Differing interest coverage as between GSM 102 and ExIm Bank products 243. Third, the United States argues that Brazil's comparison fails to account for differing levels of interest coverage by GSM 102, on the one hand, and ExIm Bank's LCI and MTI policies, on the other.388 244. Once again, had the United States taken the opportunity to raise this concern in the 7 submissions it made prior to its 2 April answers, it could have been resolved in a timely manner. Nonetheless, to answer the United States' concern, Brazil has re-run its ExIm Bank comparison to account for differing levels of interest coverage under GSM 102 and ExIm Bank's LCI and MTI policies. The results show that given the massive gap between GSM 102 fees and ExIm Bank fees, differing interest cover has no material impact on the results of the ExIm Bank comparison tracked in Exhibits Bra-536 and Bra-537.
245. The benchmarking exercise tracked in Exhibits Bra-536 and Bra-537 yields a total of 1071 comparison points between GSM 102 and ExIm Bank fees; in 97.76 percent of those comparisons (1047 of 1071 comparison points), GSM 102 fees fall below ExIm Bank fees.389 Taking account of the differing interest cover noted by the United States means that GSM 102 fees fall below ExIm Bank fees in 97.2 percent of the 1071 comparison points (or 1041 of 1071 comparison points).390 In other words, what the United States characterizes as "[t]he most significant" difference between GSM 102 ECG cover and ExIm Bank LCI and MTI cover that "Brazil has failed to address" changes the result of Brazil's comparison for a grand total of sixout of 1071 comparison points.391
246. Brazil now describes how it has factored the differing interest coverage into the comparison, and explains why even the meagre impact just described is likely exaggerated in the United States' favour.
247. As noted by the United States, in the event of default, GSM 102, on the one hand, and ExIm Bank LCI or MTI coverage, on the other, foresee payment of a share of principal, and a share of interest.
248. As far as principal is concerned, under both GSM 102 and ExIm Bank LCI cover, default results in the guarantor having to pay out 98% of the principal amount that is still outstanding; the ExIm Bank fee calculator allows the user to calculate the applicable MTI fee for 98 percent cover.392
What is the upper limit for interest coverage under GSM 102, on the one hand, and for ExIm Bank LCI and MTI, on the other?
Where do the actual interest rates on loans secured with GSM 102 or ExIm Bank LCI/MTI cover fall relative to these caps?
250. These questions are important in determining what level of interest coverage must be taken into account in comparing the GSM 102 and ExIm Bank products. In sum, for the reasons explained below, Brazil has relied on the maximum possible difference in interest rate coverage between GSM 102 and ExIm Bank LCI, to assess the significance of differential interest rate coverage.
251. Concerning the first question, the United States asserts, with supporting data, that GSM 102 interest coverage is capped at approximately 2.8%393, meaning that in the event of default by a foreign obligor, the CCC will pay the U.S. bank no more than 2.8% for unpaid interest, even if the interest rate on the loan to the foreign obligor exceeds 2.8%.
252. ExIm Bank LCI interest coverage is capped at the prime rate (the interest rate charged by major banks to their most creditworthy customers) minus 50 basis points ("bps"). Data provided by the United States shows that the prime rate less 50 bps is, today, equal to approximately 7.8%.394 Again, this means that in the event of default, ExIm Bank will pay no more than 7.8% interest cover in case of default, even if the interest rate on the loan subject to LCI cover exceeds 7.8%. ExIm Bank MTI interest coverage is not subject to a cap.395 253. As noted by the United States, maximum interest coverage is, therefore, higher for the ExIm Bank products than for GSM 102 ECGs. To answer the United States' concern with Brazil's ExIm Bank comparison, Brazil re-ran that comparison to account for differing levels of interest coverage under GSM 102 and ExIm Bank's LCI and MTI policies. In so doing, Brazil applied the maximum interest coverage available under the ExIm Bank LCI cap, and applied the ExIm Bank LCI cap for the purposes of MTI cover – or in other words 7.8%. On the other side of the equation, Brazil similarly applied the maximum interest coverage under the GSM 102 cap – or in other words 2.8%. The details of this comparison, including interest coverage, are explained below.
254. The answer to the second question explains why application of the LCI cap, like Brazil's ExIm Bank comparison overall396, is extremely conservative and favourable to the United States. In short, under both current and historical economic conditions, actual interest rates by borrowers benefiting from LCI or MTI cover fall significantly below the LCI cap.
255. The United States has provided data in these proceedings concerning the interest rates secured by foreign obligors on GSM 102-guaranteed loans. The highest interest rate tracked by the U.S. data is [[ ]]397, which at current levels corresponds to approximately [[ ]].398 A USDA FAS publication confirms the U.S. data: "Typically interest rates between U.S. banks and the importer's banks are negotiated at Libor, the London Interbank Offered Rate, plus a fraction of a percent."399 GSM 102, ExIm Bank LCI and ExIm Bank MTI products all contribute the same U.S. government credit rating to a transaction. Therefore, the rates offered on loans secured with ExIm Bank LCI/MTI cover will be the same as the rates offered on loans secured with GSM 102 cover – LIBOR plus a fraction of a percent or, today, approximately [[ ]].400 256. This evidence demonstrates that the rates secured with ExIm Bank LCI or ExIm Bank MTI cover do not reach the ExIm Bank LCI cap of 7.8%. Interest rates on loans subject to ExIm Bank LCI/MTI coverage are considerably lower than the LCI cap. While the United States argues that the absence of an interest cap for ExIm Bank MTI cover means that "one can only infer the disparity between CCC interest cover and [MTI cover] is even greater" than the disparity between CCC interest cover and LCI cover401, this is not a logical or reasonable inference at all, in light of the fact that actual interest rates fall well below even the LCI cap.
257. Nor have rates secured with ExIm Bank LCI or ExIm Bank MTI cover reached the ExIm Bank LCI cap as an historical matter.
258. Over the 10-year period of 1997-present, the prime rate has ranged between a low of 4.0% from July 2003-June 2004, to a high of 9.5% from June 2000-January 2001.402 The compliance Panel will recall that according to the United States, the LCI cap is set at the prime rate minus 50 bps.403
259. As discussed above, actual interest rates secured with LCI or MTI cover are pegged to LIBOR, with the addition of "a fraction of a percent,"404 or as the United States has shown, around [[ ]] bps.405 Over the 10-year period of 1997-present, LIBOR has ranged between a low of 1.09% in March 2004 and a high of 6.83% in November 2000.406
260. As both current economic conditions and historical conditions demonstrate, whether rates are high or low, LIBOR and the prime rate move roughly in tandem.407 At no point has the LCI cap of prime minus 50 bps come any where close to falling below LIBOR plus [[ ]], or even LIBOR plus 1 percent (100 bps). The gap between the lower interest rates accessible by borrowers benefiting from LCI or MTI cover, on the one hand, and the higher LCI interest coverage cap, on the other, always exists.
261. Even though actual interest rates accessible by borrowers benefiting from LCI or MTI cover have never reached the LCI interest coverage cap and at present economic conditions fall below the cap by [[ ]] bps (7.8% less [[ ]])408, Brazil has applied the LCI cap as the amount of interest cover available with LCI and MTI cover. Thus, Brazil's assessment of the impact of interest coverage is extremely conservative and favourable to the United States.
262. Thus, in its revised ExIm Bank comparison, Brazil assumes GSM 102 interest coverage at the cap of 2.8%, and ExIm Bank LCI and MTI interest coverage at the LCI cap of 7.8%.409 263. Under these conditions, if default occurs on a GSM 102-guaranteed loan, the CCC will pay 100.8% of the remaining principal – 98% towards principal, and 2.8% towards interest. If default occurs on a loan secured with LCI or MTI cover, ExIm Bank will pay 105.8% of the remaining principal – 98% towards principal, and 7.8% towards interest.
264. Let pgsm be the premium charged per dollar of principal for GSM 102 cover, and let pexim be the premium charged per dollar of principal for ExIm Bank LCI or MTI cover. As noted above, a GSM 102 premium pays 100.8% of the remaining principal in the event of default, while an LCI or MTI premium pays 105.8% of the remaining principal in the event of default. This means that per dollar of coverage, CCC charges pgsm/100.8, while ExIm Bank charges pexim/105.8.
265. If pgsm < [pexim x (100.8/105.8)], then GSM 102 fees are cheaper than LCI or MTI fees even after accounting for the differentials in interest coverage. Since (100.8/105.8) is approximately 95.3%, wherever GSM 102 fees are less than 95.3% of LCI or MTI fees, GSM 102 fees are below LCI or MTI fees, even accounting for differing interest coverage.
266. On the basis of the GSM 102 and ExIm Bank LCI and MTI fees listed in Exhibits Bra-536 and Bra-537410, Exhibits Bra-693 (for GSM 102 transactions involving annual repayment of principal) and Bra-694 (for GSM 102 transactions involving semi-annual repayment of principal) list GSM 102 fees as a percentage of ExIm LCI and MTI fees. In every instance in which GSM 102 fees are less than 95.3% of LCI or MTI fees, GSM 102 fees are below ExIm Bank fees, even accounting for differences in interest cover. As Exhibits Bra-693 and Bra-694 show, this is the case in 97.2 percent of the 1071 comparison points (or 1041 of 1071 comparison points).411
267. In conclusion, differing interest cover between GSM 102 and ExIm Bank products does not undermine the validity of Brazil's comparison; nor does adjusting for those differences materially influence the results of that comparison.
Fourth U.S. criticism:
Differing principal coverage as between GSM 102 and ExIm Bank MTI cover 268. Fourth, the United States notes that while GSM 102 offers coverage for 98% of principal, ExIm Bank's MTI is available for coverage of up to 100% of principal.412 In paragraph 390 of its First Written Submission, however, Brazil noted that the fee calculator available at ExIm Bank's website allows a user to reduce the amount of coverage, and to calculate the applicable MTI fee for 98 percent principal cover, or in other words, equivalent principal cover to GSM 102. Brazil did so for the purposes of calculating the ExIm Bank MTI fees tracked in Exhibits Bra-536 and Bra-537. Brazil has fully controlled for the possible difference in principal coverage noted by the United States. Not only has the United States waited nearly 5 months to comment on Brazil's ExIm Bank comparison until this late stage of the proceedings, having foregone the opportunity to do so in the 7 submissions it made prior to its 2 April answers, but it misleads the compliance Panel by raising an element that was controlled for by Brazil, expressly, in that comparison.
Fifth U.S. criticism:
Differing principal coverage as between GSM 102 and ExIm Bank LCI cover 269. Fifth, although not disputing that ExIm Bank's LCI product, like GSM 102, covers 98% of principal for transactions involving agricultural products413, the United States appears to assert that another feature of the LCI product effectively raises principal coverage to 100%. Specifically, the United States alleges that under an ExIm Bank LCI policy, "'the insured may arrange recourse or 'pass back' to a third party of all or any part of any uninsured amount.'"414 The United States asserts that "[t]his is not permitted under GSM 102," and that therefore, unlike in the case of a holder of an LCI policy, a GSM 102 holder is, under the GSM 102 regulations, not able to insulate itself from exposure to default on the 2% of principal, and any percentage of interest, not covered by the GSM 102 ECG.415 270. The United States' characterization of the GSM 102 regulations is misleading and incorrect. The regulations do not support the U.S. contention that the holder of a GSM 102 ECG "is not permitted" to insure the remaining 2% of principal not covered by the GSM 102 ECG. In fact, the regulations establish exactly the opposite – that a holder of a GSM 102 ECG can insulate itself from exposure to default on the 2% of principal, and any percentage of interest, not covered by the GSM 102 ECG.
271. The United States asserts that under Section 1493.110(b)(4) of the GSM 102 regulations, included as Exhibit US-142, "[u]pon default the claimant must subrogate to CCC the claim to the entire amount in default, not just the guaranteed portion."416 As noted by the United States, Section 1493.110(b)(4)(iv) states that the holder of a GSM 102 ECG must sign an agreement "subrogating to CCC the respective rights of the exporter and the exporter's assignee, if applicable, to the amount of payment in default under the applicable export sale."417 The United States further asserts that under Section 1493.130(a) of the GSM 102 regulations, "CCC then has the right to recover from the obligor all moneys in default."418
272. In other words, the United States implies that although a GSM 102 ECG only covers 98% of principal, in the event of default and payment by CCC to the holder of the ECG of 98% of principal, the CCC enjoys a claim on 100% of any monies recovered from the foreign obligor.
273. The United States has not been fully forthcoming with the compliance Panel. As the United States is surely aware, Sections 1493.110(b)(4)(iv) and 1493.130(a) are not the end of the story. Indeed, Section 1493.130(c) directly contradicts the United States' argument, and show that a GSM 102 ECG holder, as in the case of an ExIm Bank LCI policyholder, is indeed able to insulate itself from exposure to default on the 2% of principal not covered by the GSM 102 ECG.
274. Section 1493.130(c) provides as follows:
Recoveries made by CCC from the importer or the foreign bank, and recoveries received by CCC from the exporter, the exporter's assignee, or any other source whatsoever, will be allocated by CCC to the exporter or the exporter's assignee and to CCC on a pro rata basis determined by their respective interests in such recoveries. The respective interest of each party will be determined on a pro rata basis, based on the combined amount of principal and interest in default. Once CCC has paid out a particular claim under a GSM-102 or GSM-103 payment guarantee, CCC prorates any collections it receives and shares these collections proportionately with the holder of the guarantee until both CCC and the holder of the guarantee have been reimbursed in full.419
275. The underscored sentence is particularly significant. Following default by a foreign obligor on a GSM 102-guaranteed loan from a U.S. bank, the U.S. bank files a claim with the CCC. Upon receipt of the claim, the CCC pays the U.S. bank 98% of principal and any interest up to the GSM 102 cap. Subsequently – "[o]nce CCC has paid out a particular claim"420 – CCC seeks to collect from anyone it can. If the CCC succeeds in securing collections, the regulations state that it "shares these collections proportionately with the holder of the guarantee until both CCC and the holder of the guarantee have been reimbursed in full."421
276. If the United States were correct that the CCC is entitled to 100% of any recoveries it secures from the foreign obligor, why would the U.S. exporter, or more likely the U.S. bank, as the exporter's assignee and the holder of the guarantee, be entitled to a prorated, proportionate share of any collections secured by the CCC? If the United States were correct, once the U.S. bank, as the holder of the guarantee, was paid its claim – 98% of principal and any interest up to the GSM 102 cap – it would be entitled to nothing more. The U.S. bank would at that point "have been reimbursed in full", and any subsequent monies secured by the CCC as part of its collection efforts would be for the CCC to retain.
277. But the United States is not correct. Section 1493.130(c) clarifies that if the CCC's collection efforts are successful, the holder of the guarantee is indeed entitled to more than its claim to 98% of principal and any interest up to the GSM 102 cap. Out of any collections secured by the CCC subsequent to payment of the U.S. bank's claim, the U.S. bank is entitled to its "proportionate" share – presumably, up to the remaining 2% of principal, and the portion of interest, not covered by the GSM 102 ECG. The U.S. bank need not wait until CCC has been made whole; rather, CCC's claim on recoveries is ranked pari passu with the U.S. bank's claim on recoveries.
278. In other words, the United States has mischaracterized the GSM 102 regulations, asserting a difference between GSM 102 and ExIm Bank's LCI cover that does not exist. As with ExIm Bank's LCI policy, GSM 102 cover allows the holder of a GSM 102 guarantee to recover amounts in excess of 98% of principal and any interest up to the cap.
279. In fact, GSM 102 may well be superior to ExIm Bank's LCI cover in this regard. Section 1493.130(c) of the GSM 102 regulations, quoted at length above, provides that after CCC has paid a claim, it shares recoveries on a pro rata basis with the U.S. bank. This means that CCC's claim on recoveries is ranked pari passu with the U.S. bank's claim, rather than senior to the U.S. bank's claim.
280. In contrast, under ExIm Bank's LCI, were the exporter or the U.S. bank to arrange cover with a third party for 2% of the principal and any portion of interest not covered by the ExIm Bank LCI policy, that third party's claim may well rank junior to ExIm Bank's claim. In that case, Section 1493.130(c) of the GSM 102 regulations would mean that GSM 102 provides a superior product from the exporter or the U.S. bank's standpoint. With a GSM 102 ECG, the exporter or the U.S. bank does not stand in line behind the CCC to recover the 2% of principal and any portion of interest not covered by the GSM 102 ECG; rather, out of the first and last dollar of recoveries secured by the CCC, the exporter or the U.S. bank gets its pro rata share. If anything, this means that GSM 102 fees should be even higher than ExIm Bank LCI fees, rather than the reverse, as the United States asserts.
281. Even if this is not the case, however, as Brazil has explained above, Section 1493.130(c) of the GSM 102 regulations means, at the very least, that the difference between GSM 102 and ExIm Bank's LCI cover alleged by the United States does not exist. Having foregone the opportunity to comment on Brazil's ExIm Bank comparison in the 7 submissions it made prior to its 2 April answers and subsequent to Brazil's profer of the comparison, the United States' misleading and inaccurate characterization of its own regulations at this late stage of the proceedings is disappointing and not credible.
99. Please comment on Brazil's argument that the GSM 102 fees are not sufficiently scaled to take into account country risk (i.e. they vary only minimally according with country risk) (see, inter alia, paras. 410-412 Brazil's First Written Submission).
282. The United States argues that there is "no basis in the text" of the SCM Agreement for Brazil's assertion that GSM 102 fees are insufficiently scaled to account for risk.422 The United States notes that it "is not aware of any provision of the SCM Agreement that establishes what constitutes 'sufficient' scaling."423 283. The United States may be unaware of Article 1.1(b) of the SCM Agreement, which has been interpreted by the Appellate Body to require a comparison between the terms offered a recipient for a government financial contribution, and the terms available to the recipient for a comparable instrument secured at market.424 Brazil has demonstrated that there is no credit protection product available in the marketplace that is comparable to a GSM 102 ECG.425 Nonetheless, Brazil has additionally undertaken a comparison between GSM 102 fees and fees for comparable non-market products offered by ExIm Bank.
284. That comparison exercise, undertaken methodically on a country-by-country, tenor-by-tenor basis, demonstrates that GSM 102 fees are consistently below ExIm Bank fees. At paragraph 400 of its First Written Submission, Brazil also demonstrated graphically that ExIm Bank fees rise much more sharply than GSM 102 fees in response to increased transaction risks, even if ExIm Bank fees do not represent the market. Consistent with fundamental tenets of corporate finance, as maturity and, in particular, country risk, increases, the rate at which ExIm Bank fees rise increases significantly. The same cannot be said of GSM 102 fees, which are barely responsive to increased risks arising from longer maturities and/or increased country risk.
285. In other words, by comparison to other similar instruments, GSM 102 fees are insufficiently scaled to account for transaction risks that even non-market entities take into account. The comparison exercise undertaken by Brazil enjoys a basis in the relevant provisions of the SCM Agreement – specifically, Article 1.1(b) of the Agreement, as interpreted by the Appellate Body.
4. Item (j) of the Illustrative List Questions to both parties 102. What, in your view, explains the different results achieved by the two methods advocated, on the one side, by the United States in paragraphs 87-89 of its First Written Submission and by Brazil in Exhibit Bra-613 (other than the United States' criticism that Brazil has not taken recoveries corresponding to pre-1992 guarantees into account in its "cash basis" accounting calculations, of which the Panel is already aware)?
286. The United States suggests that Brazil is backing away from net present value accounting as a reliable way to measure the long-term costs of the GSM 102 program.426 If it is not already abundantly clear to the United States427, Brazil agrees that net present value accounting is a reliable way to account for the costs of contingent liabilities.
287. Using a net present value methodology, the CCC has, in every year since the inception of credit reform in 1992 (including in budgets for FY 2006, 2007 and 2008428, under the amended GSM 102 fee schedule), projected that costs and losses for the "cohort" of ECGs issued in the coming fiscal year would, at closing, exceed projected fees, penalties and recoveries. Using the same net present value methodology, CCC's 2006 audited financial statements state that the CCC does not anticipate covering the costs and losses of the ECG programs across all outstanding cohorts of ECGs issued since 1992.429
288. As noted in Brazil's 2 April response to question 105 (at paragraphs 283-307), it is the United States that is backing away from the net present value methodology, while trying to give the impression that it embraces that methodology.
289. First, in these proceedings, the United States consistently derides the net present value methodology required by U.S. law as "unreliable", because it allegedly does not reflect the CCC's particular experience430 – a proposition with which USDA and FAS disagree, outside the context of WTO litigation.431 290. Second, although the projections of long-term losses included in the 2006 CCC financials, and in the U.S. budgets for GSM 102 ECGs issued in fiscal years 2006, 2007 and 2008, are calculated using the net present value methodology mandated by U.S. law, the United States derides these projections as not reflective of "actual" results.432 The United States' objection that this evidence does not reflect "actual" results most clearly demonstrates its abandonment of the net present value approach. By definition, net present value calculations are projectionsof future results, discounted back to present value terms. The only way the United States will accept a net present value methodology is if it is converted into a retrospective, cash-basis accounting methodology, by taking account of re-estimates.433 This amounts to a rejection of the net present value approach.
104. Must a risk-based fee necessarily take into account foreign obligor risk? Please discuss and provide any relevant support for your position. Can foreign obligor risk be treated differently than country risk in this respect, and if so, why?
291. The United States argues that there is "no basis in the text for the obligation" to taken into account foreign obligor risk in setting an ECG fee.434 292. The United States may be unaware of item (j) of the Illustrative List, which requires an assessment of "premium rates" for an ECG program, and "long-term operating costs and losses" of the program. As noted by the original panel, item (j), "where a programme does not provide for premium rates that are fully reflective of the risks of a particular transaction, this might be one indicator that the programme was set up in such a way that its long-term operating costs and losses have to be borne, in total or in part, by the government."435 The United States may also be unaware that Article 1.1(b) of the SCM Agreement defines a subsidy as a government financial contribution provided on terms that are better-than-market. Market-based institutions do not provide credit protection instruments without taking account of foreign obligor risk.
293. Brazil has submitted evidence demonstrating that to be "fully reflective of the risks of a particular transaction"436, ECG fees must be set to take account of foreign obligor risk.437 The United States has offered no evidence to rebut Brazil's showing that market-based financial institutions (let alone other U.S. government entities providing credit protection instruments similar to GSM 102 ECGs438) do not rely on exposure limits alone to adequately manage risk.
106. The parties disagree as to whether Brazil should include recoveries for pre- 1992 guarantees in its cash basis accounting formula (Exhibit Bra-613). Is the Panel correct in understanding that Brazil's formula does not includes amounts for (1) claims paid after 1992 under pre-1992 guarantees; (2) fees paid on pre-1992 guarantees? If so, please explain the relevance or non-relevance of including recoveries under pre-1992 guarantees in light of the non-inclusion of costs and other revenues related to the same guarantees. 294. In paragraph 266 of its 2 April response, the United States addresses CCC's recent, massive write-offs of uncollectible amounts attributed to pre-1992 ECGs, as recorded in the United States' "liquidating account". In Brazil's view, these write-offs offer an additional reason why the liquidating account does not turn a cash-basis assessment of program losses into program profits, as the United States has asserted.439 Writing off billions of dollars worth of losses does not make a program profitable.440