What is Preferred Creditor Status?
Multilateral Development Banks (MDBs) are essential lenders in international financial markets. Owned by multiple sovereign shareholders, otherwise known as member countries, MDBs raise money by issuing bonds in global capital markets, which are then used towards financing projects within member countries.
Member country governments frequently borrow from their MDBs, as well as private lenders, and others, maintaining multiple creditors concurrently. If a member country experiences financial stress and has difficulties repaying the financings, a hierarchy exists in which certain creditors are prioritized in order of repayment. Those who receive repayment priority are referred to as Preferred Creditors (PCs), having been granted Preferred Creditor Status (PCS) by their borrowers. It is widely accepted that MDBs, amongst other IFIs, maintain PCS. The Islamic Development Bank Group, (IsDB), is one such MDB and, as the insurance arm established under the IsDB group, this PCS is de facto also extended to ICIEC.
According to Moody’s Global Credit Analysis, PCS is defined as an implicit accord between borrowers and lenders that loans made by these institutions receive preferential servicing and repayment treatment above other borrowing-member liabilities such as commercial bank debt[1]. PCS also grants preferential access to a lender of foreign currency in the event of a foreign exchange crisis in the borrowing country (also called an inconvertibility event). PCS thus gives MDBs a high level of assurance that sovereign and non-sovereign loans within a member country are protected against restrictions on foreign exchange, mitigating transfer and convertibility risks, and ultimately resulting in repayment. This same assurance is generally not afforded to private institutions (except when their financings are concomitant with that of the MDB’s in a structure called the A/B Loan)[2].
Since its origins, the legal basis of PCS has been questioned. Currently, general international law contains no compulsory standard of conduct requiring the preferential treatment of any external creditor, including MDBs. Thus, the current imposition of international PCS is de facto, or a matter of fact, rather than de jure, a matter of law. PCS, therefore, is an optional standard of international behaviour that must be affirmed through multilateral and/or bilateral agreements, or through a borrower’s unilateral granting of PCS permissions to an MDB. For many MDBs, PCS is embedded in their articles of association or agreement. Though these articles do not provide legal status to an MDB’s PCS, the principle is instead embodied in the practice of the MDB and its borrowers and granted by member country shareholders.
PCS is a critical tool for protecting the capital of MDBs while ensuring borrowers can still receive favourable credit terms. There are several benefits to PCS, both for MDBs and their clients. Some countries confer PCS to MDBs with the expectation that the MDB will provide credit at competitive rates during times of crisis, despite the higher risk. As default probabilities are often higher during a crisis, private creditors lending to sovereigns experiencing an emergency will raise interest rates as compensation for the assumption of greater risk. However, thanks to PCS, MDBs expect to be repaid regardless of default, thereby lowering the risk for MDBs.
A critical factor with respect to PCS is the mutual ownership structure found amongst MDBs. As member countries hold equity in these MDBs, they are financially incentivized to ensure these institutions are protected from default. Meanwhile, the mutual ownership structure also ensures advocacy from the MDBs and other IFI representatives when discussing and solving any issues or disputes over non-payment. Subsequently, IFIs can help distressed member countries formulate policies that help restore economic stability and improve the debt position while having credibility-enhancing ‘skin in the game’ at lower risk. Thanks to these benefits, MDBs awarded PCS often receive the “Halo Effect”, meaning these MDBs are seen as favourable sources of finance, resulting in increased business volumes.
ICIEC’s PCS
The Islamic Development Bank Group, (IsDB) is an AAA-rated MDB collectively owned by 57 Member Countries (MCs) across the Organization for Islamic Cooperation (OIC). IsDB has PCS enshrined in its articles of agreement, which have been ratified by the governments of all IsDB Group MCs, earning IsDB’s PCS universal recognition and acceptance. Having been established by the IsDB, ICIEC shares similar articles of agreement and is therefore conferred the same PCS from its 48 MCs. Additionally, ICIEC’s PCS enjoys recognition from entities such as bank regulators, rating agencies, and private PRI providers.
ICIEC is considered a Specialized Multilateral Insurance (SMI) provider for export credit and foreign investment. Thus, Preferred Creditor Treatment (PCT) is triggered differently. ICIEC becomes a creditor when the Corporation pays a claim. As ICIEC has PCS embedded within its articles of agreement, the Corporation is first in line to receive repayment.
For ICIEC MCs, maintaining PCS helps investors and exporters receive exceptional security at competitive rates, providing cover against potential risks that lead to barriers for investors and exporters in high-risk markets. With further security on investments and trade provided by ICIEC’s reinsurance policies, ICIEC’s PCS helps attract FDI and trade in critical sectors for the sustainable development and national objectives of ICIEC MCs.
ICIEC is also able to leverage its position within the IsDB group to advocate for priority payment with the MC. There, IsDB representatives highlight the potential ramifications of non-payment in terms of access to future credit. In doing so, the value of PCS is reinforced, and ICIEC policyholders are given a strong voice within high-risk scenarios to receive favourable treatment in the event of non-payment.
ICIEC can also extend its PCS to other institutions such as ECAs. For example, through a Memorandum of Understanding (MoU) recently signed with the United Kingdom’s Export Credit Agency (ECA), UK Export Finance (UKEF), the potential risk-sharing has been emphasized, leveraging the Corporation’s PCS across key international markets for UKEF’s support in ICIEC MCs.
ICIEC’s PCS is an enabling tool to support its partners and its shareholders. It places the Corporation in a special and powerful position as facilitator of trade and investment flows and gives a level of comfort to investors and exporters, financial institutions that support them, as well as partner credit and political risk insurers.
[1] David Stimpson, Global Credit Analysis, (London: Moody’s Investors Service, 1991), 188.
[2] https://publications.iadb.org/publications/english/document/Research-Insights-Why-Are-Preferred-Creditors-Preferred.pdf
