Global trader in the making
By Melvin J. Howard
Circumstance has a way of preparing you for life
without you knowing it. For example, when I was in College I got a job that was
arranged by my alumni department head. It was working for a major defense
contractor McDonnell Douglas in their countertrade division later I became one of their contractors. Little did I know at the time it
would play a major role in my life now? Countertrade is a term used for
parallel business transactions, linking sellers and buyers in reciprocal
commitments, which usually lie outside the realm of typical monetary trade.
Some of the common forms of countertrade transactions include barter,
counterpurchase, compensation, buyback, clearing arrangements, offset and
switch trading. More than 10% of world trade today involves some form of
countertrade. The World Trade Organization estimates that 15% or $8.43 billion
of the $5.62 trillion in international trade is conducted on a non-cash basis.
My mentor was a great teacher he was a Vice President
of the defense firm I was working for. I was learning first-hand how to do
world trade not in the classroom but on the front lines. He took me under his
wings and taught me the most basic and the most complicated forms of
Trade. Offsets–an umbrella term for a
broad range of industrial and commercial compensation practices required of
foreign suppliers under primarily government agency of state-owned enterprise
acquisitions–were made a common requirement for the procurement of either
military (e.g., fighter aircraft) or high-cost civilian hardware (e.g.,
commercial aircraft). Both defense and non-military offsets may entail overseas
co-production of the procured item, as well as other economically beneficial
transfers to the importing country that are not related to the original export.
To assist their exporters some industrialized country governments also promoted
countertrade under government agreements. For example, the French Ministry of
Agriculture signed in 1989 an agreement with the USSR Council of Ministers
which provided for exchanges of Soviet commodities for French agricultural and
food processing equipment and technologies. Other Western governments, such as
those of the United States, Canada, Belgium, Holland, the United Kingdom, and
Italy, established special countertrade service units within public agencies to
provide countertrade-related advisory assistance to their exporters. The French
Government has supported instead the formation of a separate countertrade
assistance entity in the private sector. The Swedish Government was until 1990
a major stockholder, through interests by the Swedish Investment Bank, in a
private sector company involved in countertrade. Now with trade agreements like
NAFTA in 1994, which integrate regional trade, based on free market principles
some countertrade has abated somewhat.
International countertrade practices are now
increasingly associated with bidding on major defense and non-military
government procurement contracts and with project financing–a contract-based,
off-balance-sheet finance technique whereby revenues generated from the output
of the financed project are directly allocated to service outstanding debt and
principal. A variation of the countertrade buy-back contract which links
foreign contractors’ repayments to the output products of the production
capacity they supplied, project financing relies instead mainly on contractual
recourse to the project’s revenue streams. (According to the World Bank,
developing countries are now spending around $200 billion a year on new
infrastructure investment, one-fifth of their total investment.) High procurement
costs and tighter budgets have prompted many emerging country governments in
the 1990s to issue new civilian offset regulations (e.g., United Arab Emirates,
Kuwait). Civil offset requirements, therefore, are increasingly acquiring a
financing rationale in these markets. In a global environment of budgetary
constraints, the ability of suppliers to meet offset requirements and/or to
provide their clients with financial packages that can best those of competing
bidders is a major competitive edge.
Project finance on the other hand refers to the method of financing a
particular project as a unit at least partially separate from the owner, or
“equity sponsor,” of the project. This typically means that the financing must
be repaid out of the cash flows generated by the project itself without
recourse to the cash flows or assets of the sponsor. Projects appropriate for
project finance are large in scale and require a large capital investment. In
addition, such projects will normally involve a considerable delay between
initiation and the first positive cash flow. Many of the projects are also
outside of the home country of the sponsor and in many cases are in an emerging
market. All of these, and other characteristics of typical project finance
projects, introduce several different types of risk. The key to successful
project finance is the identification and allocation of risk.
Often contractors and future operators sponsor the
project and provide a large part of the equity while a syndicate of commercial
banks provides debt financing. In addition, because project finance is often
used to finance the private provision of public services, the local government
is often involved in a contracting out or regulatory capacity and a state-owned
enterprise might be one of the participants in the project. A complex
contractual structure is usually established with lenders asking for maximum
guarantees and securities from other players. The focus of risk allocation is
usually on the construction and start-up period, which is generally the
riskiest period in the project's lifespan.
Under the financing structures, investors must look to
expected cash flows, as opposed to fixed assets, for repayment. As a result,
extremely careful risk assessment is necessary for each investor prior to
investment. With any valuation model used to assess the value of the project,
or any financial portion of the project, sensitivity analysis will be
particularly important. Analyses, which improve the accuracy of the forecasts,
and reduce the uncertainty surrounding the forecasts, such as engineering
studies, market analyses, etc. will be well worth the time and effort.
