III. Advance payment (refund) guarantees (APRC)
With regard to the KEXIM advance payment refund guarantee (APRG) programme, CESA claims it concerns a potential transfer of funds (within the meaning of Article 1.1.(a)(1)(i)) by a state controlled bank to a purchaser of a Korean ship in case of non-performance by the Korean exporter (the shipbuilder). The guarantee is granted by Kexim subject to the payment of a premium by the Korean exporter. Kexim guarantees allegedly confer a "benefit" on the exporter by providing financial support on more advantageous terms (in the form of charging lower non commercial premium fees) than the exporter in question would otherwise be able to obtain in the Korean financial market. As the guarantees are offered for the purpose of guaranteeing 100% of the down-payments for exported Korean goods any transaction financed through KEXIM's advance payment guarantee programme is necessarily an export transaction and as such the associated guarantees are expressly "contingent in law ... upon export performance." They therefore constitute export subsidies which are per se specific in accordance with Article 2.3 of the ASCM.
CESA claims that the advanced payment guarantees are not covered by item (j) of the Illustrative List of Export Subsidies in Annex I to the ASCM, which provides: "The provision by governments (or special institutions controlled by governments) of export credit guarantee or insurance programmes...at premium rates which are inadequate to cover the long-term operating costs and losses of the programmes". It is claimed that the guarantees do not cover the long term operating costs and losses of the programme and that, therefore, they constitute export subsidies which are prohibited within the terms of the ASCM15.
Under this programme, KEXIM provides a guarantee that a foreign buyer will be refunded any advance payments given to a Korean shipyard, including any accrued interest on the advance payments, in case the Korean shipyard fails to perform its obligaions under the relevant contract.
Any Korean exporter of capital goods that qualifies under KEXIM's "export loans to domestic suppliers" scheme can apply (including shipyards). Beneficiaries are either the foreign buyers making advance payments, or, the foreign banks who provide refund guarantees to foreiga buyers.
Shipyards stated that various financial institutions offer APRGs and that they constitute a necessary pre-condition for the signing of a contract (a provision on guarantees is included on all standard contract forms). Sometimes the financial institution providing the guarantee is designated by the buyer; in other cases the buyer sets credit rating requirements which have to be met by potential guarantors. Otherwise shipyards select the one offering the most favourable conditions.
Application and approval procedures
Applicants are required to consult with KEXIM in the early stages of a transaction with regard to the terms and conditions of APRGs and to provide inter alia documents on the relevant export contract, on collaterals and on the status of the applicant's liabilities. When examining requests. KEXIM takes into account a number of factors including the following:
-the capability of applicant to perform its obligations under the contract
-the creditworthiness of the applicant
-the legality of the contract
-the value of the collateral
If KEXIM is satisfied with the result of the review, it will issue an APRG.
The application and approval procedures for APRGs do not vary by industry sectors. Thus, there are no particular rules applicable to the shipbuilding sector.
Amount of guarantee
The amount of the APRG is determined by the total amount of advance payments actually paid to the shipyard prior to completion of the project (e.g. delivery of ship) plus accrued interest. Also, the guarantee methods are the same regardless of whether the transaction is short-term or long-term. APRG normally has a guarantee period of two or three years covering the period from the issuing date of the APRG to the delivery of the project.
The guarantee may be assigned to the buyer's bank. KEXIM issues a standard form APRG certificate unless the beneficiary (buyer) requests a different content. If such requests by the buyer are reasonable and acceptable to KEXIM, the content of the APRG may be modified.
Calculation of the premium
The premium is paid by the applicant, not by the beneficiary. The premium is calculated on the basis of the aggregate advance payments made to the exporter prior to delivery of the ship, plus interest thereon On January 22, 1998, KEXIM changed its APRG premium system from a fixed-rate system to a minimum-rate-system to reflect the credit risks anticipated in proposed transactions.
Basically, the premium is composed of two elements, namely, a Minimum Premium and Additional Spreads (e.g., Credit & Market Risk Spreads). The minimum premium reflects the basic risks related to the issuance of the APRG. KEXIM stated that the current minimum premium is 0.4% and is similar to that charged by other domestic commercial banks providing APRG to domestic shipyards.
The additional spreads are detennined by the following commercial factors:
||the risk level of the proposed export transaction, such as the credit rating
and financial status of the applicant, the applicant's capability of performing
the contract, and the type of collateral provided by the applicant.
||the spread levels of the other commercial banks operating APRG programmes
||the degree of competitiveness in the APRG market in Korea.
KEXIM does not apply additional spreads to applicants whose credit rating by major domestic credit rating agencies is equal to or higher than "A".
All shipyards investigated used the advance payment guarantee scheme .
During the investigation, KEXIM and the co-operating shipyards considered that any information regarding the individual terms of KEXIM financing is confidential information and that any release of information regarding the terms and conditions of KEXIM financing would cause serious commercial damage. Consequently, only general information on the whole programme was given.
In particular, KEXIM only provided the income which was derived from the APRG premiums. On the revenue side, KEXIM stated that since 1976 only one guarantee transaction had to be covered by KEXIM. This information could not be verified. In addition, no verifiable information was provided regarding the credit risk assessment of shipyards undergoing corporate restructuring or under court receivership.
KEXIM confirmed that about 70% of the total guarantee amount is provided for the shipbuilding industry.
KEXIM claimed that with the exception of one refund paid as a result of a Korean shipbuilder's default on its obligation, KEXIM has never made any payments under the APRGs, nor experienced any loss from applicants' non-performances of shipbuilding contracts. However, even in the one instance where KEXIM had to pay a refund, a domestic commercial bank provided a Letter of Guarantee (L/G) as collateral on behalf of the applicant. Thus, the domestic commercial bank immediately reimbursed KEXIM for the full amount paid. In the light of the above KEXIM claimed that the administration costs for the APRG programme are negligible, and that KEXIM has realised nearly all fees as net profit.
Guarantees are a potential transfer of funds within the meaning of Article 1.1.(a)(1)(i). Therefore, KEXIM guarantees constitute financial contributions within the meaning of the above Article.
A benefit exists to the extent that shipyards have obtained guarantees at non market rates. In particular, a guarantee by a govemment must not be considered as confening a benefit, unless there is a difference between the amount that the firm receiving the guarantee pays as a premium to the government and the amount that the firm would pay on a comparable commercial guarantee. In this case the benefit shall be the difference between these two amounts.
In the notes to KEXIM's accounts, special reference is made regarding guarantees for the Daewoo companies. In this respect, KEXIM has provided APRGs in the amount of $954 million to Daewoo which constitutes 24% of the total outstanding commitments under this scheme. It is important to note that KEXIM has classified the total amount of outstanding commitments to Daewoo as less than normal i.e. precautionary and substandard. This classification indicates that KEXIM itself has serious doubts whether Daewoo would be able to fulfil its commitments and that it is highly likely that KEXIM would have to fulfil its guarantee obligation. It would have been at least, therefore, expected that Kexim would have ceased to provide guarantees to Daewoo unless a very high risk premium was charged commensurate with the risk undertaken.
However, during the investigation, it was established that KEXIM has continued to provide APRGs after companies faced financial diffrculties and went in court-supervised restructuring or under workout. For example, in 2000 Kexim's exposure to Daewoo with respect to guarantees amounted to Won 1,424 billion out of which Won 1,374 billion was classified as precautionary; Daewoo Shipbuilding & Marine Engineering was the major beneficiary by obtaining guarantees amounting to Won 1,363 billion. As explained in the previous TBR report, this company was under workout. Under these circumstances, it should be questioned whether KEXIM was charging commercial rates in granting APRGs.
The fact that KEXIM acted in a commercial manner should be measured through the credit risk assessment of these companies. The GOK has recognised in its Letter of Intent to IMF (10 March 1999) that the specialised banks which includes KEXIM, were inefficient in the risk management. The GOK stated that it will "Improve risk management including: (i) systems to better evaluate credit risk, manage and administer loans, and limit credit exposure; (ii) systems to monitor and control risk (this would include interest rate, credit, market, and operational risk) on a bank-wide basis; and (iii) systems to evaluate compliance with established guidelines for risk management and internal audits."
Consequently, KEXIM appears to have provided APRGs without making an adequate credit risk adjustment to the APRG premiums.
Furthermore, with regard to the APRG scheme the complaint contains references of Kexim support to Halla at terms which do not seem justified by its precarious situation. It is claimed that the premiums charged on Halla's guarantees in no way reflect the fact that the guarantees are granted to a bankrupt company. In response to this, Halla has claimed that because of its financial difficulties KEXIM required Halla to provide it with additional payment guarantees from other financial institutions. Therefore, Halla had to purchase additional guarantee bonds from other financial institutions in order to obtain a KEXIM guarantee. After Hyundai begun managing Samho, KEXIM no longer required such additional guarantees. KEXIM, however, became a shareholder of Halla after the debt-to-equity swap (see previous TBR report for details). Such move, as admitted by KEXIM, was quite exceptional as it is not KEXIM's policy to become a shareholder of its customers; KEXIM stated they had only once more done a debt-to-equity swap with respect to Daewoo. KEXIM's willingness to proceed to such a debt-to-equity swap with Halla necessarily raises questions on its objectivity in applying commercial criteria in assessing Halla's credit risks.
In view of the above it is considered that the APRG programme has conferred a benefit on the shipyards.
The GOK has stated that the provision of APRG is contingent upon the existence of an export contract. Furthermore, it is precisely the purpose of the programme as presented by KEXIM and explained by the shipyards to provide guarantees covering payments for the manufacture of goods for exportation from Korea. It can therefore be concluded that the programme constitutes an export sub sidy within the meaning of Article 3.1(a) of the ASCM.
Prohibited subsidy issue
Export subsidies are prohibited unless they fall within the terms of footnote 5 of the ASCM which provides that "Measures referred to in Annex I as not constituting export subsidies shall not be prohibited under this or any other provision of this Agreement"
The GOK has claimed that the guarantees in question fall within the "safe haven" of the relevant provisions of Annex I of the ASCM and are therefore not prohibited export subsidies. In that respect, it has been claimed that the scheme in question falls within the "safe haven" of paragnph (j) of Annex I which provides as follows:
The provision by governments (or special institutions
controlled by governments) of export credit guarantee or insurance programmes,
of insurance or guarantee programmes against increases in the cost of exported
products or of exchange risk programmes, at premium rates which are inadequate
to cover the long-term operating costs and losses of the programmes.
The GOK has claimed that the APRG scheme premiums are set at levels which combined with its low administrative costs permit KEXIM to cover its long term costs of the programme16.
Nevertheless, the guarantees made by KEXIM on behalf of the Korean shipyards cannot be considered as export credit guarantees within the meaning of paragraph (j) of Annex I and thus cannot be analysed under the above provision. In particular, these guarantees are made available to foreign buyers for the purpose of ensuring the repayment of sums paid in advance of the delivery of the vessel. As explained above (see Section B.1), export credit guarantees are those provided by a third party (usually a bank or an export credit agency) on behalf of the foreign buyer in favour of the shipyard not by the shipyard in favour of the buyer.
Thus, the fact that APRG scheme premiums are set at levels which permit KEXIM to cover its long term costs of the programme is immaterial as paragraph (j) is not applicable17.
In conclusion, the APRG programme constitutes a prohibited subsidy under Article 3.1 (a) ASCM.
The provision of refund guarantees is a necessary pre-condition for the signing of a shipbuilding contract. A refund guarantee facility is a very important source of working capital for a yard; if a yard is unable to offer refund guarantees, it will not be able to negotiate any advance payments and would, therefore, be unable to procure the necessary working capital. Unless, therefore, the shipyard is able to arrange such a guarantee from its own bank it would be highly unlikely for a buyer to conclude a contract.
This is even more so for shipyards which face financial difficulties especially in the midst of a financial crisis. Consequently, although the amount of tbe actual benefit of a subsidised guarantee scheme might be small in proportion to the overall price of a ship, its impact is far greater as its very existence is decisive for concluding a contract? On the other hand, the payment of commercial level premia can be extremely costly for shipyards in difficulty forcing them to raise prices to cover such costs and thus risking loosing contracts.
15 CESA claims that
even if found to be not prohibited, such subsidies are still actionable under
Articte 5 of the ASCM since they cause adverse effects.
16 On the contrary,
CESA has claimed that KEXIM overall could not cover its costs as demonstrated
by the GOK's capital injections. Indeed, KEXIM has stated that the GOK has increased
KEXIM's paid-in capital from Won 871 billion to Won 2,676 billion in the period
1997 to 2000. In particular, that the Central Bank of Korea and the GOK injected
Won 900 billion and Won 866 billion respectively.
17 In any event, the
Appellate Body has ruled in Brazil-Export Financing Programme for Aircraft
(21 July 2000) that the provisions in question constitute affirmative defences
so that the burden of proof lies with the WTO Member invoking the defence i.e.
in this case Korea. The GOK has, however, failed to produce the relevant evidence
during the investigation.