Euler Hermes estimates that UK businesses have the potential to unlock significant working and investment capital currently reserved for traditional bank sourced letters of credit by using deductible guarantees.
“The economic recovery is encouraging UK plc to consider domestic and international investment, but many firms remain unaware of the potential strategic financing alternatives,” said Andrew Potts, head of Euler Hermes Bonding in the UK. “Letters of credit, for example, often require ring-fencing working capital facilities for potential future drawdown, reducing available company funds whether the letters are used or not.
“Alternative financial instruments, such as deductible guarantees, could help unlock billions of pounds worth of funding lines for working capital and investment in growth. Furthermore, often on significant infrastructure or other capital intensive projects, letters of credit or bank guarantees can be required for tens or even hundreds of millions of pounds. Using a recognized and proven alternative, many companies can provide the guarantees required while still retaining access to their existing working capital facilities.”
How it works
Traditional letters of credit are basically a guarantee and a promise to pay. Banks and other financial institutions issue them on behalf of companies to ensure that sellers are paid, providing specified works are completed or defined conditions are met.
In order to secure the letters, the buyer often has to agree to the bank ring-fencing a portion of existing working capital facilities – locking it away from other business uses.
Alternatively, a deductible guarantee can be utilized in place of a letter of credit. It can free up working capital lines as the issuing insurer acts as a guarantor for the delivery of goods or a service. Additional company benefits can include an enhanced security profile, an expansion of financing lines, and a diversified security portfolio for insurance companies accepting the guarantees as an alternative to letters of credit.
Potts added: “In a recent report (1) Euler Hermes predicted that the UK economy would grow by 2.3 per cent in 2014 and by 2.5 per cent in 2015. As companies start to benefit from this growth, freeing up working capital is more important than ever.
“Given the prevalence of traditional letters of credit among UK businesses, deductible guarantees and similar products, could represent a significant untapped resource for financial managers. For many companies the funds involved could be a game changer as they compete to make the most of growth opportunities.”
Notes to editors
Euler Hermes has underwritten surety business in the UK for over 40 years and is one of few insurers to provide deductible guarantees. In addition to acceptance by many major fronting insurers, the Euler Hermes deductible guarantee recently earned the Innovation award at the 2014 Commercial Insurance Awards.