Showing posts with label G-SIBS. Show all posts
Showing posts with label G-SIBS. Show all posts

Tuesday 4 May 2021

Freeport LNG Marketing LLC Financing: Did US Eximbank and PEFCO Flub Due Diligence on Greensill?



There was an article in the FT today calling into question US Eximbank's and PEFCO's due diligence in connection with an approval of a supplier credit transaction for Freeport LNG involving Greensill as lender.

The timing raises questions about the due diligence that the Exim Bank and Pefco, its funding partner on the deal, conducted on Greensill, whose German banking subsidiary was under investigation by regulators last year.

I think the questions raised can be answered: no.

Summary:

Eximbank and PEFCO have no financial exposure (credit risk) to Greensill in this transaction. As such, their due diligence was appropriate at the time it was conducted.

Eximbank’s primary focus in this transaction and others is (a) the promotion of US exports and (b) creation of US jobs.

Or in other words, Eximbank's customer here is Freeport.  Greensill is a service provider.

At this point, the ability of Greensill to fulfill its obligations under the transaction are in question. Eximbank is no doubt looking for a replacement.

That raises two issues: (a) finding an FI able to handle the supply chain invoice processing and (b) one willing to take risk (10%) on Freeport.

Detailed Argument

Now to the details that support those contentions.

At its 29 September 2020 Board of Directors Meeting ,US Eximbank approved a 90% guarantee under its Supply Chain Finance Program for transactions involving Freeport LNG Marketing LLC as the obligor. (Eximbank reference AP089370XX).

Note that date. Eximbank issued its commitment in September 2020.

At this point concrete news about Greensill’s situation was much different than in January 2021. So if there is an issue with Eximbank’s due diligence, it has to be focused on the period before 29 September 2020.

Eximbank lending is highly rules based. Procedures for approval are more complex and thus more time consuming than in a typical financial institution.

The board approval package would have been prepared, reviewed, and finalized well before the board meeting

You can well expect that as well preparation and approval of transaction documentation is similar. That explains the time taken to finalization.

Some key points about this transaction.

  1. Freeport is the obligor on the loan. Eximbank's credit risk lies squarely here.

  2. US Eximbank guarantees to pay the lender 90% of principal if Freeport doesn’t pay.

  3. The lender bears the risk of the unguaranteed 10%.

  4. US Eximbank is providing a guarantee not funding.

  5. If the lender does not or can not lend, then Eximbank has no exposure to either the obligor (in this case Freeport) or any obligation to the lender (Greensill).

  6. Eximbank reviews the documentation for each transaction under an approval for compliance with (a) the terms and conditions of its approval and (b) US content requirements. Then and only then it issues a “guarantee” for that transaction.

Clearly, then the primary focus of Eximbank’s due diligence would be on Freeport.

Due diligence on the lender would focus on its ability to handle a supply chain transaction both in terms of systems and experience as well as no "blocking" issues.  

Those would include legal prohibitions, e.g., US sanctions, etc.

Greensill passed those tests at the time of due diligence.

If the bar were set to exclude those FIs that engaged in reckless banking practices (imprudent lending, over concentration of risks, market manipulation) or illegal behaviour, then the set of "acceptable" banks for US Eximbank would appear to be fairly limited.  And exclude a large number of the G-SIBs.  



PEFCO is a specialist private sector owned lender that provides primary and secondary funding for loans guaranteed by US Eximbank. It also does a very minuscule business in other sovereign guaranteed loans. Roughly 1.4% of total loans.

Eximbank exercises “oversight” on PEFCO’s operations beyond that it does with other financial institutions to which it may give a guarantee.

Given the nature of its business, PEFCO is able to access both fixed and floating rate funding at very attractive rates.

In the Freeport transaction, PEFCO reportedly acquired a 100% “participation interest” in the Eximbank guaranteed portion of the Freeport loan.

That would mean that Greensill remained at risk of non payment on the unguaranteed 10%.

For the same reasons as above, PEFCO has no credit risk exposure to Greensill.

Given the Eximbank guarantee, it has none to Freeport.

Its decision to enter the transaction was almost certainly based on the US Eximbank guarantee.

PEFCO’s s role in the transaction would be to provide competitively priced funding in the form of a lower discount rate than Greensill could obtain in the market

That is, when Greensill presented PEFCO an Eximbank approved (guaranteed) supplier invoice, it would buy the invoice from Greensill at an agreed discount rate.

To reiterate: Eximbank's guarantee is evidenced by its issuance of a document after it examines the invoice and any supporting documents to ensure that (a) US content and other requirements have been met and (b) the transaction complies with the conditions of that approval.

PEFCO would make sure to confirm the guarantee.

Greenill’s compensation would be potentially a mixture of (a) the difference between its discount rate and PEFCO’s (b) any upfront fee it charged Freeport, and (c) any fees it charges Freeport for the processing of the supplier invoices.

What is to be done now?

Now there is a question as to what Eximbank “should” do now that Greensill has crashed or when the probability of its crash became apparent.

As noted above, Eximbank’s mission is to promote US exports and US jobs. 

So it would be rather reluctant to throw the Freeport "baby" (its customer) out with the Greensill "bathwater" (a service provider).  

As a general rule, Eximbank tends to very "high church" in honoring commitments/approvals it has given.  

Part of this is institutionally motivated to maintain market confidence in its "word".  

Part is concern that its customer may have made financial commitments and would therefore incur a loss, if Eximbank were to walk away. 

Eximbank and Freeport are no doubt looking for a replacement institution with the capacity to process supply chain finance.

And the willingness to hold 10% of the risk of any outstandings within the US$ 50 million.  

Two other key considerations for Eximbank.

The SCF program has been in existence for a few years. Frankly, usage has been disappointing. 

Eximbank has also domestic political considerations given its recent close encounter with the grim reaper.


Saturday 1 April 2017

BIS: GSIBs Risk IT Systems Weak

Unnamed GSIB Data Scientist /Risk Manager Demonstrates New Techology

In January 2013, the Basel Committee published the Principles for effective risk data aggregation and risk reporting (the “Principles”) to remedy deficiencies in risk management disclosed by the 2008 “Great Financial Crisis” (first euphemism of the post).  G-SIBS (Globally Systematically Important Banks) identified in 2011 and 2012 were required to fully implement the Principles by January 2016.

The BIS explained its action as follows:
“One of the most significant lessons learned from the global financial crisis that began in 2007 was that banks’ information technology (IT) and data architectures were inadequate to support the broad management of financial risks. Many banks lacked the ability to aggregate risk exposures and identify concentrations quickly and accurately at the bank group level, across business lines and between legal entities. Some banks were unable to manage their risks properly because of weak risk data aggregation capabilities and risk reporting practices. This had severe consequences to the banks themselves and to the stability of the financial system as a whole.”
In March this year, the BIS issued a progress report on implementation of the Principles.  Italics courtesy of AA.
“The latest assessments by supervisors show that banks’ level of compliance is unsatisfactory and the overall implementation progress remains a source of concern to supervisors. Based on supervisors’ assessments, only one bank fully complied with the Principles, even though the implementation deadline for global systemically important banks (G-SIBs) identified in 2011 and 2012 had lapsed in January 2016. In view of the unsatisfactory assessment results, banks are urged to step up efforts to comply with the Principles. Supervisors are expected to monitor progress and call on banks to address observed weaknesses.” 

There were some 28 G-SIBS as of November 2012. 

One out of 28 is roughly 3.6% compliance.

Not a very impressive performance from these megabanks who tout their capacity to provide state-of-the-art banking services based not only on their self-proclaimed profound intelligence but also their ability to perform complex mathematical analyses and calculations. These are also the same banks that have convinced their regulators that their internal risk models are sufficiently robust so that they should be used to determine their “true” exposure to various risks and, thus, their required capital under the Basel Framework.


The BIS progress report indicates that these self-assessments may be “overly optimistic” (second euphemism of the post). 

What’s even more disturbing is the BIS assessment of the reasons for the failure to reach compliance. You can read that in detail in Appendix 2.  Here’s the BIS’s take on “technical shortcomings”.

“Difficulties in execution and management of complex and large-scale IT and data infrastructure projects, such as resources and funding issues, deficiencies in project management, and coordination with other ongoing strategic programmes.

Overreliance on manual processes and interventions to produce risk reports, although some manual processes are unavoidable.

Incomplete integration and implementation of bank -wide data architecture and frameworks (eg data taxonomies, data dictionaries, risk data policies).

Weaknesses in data quality controls (eg reconciliation, validation checks, data quality standards).”

On a positive note, the BIS may have just supported US corporation and banks’ contention that they are incapable of determining the ratio of their CEO’s pay to the average for all other employees.

If we accept that as a working hypothesis, would you buy a product or place a deposit with a bank unable to measure its risk exposure or perform simple math (Dodd Frank)?