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CHAPTER TWO
ACCESS TO EXPORT CREDIT, WORKING CAPITAL AND OTHER FINANCIAL SERVICES

THE NEED

A major issue for existing and would-be SME exporters is the question of financing deals and obtaining related services such as credit insurance. Other preoccupations of SME exporters include having sufficient working capital and being able to operate without too much reliance on receivables. Members heard considerable evidence about the importance of competitively priced financing and insurance for SME exporters. Garth Jenkins, President of Abegweit Seafoods Inc., expressed the view of many SMEs about the relative importance of financing when he said:

I think the biggest problem with small and medium-sized exporters is financial. That's the single biggest common thread through the whole thing. [SMEs] are not on a level playing field when it comes to other countries. . . If the government, with industry and the banks, can put together better financial systems, then that would be one of our biggest steps forward. (70:16)
For SMEs, financing an international transaction is a multi-faceted problem. First, there is a general bias within both the private sector and government in favour of larger companies with large, high-profile export or investment contracts. There is a sense among many SME entrepreneurs that private sector financial services firms view the financing of SME export contracts as a costly and risky venture with little short-term return. According to Caisse centrale Desjardins President Jean-Guy Langelier, the application process has to be improved: ". . . [in] the vast majority of cases, applications from small businesses take longer to process because information is often missing or because the sale is of low value; as a result, these applications are not given the desired priority". (71:3)

Many SMEs argue that banks and other financial firms do not tailor their services sufficiently towards the needs of SMEs and how they operate. In particular, there seems to be a general unwillingness among institutional lenders to provide short-term, pre-shipment, working capital for export contracts and to take into account an SME's foreign accounts receivable in calculating their line of credit. David Killins, President of Legacy Storage Systems International Inc., and Paul Russo, President of Genesis Microchip, both argued that financial institutions require too many personal guarantees, even in respect of publicly-traded companies. Mr. Russo said that, where there are a number of shareholders, personal guarantees are not practical, and this requirement effectively prevents some companies from accessing sources of credit, including government lenders such as the Business Development Bank of Canada.

One effect of this absence of specialized services for SMEs is that smaller companies do not generally get the same access to capital as larger companies. In addition, many SMEs find that when they convince their creditors that they meet the eligibility requirements, they often find that strict limits are placed on the level of credit for which they are eligible. In his experience, William Friend, CEO of ATS Aerospace Inc., said that SMEs require approximately 25 percent of their annual turnover as a line of credit in order to be able to operate successfully in the international market. This is a higher level than what financial institutions are generally willing to accommodate. (66:9)

In cases where smaller companies gain access to capital, they frequently find that the interest rate charged is higher than what their larger domestic and foreign competitors have to pay. Robert Shore, President of Shore Holsteins International Limited, said that his company lost sales in Brazil in 1992-93 because EDC could not provide the same kinds of payment terms that European companies were receiving from their governments' respective export development agencies (submission, p. 11). Jean-Guy Langelier observed that Canadian SMEs are at a disadvantage vis-à-vis their competitors in some OECD countries that do not fully respect the international consensus rules on export financing. For example, the EDC "always requires a deposit from foreign buyers, and grants financing based on market rates; other countries, through a series of arrangements, manage not to require a deposit or demand only a bare minimum, and provide financing at favourable rates". (71:3) Observations from other witnesses confirmed the importance of competitive financing terms to customers so as not to be excluded from developing export markets, especially in the emerging markets of Eastern Europe, Asia, and South and Central America.

Closely linked to the issue of export financing are credit insurance and risk insurance. Witnesses stressed the importance of access to insurance, not only for prudent business reasons, but also as a condition of credit imposed by Canadian banks. William Friend noted, ``Banks don't lend risk money. They lend money on certain receivables if they are within 90 days. Often an export requirement is for longer than 90 days. So they won't move unless EDC moves or unless you have a CCC backing.'' (66:10)

GOVERNMENT PROGRAMS AND SERVICES

The Export Development Corporation

The EDC is Canada's source of official export credit. The Crown Corporation provides four main services: export credit insurance; export financing; surety bonding; and foreign investment insurance. EDC's export insurance protects exporters against 90 percent of losses due to non-payment relating to commercial and political risks. EDC provides short-term or medium-term insurance, performance-related guarantees and foreign investment insurance. In export financing, EDC extends medium or long-term financing to a foreign buyer to purchase Canadian capital goods or services. EDC will finance up to 85 percent of the Canadian portion of an export deal and will assume the financing repayment risk for the exporter. Financing services offered by the EDC include loans, lines of credit and loan guarantees. Companies seeking EDC insurance or financing must satisfy EDC's minimum 60 percent Canadian content requirement.

The EDC operates two main accounts: the Corporate Account and the Canada Account. The Corporate Account is operated on a user-pay basis with revenues generated through premiums, fees for insurance and fees associated with loans and guarantees. All loans in this Account are fully repayable with interest. No grants or contributions are available through the Corporate Account.

Under the Export Development Act, the Government of Canada is authorized, in prescribed circumstances, to undertake certain activities of a financial nature to facilitate and develop export trade. In these circumstances, the EDC, through its Canada Account, acts as the agent for the government in executing the financial transaction and is reimbursed for its services. In 1994, the Canada Account paid the Corporation $12 million for expenses incurred in administering this portfolio.

Export insurance is the largest component of EDC's activities, representing almost81 percent of total business volume of $12,265 million in 1994. The Corporate Account represents almost 95 percent of all business volume, while the remaining 5 percent consists of activities undertaken under the Canada Account. More than 83 percent of business under the Corporate Account consists of export insurance in contrast to the Canada Account where export insurance at $170 million represents only one third of the export financing business amounting to $454 million.

In 1994, 84 percent of all EDC customers were SMEs. Moreover, 9 out of every 10 of EDC's short-term insurance policyholders are SMEs.11

EDC's role in export finance

There were suggestions that the EDC, the banks, and other financial services firms are competitors with each other in providing export financing for SMEs. However, EDC President Paul Labbé claims that the role of the EDC "is largely complementary, rather than competitive, with the private sector." He said, "If we have competition, it comes primarily from the export credit agencies of other countries. Thus, on an international level, we are working to ensure that there is a level playing field for Canadian exporters." On the issue of foreign competition, Jean-Guy Langelier argued that Canada's approach to the voluntary limits to concessional financing that it has agreed to with other OECD countries "puts Canadian SMEs at a disadvantage, particularly in relation to competitors in signatory countries that respect only the spirit of the consensus."

EDC's specialization in credit and risk insurance

But financing is only part of the equation. Credit and risk insurance were also identified by witnesses as a critical part of putting together an export deal.

EDC export credit insurance policies insure exporters for up to 90 percent of the value of their exports against non-payment by the foreign buyer. Many exporters also use EDC-insured export receivables as collateral to access working capital from their banks. On January 17, 1996, EDC added to its list of credit and risk insurance products and announced that it was improving its risk protection for new exporters by eliminating a claims deductible from its small business credit insurance that had previously been automatic for companies new to exporting.

Credit and risk insurance broker, Ron Doyle, identified six areas where EDC services are either cheaper than, or not available, in the private sector:

While recognizing that the numbers of providers of credit and political insurance are expanding rapidly, Mr. Doyle said these changes will benefit mostly the medium and larger-sized exporters, because "the private market is not focussing on the needs of smaller companies."

There is also room for improving the application process for EDC insurance. The Committee heard that certain terms and conditions make EDC's insurance too expensive for Canadian companies competing with companies from other developed countries. The way in which companies are organized can also have an impact on the price of their export finance. Commenting on the price of EDC insurance, Ron Doyle said that EDC is competitive with European insurers. He suggested that the difference in insurance costs to SMEs in Europe versus those in Canada, may be due in part to the European practice of exporters working in consortia that have financing groups associated with them. Working in partnership with a group of companies, European SMEs try to use consortia for increased leverages in gaining greater access to and better terms for their export financing.

The Committee's examination of the EDC focussed mostly on two initiatives that were launched in March 1995: the Emerging Exporter Team (EET) and the MARG Program. The EET provides specialized services for SMEs, while the MARG Program was established to encourage banks to extend incremental operating lines of credit to exporters against their foreign accounts receivable.

In order to target their services more directly at SMEs, the EDC established its Emerging Export Team in March 1995. The EET's has four main objectives:

Service to SMEs has been increased by launching a 1-800 line that links small business directly with EDC representatives who specialize in small business financing and insurance services. The EET has conducted company surveys and focus groups in order to help determine the best way to market their services to potential EDC customers.

The EET is also working with other federal and provincial programs and with trade associations to build their customer base and to increase the satisfaction levels of existing customers. Existing market research suggests that SMEs are generalists, want only the essential information, dislike bureaucracy and are pressed for time. They are uncomfortable with large organizations and they value government backing on their contracts. The EDC has reacted to this reality by setting up a core group of SME specialists in an attempt to streamline further all of their processes and by producing clearer and more concise documentation on the agency's services.

The Master Accounts Receivable Guarantee (MARG) Program

Several witnesses commented on the difficulties of using foreign accounts receivable as collateral for securing working capital to finance export contracts. Several reviews of the needs of SMEs, including the Wilson Report, recommended that EDC develop, in cooperation with Canadian financial institutions, new export financing instruments to deal with this issue. This led to the launching in 1995 of pilot projects between EDC and the Bank of Montreal and the Royal Bank of Canada of the MARG Program. Under this Program, smaller exporters are able to secure operating lines of credit from the participating financial institutions of up to $500,000 against the value of their foreign accounts receivable. Exporters must have total annual sales of less than $5 million to be eligible for this Program. The difference between MARG and EDC credit insurance is that MARG provides the exporter's bank with protection against 90 percent of the funds of an operating line if the exporter's company fails; EDC credit insurance provides exporters with up to 90 percent protection against non-payment by foreign buyers.

Based on the positive experience of the two pilot projects, EDC announced on February 8, 1996, that it was expanding the Program to all Canadian financial institutions. EDC has so far secured the additional participation of the National Bank of Canada, the Caisse centrale Desjardins, the Toronto Dominion Bank, the Bank of Nova Scotia, and the Canadian Imperial Bank of Commerce (CIBC).

EDC has also established a risk-sharing framework with the banks to serve the medium-term export financing requirements of SMEs. Under this framework, EDC is prepared to guarantee 75 percent of the medium-term export financing provided by banks to SMEs. According to EDC President Paul Labbé, "risk-sharing between EDC and the banks is essential in mobilizing increased support for SMEs, and (EDC hopes) these new initiatives via these partnerships will encourage banks to reengage in this essential market segment".

SERVICING THE SME: ASSESSING GOVERNMENT-SPONSORED EXPORT FINANCE SERVICES

The Committee received generally positive reviews about the MARG Program and the EET's focus on SMEs. However these two programs are relatively new initiatives, and it will be important to evaluate their effectiveness over the longer term. Paul Russo, President of Genesis Microchip, said emerging high-tech companies frequently find it extremely difficult to receive bank financing for international sales. Mr. Russo expressed the view of many of the SMEs who appeared before the Committee when he said, "EDC provides reasonably priced receivables insurance, thereby facilitating bank financing." Commenting more generally on EDC insurance services to SMEs, Namtrade International President Christine Jalilvand said that EDC programming "has improved tremendously," although she pointed out that improvements in service delivery and further streamlining are still required.

Many SMEs said they continue to find application procedures too time-consuming and the bureaucracy too cumbersome. Although many recognize that EDC has launched the EET to address these kinds of issues, there continues to be a lack of information and awareness of how procedures have changed with this reorganization. Finally, the perception persists that despite the reorganization of EDC and the fact that SMEs now represent 84 percent of EDC customers, government programs still principally cater to large companies.

Jean-Guy Langelier, President of Caisse centrale Desjardins, may have provided at least one explanation for this perception when he explained that:

Some SMEs develop foreign markets for which no Canadian financing is available either because the country is not eligible for government programs or because the financing limits set by the EDC for the country have already been reached. A foreign country's eligibility may also be suspended for political reasons.
The Wilson Report recommended three guiding principles for determining the role of public sector financing programs and services:

Generally speaking, the SMEs and other private sector representatives agreed with these principles. Lindsay Gordon of the Hongkong Bank of Canada expressed well the private sector perspective:

. . . government support programs for export financing should be focussed on the assumption of risks where banks' capacities end and thereby avoid overlap. These programs should also be run on a cost recovery basis.
At the same time, there is a need for mechanisms to coordinate private and public sector programs. Paul Langelier argued that current circumstances require the development of "a more cooperative approach among the various public and private sector stakeholders. . . The main private sector stakeholders and the financial institutions must be called on to contribute, each one doing its share."

RECOMMENDATIONS

    To press financial institutions to be more forthcoming with SMEs, the Committee recommends when conducting the regular reviews of the Bank Act that the federal government evaluate the performance and future intentions of financial institutions with respect to SMEs in export markets. If this effort is deemed inadequate, the government should take this into account in its decisions.
    The Committee recommends that the government should also encourage other financial institutions, in addition to schedule I banks, such as insurance companies, pension funds, credit unions and caisses populaires, to provide funds needed by SMEs for export trade. Those institutions that enjoy special tax advantages should receive particular attention.
    The Committee recommends labour sponsored venture capital corporations and RRSP eligible equity securities be encouraged to form strategic alliances for the purpose of risk sharing in small and medium business export programs.

Progress Payment Program of the Canadian Commercial Corporation

In February 1995, the Canadian Commercial Corporation - a federal agency established to assist Canadian business sell to foreign governments and international organizations - launched the Progress Payment Program (PPP). Its purpose is to provide small Canadian companies with better access to pre-shipment financing. This initiative responds to concerns expressed by banks and exporters in 1994 during the Standing Committee on Industry's investigation of the financing challenges facing Canadian SMEs. The concept of the PPP was also endorsed by the Wilson Report.

The objective of the PPP is to match the CCC's expertise in contract management and administration with the commercial financing capabilities of Canada's financial institutions. Pursuant to agreements with the banks, the CCC examines a project and assesses the risks associated with the supplier, the customer and the deal overall. This is done in order to determine whether the CCC can guarantee completion of the contract. Doug Patriquin, Executive Vice-President of the CCC said, "When the Corporation accepts the project and the company's banker is satisfied with the overall financial condition of the transaction, the bank will lend beyond a company's normal line of credit." In most cases, the CCC acts as a prime contractor in sales, monitors progress of work by exporter and administers progress payments from the bank.

Unlike its other services the CCC charges the Canadian firm a fee under this program. Depending on the specific contract, the CCC charges a minimum of 1.5 percent above prime to cover the interest rate on borrowed funds and the risks assumed by the CCC. There is also a non-refundable application fee of $500, which is included in the costs of monitoring and administration if a deal is approved. These latter costs are normally no more than 2 percent of the contract value.

It is the government "stamp" that gives the Canadian Commercial Corporation its raison d'être. Foreign governments and agencies and international organizations turn to the CCC for bids and these same customers become buyers of Canadian goods and services through the CCC because they put a value on having the government's "stamp" on the contract.

SMEs and other private sector representatives were extremely supportive of the Corporation's Progress Payment Program.

CIDA

Under its Partnership Program, CIDA provides "incentives to Canadian, international and developing countries private investors, institutions, organizations, and governments in support of industrial cooperation programs, projects and activities as well as special program and project expenses directly related thereto." Commonly known as CIDA Inc., this group of incentives has a budget of $65.1 million for 1995-96. Since its inception in 1978, the Program has invested $670 million in projects in 115 countries.

CIDA Inc. has four main objectives:12

CIDA Inc. provides financing assistance for two kinds of activities: professional services and investment. Under its professional services mechanism, CIDA Inc. provides funding to assist companies in bidding for capital/infrastructure contracts with international organizations. This includes financial assistance for pre-feasibility studies, detailed studies of the capital project, and capital project support. The clients for this mechanism are mainly large engineering companies.

Under its investment mechanism, CIDA Inc. focusses on manufacturing companies interested in pursuing commercial activities with a developing country partner. The mechanism will provide assistance for a number of activities related to assisting in the development of such joint activities, including pre-investment costs (e.g., exploratory study to find local partners), training for technology transfer, and the costs associated with adjusting equipment to local needs.

When examining an application from a Canadian company, CIDA Inc. considers the benefits the project is expected to generate for both the developing country and Canada. Among the benefits sought for the developing country: job creation; gains in production; improvement of technical skills; import substitution; export generation; foreign exchange earnings; and long-term business collaborations. CIDA Inc. eligibility criteria also require that the project generate the following benefits for Canada: identification of investment opportunities; foreign market development; export of goods and services; job creation; identification of import opportunities; and long-term business collaborations.

All of CIDA Inc. assistance is demand-driven: it is up to the private company or consortium of companies to apply for assistance. Over the last seven years there has been no shortage of demand: between 1978-79 and 1995-96, CIDA Inc. has received9,908 proposals for projects or studies submitted by 4,118 Canadian companies. About55 percent of applications each year are new clients. The rate of approval of proposals is about 60 percent. The issue, therefore, is not demand but rather supply: the budget for CIDA Inc. was reduced by $7.2 million for the 1995-96 fiscal year. In order to attempt to reduce the number of applications for assistance, CIDA Inc. now limits assistance under the investment mechanism to companies with more than $1 million in annual sales. There are two exceptions to this criterion: if three companies in a consortia can demonstrate that they generate collectively more than $1.2 million in annual sales; and if approved by the Minister because the application focusses on a unique niche.

In her testimony before the Committee, CIDA President Huguette Labelle explained that while CIDA Inc. is targeted specifically at private sector development in developing countries, support for such initiatives is also available through other channels. For example, CIDA's geographic programs "support private sector entrepreneurship and, in specific cases, use Canadian private sector partners to implement a given project." CIDA support for private sector development is also available through Bilateral Programs and through the Multilateral Branch, which funds programs and projects, involving the private sector, that are undertaken by international financial institutions.

The Renaissance Eastern Europe Program is also involved in promoting expanded international trade relations. The Program, which is funded by CIDA, supports a number of activities, including trade missions and trade fairs, bilateral trade councils and other initiatives to promote international business development.

Two of the witnesses who appeared before the Committee had had direct experience with CIDA Inc., and both expressed support for the Program. Robert Shore said assistance from CIDA Inc. proved invaluable for export promotion into developing countries:

. . . CIDA Inc. programs are very valuable to exporters opening new markets in developing countries. Training and technical assistance are crucial to developing new livestock operations. Without this support, the project is doomed to failure. This process is very costly and takes time. CIDA Inc. can provide the support required to ensure the success of new operations in developing countries, and therefore opening new markets for Canadian sales.
Jayson Myers of the Canadian Manufacturers' Association (CMA) also commented on his association's experience with using CIDA Inc. assistance to developing linkages between Canadian and developing country firms, and specifically in India and Latin America. According to Myers, by leveraging its strengths as a national industrial network, CMA "is able to multiply the benefits of CIDA Inc. funding by recruiting and providing assistance to a wide range of Canadian companies from across Canada and in a variety of industrial sectors."

In its report, the Special Committee Reviewing Canadian Foreign Policy recommended "that any functions of CIDA found to be essentially trade promotion activities be transferred to the Department of Foreign Affairs and International Trade or to the Export Development Corporation where they belong." The Wilson Report recommended that CIDA Inc. remain within CIDA but that responsibility for it be transferred from the Minister of Foreign Affairs to the Minister for International Trade. (As of January 25, 1996, the position of Minister for International Cooperation was created, with responsibility for CIDA and CIDA Inc.)

    The Committee further recommends that trade development and promotion programs, services and activities of CIDA be placed in the Department of Foreign Affairs and International Trade and that the mandate and operations of CIDA should be reviewed by the Minister concerned in the context of this recommendation.
11EDC defines SMEs as companies with less than $25 million in revenues; the threshold for SMEs under DFAIT and many other government programs is $10 million.

12Canadian International Development Agency, 1995-96 Estimates (Part III - Expenditure Plan), (Ottawa: CIDA, 1995),p. 36.

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