1 BONDS & GUARANTEES Domenico AUSILIO Integration Course 9 – from 18th to 22nd June 2007

2 A) Definition and features

© Coface University 2007 –All rights reserved 18th to 22nd June Guarantor/Surety company Creditor/ Beneficiary Debtor/ Principal Compensation Main Obligation Guarantee/Bond The bond/guarantee is the commitment made to a creditor/beneficiary by a third party called a guarantor/surety company to fulfil the obligation if the debtor/ principal does not fulfil it himself. Definition and features

© Coface University 2007 –All rights reserved 18th to 22nd June Guarantee features The commitment is intended to consolidate the creditor’s rights. It is a personal security as opposed to a real security (mortgage). The guarantee is an incidental contract to the main obligation established by a contract linking the debtor to the creditor. If the debtor defaults and the guarantor is obliged to take the debtor’s place, the guarantor is subrogated with regard to the creditor’s rights and can enjoy exercising them from then on. The risk lies in the debtor’s possible shortage of assets, which would mean that the sum paid by the guarantor could not be reimbursed.

© Coface University 2007 –All rights reserved 18th to 22nd June Similar instruments: Independent (abstract) guarantees:  Recently created, first decisions on this date from  An independent guarantee is independent of the basic contract and is governed only by the wordings.  The guarantor cannot benefit from the exceptions which the debtor can apply to the creditor.  If the guarantee is specified as payable on first demand, it must be paid immediately and unconditionally, unless some act of fraud or misuse on the part of the beneficiary comes to light.

© Coface University 2007 –All rights reserved 18th to 22nd June Credit insurance Credit insurance:  Policy subscribed by the creditor  The contract is signed without the debtor (buyer) knowing anything about it  The credit insurance contract is a main contract  The premiums are payable by the creditor  Non-payment of premiums is grounds for discharge of the insurer’s obligations  Credit insurance represents the transfer of a risk which already exists from the creditor to the insurer.

© Coface University 2007 –All rights reserved 18th to 22nd June Credit insurance Guarantee Credit insurer Insured/Seller/ creditor Buyer/debtor Insurance contract Compensation credit limit Guarantor/ surety (COFACE) Seller/Principal/debtor Buyer/Beneficiary/ creditor Commitment to compensation Non-changeable credit limit requested by the debtor Guarantee procedure

8 B) Underwriting

© Coface University 2007 –All rights reserved 18th to 22nd June Underwriting for a bond cannot be based on a statistical risk approach. The premium is directly linked for the insurer to the probability of a claim and the mutualisation of the risks. This concept does not apply in bonding business. The underwriter has to take into account: - objective factors evaluating the risk of the contract based on the level of difficulty in fulfilling the contractual obligation. - subjective factors: probability of the principal defaulting from an technical and financial perspective (possibly as a result of other contracts). - “environmental” factors: area of business, geographical location where the contract is being provided, etc.

© Coface University 2007 –All rights reserved 18th to 22nd June Evaluating the risk: Financial risk :  Balance sheet analysis  Ratings from agencies, B2F, etc.  General development over 18 or 24 months Underwriting risk :  Contract analysis  Technical ability of principal to fulfil contract Achieving the right balance between the risk involved and the principal’s ability to pay, if called upon to do so :  Parent company guarantee  Cash deposit  Personal, joint and several guarantee from owner of the principal

© Coface University 2007 –All rights reserved 18th to 22nd June Premium Premium rate:  type of bond  rating and assessment of the risk Premium:  Annual rate * amount*duration (year)  Tax (depending on the Country, e.g. no tax in France, 12,50% in Italy)  Payment of premium is due in full when issued  Non-payment of the premium is ineffective against the beneficiary

12 C) Making a claim

© Coface University 2007 –All rights reserved 18th to 22nd June Reasons: The principal has not fulfilled its contractual / legal / regulatory obligations:  Technical difficulty  Financial difficulties  Disputes among the parties As the principal being guaranteed has not fulfilled its obligations, the amount called on by the Beneficiary represents the indemnity.

© Coface University 2007 –All rights reserved 18th to 22nd June Procedure for action: The surety must first of all verify that the beneficiary is entitled to call upon the bond (to fulfil all his contractual obligations) The surety who has paid the debt is subrogated with regard to all the rights the creditor had against the debtor The surety will use the individual guarantees obtained when the bond was set up: cash deposits, personal and joint and several guarantee from the owner of the principal, collateral, etc.

15 D) The role of bonds in the COFACE Group

© Coface University 2007 –All rights reserved 18th to 22nd June Common classification The Group’s companies have drawn up a common classification for bonds bonds are classified according to a scale of risks Standardising objective underwriting criteria. The boards remain responsible for the final underwriting criteria

17 Group companies operating in the bonding sector

© Coface University 2007 –All rights reserved 18th to 22nd June Group companies operating in the guarantee sector – 2006 results Coface Assicurazioni (Italy)  Centre of excellence for Bonding within the Group  No. 1 in the Italian market  Premiums: 43 million €  80,000 bonds issued CDE  Premiums: 4,5 million € COFACE AUSTRIA  Premiums: 3 million € CUK  Premiums: 1,1 million € Total: 54 million € / 5,6% of the whole Group’s Insurance sector turnover

19 E) Bonds in Italy

© Coface University 2007 –All rights reserved 18th to 22nd June Different types of bonds Contract bonds:  Bid bond  Performance bond  Retention payment bond  Advance payment / Subcontractor Waste disposal bonds Building licence bonds VAT bonds Custom bonds

21 F) COFACE ASSICURAZIONI BOND ACTIVITY

© Coface University 2007 –All rights reserved 18th to 22nd June Scope of application Contract bonds :  Bid bond: ◘ Amount: 2% of the contract amount ◘ Guarantee: the good faith of the bidder, with the latter fulfilling his obligation to sign a contract with the beneficiary.  Performance bond: ◘ Amount: starting from 10 % of the contract amount ◘ Guarantee: the fullfilment of the contract.  Advance payment bond: ◘ Amount: it changes according to the contract, but can be as much as 30% of the contract value and decreases as the contract is being performed ◘ Guarantee: sums advanced by the beneficiary to enable the principal to cover expenses incurred before the contract is implemented.  Retention payment bond: ◘ Amount: usually 5% ◘ Guarantee: rectifying any faults which occur during the warranty period

© Coface University 2007 –All rights reserved 18th to 22nd June Scope of application Waste Disposal Bonds:  Bonds concerning the activity of waste disposal: they cover the obligations coming from the authorization to supply waste disposal services. They are related to: –Waste collection and transport –Waste treatment –Waste final storage  Bonds to get the registration to the Waste Operators Registry: they cover the obligations coming from the registration and concern the activity of waste collection and transport.  Bonds covering the obligations coming from trans-frontier waste shipment: they concern the waste operators that make trans-frontier waste shipment.

© Coface University 2007 –All rights reserved 18th to 22nd June Scope of application Customs bonds: ◘ They cover the payment of customs duties / taxes VAT bonds : ◘ They cover the correctness of VAT declaration and the reimbursement of VAT credit. Building licence bonds:  They are requested by the Municipalities for issuing the building licence and cover the taxes due for urbanization charges and construction costs or the direct realization of the urbanization works.

25 Request of a bond / The bonding facility / Issuing a bond

© Coface University 2007 –All rights reserved 18th to 22nd June Application file Report from the Agency about the request Legal documents of the Principal (Statute and Deed of Partnership) Last 2 balance sheets Contract / Law / Regulation Wordings of bonds requested (if specific) Credit information

© Coface University 2007 –All rights reserved 18th to 22nd June Company response Decision of the surety: yes - no The Bonding facility specifies, in particular, the terms for issuing bonds:  Annual rate  Possible counter-guarantees

© Coface University 2007 –All rights reserved 18th to 22nd June Issuing bonds Issuing:  A bonding facility must exist in the IT System  Amount and features of the guarantee are entered  Once the bond is issued, the exposure of the Principal is automatically updated in the IT System  The bond is signed by the Principal  The original copy of the bond is given to the Principal  Premium is collected