a crisis like the one we had in 2008. They learned to adjust to more sustainable pricing to be more risk based and less commercial.
Today, insurers have the most reliable and cost-effective source of protection worldwide and their pricing guarantees the appropriate technical equilibrium of the policies.
Many investors see Expo 2020 more as a target instead of a milestone, so they think there might be a cliff after 2020. What do you think Dubai can represent for global investors and especially American financial institutions that are willing to diversify their portfolios towards the MENASA region?
Expo 2020 is a huge opportunity and will be also a huge opportunity after the 2020 date. I don’t think there will be a slowdown after 2020. Expo will generate 250,000 jobs; it will be a major window for global investors. Also the stress the Committee is placing on renewable energy will make Expo 2020 very innovative. Again, this is another reference model which can be an inspiration for many other countries.
It’s a prototype of a society; it is much more than an expo. Expo 2020 will be like the fractal, the smallest structure of a snowflake. Nature has invented a unique shape of that crystal: this is the Expo. It’s an example of engineering, sustainability, mobility, and connectivity that can be replicable and scalable to create something magnificent. It can be revolutionary.
This is a vision that doesn’t belong to old traditional economies. This belongs to innovative, state-of-the-art and dynamic economies like the American or European ones.
Expo 2020 will go far beyond a traditional expo where you only show the product and the goods of a country. It’s how they are connected, how together they can make a system. I am very anxious to see how Expo 2020 will be, because this will inspire investors and countries, and set new megatrends.
His Highness Sheikh Mohammed Bin Rashid Al Maktoum, Vice President and Prime Minister of the United Arab Emirates, and Ruler of Dubai; summarized the vision behind the Expo 2020 project: to think that the impossible doesn’t exist, to go beyond your limits. What is limitless? Your mind and your heart; and the combination of the two is the DNA of Expo 2020.
This should attract investors. An investor is not a financial person; an investor is a visionary who sees things where others don’t see.
Dubai has been very successful at branding itself; and it’s now regarded to as a symbol of luxury and opulence. Yet, very few people know what it actually means to live here. What has surprised you the most about living here in Dubai?
The speed of how things happen. The velocity and effectiveness of decision-making process is very unique and crucial to the success of the UAE.
The second one is the cosmopolitan society. It’s like Hong Kong or Singapore. More than 80% of residents come from different nationalities.
Third, it’s how Emiratis successfully created an environment to ease such multicultural population living together, respecting and integrating every nationality cultural background, and developing trust and partnerships between the local and international community.