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Lending to multi-nationals: The risks

Lending to multi-national companies brings with it some very specific – but very real – risks. Here are three of major ones;

Lending to multi-nationals – Where does the money go?

If you’re lending to a multi-national business for the first time, how can you be sure that the money you lend won’t find its way to the foreign operation? 

You might find that your lending is used to buy assets in another country. As a result, you won’t have access to those assets should the lending not repaid as agreed.   

There is no easy way you can prevent this. You can insert an undertaking from the company not to do that in the facility letter, perhaps. But once the money’s gone, it’s gone.

To manage the risk you could assess the strength of the local operation’s assets and cash flows. Then see whether the local business could repay the debt, should the foreign operation fail to repay.

Are you lending in a different currency to the one in which the business receives its revenues?

There’s a chance that your own currency (the one in which the debt is denominated) will strengthen against the foreign currency in the future. If that happens, the real value of the scheduled repayments will be higher for the business than it anticipated. That may cause some cash flow issues for it.

To avoid this risk, depending on the size of the debt and the frequency of repayment, it might be possible to arrange forward exchange contracts to fix the value of the repayments for the near future at least.

Is there some transfer and convertibility risk?

A major challenge when lending to multi-nationals is when revenues and cash flows, which are the source of repayment, are generated in another country’s currency. Then you would need to be concerned about whether the forex market in that country is sufficiently robust to ensure that the currency can be easily converted to the currency in which repayments have to be made.  If it’s not, the obvious result is that you won’t get your debt repaid.

This commonly happens in Africa when local currency can’t be exchanged for US dollars. That happens because the dollars are sometimes just not available in the market.  It happened to SABMiller with its brewery in South Sudan a while ago. The local brewery there couldn’t pay for its imported supplies. There were no US dollars available in the local forex market due to the civil war.  Because there was no alternative local supply of acceptable quality, the brewery there was eventually closed down.

Transfer risk occurs when a country prohibits the movement of money across its borders by shutting its forex market.  If that happens, repayment of your debt is questionable, certainly in the short term.

The way to avoid these risks is to have an alternate source of repayment. That would take the form of a source of funds in a country separate from the one in which the revenues and cash flows are generated. Ideally, that country would be one that is unlikely to experience these issues in its economy.

The source of funds there could be in the form of a cash deposit held in a bank, a guarantee from a good bank in that country, or simply a guarantee from an arm of the multi-national operating in that country. The choice of collateral would obviously depend on the multi-national’s financial standing.

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