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60 years of investment guarantees: the Federal Government’s successful foreign trade promotion scheme

 

2019 marked a jubilee: on 25 November 1959 – that is, 60 years ago – a German company made the first application for an investment guarantee from the Federal Government. The legal foundation for this had previously been laid with § 18 of the Federal Budget Law in 1959. In the first meeting of the Interministerial Committee for German Direct Investments Abroad (IMC-DIA) on 14/15 January 1960 the Federal Republic of Germany assumed the first guarantee, which was for a project of a German SME in India.  Germany was at that time – after the USA and Japan – the third country to introduce a promotional instrument to protect foreign investments against political risks. Today, virtually all OECD countries and many other states offer such guarantees.

 

The demand for investment guarantees has grown steadily since then, from a guarantee portfolio of some five million euros in 1960 to a guarantee portfolio which regularly tops 30 billion euros since 2011.

 

German companies make use of the instrument for the promotion of foreign trade in various different ways. In some cases they only consider the support of the Federal Government necessary during the first few years of market entry in a developing country or emerging market. In the majority of cases, however, the policyholders secure this “protective umbrella” from the Federal Government on a permanent basis. In this way, the investment guarantees have established themselves for many companies as a central instrument of risk management in foreign investments.

 

The main focus of investment for German companies, like the political map of the world, have been in a constant state of flux over the years. In the first years of the guarantee instrument, policyholders mostly invested in Latin America and Africa. In the 1960s, Latin America was one of the most rapidly expanding regions of the world; many of the countries there, for instance Brazil or Argentina, posted high rates of growth over a long period and thus had a reputation as attractive destinations for investment. Many small and medium-sized enterprises were also represented with subsidiaries – in most cases sales organisations - in African states and covered themselves against risks to their investments by means of Federal Government guarantees. In the 1980s and 1990s this was followed by the opening up of Asia – in particular China and India. Since Latin America was afflicted in the 1980s by a persistent crisis, companies redirected their expansion activities accordingly.

 

On top of this, German companies turned their attention after the end of the Cold War increasingly to the markets in Central and Eastern Europe, which were now open for business. This also led to a rise in demand for investment guarantees, first of all in countries like Poland and Hungary, which only later fell back again with the eastward expansion of the European Union. Besides this, German companies started to expand into Russia and Ukraine at the end of the 1990s. In 2013, investment guarantees for Russia already accounted for a third of all new business; Ukraine, too, has ranked for a number of years now among the Top 10 countries for investment guarantees.

 

Thus the volume of cross-border direct investments in 2018, 1.3 trillion US dollars, represented a decrease for the third year running. Although this volume is expected to have gone up again globally to 1.5 trillion US dollars in 2019, this figure also lies below the average value of the last ten years (cf.: UNCTAD: World Investment Report 2019, June 2019). While the overall volume of direct investments going to the industrialised countries has declined, there was no change as regards developing countries and emerging markets in 2018 (something like 0.7 trillion US dollars). The United Nations Conference on Trade and Development (UNCTAD) assumes that the greater part of global direct investment flows in 2019 once again went to developing countries and emerging markets. Africa is here seen as the region with the highest growth rates worldwide. That means that overall, companies are increasingly turning their attention to new markets – a development which the Federal Government is actively supporting with the Compact with Africa initiative. As a consequence of this focus on new markets, a greater diversification of the host countries for investment guarantees can also be seen over recent years. In this context, the Federal Government has assumed guarantees for the first time for projects in Kyrgyzstan, Mozambique, Mali and Armenia.

 

It is a crucial precondition for the assumption of an investment guarantee that a sufficient level of legal protection exists in the host country. The key basis for the assumption of investment guarantees in this respect is given by the bilateral investment treaties (BITs) concluded under international law between the Federal Republic of Germany and the host country in question. The Federal Republic of Germany concluded the first of these treaties in 1959 with Pakistan. The Federal Republic of Germany subsequently negotiated and concluded numerous treaties of this type; there are currently 125 BITs in force. With the Treaty of Lisbon in 2009, the responsibility for foreign direct investments  (including the protection for such direct investments) passed to the European Union. This means that today only the European Commission is in principle able to negotiate uniform agreements on behalf of the EU and its member states with third countries. These agreements then come into force after ratification by the national parliaments of the member states; the intention is that they should successively replace the bilateral BITs of the individual member states. 

 

Individual countries have cancelled their bilateral BITs with Germany over recent years. These include India, South Africa, Indonesia and Ecuador. In such cases the option is still in principle available that the Federal Government can assume an investment guarantee on the basis of the national legal framework in the country concerned instead of a BIT. The prerequisite for this is however that the domestic legal system of the host country in question affords a comparable level of legal protection for the investments of the German company as would be given under a BIT. Thus, for instance, the Federal Government has assumed many investment guarantees for projects in Brazil despite the fact that a BIT has never existed between Germany and Brazil. Similarly, the Interministerial Committee for Direct Investments Abroad has made positive decisions concerning applications for projects in India again as of 2019 following a comprehensive analysis of the Indian legal system.

 

A further important precondition for the Federal Government to assume an investment guarantee is the eligibility for cover (Cf.: Preconditions for an Investment Guarantee - eligibility for cover) of the specific project in question.

 

The Federal Government has developed the instruments of the investment guarantee scheme on an ongoing basis over the last 60 years, adapting them to the constantly changing requirements of German industry. Examples for such ongoing development are guarantees for loans in local currency, variable earnings cover for equity participations, operational unit cover as well as the cover options against terrorism risks or breach of contract cover.

 

For 60 years now, the investment guarantees have been making an important contribution to supporting and promoting German companies in their activities opening up foreign markets. This makes them a crucial instrument for safeguarding growth and jobs in Germany.

 

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Michael Waitz, Team leader of the structural consultancy of KfW IPEX-Bank GmbH, Frankfurt a. M.

“Through deploying Federal Government investment guarantees we were able to provide effective support for projects of German companies abroad once again in the year just ended by making long-term finance available. German investors are often faced with international competition when they go abroad. The financing conditions, which profit from the risk mitigation effect of such cover, can be the decisive factor in successfully realizing the German investor’s project.”