As Egypt’s economy endeavours to provide the basic needs of its people while meeting its foreign-currency obligations, some have come up with the idea of securitising future dollar revenue from the Suez Canal through the issuance of bonds to international investors to provide much-needed foreign exchange.
Some media reports say that Egypt is studying securitising up to 25 per cent of its US dollar revenue in a move meant to raise hundreds of billions of dollars through 2030. This also coincides with the ambitious six-year plan that is part of the government’s Strategic Directions Document released earlier this year. The document is meant to put forward a comprehensive eight-directional economic strategy for the period from 2024 to 2030.
The idea has been presented in an attractive and promising way that raises hopes of levelling the country’s economic hurdles at low or no cost. However, a closer look at the idea reveals that what might look attractive on the surface is in fact extremely harmful and destructive upon closer inspection. To identify the dangers associated with such a move it is essential to understand how this type of financing is structured and how it works.
If the government goes ahead with this idea, it then becomes the originator of the securitised deal. It sells its rights to the future cash flow from the canal to what is called a Special Purpose Vehicle (SPV), also known as a Special Purpose Entity (SPE), for an up-front price. A SPV is a legal entity created for a limited purpose and is used for purposes like the acquisition or financing of a project or the setting up of a securitisation. A SPV may take the form of either a trust or a corporate vehicle and is usually constituted as an offshore entity in a tax-neutral jurisdiction to ensure it is under the jurisdiction of a trusted legal system and claims against it are actionable in international courts.
One of the key reasons for establishing a SPV is to insulate it from pre-existing obligations or debts and to separate it from entities involved in its setting up, ensuring accounting, tax, and insolvency autonomy.
The SPV funds the purchase value of future cash flow by issuing debt securities earmarked to service the issued instruments. The sale of receivables takes place through an irrevocable contractual arrangement often referred to as a notice and acknowledgment agreement. This involves the obligor (the party undertaking an obligation) agreeing to make payments to an offshore escrow account held by the SPV with a trustee overseeing the process. The receivables are typically in a convertible currency (US dollars), where the originator can demonstrate a consistent track record of receiving such cash flows.
The foreign exchange accumulates in the trust account as the obligor makes its payments, providing a pool of funds for the scheduled payment of the principal and interest on the issued instruments. Once the obligation has been paid, the trust may then release any excess earmarked receivables and return them to the originator.
To mitigate the risk of fluctuations in inflows from the obligor, the financing structure incorporates a debt coverage ratio significantly above one, meaning that the amounts needed to service the debt are a fraction of the pledged future inflow. This provides additional security to the lenders and reduces the risk associated with receivables generation (the risk that the expected cash flow may not materialise as anticipated).
The complicated risk-management strategies embedded in securitisation deals bring complexities and drawbacks for the issuer. If the inflow of receivables turns out to be insufficient to meet the debt-service requirements, different scenarios will unfold. In some cases, the issuer may be declared in default, leading to direct recourse to the originator (the Egyptian government in this case) for payment.
Alternatively, specific covenants for accelerated amortisation may come into play. This point is extremely important in the Suez Canal’s case because its revenue is dependent on the volume of traffic, which is to a large extent dependent on factors beyond the country’s control such as the volume of international trade, maritime security, and competing routes.
There is also an embedded risk that debt-holders have recourse to the Suez Canal itself in the event of default. The extent of the recourse would depend on the deal itself, which may have a non-recourse structure, a limited recourse, or covenants and agreements outlining rights and remedies. The extent of recourse will not be determined by just the negotiation skills of the parties involved, but will also reflect other profound factors.
The borrowing needs of the originator will have a significant impact on the terms of the deal, including the extent of recourse. Strong borrowing needs will raise the originator’s risk appetite and motivate it to structure the deal in a way that attracts investors and provides them with favourable terms. The prevailing market conditions can also influence the terms, where in times of economic uncertainty investors demand more favourable terms, including increased protections and recourse.
Both Egypt’s limited ability to access international capital markets for new loans and global market uncertainty put the country in a weak position that could induce the government to accept recourse on the canal.
There are other limitations on the country if it chooses this type of financing. Debt covenants play a crucial role in governing the activities of both the originator and the SPV in securitisation deals. These covenants may include requirements for the originator to maintain the activities generating the receivables, conditions preventing the originator from divesting these activities to a third party, and clauses prohibiting the SPV from issuing other debt backed by the receivables or engaging in any other business. Breaching these covenants can result in litigation and immediate demands for the repayment of the principal, underscoring the stringent nature of these financial arrangements. Though covenants primarily aim to lower performance or diversion risk, they also pose a threat to the issuer and limit its flexibility in managing its economic activities.
One of the most pressing risk mitigants in securitisation is early amortisation triggers, i.e. events that would direct all cash flow to repaying the investor principal in the case of a threat to the performance of the securitisation. These triggers may include a falling debt-coverage ratio, late debt-service payments, obligors failing to meet certain credit-quality requirements, litigation against the originator having a materially adverse effect on the securitisation, or sovereign interference affecting the originator’s ability to direct cash flows to the SPV.
While these triggers are designed to provide investors with redress in the event of nonperformance by the originator, they also represent restrictions on the ggovernment in managing the economy.
The proposed securitisation is therefore not a risk-free deal. Quite the contrary, the risks are many and are inherent to this proposed deal. The aftermath of the deal is hazardous as well, because its proceeds, if spent the right way, would only give temporary relief. They do not in themselves guarantee that the economy is on the right track.
If not spent in the right way, as has sometimes happened in the past, this would aggravate the problem. The core issue lies in the way the economy is managed and whether economic fundamentals and structural weaknesses are addressed. Concluding such a deal without addressing the fundamental weaknesses and distortions in the economy means that the country would be back to square one having sacrificed the income from the jewel in the economy’s crown.
The Suez Canal, being the country’s most-strategic asset and the most well-organised and profitable venture, should not be subject to hasty deals. The economic challenges facing Egypt are undoubtedly significant, but attempting to solve them through a complex financial arrangement without addressing the root causes of the problems is a precarious approach.
From an economic standpoint, it is crucial to consider the long-term implications of the proposed securitisation. While the infusion of funds may provide a momentary economic boost, it does not constitute a holistic solution to the systemic issues that are draining the economy. It would also deprive the country of its most-stable source of foreign currency as long as part of the securitised revenue deal remains outstanding.
On a strategic level, decisions regarding the Suez Canal should be approached with meticulous planning and foresight. The canal serves not only as an economic lifeline, but also as a symbol of national pride and sovereignty. Rushed or poorly considered deals will not only jeopardise the stability of this vital asset but will also have repercussions extending beyond the economic realm.
From an emotional standpoint, the Suez Canal holds a special place in the hearts of the Egyptian people. It represents a source of national identity, historical significance, and a tangible manifestation of Egypt’s geopolitical importance. Any decision regarding the canal’s financial future should be made with a deep understanding of its symbolic and emotional value to the nation.
It is not only advisable but imperative to reject this proposal. The country’s future depends on judicious decision-making, and we owe this to ourselves and future generations.
The writer is a banking consultant.
* A version of this article appears in print in the 1 February, 2024 edition of Al-Ahram Weekly
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