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1 practical information hermes cover special Cover for local-currency receivables march 2012

2 practical information hermes cover special Cover for local-currency receivables Export contracts are for the most part denominated and financed in hard currencies, particularly the euro, the US dollar and, to a lesser extent, the Swiss franc, pound sterling and the Japanese yen. It has been standard practice for a long time for Hermes Cover to be provided for export credits denominated in these currencies. In the case of single transaction cover, contract bond cover, credit framework cover and securitization guar antees, it is also possible for the guarantee contract to be ex - ecuted in the contractual currency in full, i. e. includ ing the calculation of the premiums and payment of indemnification. However, German exporters and banks are increasingly being asked by their foreign customers to have trans - actions handled in their local currency, which may not be one of the standard currencies for international trade. Hermes Cover has been available for many years for such transactions on short payment terms and with - out any further covenants. Since 2001, it has also been possible to obtain cover from the Federal Government for credit receivables in these local currencies ( localcurrency receivables ). The availability of cover for local-currency receivables on credit terms depends on special criteria being satisfied. These relate to the eligibility of the receivable for cover and the handling of such cover. This document describes the main conditions for and special characteristics of cover for local-currency receivables. Accordingly, the Export Credit Guarantees of the Federal Republic of Germany constitute a further instrument for addressing the challenges of the market and reinforcing the com peti - tiveness of the German economy. The range of such bespoke finance solutions can help to focus attention more squarely on the quality of the prod ucts and services during pre-contractual nego - tiations, thus heightening German suppliers business opportunities. what advantages does local currency finance offer? Local currency finance is particularly sought when the foreign customer generates most of its income in its local currency. It also facilitates the integration of German deliveries in an overall finance package denominated in the customer s local currency, something which can offer advantages in the case of major infrastructure projects, for example. This makes it easier for the foreign debtor to calculate its repayments as it does not have to take account of exchange-rate fluctuations. This therefore reduces the currency-related default risk. At the same time, there are advantages for the customer s country itself. As local-currency debt can be managed using the instruments of monetary and fiscal policy, it is not necessary to resort to foreign currency reserves. This strength - ens the domestic financial market and avoids the risk of major projects in particular exerting additional strain on the country s foreign debt position. By the same token, it does mean that the exchange-rate risk shifts to the creditor. Ideally, the financing bank or exporter will provide the funds via its own local branch. If this is not possible, suitable financial instruments must be utilized to hedge against the exchange rate risk 2 Export Credit Guarantees of the Federal Republic of Germany

3 what does local-currency cover mean? Under local-currency cover on credit terms, receivables are covered in currencies which are not hard currencies but which the Federal Government considers to con sti - tute an acceptable risk. This cover is available for both supplier and buyer credit cover and supplements conventional cover for receivables denominated in the conventional trading currencies (i.e. EUR, USD, GBP, JPY, CHF, CAD, AUD). The term local-currency cover is used to distinguish this product from conventional foreign currency cover, which is also provided for a receivable denominated in a differ - ent currency. In the latter case, it is possible to enter into the guarantee contract either in the same foreign currency or in euros, i.e. the premiums and indemnification are also denominated either in the foreign currency or in euros depending on which option is selected. In the case of local currency cover, the guarantee contract between the insured and the Federal Government is always de - nominated in euros. how is local-currency cover granted? The Federal Government provides cover for local currency finance after examining the merits of the indi vidual transaction and determining the currency involved. In addition to the standard details on the transaction concerned, the application should also explain why local currency finance is being sought for the deliv ery in ques - tion. The application should also state whether provision has been made in the contract for the currency of the covered loan to be converted into euros in the event of protracted default and, if not, the reasons for such waiver. In the case of buyer credit cover, additional in - formation on the amount of and the method for calcu - lating the interest must be provided so that the premium can be calculated. Upon receipt of the application from the exporter or the bank, the mandataries conduct a preliminary examination to determine whether the local currency in question is eligible for cover in the light of current conditions. On the basis of the individual application, the under - lying economic conditions and the situation to date in the buyer s country are examined. In addition to the stability of the currency relative to the euro, the currency regime and convertibility, the criteria considered in de - ciding on whether cover is to be granted and for calcu - lat ing the premium also include the state of the local currency and credit market, interest rate structures and inflation levels. In the case of local-currency cover, the application should be submitted as early as possible to avoid delays in the negotiations as a result of the more extensiv review process. To date, cover has been provided for transactions in Indian rupees, Mexican pesos, Russian rubles, South African rands and Taiwanese dollars on credit terms. 3

4 the insured risks As a matter of principle, local-currency cover applies to all political (e.g. acts of government, unrest) and eco - nomic (e.g. insolvency, default) risks provided for in the General Terms and Conditions applicable to the form of cover sought (supplier credit, buyer credit). On the other hand, conversion and generally also transfer risks do not arise as payment is normally made in the buyer s country. If this is not the case, the transfer risk is covered on condition that all necessary government approvals permitting transfer of the foreign currency out of the country in question have been received. The un - insured percentage is the same as that provided for in the General Terms and Conditions for the specific form of cover. handling and calculation of indemnification Indemnification for a local-currency receivable is paid in the same way as for other types of cover, i.e. it is gener - ally paid in installments. The currency of the indemnifi - ca tion is always the euro. For this purpose, the value in euros of the credit installment for which indemnification is payable is determined on the date on which it is due for payment. Normally, cover is applied for in such a way that the exchange rate applicable on the date of the premium invoice, which would otherwise cap the amount of indemnification, is irrelevant. This is consistent with the procedure which is also normally used for cover for re ceivables denominated in US dollars or other hard currencies in cases in which the no exchange rate cap option is selected. This limits the risk for the insured of the local currency appreciating as it is possible to receive a higher euro - denominated amount as indemnification than the amount which would be due if the receivable were converted at the rate applicable on the date on which cover is provided. On the other hand, the insured must use suitable financial market instruments to limit the depreciation risk, i.e. the risk of the amount after conversion to euros being lower than the receivable in question on the date on which indemnification is paid. To ensure that the insured is able to match maturities, the Federal Government generally waives lump-sum payment of the entire indemnification and instead pays it out in installments. As a matter of principle, the credit contracts for which cover is sought should include a crystallization clause stipulating that the indemnified receivables are to be crystallized at the exchange rate applying on the date on which they originally fell due for payment. This can be achieved by converting the receivable to a genuine eurodenominated receivable or by determining that local currency units are now to be owed in an amount equaling the euro-denominated amount derived by applying the exchange rate applicable on the date on which the re - ceivable is due for payment. The purpose of the crystal - lization clause is to provide the Federal Government with a right of recourse towards the foreign debtor in an amount equaling the indemnification paid (in euros) and to shield it from exchange-rate losses during the recourse period. If it is not possible to incorporate a crystallization clause in the agreement, the reasons for this must be set out in detail. Export Credit Guarantees of the Federal Republic of Germany 4

5 what costs are involved? Local currency cover is subject to the standard principles for calculating premiums for the type of cover in question comprising handling fees and the cover premium. The fees and premium are always charged in euros. If cover is being sought for very high financing costs, an additional surcharge may also be necessary. As a matter of principle, handling fees are calculated according to the value of the order or the loan amount. In the case of cover for receivables, the premium is for the most part calculated on the basis of the credit amount, the risk rating for the country in question (country risk category), the debtor s cred it rating and the term of the credit in question. A sur - charge of 10% is added for additional indemnification in the event of any appreciation in the local currency. The OECD guidelines for officially supported export cred - its also provide for a discount on the premium for localcurrency finance in the event of reduced political risks. In Germany, the Interministerial Committee decides on whether these conditions are satisfied and whether a deduction is warranted. If you have any further queries, please do not hesitate to contact us. You will find the contact data on our website under the heading Cover Policy/ Cover Policy on each Country. Martin Schmerbach The interest covered by local currency finance is fre - quently higher than the interest on comparable finance in euros or US dollars. However, as the premium is only calculated on the basis of the capital covered, an ad di - tion al fee may be charged in the event of substan tially high er financing costs. This is calculated on the basis of the interest rate applicable to the loan and the horizon of risk. An interest rate for local-currency finance is considered to be substantially higher if it is more than three percentage points greater than equivalent euro finance. If the actual interest rate is not yet known as of the date from which cover is provided, the difference between the applicable base rates can be used as reference. Export Credit Guarantees of the Federal Republic of Germany 5

6 Euler Hermes Aktiengesellschaft Export Credit Guarantees of the Federal Republic of Germany e 0715 Postal address Hamburg, Germany Office address Gasstraße Hamburg, Germany Phone: +49 (0)40/ Fax: +49 (0)40/ Branch offices: Berlin, Frankfurt, Hamburg, Cologne, Munich, Stuttgart

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