What is Offset Countertrade & Structured Finance

Ask an Asian what is countertrade, offset and structured finance? Probably, 7 out of 10 may tell you countertrade is barter and no more. In addition, around 9 out of 10 may think you are in the printing business if you tell them you are involved in offset. Ask 10 persons what is structured finance and you may get 10 different answers. These may seem trivia until you consider the following.

Approximately 130 out of 192 countries in the world require countertrade, one form or another, in their procurements. Many of them did so after having undertaken intensive and serious studies. Many global companies have dedicated in-house specialists dealing specifically with countertrade. Some 20% to 30% of world trade is countertrade. The annual global market size for countertrade is estimated to be between US$200 to US$500 billion. No one really knows what are the correct percentages are and how large the true market size is. The potential for its growth is so large that efforts were made by some countries to curb the growth of certain forms of countertrade at the World Trade Organisation (WTO). Yet the majority of these very countries are the biggest perpetrators of its practices, restricting their practices within the exceptions contained in the agreement promulgated at the WTO.

If you do not know the above, you may wish to ask, what have you (“you” referring to both governments and industries in Asia) been missing? And ask further can you afford to?

Countertrade is a generic word, or umbrella term, representing various types of reciprocal arrangements and linked transactions. At one time one can be contented with just “reciprocal arrangements”, but it will not be complete today, without adding “linked transactions” to this definition. This is not to suggest that “reciprocal arrangements” is wrong. This article explains why “linked transactions” is a necessary addition, fortifies the knowledge we have of the growing value of reciprocal arrangements to the Asian economies and why the anomaly referred to at the beginning of this article will be short-lived.

One can at the risk of over simplification suggest that some of the problems facing governments and industries in Asia, are the insatiable hunger for liquidity, dealing with increased risks in the environment, facing the ever growing intensity of competition and even merely living this shrinking world epitomized by the word “globalisation”.

Liquidity and Risks
The commodity- and resource-rich countries of Asia know what is barter and derivatives of barter known generally as clearing arrangements although not necessarily that it is but only one form of countertrade. They like their western counterparts too practised these since time immemorial and the practices continue to be prevalent albeit at government-to-government levels mostly.

Thus a proposal have been made by some ASEAN countries to enter into Bilateral Payment Arrangements as an alternative trade mechanism allowing the use of local currency in payment of goods traded between two contracting countries. Those who are not so endowed by Mother Nature, like Singapore, will have to ask themselves the extent of their trade with commodity-rich countries, whether it possesses comparative advantages to play a part in the supply and value chain and whether it is still necessary to speak the countertrade language, notwithstanding.

Aside from such reciprocal arrangements, what Asian countries have still to grapple with are structured finance techniques where the underlying transactions are founded on various known forms of countertrade notably those known as buyback and counter purchase. Until an agreed definition of structured finance was finally reached through the efforts of the United Nations Conference on Trade and Development (UNCTAD) in 1999 as a technique where certain assets with cash flows can be isolated from the originator in order to deal with the risks specific to these assets, the objective being to secure or improve credit, structured finance was a confusing scene in Asia. Witness the following wide and almost meaningless range of definitions : –

“Refers to the sum of banking operations pertaining to an import or export of commodities which are not plain vanilla”

“Provides working capital in difficult environment by mitigating the risk through mortgaging an export flow”

“Include a wide array of instruments, leverage buyouts, management buy-outs, restructuring, industrial projects, infrastructure projects, secured debts, term loans, operating loans and asset based secured lending”

“Makes the use of commodity or asset to improve the credit quality of financing”

We now arrive at the first observation. Whilst alternate forms for generating liquidity are within the able grasps of most Asian countries, the techniques of structured finance have yet to be fully exploited by Asian enterprises. This leaves a big void in risk mitigation methods.

It is already known that the Basle Committee on Banking Supervision meeting in the Bank for International Settlements will be recommending replacing by 2005 a one-size fit all and broad-brush structure with a risk sensitive framework for bank regulators to adopt. One word describes the cost of capital rising from the need to price risks after 2005, judging from the risks already inherent in the Asian environment. Painful. Kudos to those who are already risk-centric in their operations for they will streak further ahead in the widening divide so characteristic of globalisation between the able and the less able. The mitigating of systemic risks cannot however be the concerns of Asian industries alone. The Asian governments have an important role to play for it is they who must bring about structural and legal reforms, infrastructural developments and generally create the right macro environment.

Competition and globalisation. 
Everyone knows that the cheapest price competition model of most Asian countries is under severe threat today. China produces far cheaper than many Asian countries. With price advantages gone (in some cases, gone for good) the only avenue left for Asian industries is to differentiate its offerings from those of its competitors and compete beyond price, quality and service.

Differentiation means either the seller proactively adds value in order to beat the competition or wait for the buyer to determine and compel the value added it wants. The Seller who fails to meet the requisite value added loses the sale. What seemed to be still overlooked by some Asian countries is the power of a Public-Private-Partnership, (or PPP as it is known in the West) which the specie of countertrade known as offset engenders. Those already in the know will appreciate that it is one tool to neutralise some of the unavoidable consequences of globalisation.

What then is offset? Offset is a practice whereby a seller agrees as a condition of his sale to undertake activities, which will benefit the buyer, giving the buyer more value for his money. That a government can in its various procurements require the seller to benefit its own industries makes offset an apt tool to advance a country’s PPP initiatives.

Many Asian countries have already awakened to the benefits of offset. In Malaysia for example, one finds both types of buyer and seller driven offset initiatives. Defence contractors know that the Malaysian government requires in their defence procurements that the contractors assist to promote the sale of Malaysian palm oil. Never mind if the defence contractors do not know the difference between palm oil and the oils for their gun barrels.

In the bidding for the construction of hydroelectric dam project, Chinese contractors proactively offered to commit, among others, to a long-term purchase of Malaysian palm oil if they get the construction job for the main dam. Another bidder offered to bring in Middle East investors to set up by way of a foreign direct investment (FDI) an aluminum smelting plant near the dam site if they get the job for the main dam. Will the Chinese be outdone? One thing is for sure: come 2004, when the grace period for the conditions for China’s full accession to the WTO take effect, China’s industries would be clamouring for more PPP assistance by way of offset in order to be more competitive. They are after all battle scarred and experienced.

This brings us to our second observation. The form of countertrade known as offset or “industrial participation”, “industrial cooperation”, industry involvement”, “industrial and regional benefits” or simply, “local contents” as some countries confusingly call it is poised to grow phenomenally in Asia. The offset practices now prevailing in Asia badly needs to catch up with the changes and sophistication achieved in the West. If the Chinese dragon is already so feared today, than, as our American friends will say, “We ain’t seen nothing yet” when China embraces offset.

So countertrade is an umbrella term for all types of reciprocal dealings and linked transactions. What then are the objectives? The better-know objective is to provide solutions, complimenting conventional methods, which are inappropriate or unavailable. Less known – and possibly more important in both good or bad times alike but more so the latter – is the objective to create opportunities to multiply, direct or bring additional benefits from one originating transaction.

It does not seem so preposterous after all that some 130 countries require countertrade with the number growing. Some governments form specialized agencies to help their own industries with countertrade in order to better compete abroad. Global companies see it fit to have in-house countertrade specialist and as much as 30% of world trade is attributable to countertrade with a market size reaching US$ 500 billion. Efforts at the WTO to stem its growth have only succeeded in part. Perhaps it is time for Asian governments and industries to ask if they have been missing out? If so, welcome to the world of countertrade.