INSIGHT CENTRAL & EASTERN EUROPE

BUSINESS AS USUAL

CEE GOING FORWARD

LONG-TERM COMMITMENT

ING GUIDE TO COMMERCIAL BANKING IN CEE

BUILDING DEEPER RELATIONSHIPS

9 5 717

8 Czech Republic 16 Romania 20 Russia 26 Slovakia 34 Bulgaria

CONTENTS

Introducing CEE

Long-term commitment to the regionThe fact that we have been in Central & Eastern Europe for virtually 25 years gives us a lot of knowledge of the region. Our history is one of our strengths.

Business as usual

Sector view The economic uncertainty of recent years has highlighted CEE’s strengths in many of the world’s most important sectors.

4 Foreword by Alexander Pisaruk, Regional Head Commercial Banking CEE 10 Bracing for the climb: macro-economic outlook on Central & Eastern Europe 70 ING Commercial Banking in Central & Eastern Europe

6 Long-term commitment to the region

40 Kazakhstan 44 Hungary 56 Poland 62 Ukraine 68 Turkey

36 Combining CEE knowledge and structured finance strength 38 Developments in metals and mining 42 Finding directions in CEE – infrastructure developments 46 Connecting CEE to the rest of the world – telecom, media and technology 48 Syndicated lending and financing projects 50 Time to harvest – agricultural finance 58 Source of opportunities – energy and utilities

INSIGHT CEE - edition 2014 ING Commercial Banking, Central & Eastern Europe

Developments in financing18 Building a deeper relationship 22 Evolution in CEE lending market 28 Increasing focus on cash management in CEE 64 FX hedging to the fore 66 Commodity derivatives 67 Securities finance

Cover world map ING Commercial Banking

Thanks to: Laurence Neville, Anna Lvova, Pieternel Boogaard, Julia Chekrygina, Tibor Bodor, Stefan Verhoeven, Andre Rijs, Michiel de Haan, Michael Dinham, Pieter Puijpe, Ali Miraj, Alexander Alting von Geusau, Rodolphe Olard, Arek Szperna, Jens Vrolijk, Jason Cade, Richard Pryce.

For more information please contact Vincent Verhoeff manager marketing & communications ING Commercial Banking Central & Eastern Europe at vincent.verhoeff@ing.nl.

Client cases32 Grupa Żywiec 54 Kernel 72 Client cases - overview

contents

Welcome to Insight CEE, ING’s guide to Central & Eastern Europe (CEE) We hope this guide will help you understand the trends that will shape CEE in the coming years. In here we assess the economic outlook, highlighting both the risks and opportunities across the region. We also look at some of the most important markets, such as infrastructure finance, project finance, syndicated lending and derivatives, as well as sectors including, telecom, media and technology, metals and mining, energy, infrastructure and agriculture.

CEE weathered the financial crisis well and is now enjoying a solid, albeit slow, recovery. As economic growth gathers pace in the European Union – by far CEE’s largest trading partner – companies in the region will benefit. Meanwhile, the economic fundamentals of most CEE countries are broadly positive. While many emerging markets have been destabilised by capital inflows spurred by the Federal Reserve’s quantitative easing, inflows to CEE have been modest. Consequently, outflows driven by impending tapering should also be modest.

ING serves companies across all sectors with a range of products and services that are carefully tailored to each client and market. ING was one of the first banks to arrive in CEE in 1991 and unlike many interna-tional banks ING has demonstrated a consistent commitment, also during years of crisis and uncertainty such as 2008 and 2009. ING has continued to invest and reap the rewards as CEE has bounced back quicker than Western Europe. Clients appreciate ING’s commitment to the region and its approach to service.

In view of the nature of CEE, lending, cash management and FX are central to ING’s relationship with companies in the region. ING has a comprehensive track record of meeting its clients’ needs in these areas and leveraging its operations across the region to make it easier for clients to gain assistance wherever they need it. The bank’s longstanding presence in the region makes integration and control straightfor-ward and secure. In transaction services, including payments and cash management (PCM), ING has a world-class offering in the most important markets in CEE. We act as both a local and an international bank, combining the benefits of flexibility and standardisation of documentation and customer support internationally. Similarly, in FX we combine global emerging markets FX desks in Amsterdam, Brussels and London with our local knowledge, execution and research across CEE.

In order to ensure that its capital is targeted at the most appropriate clients, ING focuses on client relationships that are complementary for both parties. ING continues to have the capacity and a willing-ness to lend and provide cash management and FX services. In return we expect clients to recognise ING’s expertise – both within CEE and internationally – across a wide variety of products, including capital markets and M&A advisory.

ING does not expect a client to select anything other than the best provider. That said, clients can be confident in the knowledge that working with ING means gaining access to world-class products and services. Our in-depth knowledge of local market conditions enables us to take a proactive approach to the challenges our clients face whether they are related to financial markets services such as foreign exchange, commodity and interest rate hedging, or project and infrastructure financing. We expect to be on a client’s shortlist in the many areas where ING offers competitive solutions.

CEE is at the heart of ING’s vision for the future. We understand that our success in the region depends on meeting our clients’ expectations. As CEE’s economic recovery strengthens in the coming months we are ready to help our clients take advantage of emerging opportunities and achieve their strategic goals. We hope this guide provides useful insights and prompts thoughts and ideas about the opportunities in CEE. We would be delighted to hear from you if you would like to learn more.

Alexander PisarukRegional Head ING Commercial Banking Central & Eastern Europe

5introduction

First account for Russian client at Barings Established in London in 1762, Barings (part of ING) rapidly emerged as the world’s leading merchant bank. The firm undertook prestigious transactions worldwide and the first account of a Russian client was opened in 1775. From the eighteenth century Barings also financed Russian trade. As merchants, the firm traded in a wide variety of Russian goods through the ports of St Petersburg and Rostov. Timber was of special importance but hemp, tallow, flax, hides, linseed and grain also figured.

LONG-TERM COMMITMENT TO THE REGION“Our history is one of our strengths. The fact that we have been in Central & Eastern Europe for virtually 25 years gives us a wealth of knowledge of the region. The fact that we have been building this presence carefully, and mostly organically, means we know what we are doing in the region. This has helped us to stay here throughout the business cycles — even during the recent turmoil we remained committed because we have always known what we are doing and where we are going.” - Alexander Pisaruk

Bank Śląski and ING start cooperation Bank Śląski was established in 1988 as a result of a spin-off from the National Bank of Poland. In 1991 it was transformed from a state bank into a limited company and in 1994 it debuted on the Warsaw Stock Exchange. ING Group has been the bank’s majority shareholder since 1996.

In 2001 Bank Śląski merged with the Warsaw branch of ING Bank N.V. and the bank has been operating since under the name ING Bank Śląski.

ING opens offices in Romania, Bulgaria & Ukraine

20xx

ING sets foot in Turkey

Poland and Ukraine successfully host EURO 2012

Virtually 25 years of continuous presence in CEE Today ING is highly regarded for its expertise in emerging markets in Central & Eastern Europe. With offices in Russia, Bulgaria, Czech Republic, Hungary, Kazakhstan, Poland, Romania, Slovakia, Turkey and Ukraine, the bank offers a wide range of financial services mainly focused on cash manage-ment, financial markets, lending and structured finance.

6

1775

1991

1992

End of the eighties - new opportunities The 1990s marked the start of a new era with the fall of the Berlin Wall. Not only for the countries in Eastern Europe, but also in the banking business. ING continued as a single entity in 1990 when the legal restrictions on mergers between insurers and banks were lifted in the Netherlands. This prompted insurance company Nationale-Nederlanden and banking company NMB Postbank Groep to enter into negotiations and eventually merge into Internationale Nederlanden Groep (ING) in 1991.

ING expands into CEE Leveraging on the new opportunities, ING developed into a strong multinational bank through a combination of organic growth and various acquisitions. ING opened its own office in Hungary in 1991, followed by branches in Czech Republic and Slovakia in 1992.

1993 ING opens Russian offices in Moscow & St Petersburg

1994

1997

Kazakhstan office opened

1997

2014

history 7

1989

2009

2012

Global services and operations hub opened in Bratislava to serve clients more efficiently

Business as usualPRAGUE, CZECH REPUBLIC 10.15 AM

CZECH REPUBLIC

GDP change %

Private consumption% change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

czech republic

Source: ING

estimated average growth 2014/ 2015

9

More information on ING CB in Czech Republic visitingcb.com/czechrepublic or view the introduction video [click here]

BRACING FOR THE CLIMB macro-economics

by Rob Rühl, Head of Business Economics ING Economics Department Global Markets Research and Mohammed Nassiri, Researcher ING Eco-nomics Department Global Markets Research

CEE economies are well-positioned compared to their 2008/2009 battering to show positive economic growth rates in coming years. Years of poor growth are starting to make way for improved external balances and financial stability. However, increas-ing political and policy risks in the region cannot be ignored as numerous elections are approaching. Moreover, while most CEE countries are recovering, they remain some way from the heights achieved in the pre-2008 period.

Recent performance Compared with other regions CEE enjoyed moderate economic growth rates during 2013 with central banks across the region trying to support growth by lowering offi-cial interest rates or, in countries with rela-tively high inflation, implementing liquidity support measures. Positives for the region included a clear recovery in other parts of the world, low foreign interest rates, ample global liquidity and stable commodity prices. However, the ongoing recession in the EU had a major impact on trade and financial flows in CEE. Output weakness in 2012/2013 can nevertheless be attributed to a lack of domestic demand rather than disappointing export performance.

Fixed investment slowly recovered in 2013. This reflects lower capital inflows as well as policy restraints. Other headwinds for the region include deleveraging pressures on banks and regulatory changes which are increasing the cost of capital allocated to CEE. In the aftermath of the financial crisis there was a surge in non-performing loans as growth slowed, unemployment rose and the housing boom ended. Bank lending fell as a consequence while households facing an uncertain future in terms of income cut spending and boosted savings.

Most governments in the region have succeeded in keeping government deficits below the magic 3% of GDP level (the so-called Maastricht criteria for the eurozone). Exceptions include Poland, the Slovak Republic and Romania. Similarly, govern-ment debt was kept below 60% of GDP everywhere except Hungary and, outside the EU, Russia. While oil and gas revenues supported government finances and its

international reserves position, the country nevertheless faces significant challenges. Insufficient investment, lagging structural reform and an adverse investment climate are constraints to potential growth.

One advantage of the slow growth in domestic demand across CEE is downward pressure on inflation and improved current account deficits in many countries. The latter reduces the reliance of CEE countries on foreign savings. However, Turkey and Ukraine still depend on large foreign capital inflows. As a consequence both countries’ currencies depreciated heavily against the dollar and the euro following the 22 May announcement by the US Fed-eral Reserve Bank that its loose monetary policy would be curtailed in future (a so-called tapering process starting in January 2014).

Prospects for 2014-2015With growth in the eurozone picking up, the outlook for CEE countries will improve in 2014-2015. The EU5 (Bulgaria, Czech Republic, Hungary, Poland and Romania) will benefit the most with Turkey profiting to a lesser extent. ING’s base forecast for most of the region is for a slow growth recovery. The large build-up of slack in recent years will act as a stabilising factor for short-term interest rates as it will delay any build-up of inflation.

Consumers across the region will gain confidence and start spending money on consumer durables. Similarly, companies should resume investments, especially those associated with replacing existing production facilities to improve produc-tivity and save energy. As a result imports

are likely to pick up, reversing the trend towards lower current account deficits.Governments are expected to support the revival of private domestic demand as the key adjustments required to ensure eco-nomic stability have already been made. Bulgaria, Romania and Hungary may have room for fiscal relaxation to stimulate domestic demand while pension reforms in Poland have made room for extra government spending ahead of the 2015 parliamentary elections.

The EU5 countries will benefit from the disbursement of funds under the EU 2014-2021 budget, as well as from a boost in infrastructure investments. Poland appears best-positioned to absorb these EU funds as the absorption capacity in the other four countries is still limited.

The downside risks to growth are most prominent in Hungary. Taxes on banks and schemes to convert foreign exchange-de-nominated mortgages into Hungarian forint will constrain bank lending. Mean-while Turkey will have to adapt to years of lower foreign capital inflows. As a conse-quence the country faces difficult decisions if it is to reduce its current account deficit. One option would be a depreciation of the currency to stimulate exports and reduce imports. However, that would jeopardise the policy goal of the Turkish central bank to keep inflation under control. The most likely outcome would appear to be for the central bank to raise interest rates in order to reduce domestic demand.

Unlocking potential growth in Russia will require investments in infrastructure and improvements in the ease of doing

11macro-economics

business. Neither objective looks likely to be achieved in the short run. The govern-ment is expected to stick to fiscal tight-ening in line with the 2014-2016 budget framework. So while Russia will remain financially stable – thanks to its oil and gas reserves – the outlook for economic growth will be constrained. Neighbour-ing Ukraine faces a period of important adjustments to reduce its fiscal and current account deficits: the country could suffer a severe loss of income and output and from a depreciation of the hryvnia. Support from Russia will mitigate the negative impact of developments in Ukraine. All in all the CEE & CIS region will profit (GDP growth 3.5%) from a moderate economic recovery in the European economies (1.3%) and domestic policy adjustments in 2014/2015. Increas-ing political pressure due to upcoming elections may have a negative impact.

CEE and Western Europe growing closer The CEE economic block is becoming a more open region with an increasingly important role as a global trading partner. CEE exports grew at a compound annual growth rate (CAGR) of 15% between 2002 and 2012 (figure 2). The merchandise trade ratio increased from 63% to 84% of GDP, showing that trade is becoming more important for the region’s economy. At the same time the region’s share of global trade increased by 1.2 percentage points to 5.0% of global exports. This is partly the result of a high growth rate of trade with the own region (so-called intra-regional trade). The euro area is still, however, the most important trade partner for the CEE countries, while emerging countries

outside the own region only play a minor role (figure 1).

The top three exporting countries in the CEE region in descending order are Poland, the Czech Republic and Turkey. The same countries are the main importers and are together responsible for 57% of the region’s foreign trade. Intra-regional trade increased between 2002 and 2012 from 16% to 22% of total exports, reflecting the growing interdependence between countries within the region. Poland (17%), Czech Republic (17%), Slovakia (15%) and Hungary (14%) are together respon-sible for 63% of this intra-regional trade. Growth in intra-regional trade is one of the quick wins for the region’s trade develop-ment and is mainly due to an increasing importance in the European supply chain.

This will continue in 2014/2015. Not only by trade ties between CEE and WEU ties became stronger. Foreign direct investment and bank lending from Western Europe-an banks helped to finance the transfer of production capacity to CEE countries, enabling CEE to link its industrial sectors to the successful European supply chains in the technological industries.

Trade within CEE and with CIS and the Middle East & North Africa (MENA) is gradually increasing. However, CEE exports continue to depend heavily on Western European markets, which accounted for 53% of exports in 2012 (the EU accounts for 43% of the total). Consequently, the outlook for CEE is closely linked to recovery in the EU. The nascent recovery in many eurozone countries therefore bodes well

for CEE in 2014/2015. 12% of CEE goods go to emerging countries in other regions such as Asia, Latin America (LATAM) and MENA. Excluding trade with the MENA region – which is dominated by Turkey with almost 75% of the total CEE trade – this share is even smaller (5%). Despite this low share CEE is well-positioned through its ties to the supply chains of countries like Germany to benefit indirectly from high growth rates in emerging countries. Nevertheless, exporting more to emerging countries directly could help CEE become more diversified and less susceptible to a possible economic slowdown in Europe.

Cars and machines in exchange for mineral fuelsMuch of CEE’s dependence on the EU as an export market stems from devel-opments in the 1990s when there was a considerable transfer of production capac-ity by original equipment manufacturers from Western Europe. From the mid-90s onwards CEE became a major exporter of machinery and transport equipment. The continued high share of intermediary prod-ucts in total exports shows the importance of the region’s role as a supplier for both the euro area and the region itself. The CAGR of machinery and transport equip-ment exports between 1995 and 2012 was

17%, making it by far the most important export sector. By 2012 machinery and transport equipment represented 39% of exports (with 61% of these exports shipped to Western Europe). Machinery and transport equipment is gen-erally characterised by its high added value, underlining the increasingly sophisticated export profile of CEE (figure 3). In Germany in particular (which accounts for 20% of CEE exports) CEE products are important input for the production of cars and ma-chines. Almost 50% of all foreign interme-diate products for motor vehicles and 30% of the machinery used by German sectors is produced in the CEE region. This makes

Source: UNCTAD, ING calculations

> 30 bn. USD 20 - 30 bn. USD 10 - 20 bn. USD 0 - 10 bn. USD

Figure 1 - CEE export growth by country 2002-2012

67%

21%3%9%

USD 213 bnRest of the world

MENA

Emerging Europe

Western Europe

RU 5%

CZ 3%

PL 3%

53%

30%

USD 873 bn

GE 20%

IT 6%

UK 5%

FR 5%

7%

9%

+15%

Major countries within the region% share total exports 2012

59%

23%

7%12%

USD 277 bnRest of the world

MENA

Emerging Europe

Western Europe

RU 11%

CZ 3%

PL 3%

46%

31%

USD 975 bn

GE 18%

IT 6%

NL 4%

FR 4%

11%

12%

+13%

Major countries within the region% share total imports 2012

CH 7%

2002 20122002 2012

Figure 2 - Development of exports and imports in Central & Eastern Europe by region 2002-2012, value USD billion

Source: UNCTAD, ING calculationsNote: Emerging Europe consists of CEE + CIS

13macro-economics

CEE well-positioned to benefit from the positive outlook for German sectors such as the transport and machinery sectors in coming years.

Despite the export success of CEE the trade deficit almost doubled in the last decade from USD 64 billion to USD 102 billion. The main contributors to the region’s trade deficit (60%) are Turkey and Romania (oil bill). Czech Republic, Slovakia and Hungary were able to turn their deficit into a surplus mainly by exporting more road vehicles, electrical machinery and telecommunica-tion appliances. More exports of cars and machines in exchange for mineral fuels will be the name of the game in CEE in the coming years. The expansion of the pro-duction capacity of high-tech goods and the continued strong market position in intermediary products will help to achieve this goal.

CEE technological sector continues to growThe CAGR of the production of invest-ment goods and consumer durables was between 8.6% and 8.8% from 1998 until 2012 – double the regional GDP growth rate. Globally CEE accounted for 7.6%

of worldwide durable consumer goods production and 4.8% of the production of investment goods in 2013. As shown in figure 4 we expect industries included in the production of technological goods (indicated by blue bulbs) to show the high-est growth rates in 2013-2018. Foreign direct investment made before the start of the global crisis and adjustments to in-vestment plans resulted in idle production capacity later. This capacity will be used in the coming years to increase production for domestic sales and exports. Europe-an producers will continue to allocate production to the CEE region. Some critical production processes for the European market can be transferred from Asia to countries in the CEE region. With sales prospects for Asian companies improving in Europe, more Asian companies are expected to step up foreign investments in CEE. Cost advantages of producing in CEE, direct access to the EU market and lower transport costs are the main drivers for Asian companies to establish themselves in the region. Foreign direct investment by companies in the automotive, comput-er and office equipment, and domestic appliances sectors have driven production growth: 65% of automotive production in the region was started by Western

European companies. The best-known examples of international firms that have established a significant presence in CEE are Volkswagen in Czech Republic and Renault in Romania. Asian companies have also established production facilities in the region, such as Kia in Slovakia and Toyota and Honda in Turkey.

Russia, Poland, Turkey and Czech Republic are the most important producers of tech-nological products. Although technological production attracts most of the attention, the production of intermediate products and food is still an important cornerstone for the CEE economies. Growth in the production of chemicals, wood products, coke and refined petro-leum products and basic metals will keep pace with GDP growth. Turkey will be the main source of growth in these sectors as investment activity in Turkey is highly focused on these sectors. Food, beverag-es and tobacco will continue to play an important role (7% of global production) with Turkey, Russia and Poland being the main food-producing countries in the re-gion. Turkey’s leading role is supported by its high agricultural share (3.5%) of global production.

Russia: global producer for domestic marketRussia’s economic performance is main-ly linked to the oil and gas industry. A lesser-known fact is that the country is by far the largest producer of investment goods with a global market share of 5.1% for the production of computers, for example. The country is also the largest producer of cars and other vehicles, with a global market share of 2.1%. The focus of Russian production is mainly on the domestic market and the markets of the countries of the Customs Union (Russia, Belarus and Kazakhstan). At the same time the Russian market is known as one of the most protected markets. Russia’s focus on the creation of a customs union and the protection of its own markets limits the Russian technological sector’s ability to play a more important role in global trade, thus preventing Russian industry from unlocking its potential.

105

343

343

167

Machinery and transport equipment

Manufactured goods

Miscellaneous manufactured articles

67 Chemicals and related products

65 Food and live animals

54 Mineral fuels

31

4

Crude materials, inedible

Other products29

9Beverages and tobacco

Animal and vegetable oils, fats, waxes

PRODUCT GROUP SHARE (%)1995

SHARE (%)2012

CAGR (%)1995 - 2012*

1 0.4 11

2 1 9

1 3 22

5 4 10

5 6 14

10 7 11

9 8 11

20 12 9

27 19 10

20 39 17

Figure 3 - Exports Central & Eastern Europe by product group, 2012

Source: UNCTAD, ING calculations

Figure 4 - Development sectors by output growth and share in global production (CEE and CIS)1

Food, beverages and tobacco

267 USD bn

Paper and printing

267 USD bn 67

% of global production 2012

FIGURE 5 Development sectors by output growths and share in global production (CEE and CIS)1

7.5%

7.0%

6.5%

6.0%

5.5%

5.0%

4.5%

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0%

0 2 4 6 8 10 12

Transport equipment266 USD bn

High-tech goods141 USD bn

Chemicals and pharmaceuticals

168 USD bn

Mechanical engineering

92 USD bn

Basic metals

155 USD bn

Utilities177 USD bn

Extraction184 USD bn

Leather goods8 USD bn

Garments23 USD bn

Textiles44 USD bn

Agriculture, forestry and fisheriy

257 USD bn

Othermanufacturing38 USD bn

Furniture manufacturing27 USD bn

Metal products

87 USD bn

Electric machinery and apparatus

108 USD bn

Non-metallic minerals

83 USD bn

Rubber and plastics

110 USD bnWood and wood products34 USD bn

% a

vera

ge

gro

wth

201

3 -

2018

average growth all sectors

Source: Oxford Economics, ING calculations1. Total region consists of Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Slovak Republic, Slovenia, Turkey, Ukraine

* CAGR ‘95 - ‘12 of all products = 12%

macro-economics 15

Business as usualDANUBE, ROMANIA 3.58 PM

14

ROMANIA

GDP change %

Private consumption% change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

romania

Source: ING

estimated average growth 2014/ 2015

17

More information on ING CB in Romania visitingcb.com/romania

CFOs and treasurers in Central & Eastern Europe face challenging conditions for the foreseeable future, not unlike their peers elsewhere in the world. By working with their banks to improve liquidity management and de-risk their balance sheets, companies in emerging Europe are ensuring that they are well positioned for every eventuality - by Tibor Bodor, Head of Client Coverage CEE

The global economy and financial markets have created headwinds for corporate growth in emerging Europe. Many of the region’s exports go to the troubled eurozone, while regulatory reform and upheaval in the banking sector threaten to reduce companies’ access to capital. In response CFOs and treasurers in the region are focusing on two key priorities, according to research by ING.

The first is to improve liquidity manage-ment and working capital. The second is to identify opportunities for improved efficiency and to reduce risks, both operationally and on corporate balance sheets. In terms of liquidity management, many firms initially focused on rationalis-ing their inventory before seeking to extend payment terms with suppliers. There has also been a drive to improve receivables management. Recently there has been an increase in interest for more sophisticated working capital and trade finance solutions, including supply chain finance and factoring. Solutions such as these have been popular in other emerg-ing markets, most notably in Asia, for many years. However, their adoption in emerging Europe has been delayed for a number of reasons. The fragmented regional banking market serves as one explanation. State-owned banks have continued to make their balance sheets available, regardless of market conditions.

Similarly, a number of banks competing in the region are not subject to Basel requirements, enabling them to make funds available at a lower cost than banks headquartered in Western Europe, for example. Secondly, many corporates have, until recently, been unfamiliar with more sophisticated financing solutions. For example, it takes time to understand why the internal reorganisation required for factoring is worthwhile. A high degree of customisation is necessary to accom-modate local legal structures and requirements, even for banks that offer supply chain finance or factoring in markets outside of emerging Europe. Not all banks have been willing to make these investments.

De-risking corporatesChief financial officers’ second most important priority is de-risking their balance sheets. Treasurers and CFOs alike are scrutinising the banks they work with. Over the past year some international banks have exited the region while others have scaled down lending and retrenched capital. Since many companies in the region have sound balance sheets, few financial executives have found them-selves facing an immediate problem. However, there are genuine concerns about which banks will continue to provide funding and services in the coming years. Fast-growing companies in

BUILDING A DEEPER RELATIONSHIP

particular are worried about continued access to capital. The topic of bank lending is especially pertinent because the majority of corporates in the region are reliant on bank debt. Moreover, most large enterprises receive the largest portion of their funding from international banks, making them vulnerable to further retrenchment. Such companies are now considering alternative funding sources.

The syndicated loan market has largely dried up and international capital markets are currently accessible only to the largest firms in the region. However, some anticipate that international investors will view sovereign and corporate debt in CEE as an opportunity to seek the higher yields available there. While banks may have little appetite for 10-year lending, pension funds and other investors have long-term liabilities that must be matched.

Furthermore, pressure to generate yields is likely to spur a revision of investment policies. This change is being driven by the realisation that many countries in the region that are rated below investment grade might offer greater risk-adjusted returns than, for example, investment grade Spain. CEE’s weighted average debt-to-GDP ratio is 47% compared to 83% for Western Europe.

As a result, a number of emerging European corporates are now preparing IFRS accounts in order to access private placement and money market fund investors for the first time. ING has used its Eurobond platform to enable borrow-ers from Turkey, Poland and elsewhere to bring new issuances to the market. A recent beneficiary is Czech railway operator Ceské Dráhy, which raised EUR 300 million at 4.125% in July 2012. De-risking balance sheets also means identifying opportunities to unlock cash. For example, corporates are increasingly considering sale and leaseback arrange-ments to unlock real estate assets.ČSimilarly, there is increasing interest in identifying risks that were previously ignored, such as pension liabilities, and hedging volatile commodities like grain, oil and diesel. In order to respond to the needs of financial executives, some banks that are active in emerging Europe are changing how they serve the region. ING has adopted a new client-focused approach that complements its strategy in the rest of Europe. For banks willing to commit to a long-term future in emerging Europe, there is a need for more than just lending. They must adopt a relation-ship-focused approach that showcases

their capabilities, knowledge and people in order to win more business. Historically, banks in the region have taken a product-oriented approach that has failed to deliver cohesive solutions and has resulted in treasurers and CFOs spending disproportionate amounts of time on managing meetings with banks.

An alternative approach tasks bank product teams from a variety of areas with explaining the advantages and disadvan-tages of various options to finance chiefs in an unbiased way. This approach to relationships can prompt banks to focus on clients that are the best fit for their capabilities. Both banks and corporates stand to gain if banks re-evaluate how they serve clients in emerging Europe. For banks, understanding clients’ needs and business models helps them win addition-al business and create a more sustainable business model. For corporates, an increased understanding of their business means they receive better service while no longer having to meet with multiple product specialists. Perhaps most importantly, such an approach can enable the region’s companies to access the sophisticated solutions they require as they expand both regionally and internationally.

19

It’s about having a deeper understanding of what really drives our clients

clients

Business as usualMOSCOW, RUSSIA 6.21 PM

18

RUSSIA

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

russia

Source: ING

estimated average growth 2014/ 2015

21

More information on ING CB in Russia visitingcb.com/russia

EVOLUTION IN CEE LENDING MARKET corporate lending

The corporate lending market in Central & Eastern Europe is experi-encing a cautious recovery. Stefan Verhoeven, head of Corporate and FI Lending for Central & Eastern Europe at ING Commercial Banking, explains how the market is chang-ing and why relationship lending is set to become more important for corporates.

As the storm clouds over Central & Eastern Europe (CEE) begin to recede, the region is enjoying an increase in confidence in both the corporate world and the bank lending market. However, with recovery in the European Union – CEE’s largest export market – still under-whelming, the borrowing appetite of corporates remains relatively low compared to the period before the start of the financial crisis.

lending services 23

This low level of activity also reflects changes in the behaviour of corporates. Companies in CEE have become resilient by necessity: having been through multiple crises in the past they are adaptable and have learned to handle external shocks well. Companies that had high capital ex-penditure and high leverage and that relied on short-term financing before the crisis have now changed their ways.

Many corporates subsequently de-lever-aged while others successfully refinanced in 2010 and early 2011, when a number of banks were trying to boost their market share by offering lending at attractive rates. In addition, the experience of cor-porates during the crisis in 2008 and 2009 encouraged them to become more pru-dent and depend more on internal sources of funding, reducing demand for lending.At the same time some borrowers, par-ticularly higher quality names (many of which are from Russia), have turned to the bond market as an alternative source of funds, reducing their dependence on bank lending.

It should, however, be noted that CEE – which implies the CEE lending market – is far from homogenous. Each national market has different dynamics with Turkey and Russia experiencing the strongest loan growth in the region on the back of rising GDP. At the same time, the dynamics of each market vary. Corporate lending in Russia and Ukraine tends to be dol-lar-based, for example. Most other markets in the region are focused on local currency lending although there is also appetite for euro-denominated loans, both in eurozone and non-eurozone countries.

Changes to lendingAs the patterns of demand for borrowing change, so too is the supply of funding. CEE lending remains dominated by banks with foreign owners and the nature of many banks is changing. Pressure by regulators to retain capital in-country, for example, is prompting international banks to become more local in their approach.

Similarly, while historically there has been a relatively low level of deposits to fund as-sets in the majority of CEE countries – with Czech Republic the most notable exception – dependence on cross-border funding of loan assets is now being reduced. This reduction is partly the result of regulatory restrictions on the movement of liquidity between markets and an increased reg-ulatory focus on the deployment of local deposits. However, in many countries (such as Poland) local deposits have grown signif-icantly as consumer savings have increased in the wake of the crisis and banks are simply putting these local currency deposits to work in the local market.

Given relatively weak demand – and mul-tiple alternative sources of supply – com-petition among banks to lend is strong. Despite concerns of a knock-on effect from the crisis, most banks remained in CEE. Moreover some bank have expanded their presence in corporate lending, most nota-bly Russian state-owned banks: last year one leading Russian bank bought the CEE operations of a Western European bank. Russian banks are generally increasingly lending, not only in Russia and Ukraine but also elsewhere in Central Europe.

lending services

borrower wants to borrow only in dollars, a bank may offer a club loan with euro and dollar tranches with different lenders par-ticipating in each of those tranches. That means that the freedom to borrow in any currency of choice with no impact in terms of cost is a thing of the past.

Banks are generally becoming more careful about the options they offer borrowers, also in their approach to liquidity back-up lines. This is largely prompted by the impending introduction of Basel III, which will raise capital requirements for banks and introduce a leverage ratio and stricter liquidity and funding requirements. There is also less emphasis on asset-based lend-ing and more focus on cash flow-based lending.

At the same time borrowers are also becoming more sophisticated in how they access funding. In the past, many companies simply looked at borrowing on a country-by-country basis. However, companies in CEE are increasingly expand-ing cross-border and are seeking to take a broader view of their overall borrowing requirements. Banks that operate across CEE can play a helpful role as companies adopt such strategies.

Relationships to the foreAs some new players have entered the CEE loan market, the changing characteristics of the market have elevated the impor-tance of relationship lending. For banks, lending to longstanding clients makes sense: the bank understands the client’s business and credit profile and has the ability to cross-sell, which is increasingly important for allocating scarcer capital and returns on such capital. Relationship

lending is also attractive for borrowers. It makes banks more willing to lend at times of uncertainty or credit scarcity. As a result, it provides greater predictability and stability in terms of certainty of funds. The period of post-crisis uncertainty – for both banks and corporates – has meant that many recent syndicated corporate deals have involved predominantly bank clubs composed of relationship banks.

ING is committed to CEE: it has extensive operations, a willingness and capacity to lend along with a strong track record and history of capital investment in the region. The bank is strengthening its core client relationships and seizing opportunities in the market. ING expects lending to be mu-tually beneficial: in return for dependable lending, it wants to be part of a long-term cooperation that includes non-lending business.

When ING commits to lend to a client, over time it expects to become a core bank and reciprocates by taking the time to really un-derstand the client and its sector so that it can become a trusted partner and advisor. ING is also eager to leverage its interna-tional network in CEE, Western Europe and globally to support clients as they become increasingly regional or global in nature. ING offers a common approach to banking relationships across multiple markets and provides guidance as they seek to broaden their sources of funding, for example by accessing the bond markets.

Meanwhile some European banks have been forced to scale back their lending ac-tivity due to capital constraints, impending regulatory change and the need to delever-age. However, the impact of deleveraging by European banks has generally been low-er than expected following ECB liquidity programmes and the postponement of the Basle III liquidity ratio. Moreover, greater competition from Russian banks – as well as some US and Japanese banks – has more than filled the gap in the current low demand environment.

Changed lending dynamicsThe resilience of most existing banks and the entry of new banks into the CEE lending market have ensured that credit remains available for many companies. Moreover, given strong competition – both between banks and between bank lending and the bond market – pricing has fallen sharply in many markets (with the largest drops in markets that have enjoyed strong liquidity, such as Poland). However, there is an important caveat as attractive terms and less restrictive covenants are only available for the best quality names.

Given the constraints in funding markets, banks are now more careful regarding the currencies of the loans they grant in CEE and also differentiate more clearly be-tween currencies in terms of costs. When a

25

slovakia

SLOVAKIA

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

Business as usual

BRATISLAVA, SLOVAKIA 7.23 AM

27

Source: ING

estimated average growth 2014/ 2015

More information on ING CB in Slovakia visitingcb.com/slovakia

INCREASING FOCUS ON CASH MANAGEMENT IN CEEtransaction services

Multinational companies usually di-vide the world into distinct regions for payments and cash management in order to maximise efficiency and minimise costs. These regions are determined not just by geography but to some extent also by shared characteristics. As a result, CEE is of-ten treated as a separate region to Western Europe. The irony is that CEE is an incredibly diverse region - by Andre Rijs, Head of TS Sales CEE at ING Commercial Banking

Unlike much of Western Europe, most CEE countries use national cur-rencies rather than the euro. Moreover, countries in CEE have starkly different regulatory regimes and controls regarding the movement of currency and capital.

One thing that many countries in CEE have in common is that inter-national perceptions of their currency and country risk have changed dramatically in recent years. Where political instability and macro-eco-nomic volatility were once the hallmark of many CEE countries, they now look impressively stable compared to many countries in the eurozone.

CEE has weathered the financial and economic crises since 2008 better than its Western European neighbours and has significantly lower levels of government debt. Given weak growth in much of the developed world, multinationals are seeking new growth opportu-nities and markets with growing demand and high margins. Many countries in CEE – most notably Turkey with its rapid growth rate and strong demographics – fit that description perfectly.

From a payments and cash management perspective, conditions continue to improve in CEE. Some countries, such as Poland, have reached a stage in their development where they are largely indistin-guishable from Western European countries in terms of their finan-cial market infrastructure and operating environment. Nevertheless, there are still challenging markets in the region. Broadly speaking the further east one travels, the more complex payments and cash management becomes. An example is Ukraine where interest rates are extremely volatile and the regulatory environment is closed.

Consequently, international companies seeking to operate in CEE must be flexible in the way they approach this diverse region which spans open economies that use the euro and closed economies with currency controls. It is therefore essential for corporates that operate in multiple CEE markets to work with a bank that has on-the-ground knowledge and expertise of market and regulatory conditions.

29transaction services

What clients needRegardless of the complexity of the regu-latory environment, the number of banks they work with, the range of currencies in use or the number of individual markets in which they operate, corporates want visibility of their cash. To some extent, the complexity of CEE cannot be overcome. It is a fact that CEE countries use many dif-ferent currencies and ING can help clients to rationalise their account structures and banking relationships so that they have the most efficient and effective payments and cash management structure possible in the region.

Dealing with the risk presented by multiple currencies is also a priority for multination-als that operate in CEE. There are effec-tively two strategies at their disposal. They can either retain local currencies or, for currencies of countries perceived to be at particular risk, convert them to lower risk currencies. Any decision about currencies must also take into account the use of funds and whether cash balances can go to a pool elsewhere or alternatively can be used to fund local operations.

Cash pooling in CEE is inevitably more complex than in Western Europe as not all currencies are freely convertible. However, contrary to many multinationals’ expec-tations, cash balances in currencies such as the Polish zloty, Hungarian forint and Russian rouble can now be maintained in countries including the Netherlands. Often used as a treasury location by multina-tionals, the Netherlands has tax treaties with most CEE countries to avoid double taxation.

Despite advances, challenges with pooling remain. For example it is still challenging to bring positions from Romania, Bulgaria and Turkey into a cash pool. However, while currency controls cannot be avoided some of the more onerous requirements

associated with them can still be over-come. ING has a branch in St Petersburg in Russia – where many auto part suppliers are based – that can complete much of the paperwork associated with moving funds, thus helping to reduce the adminis-trative burden on clients. ING can insource other activities for clients and also provide clear regulatory and tax advice on the implications of moving positions between countries.

Within CEE, clients can either physically move cash using zero-balancing account structures or adopt notional pooling struc-tures. In some circumstances, physical cash concentration using a zero-balancing struc-ture can be advantageous for corporates. For example, by pooling euros it might be possible to get a better return at the centre than in a particular CEE country. In some countries, concerns about the likelihood of regulatory change might encourage companies to physically take funds out of a country.

Another reason to adopt a zero-balancing structure is that corporates may need the funds elsewhere in the group or want to sweep funds back to a European hub in or-der to repatriate them to head office more easily. A further reason is that companies may not want to allow local operating companies to retain control over cash (as they would do under a notional pooling arrangement).

However, in most circumstances ING advises the use of notional pooling because it does not entail a change in ownership of funds or require potentially complex intercompany lending arrange-ments. The pooling account is in the name of the CEE entity but the central treasury has access to, and control of, the cash that can then be used to fund manufactur-ing in one country, for example by using sales proceeds from other CEE countries.

Regardless of the strategy adopted, ING’s depth in CEE enables it to deliver stand-ardised processes and services across the region in order to improve visibility, control and efficiency.

Meanwhile companies are increasingly creating regional payment hubs in coun-tries such as Poland and Hungary. By being close to the markets they serve, such hubs can reflect the diversity of the region more accurately. They offer a level of skills and language capabilities similar to Western Europe but at a significantly lower cost. ING is capable of offering full support for CEE-based payment hubs as well as for accounts payables and receivables.

Risks and challenges remainCEE continues to be a dynamic region. For example, the decision in November 2012 by Hungary to effectively double the tax on financial transactions has significant implications for corporates that operate in the country. ING is working with its clients to assess whether transactions should con-tinue to be made onshore or if they should be moved offshore in order to lower costs. Regulatory initiatives are also impacting payments and cash management in the region. Many international companies assume that the Single Euro Payment Area (SEPA) and the EU’s Payment Services Directive (PSD) are focused solely on West-ern European countries in the eurozone. However, both initiatives have significant implications for CEE and corporate interest, and the impact of SEPA and the PSD in CEE is growing rapidly, particularly in Slova-kia and Romania. SEPA and the PSD will enable corporates to increase the standard-isation of payments and lower costs. Given the multiplicity of regulatory and other changes in the region it is essential that companies seek advice and expertise on a pan-regional basis.

transaction services

Why ING is differentING has been an integral part of the banking industry in CEE since the late 1980s. As a leading bank it contributed to the founding of many clearing systems across the region and played a ma-jor role in helping to develop the regulatory landscape. The bank’s relationships with regulators, which it mobilises for the benefit of clients, and its insight into how the landscape is evolving, are second to none.

Moreover, ING has repeatedly shown its commitment to CEE. While many international banks have proved a fair-weather friend to CEE, ING is committed to the region and its clients through every stage of the CEE’s development – including in times of crisis. Finding a banking partner in times of prosperity is easy but ING has demonstrated that it is also prepared to stand by its clients in tough times.

ING is active in the nine most important markets in CEE. Its presence in each country extends not only to payments and cash management but also to a full-service commercial banking operation. In Poland, for example, ING operates a full network with 300 branches. This depth of knowledge about local market conditions enables ING to take a proactive approach to the challenges facing its clients, for example by rapidly informing its clients about the implications of the imposition of Hungary’s transaction tax.

In every market in which it operates ING behaves and acts as both a local and an international bank, combining the benefits of flexibility and standardisation. For example, ING can provide all local products and services, including domestic payment instruments. ING offers all of its products and services with standard international terms and conditions, making it easy for mul-tinational companies to manage their relationship with ING. It also offers service and customer support in an internationally consistent way to give clients the control and visibility they need across multiple countries. ING can also connect its solutions in CEE to any global solution in Asia, the US or anywhere else a multinational does business.

The strength of ING’s offering in CEE was recently recognised by TMI magazine for the second consecutive year with an award based on a readers’ poll. The award acknowledges ING’s history of innovation – the bank has invested heavily in solutions including electronic cash vaults that al-low cash collections to be posted to companies’ accounts on the day of collection (before being physically delivered to the bank) by installing deposit machines on the client’s premises. ING has also introduced virtual accounts that allow companies to create virtual accounts for their custom-ers so that payments are easy to reconcile. In July 2013 ING changed the way it provides trans-action services to better reflect how its clients operate. Instead of individual product teams, ING now meets client needs holistically through transactional banking consultants who can address multiple product areas and find the most appropriate solutions. The integration of payments and cash management with working capital solutions and trade finance services (which includes supply chain finance, traditional trade finance products such as letters of credit and the ability to access independent trade finance platforms) is not only aligned with how corporate treasur-ies are organised but also ensures that solutions are structured to optimise efficiency, maximise benefits, reduce risks and lower costs.

31

client case GRUPA ŻYWIECAs a result of a largely cash-driven payments culture in Poland, Grupa Żywiec collects part of its revenues in cash from thousands of customers across Poland. As cash collection can often be expensive and subject to a variety of risks, it was very important for Grupa Żywiec to have an efficient, cost-effective and risk-averse means of collecting, posting and reconciling cash. This article outlines how the company embarked on this transformation and the outcome it has achieved so far.By Karolina Tarnawska, Treasury & Credit Risk Director, Grupa Żywiec

Business modelGrupa Żywiec is a related entity to Heineken group. Of the c.a. 25 beers we offer on the market, the most famous brand is Żywiec which is one of the leading premium beer brands in the country. We also sell a number of other alcoholic and soft drink brands. We are Poland’s largest employer in the alcohol industry, with around 4,500 staff across the country. We have five breweries, with sales and distribution model, covering all group of clients: from small shops to large stores. We sell our products to around 60,000 customers across Poland, ranging from small shops to large stores. There are a variety of reasons why we have adopted this distribution model. One is that we are able to maintain a closer relationship with our customers than we could through a ‘reseller’ model. In addition, rather than channeling our business through a few wholesale partners which might create substantial business and credit risk, a direct sales model enables us to diversify our credit risk more widely.

Importance of cashOur direct sales approach influences every aspect of our business. We have a total of around 2,000 sales representatives and drivers who deliver goods and collect cash. These people are linked to one of 50 de-pots across the country and visit customers at least once a week. Larger customers, particularly wholesalers, generally pay through bank transfers. We do not use a direct debit scheme as this is not support-ed by law in Poland, which means that collection can be unpredictable. Smaller customers, such as retailers, typically pay in cash, both under cash-on-delivery arrange-ments and when credit terms are offered. Cash is the primary method used for retail payments, partly as widespread familiarity with or confidence in banking services is still lagging and the use of cards is not prevalent in many parts of the country. Amongst those customers with bank accounts, the use of electronic banking (particularly in more rural communities) is still rare, especially as internet access may be poor. Furthermore, paying cash into a bank branch is expensive due to high cash counting fees. Consequently, most business owners, who themselves receive payments in cash, prefer to pay cash to their suppliers to avoid additional costs.

Legacy cash collection processIn the past, the cash collection process was managed by sales representatives, who then went back to the depot and passed the cash on to the cashier. The cashier then counted and reconciled the amounts against the customer’s outstanding receivables. Cash was held in a safe box at the depot and then transported to the bank via secure courier to be booked on our account. This process had numerous disadvantages. Sales representatives were spending too much time on the cash col-lection process, which meant that they had less time for sales when visiting customers. They then had to wait a long time at the depot for the cash to be counted, often late in the day. Furthermore, once cash had been received at the depot, it could take another two days until it was posted on our bank account.

Seeking an alternative solutionAs a company, we are committed to the highest standards of customer service, financial integrity and efficiency. We therefore recognised the need to enhance our cash-collection processes as part of a wider initiative to update our business infrastructure and business processes. For example, we set up a central customer services division to ensure a consistently high-quality experience for customers and participated in a Heineken-wide project to implement a single ERP system across the business. Having discussed our cash collection challenges with other parts of the Heineken group, we identified a variety

of objectives for a revised process. Two of the most important objectives were: firstly, we wanted cash to be counted and booked on our account before being physically delivered to the bank. This included ensuring that the bank would be responsible for the cash as soon as it had been entered into the system, without the need to buy depositary machines for which we would be responsible. Secondly, we wanted to be able to post and rec-oncile the amount paid by the customer immediately to avoid the risk of theft or misrepresentation by the individual receiv-ing the cash. We approached our banking partners to discuss our requirements. This took a great deal of time because in many cases our banks did not understand or could not support what we were trying to achieve. We requested proposals from five banks but the quality of the respons-es we received was unsatisfactory, even from the largest banks. However, we found that ING was far more responsive and flexible, and committed time and resources to exploring our needs and devising an appropriate solution. Conse-quently, we were pleased to extend our relationship with ING into collections.

A new cash collection modelThe first deposit machine was installed in our depot in February 2012 and the last one in June 2012. Sales representa-tives are no longer responsible for cash collection, which is now undertaken only by drivers. This made it easier to roll out, particularly as our ERP system provides strong functionality for drivers. Drivers no longer have to wait at the depot for cash counting and any errors or inconsistencies can be identified more quickly thanks to barcoded envelopes used in the process of remote posting and reconciliation. . We have been able to book cash two days earlier, whilst also requiring fewer resources, enabling us to appoint former cashiers to other responsibilities. Our credit risk has been reduced and we are able to post and reconcile collections against credit lines very quickly, improving the service we provide to customers and enhancing our cash management and forecasting efficiency.

Business impactThe new cash collection process has been received very positively by the sales team, drivers and depot managers alike. As there is often a natural disinclination to change, we spent time on working out the best way of communicating on the new processes across the team with the strong support of senior management. In addition, we received advice and assis-tance from ING. Our business divisions typically operate quite independently of each other, so this project was an oppor-tunity for Treasury to work more closely

with our colleagues in Distribution and Sales. We involved them in decision-making which in turn encouraged broader-based support and ensured that the implementa-tion, which was undertaken by local teams, was consistent. As a result of this upfront effort and collaboration the new cash collection process has received widespread support.

Moving forwardAlthough our depots now operate using the new cash collection process, there are still enhancements we make. We need to ensure that we have sound contingency arrange-ments in place as maximising the security of our people and the cash machines is a priority. Another potential improvement is to reduce the number of exceptions between declared and deposited amounts. For example, there may be an input or round-ing error which would prevent automatic reconciliation. Our control mechanisms allow to identify any attempt of fraud or theft immediately but we are still trying to counteract the risk through such measures as scanning rather than manual inputting the collection amount.

This has been a pioneering project in Poland leveraging technology to enhance efficien-cy, risk management and customer service, whilst respecting the way in which our customers wish to operate. The initiative has also been very valuable in demonstrating the benefit of collaboration across different parts of the business to create a more inte-grated solution. We have been very fortu-nate to be able to leverage ING’s experience, expertise and innovative know-how, and the project would not have been possible without the flexible, ‘can do’ attitude that sets the bank apart from others that we approached. We look forward to contin-uing to enhance our cash collections and other financial processes, in the future, as part of our commitment to leading industry practices.

33grupa żywiec

Business as usualSofia, BULGARIA 9.12 AM

BULGARIA

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

35

Source: ING

estimated average growth 2014/ 2015

bulgaria

More information on ING CB in Bulgaria visitingcb.com/bulgaria

The economic uncertainty of recent years has highlighted CEE’s strengths in many of the world’s most important sectors. Metals and mining companies and energy firms from CEE are not just regional powerhouses but crucial global players now. Few regions match the agricultural poten-tial of CEE. As companies consolidate and become more efficient, CEE will become ever more central to the world’s ability to feed itself. Elsewhere, in sectors such as infrastructure and in particular telecommunications, media and technology, the dynamics that became associated with CEE in the late 1980s is resurgent.

What these diverse sectors have in common is a need for finance. Given the nature of CEE and the changing needs of companies in the region, structured finance – which uses cash flow or asset-based financing structures – continues to play a crucial funding role alongside the ever-de-veloping debt capital markets. Effective structured finance requires wide-ranging and extensive connections with other financial institutions. It also demands structuring expertise, which comes from a combination of commitment to innovation and longstanding experience. At the same time in-depth knowledge of sectors and regions is equally important to structured finance.

The structured finance business is changing as the capacity of many banks to lend is curtailed by regulatory reform such as Basel III, which requires them to hold more capital. At ING we have re-affirmed our commitment to global structured finance as we remain a top 10 player, and to CEE where we have a 20-year track record and are consistently a top 3 supplier of structured finance solutions to our ever-growing client base. As arranger and underwriter we continue to play an active role in domestic and international deals in the club and syndicated loan market. We also offer advisory services that leverage our structured finance expertise and sector knowledge to give clients the edge when it comes to financing projects and acquisitions, or optimising their capital structures.

COMBINING CEE KNOWLEDGE AND STRUCTURED FINANCE STRENGTHstructured finance

ING combines its deep understanding of CEE and the region’s leading business sectors with its acclaimed capabilities in structured finance to give its clients world-class service and sup-port, according to Michiel de Haan, Head of Structured Finance for ING in CEE.

37structured finance

While most CEE companies restored their investment programmes cautiously following the 2008 and 2009 financial crisis, their plans were nevertheless predicated on a continuing commodity boom. In particular, there was an assumption that growth in China, which had fuelled the commodity boom, would continue and it would seek an ever-larg-er quantity of metals and mining products for its growing manufacturing sector.

In reality, China’s growth has slowed and it is now trying to shift to a consump-tion-based economy – there is no immediate prospect of metals and mining demand meeting previous expectations. Falling prices and lower than expected demand mean that companies have been forced to reconsid-er their capital expenditure given over-production. Planned projects are being put on hold or scaled down, inefficient capacity is being closed and non-core assets are being sold.

In the pre-2008 period (and also in 2010 and 2011 when there was a brief recovery), there was significant M&A activity in the metals and mining sector: many companies assumed that prices would continue to rise and achieving scale and raising volumes would be critical to future success. Falling prices and demand mean companies are now concentrating on low-cost producing assets and divesting assets rather than acquiring new ones (while also focusing on controlling expenses and decreasing their working capital requirements).For example, Mechel, the leading Russian coking coal producer, bought assets in the US, Ukraine and Kazakhstan during the M&A boom. Now, struggling with its pre-2008 debt burden, the company has sold off Romanian plants and some assets in Russia and Kazakhstan.

Crucially, the buyers of these assets are not global metals and mining groups. In Turkey, for example, Mechel sold several ferroalloys assets to Turkish diversified

industrial group Yildirim. Similarly, assets in Romania have been sold to domestic buyers.

Strong liquidityFinancing conditions for high quality metals and mining companies have improved markedly as the eurozone crisis, which severely affected some European banks’ ability to serve the sector, has subsided. Actions by the Federal Reserve and European Central Bank have provided banks with plentiful liquidity. Moreover, contrary to some expectations banks’ preparation for Basel III, which will increase the amount of capital they must hold for certain risk assets, has not decreased banks’ appetite for good quality metals and mining assets.

Pricing has fallen for high quality metals and mining companies and terms have become more attractive to borrowers. Indeed, for the first time leading companies in the sector have been able

Companies in the metals and mining sector in CEE, which is dominated by Russia but with major production in Ukraine, Kazakhstan and elsewhere, are global players. Consequently, they are affected by trends at a global level. The dominant issue in the post-2008 period has been a significant de-crease in prices for many hard commodities and over-capacity in metals and mining - by Julia Chekrygina, Head of Metals, Structured Metals and Energy Finance

DEVELOPMENTS IN METALS AND MINING

metals & mining

to access unsecured funding (previously competition was solely on price).For example, in September Magnitogorsk Iron and Steel Works, which is non-invest-ment grade, was able to borrow $500 million over four-years on an unsecured basis from a group of five banks, including ING. Similarly, Russian nickel and palladium giant Norilsk Nickel was able to borrow $2.35 billion over five-years on an unsecured basis from 16 banks, including ING.

While the best pricing and terms are only available to the strongest companies, buoyant liquidity conditions have allowed companies facing challenges to restructure their debt. For example, ING was a coordinator (together with Unicredit) for a $500 million three and five-year loan that refinanced Ukrainian steelmaker Donetsk-steel – Iron and Steel Works’ debt following a restructuring that began in 2008. The success of the deal despite the difficult backdrop – including the rating downgrade of Ukraine – highlights the strength of bank liquidity.

Currently, the only restriction on bank lending to high quality metals and mining companies is banks’ country limits, which – in some instances – have been filled by huge deals such as $22.5 billion raised by Rosneft through several syndicated facilities to finance its TNK-BP acquisition.

During the first half of 2013, metals and mining companies also enjoyed strong conditions in the bond market. ING acted as joint lead manager and bookrunner for a $1 billion seven-year eurobond offering from Russia’s large steelmaker Evraz in April. However, conditions in the bond market have become weaker since the Federal Reserve indicated that it would begin to taper its asset purchases and supply has dried up. Consequently, metals and mining companies have sought funds from their relationship banks instead.

ING’s metals and mining strengthING has a well-deserved reputation in the metals and mining sector in CEE having supported many of the leading companies from the region since their inception in the early 1990s: few banks can claim 20 years of experience in structured metals financing in CEE. As a result, ING has a deep understanding of the operating models of the region’s companies and their needs.

Moreover, throughout its long history of activity in CEE, ING has built up knowl-edge of the sector and created capabilities that rival any bank in the world. Using its network of local offices, ING offers comprehensive relationship coverage on the ground. This is combined with teams offering global capabilities in equity capital markets, debt capital markets and mergers and acquisitions advisory, which have an excellent track record in serving the metals and mining sector.ING’s strength across lending, structured

finance and corporate finance in metals and mining in CEE fits perfectly with the bank’s approach to working with clients on a relationship basis – taking a holistic view of their needs – rather than focusing on individual product offerings. ING’s event finance team, based in Amsterdam, coordinates all product activity so clients get the right solution for their specific requirements. This approach also better reflects the changing needs of the sector, following widespread restructurings in recent years.

ING’s long track record serving companies in the metals and mining sector in CEE is different to its competitors because the bank stands by its clients throughout the cycle – regardless of commodity price volatility or liquidity problems in the banking sector. ING provides not just products and services but also guidance and advice on balance sheet structuring and hedging that are only possible as a result of a deep and long-term relation-ship.

39

kazakhstan

Business as usualKAZAKHSTAN 2.13 PM

KAZAKHSTAN

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

41

Source: ING

estimated average growth 2014/ 2015

More information on ING CB in Kazakhstan visitingcb.com/kazakhstan

FINDING DIRECTIONS IN CEE

The need for infrastructure development in CEE is significant. Despite huge investment in the region since 1989, utilities, road, rail and air infrastructure as well as other public and social infrastruc-ture continues to suffer from a legacy of historic underinvestment over many decades. Much ground still needs to be made up to raise infrastructure fully to EU standards - by Michael Dinham, Head of Infrastructure Finance for ING

Partly because of this inherent demand, infrastructure spending in CEE has remained impressively consistent over the past five years despite the financial crisis and the economic downturn that followed. The commitment of CEE governments to infrastructure has stayed strong while bank interest in infrastructure projects has been steady – the underlying potential for growth of much of CEE has ensured that it is a priority for banks involved in infrastructure finance.

Moreover, while CEE has not escaped the turbulent conditions of the past five years, its economies have performed significantly better than southern Europe, for example. Generally, most CEE economies recovered quicker than those in southern Europe – in-deed Poland was the only country in Europe not to suffer a recession – while banks in CEE did not require public bailouts. Investors are also reassured by CEE’s low public debt compared to much of the rest of Europe.

A diverse marketCEE is a diverse region that is often viewed as three distinct country groups rather than a single market. The first group includes EU members such as Poland, Czech Republic, Hungary, Slovakia and the Baltics that are perceived to be broadly economically successful with functioning legal and financial systems. The second group comprises weaker EU member states such as Bulgaria and Romania that have experienced economic or political problems in recent years that have undermined investor confidence. The third group includes Turkey and Russia which are seen as being distinct from the rest of the region given their size, location and characteristics.

Accordingly, these three groups of countries attract different levels of bank interest in terms of infrastructure finance. Their relative attraction has changed little in the post-fi-nancial crisis period. The first group of EU member states has always received strong

infrastructure finance

infrastructure investment while the weaker members have been less favoured. However, one notable change in recent years is that Russia and Turkey have become more attractive infrastructure investment destina-tions given their above-average growth potential.

The three groups of CEE countries – success-ful EU states, less-successful EU states and Turkey and Russia – have starkly different track records of involving private investors in infrastructure projects.

Predictably, the first group of EU countries has successfully adopted public private partnerships (PPP) as well as directly selling infrastructure assets to private entities, in line with EU guidelines. While attempts have been made by the second group of countries to use PPP and to even privatise assets, little progress has been made in both areas because of weak institutions, a lack of transparency and an insufficiently robust legal environment.

Turkey and Russia share some characteristics with Bulgaria and Romania in terms of uncertainty over some aspects of their legal and political environment. However, their scale – and the scale of funds available to spend on infrastructure within the countries – means they have attracted greater interest from international investors for PPP projects (although they have a patchy track record of privatising state-owned infrastructure assets).

Developments in financingFinancing structures for PPP have remained broadly similar in recent years: debt (provid-ed primarily by banks) typically makes up 80%-90% of a project’s finance and the remaining 10-20% is equity (provided by construction companies, infrastructure funds or other investors).

One change is that debt costs have risen compared to the period before 2008. However, the change has been relatively slight (with the exception of Hungary where political risk has made funding expensive). Another change in the post-crisis period is

that bank appetite for long-term risk (over 20 years) has diminished although there is still plenty of appetite to go to 15 years.

To fill this gap, there have been increasing efforts by some banks to involve bond and other investors in long-term infrastructure debt financing. For example, Slovakia has a major PPP motorway project which is seeking to place bonds privately to investors, including pension funds and insurance funds, with a tenor of 25 years. Structures and terms for such deals are broadly similar to those that would have been achievable from the bank market in past years.

In the infrastructure finance market below 20 years, there has been some change in the composition of the banks involved in the market. Those international banks that invested in infrastructure before the crisis have continued their commitment to the region. However, there is increasing domestic bank involvement in many markets, especially in Russia and Turkey. As a result, competition has kept pricing lower than it otherwise might have been.

Strong bank appetite for CEE infrastructure risk has also meant that the role of multilat-eral institutions in most of the region is limited. Although the European Bank for Reconstruction and Development (EBRD) seeks to play an active role in the develop-ment of CEE infrastructure, its involvement in deals has decreased in recent years (even before the crisis) with investors even resisting deals with EBRD cover in some instances because it limits their upside. However, multilateral involvement remains helpful to provide political risk insurance and ensure the success of long-term infrastructure finance deals in Russia and Turkey.

On the equity side of infrastructure finance, there has historically been a reluctance from most infrastructure funds to invest outside Poland and Czech Republic, as these are perceived to be the most mature and stable markets in CEE. Most equity investors seek a low risk proposition and are unwilling to accept political and currency risks. However,

there have been exceptions such as the involvement of Singapore’s sovereign wealth fund GIC in a consortium that owns Budapest Airport.

ING’s strength in infrastructure finance ING’s long history in CEE, broad regional footprint, strong track record and proven strategy in infrastructure finance has resulted in a reputation for consistency and commit-ment to the region. ING combines a nucleus of world-class expertise in London and Amsterdam with regional and local insight delivered by teams across the region. As a result, ING is able to provide a powerful infrastructure finance offering.

ING infrastructure finance operates mainly as a lending business and has more than doubled in size in Europe over the past five years. Within CEE, ING has financed airports, motorways and various utilities across the region, including in Bulgaria, Czech Republic, Hungary, Poland, Slovakia and Turkey. In recent years, the bank has shortened its average portfolio maturity to around six years as part of a broad emphasis on discipline and risk management (and also in response to Basel III). However, ING retains an appetite to commit to longer-term infrastructure projects where appropriate.

While ING infrastructure finance is heavily focused on managing the bank’s infrastruc-ture portfolio, it seeks to cover the full spectrum of infrastructure financing activity, from greenfield project financing to acquisitions, refinancing, whole business securitisation, restructuring and advisory work. ING continues to seek new ways to finance infrastructure and has recently set up a joint venture between structured finance and debt capital markets to promote project bonds. Across the bank, ING works with a variety of clients including utilities, construction companies, specialist operators and funds and the bank’s specialist industry knowledge serves as a valuable risk mitigation and marketing tool.

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infrastructure finance

hungary

HUNGARY 1.22 PM

HUNGARY

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

Business as usual

45

Source: ING

estimated average growth 2014/ 2015

More information on ING CB in Hungary visitingcb.com/hungary

CONNECTING CEE TO THE REST OF THE WORLD

The telecom, media and technology (TMT) sector in CEE has experienced significant growth over the past five years despite the financial crisis and economic downturn in many countries in the region. Having put in place considerable communication infrastruc-ture, such as mobile networks and broadband

capacity, TMT companies have been able to reap the benefit of changes in consumer and corporate behaviour. By Pieter Puijpe - Global Head of Telecom, Media & Technology

telecom, media and technology

telecom, media and technology

New products such as smartphones and tablets have resulted in fundamental growth in consumer demand for data capacity and mobility needs. The result has been exponential growth in mobile and broadband use in CEE.

Sustained investment over the past decade in CEE means that many countries in the region now have a mobile telecom infrastructure that can match the best in Western Europe. However, as in other parts of the world geography plays a major role in deter-mining broadband speed and access to mobile connectivity. For example, sparsely populated areas have different technology infrastructure requirements and some developing markets may not have legacy infrastructure to build on. Despite the diverse operating environ-ment across CEE, there are countries with shared characteristics. For example, Poland, Czech Republic, Slovakia and Russia have highly developed mobile markets.

Consolidation trendsOne of the trends in the TMT sector in recent years has been consolidation. Although there are instances of regional consolidation, the majority continues to occur at country level. Consolidation now also takes place across sectors, with cable, mobile and fixed-line assets being combined to enable companies to offer a more integrated product offer (often described as triple/quadruple play).

Increasingly, consolidation involving media companies – previously mostly a separate business – is occurring with telecoms and other companies seeking content to exploit their infrastructure assets and customer bases. Meanwhile large investments continue to be made in network upgrades and connectivity (such as telecom tower infrastructure and fibre backhaul networks). Consolida-tion at a country level is being facilitated by divestments of larger European incumbents. Many of these companies bought assets in CEE in the 1990s and 2000s and are now selling them to focus

on their domestic markets, which have increasingly large investment requirements and have become more competitive. An example is Telefonica which announced plans in October 2013 to sell its stake in Telefónica Czech Republic to streamline operations and cut company debt.

Another prominent example was the acquisition in November 2011 by Polish entrepreneur Zygmunt Solorzak of Polkomtel, the number two mobile operator in Poland in terms of revenue. Vodafone and a number of state-related industrial owners were the sellers. Solorzak owns Polsat, Poland’s number one free-to-air private TV station and Cyfrowy Polsat, the largest DTH satellite platform in Poland, as well as wireless internet network companies. The acquisition was supported by a PLN 14.3 billion financing package which ING refinanced in July 2013 as a mandated lead arranger (MLA) with a PLN 7.95 billion senior secured acquisition bank facility. The facility was provided on a club basis by 17 financial institutions.

Financing CEE TMTTMT is a sector with strong underlying fundamentals, including growing demand, strong cash flows and a sticky customer base. Consequently, many borrowers from CEE can potentially access the debt capital markets. Although bank liquidity for TMT borrowers remains strong, disintermedia-tion is an important theme for CEE TMT companies and bond issuance is expected to grow strongly.

ING was joint lead manager and bookrun-ner for Russian integrated telecoms company VimpelCom’s dual-currency three-tranche USD 2 billion Eurobond offering in February 2013. The deal included the first-ever rouble-denominated Eurobond by a non-state owned corporate and – despite a pricing environment that was not ideal – generated significant oversubscription in both US dollar tranches allowing pricing to tighten compared to the initial guidance. While bond investors are playing an ever-increasing role in TMT financing, term lending and project

finance from banks remains essential to finance capital expenditure, for example in greenfield infrastructure development. Despite turbulent conditions in some markets in recent years, TMT has continued to perform strongly as an asset class. With strong liquidity from international banks active in CEE – and extremely strong liquidity in local currencies from domestic banks in Poland, Russia and Turkey – conditions are competitive. As a result pricing has actually fallen over the past five years.

ING’s strength in CEE TMTING’s deep industry knowledge of TMT – driven by teams in Amsterdam, Frankfurt, New York and Singapore – enables the bank to add value for clients because it under-stands market dynamics. Moreover, the bank’s expertise gives it the confidence to lend over the long-term despite the risk of disruptive technology in TMT (few predicted the growth of smartphones and tablets five years ago, for example).

ING has recently restructured its sector approach and fully integrated its TMT specialists to further align with the compa-nies it services. The bank also offers specialist satellite financing and a broad range of media financing solutions, ranging from the free-to-air television sector to outdoor advertising. ING combines industry knowl-edge with a broad local presence across CEE, enabling the bank to follow its clients wherever they go.

ING applies an agnostic approach to financing. It seeks to provide its clients with financing solutions that best serve their individual objectives and achieve the best possible terms and conditions, either through offering structured lending – draw-ing on ING’s industry knowledge to achieve optimal structures – as well as intermediat-ing in the debt capital markets. As noted, ING has recently demonstrated its creden-tials in the bond market with VimpelCom’s USD 2 billion Eurobond and in October acted as MLA for a USD 225 million senior bank facility arranged by EBRD for Cosmote, the third largest mobile operator in Romania.

47

Given the diversity of the economies of CEE countries, it is difficult to pinpoint broad regional trends as CEE countries tend to function independently of one another. Deals in each country differ because countries have different assets to finance and different regulatory environments. The dynamics of the local banking market also vary –some CEE markets, for example, are home to strong domestic banks that play a major role in project finance.The scale of deals plays a large part in determining the involvement of international project finance banks and domestic players. The EUR 1.6 billion acquisition of Czech gas pipeline operator NET4GAS (formerly owned by Germany’s RWE) by Allianz and Borealis Infrastructure, which was completed in August, was sufficiently large to attract international banks whereas numerous recent smaller deals in Poland and Romania have been financed locally given their scale and the strong liquidity of local banks.

Changes in syndicated lendingIn a typical acquisition transaction, compa-nies or consortia bidding for an asset approach banks in advance to line up syndicated finance. In many instances, these bidders seek an underwritten commitment because it means they do not have to manage multiple banks and – more importantly – because it enhances the speed of execution, which may be crucial in order to meet a bid deadline.Typically, underwritten risk might be held by a bank for up to six months during which time the debt is syndicated. While some banks sell down all of their underwriting risk, ING is relationship-driven and always retains a portion of the risk on its books, providing comfort to other investors and ensuring a supply of high-quality assets for the bank’s portfolio.

While underwriting remains popular for certain types of deals, one increasingly prevalent trend is the use of club-style deals using a large group of banks. The growth in

the use of club-based lending is driven mainly by borrowers’ reluctance to pay underwriting fees. ING is willing to participate in club-style deals as the bank’s goal is always to act in the best interest of clients.Around two years ago, there was a step back from project finance syndicated lending by some banks – especially at maturities over 20 years – because they had a need to de-risk their balance sheets in the wake of the financial crisis (and, to a lesser extent, to respond to Basel III). However, in 2013 many banks completed their de-risking while the cost of funds for banks also fell. As a result, many banks’ appetite for long-term lending is returning.

New lenders are emergingThe withdrawal of some banks from long-term syndicated lending in recent years prompted efforts to encourage non-bank financial institutions (FIs) to enter the market and fill the funding

Syndicated lending is a vital tool in financing a wide variety of infrastructure projects such as road and rail or gas and electricity distribution networks. Globally, project finance syndicated lending volumes fell 12% to USD 193.2 billion for the first nine months of 2013 compared to the same period a year earlier. However, while detailed figures for CEE are not available, syndicated lending plays an important role in financ-ing projects in the region. - by Ali Miraj, ING Syndicated Finance

SYNDICATED LENDING AND FINANCING PROJECTSsyndicated lending

syndicated finance

gap. A number of FIs, including pension and insurance funds, have begun to invest in project finance.Different investors have adopted different approaches to project finance depending on their size and level of expertise. Some large institutional investors have set up teams of former monoline specialists and are therefore willing to take greater risk (including construction risk) in public private partnership (PPP) projects. Other investors have fewer specialist resources and their priority is to ensure that loans are robustly structured so that their risk is limited.

The requirements and expectations of investors vary widely. For some investors, prepayment protection – to eliminate the risk of early payment by the borrower or termination of the PPP – using ‘make whole’ provisions is critical. Other institutional investors may require an external credit rating (often investment mandates specify such a requirement) or for a loan to be structured with a fixed rate (rather than the floating rate commonly used in project finance).

In response to the needs of some investors for well-structured infrastructure assets, ING has developed a format called Pan European Bank to Bond Loan Equitisation (PEBBLE). PEBBLE works by providing a debt cushion – or first loss piece – during the riskiest phase of a project (construction and ramp up) where the commercial bank lenders respond to waiver and consent requests as controlling creditor and improve the credit quality of the more senior institutional investor tranche.

PEBBLE has been developed as an open format for broad market adoption, with documentation made public by the International Project Finance Association (IPFA) for market comment. By using standardised documentation (such as inter-creditor agreements), PEBBLE helps to overcome the administrative burden associated with project finance (in relation to cash management and waiver requests, for example) as well as potentially enhancing the rating of projects which are typically investment grade equivalent. The presence of experienced structuring banks putting together a PEBBLE financing and retaining a portion of the subordinated debt provides institutional investors with additional assurance.PEBBLE has yet to be used in CEE but made its debut in the project financing of the Dutch Zaanstad prison in September 2013. Given the limited supply of similar projects in Northern and Western Europe and the scale of institutional investor appetite for such projects, it seems likely that PEBBLE and other credit enhancement tools may be used in CEE in the medium-term.

ING’s role in project finance syndicated lending In CEE ING has a track record of more than 20 years as a project finance lender. It combines deal structuring experts in London with an on-the-ground presence across the region. This local knowledge gives ING an edge over its competitors and enables it to offer seamless execution that takes account of local nuances. ING also differentiates itself by the strength of its commitment to clients: the bank is prepared to follow sponsors wherever they operate.

Recently, ING coordinated the CZK 3.3 billion (EUR 130 million) refinancing of Aqualia Czech’s water utility SmVaK which was closed in March 2013. ING also took part in the European Bank for Reconstruc-tion and Development B loan for a Romani-an wind project.

In December 2012, ING acted as mandated lead arranger (MLA) for acquisition financing

for Macquarie to purchase a 35% stake in RWE Grid Holding A.S - a regional gas distribution network in the Czech Republic. ING also acted as bookrunner and MLA for Czech energy company EPH’s EUR 2.6 billion acquisition of a 49% stake in Slovak gas utility SPP from Germany’s E.ON Ruhrgas and France’s GDF Suez in January 2013.

Further, ING is acting as co-financial advisor for the offshore section of the South Stream pipeline to transport Russian natural gas through the Black Sea to Bulgaria in a project involving sponsors Gazprom, Eni, Wintershall and EDF. All in all, the PEBBLE credit enhancement product demonstrates ING’s history of innovative thinking in project finance.

49

Challenges to project financeWhile there is a strong appetite among many banks to be involved in syndicated lending to finance projects in CEE, infrastructure projects in some markets face increasing challenges. In the power industry, for example, there is growing uncertainty in Poland, Romania and the Czech Republic. State support for renewable power will end in the Czech Republic in 2014 while in Poland there has been uncertainty about renewables for several years. Romania is considering reducing green certificates for renewable power projects and Bulgaria has imposed high grid access fees for renewable energy producers.

These changes in policy – prompted largely by efforts to control government spending and lower costs to consumers – make it difficult for equity investors to commit to projects. As a consequence there are likely to be fewer renewable power projects available for banks to finance in the future. Those that do make it to market will have increasingly conservative structures, with more equity (possibly as much as 50%) and shorter tenors for debt reflecting the reduced visibility that investors will have of the regulatory environment.

Appetite for long-term lending is returning

UNIQUE OPPORTUNITIES IN AGRICULTURE agriculture finance

Rising global demand and im-provements in productivity will transform the agriculture sector in CEE in the coming years. With effective financing, companies from the region can play a lead-ing role in the evolving global agriculture market. - by Pieternel Boogaard, Head of Agricultural Finance, CEE at ING Structured

Finance.

Food, and therefore agriculture, is becoming an ever more important issue for the world. Global grain consumption is expected to grow by 250 million metric tonnes over the next ten years. Population growth, a changing diet – especially in emerging markets – with increasing meat consumption (which requires more grain for animal feed), and the growing use of grains in biofuels are all driving demand.

Production cannot keep pace with rising demand. Globally, there is a shortage of suitable land while yields per hectare are levelling off in the US and Europe. As a result there are huge opportunities for agricultural producers in suitable locations.

CEE – already a major producer of grain, wheat, corn, barley, veg-etable oil and sugar – has large quantities of potentially productive land, enormous potential to improve yields from naturally fertile land (especially in Russia and Ukraine) and low labour, fertiliser and diesel costs. Moreover, it is in close proximity to some of the world’s largest importers of grains in North Africa.

51agriculture finance

Increasing support in RussiaSupport for agriculture varies across CEE. In Russia, the government has significantly increased its focus on agriculture as it seeks to diversify the country’s economy. Russia, which joined the World Trade Organisation (WTO) in 2012, sees huge opportunities for its agriculture sector.

Russia’s agricultural goals are twofold. Firstly, it is committed to self-sufficiency in its food production by 2020. While Russia exports large quantities of grain, it wants to reduce imports of sugar (it is currently one of the world’s largest importers), poultry and pork. Russia’s second objective is to broaden its economy and increase exports to reduce its dependence on revenue from metals and oil and gas.

The drive for self-sufficiency will not crowd out the goal of increased exports because Russia has such large amounts of land to be brought into production. The country has 120 million hectares of available land – 8% of the global total – while yields remain well below the world average.

A huge improvement in production and productivity is therefore achievable. Russia is supporting the expansion of agriculture primarily through the provision of subsidies for interest on bank loans. Around two-thirds of interest costs are paid by the government. Loans are available through all banks licensed to operate in Russia (includ-ing ING) and loan growth has been significant.

The Russian government has allocated around USD 10 billion a year for loan subsidies to farmers. While the WTO is working to reduce agriculture and other subsidies – and Russia has agreed to these goals – Russia’s current level of subsidies has been approved by the WTO. Russia is likely

to continue to support its farmers extensively even after 2020.

Dynamic companies in Ukraine In contrast to Russia, Ukraine has little government support for agriculture and no subsidies. Perhaps as a result of this lack of official support, the agricultural sector is dominated by competitive, large, well-man-aged companies – such as poultry producer MHP, Kernel and Mriya Agro Holding – that have made significant advances in achieving international standards of efficiency, corpo-rate governance and productivity.

International investors are often cautious about Ukrainian companies because of the country’s macro-economic and political risks: the government’s rating was downgraded to Caa1 from B3 and placed on review for downgrade in September. However, the agri-business sector in the country remains competitive and dynamic.

Ukrainian agriculture companies can withstand the country’s turbulent mac-ro-economic backdrop because of the strength of their market positioning. Companies such as soft commodity producer Kernel Holding are strongly export-focused while others, such as MHP, are positioned in markets – such as poultry – where domestic demand remains strong even during difficult times.

Furthermore, many Ukrainian agriculture companies are strengthening their position by becoming vertically integrated. For example, Kernel began as a sunflower trading company before adding crushing capacity (increasing its margins). The company has since added ports and silos and is now also one of Ukraine’s largest farm operators. Similarly, Astarta, which listed in Warsaw in 2006 via ING, started as a sugar beet producer but has moved into soy

production and crushing to produce soy oil and meal and also into dairy production.

Companies are now also expanding cross-border and larger players are emerging that could change the dynamics of the business. Russian companies are expanding into Ukraine, for example, while Kazakh companies are moving into Russia. Ham-pered by logistical problems when selling globally, Kazakh companies are also expanding their regional sales. Ukrainian companies are eager to avoid the high funding costs (due to elevated credit and transfer risk) associated with companies operating solely in Ukraine and are also diversifying geographically.

It is now possible for international compa-nies to own land in Russia through a Russian company. In Ukraine land can currently only be leased. However, while there may be a legal right to buy land in Russia, in practice it remains impossible given the absence of a land registry. The greatest opportunities for foreign investors therefore lie in the provision of silos (which provide access to grain supplies), crushing plants, sugar plants and logistical capabilities. In these areas, foreign investment – notably from Asia – continues to enter CEE.

Decreasing market intervention In recent years, both Russia and Ukraine have intervened in the market. In 2010 Russian exports were restricted by the government following a poor harvest and consequent high prices. Similarly, in 2011 the Ukrainian government, which previously subsidised exports by refunding VAT, decided not to return VAT to traders given what it viewed as high prices (which it believed removed the need for a subsidy) and the difficult economic outlook.

In 2012 there was a poor harvest in both Russia and Ukraine but despite high prices neither government introduced an export ban. Both governments appear to have recognised that export bans are unhelpful for producers and consumers. Instead, there is an encouraging trend of increasingly relying on voluntary export limits and agreements between government and companies to supply local markets. Likewise, the Ukrainian government has not re-instat-ed VAT refunds for exports, which the market has now accepted as the status quo.

Servicing the agriculture sector Across the region – but especially in Ukraine given the political risk – the role played by the European Bank for Reconstruction and Development, the International Finance Cor-poration and the European Investment Bank has increased significantly. These multilateral lenders typically lend with a longer tenor than commercial banks (although they also compete – and cooperate –with commercial

banks to lend at shorter tenors).Overall, credit has continued to flow sufficiently to allow investment in agriculture to continue across CEE. Russian state-owned banks – prompted by the government – have expanded credit provision not only in Russia but also in Ukraine and elsewhere.

A tailor-made solution ING continues to play a leading role in the agricultural market in CEE: in the past year it established a USD $100 million bilateral facility with MHP to fund oil seed purchases. The deal represents an expansion of ING’s re-lationship with MHP, which also has working capital facilities with the bank.

ING has played a leading role in many landmark agricultural transactions in CEE. In August 2011, ING arranged a USD 500 million pre-export lending facility – the largest ever from the region – for Kernel. The syndicated loan achieved a 100% hit rate and closed oversubscribed. Having long been focused on pre-export financing, ING has also expanded into capital expenditure financing for agricultural companies and short-term local working capital financing (repaid from local sales).

Both international and domestic companies active in agriculture in CEE need a partner with sector expertise. Only by understanding the seasonal dynamics of agriculture – high seasonal leverage, a sharply differing need for credit depending on the outcome of the season and a long asset conversion cycle – can companies be assured that they will

get the support they need to achieve their goals.

ING focuses on the top five players in each sector in each country. It offers a strong combination of structuring capacity and network breadth across CEE. While some banks have multiple departments pitching different products, ING puts the client first and considers its needs before delivering a coordinated offering. ING’s flexibility is important given the challenges of financing agriculture in CEE.

ING has a proven track record in agriculture in CEE. Its use of local staff in Kazakhstan, Russia and Ukraine to structure and originate its financial solutions means that it really understands the companies it works with, their business models and the dynamics of the agricultural market. It is therefore able to align its strengths to support agricultural companies in a wide range of areas.

ING tailors solutions in corporate finance, including IPOs and mergers and acquisitions advisory. It offers lending with great flexibility: to local entities and/or offshore; provided from Amsterdam or locally; in foreign or local currency; short or long term; committed or uncommitted; syndicated or bilateral; and multipurpose. ING can also provide additional FX, interest, commodity hedging and trade financial services (documentary services).

53agriculture finance

CEE has large quantities of potentially productive land

client case KERNEL Population growth, increasing consumption and erratic climate conditions have combined to make soft commodities a strong performer in recent years. As prices have increased, atten-tion has focused on companies that operate in the sector. One of the leading soft commodity companies is Kiev-based Kernel Holding which operates in Ukraine and has recently expanded into Russia.

Kernel is an export-orientated business that generates 60% of its revenue from sunflower oil (sunflower meal, a by-product, is exported as a cattle feed component) with the remainder generated from grain. The company has the largest asset base across the value chain in Ukraine – and is one of the most vertically integrated companies in its sector globally. Kernel spans black soil farms, a silo network, oilseed crushing plants and port facilities to tranship the final product. This integration delivers synergies while the company’s size produces economies of scale.

Kernel has been instrumental in improving the efficiency of Ukrainian agriculture, which had suffered from years of under-investment. Over the past decade Kernel has invested heavily and consolidated the sunflower sector in Ukraine: it is now the country’s largest exporter of sunflower oil and processes 30% of Ukraine’s seed production. As befits a company focused on producing a healthy product – sunflower oil – Kernel is also environmentally conscious: sunflower husks are burnt to power

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See how we arranged a USD 500m pre-export facility for Kernel to expand their sunfl ower oil production

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most of its plants instead of natural gas.Aided by significant improvements, the outlook for Ukrainian agriculture remains attractive. Many farms remain relatively inefficient and use unsophisticated produc-tion models: there is still scope for further gains in productivity towards international levels. In addition, the scale of available agriculturally productive land is sizeable. Moreover, domestic demand in Ukraine is currently fully met – so any increase in production can be exported.

In 2012 Kernel entered the Russian market, with the acquisition of three crushing plants and the signing of a joint venture with Glencore for a grain terminal in the south Russian deep-water port of Taman. In the long term, Kernel plans to replicate its Ukrainian business model in Russia. Despite being the largest global producer of sunflower oil, Russian agriculture is currently less developed and consolidated than in Ukraine and it therefore offers greater opportunities. Moreover, the Russian government consistently supports agri-business.

Working capital challengesAs with any company, Kernel’s expansion by acquisition has increased its need for financing and working capital: leverage has inevitably increased. This growth in credit demand must be carefully balanced with fi-nancial discipline to ensure that profitability is maintained as volumes grow. Key to this balance is the effective integration of new assets and rapid improvements in efficien-cy. In addition to the normal challenges of growth, the sunflower oil business presents working capital challenges. Sunflowers are harvested in September and October and up to 70% of production is purchased be-tween September and December. However, seeds are crushed all year around (seeds can be stored for more than twelve months without any deterioration in oil yield). Sun-flower seed processing represents around 60% of Kernel’s revenues.

“Historically, Kernel used several bilat-eral facilities to finance the purchase of sunflower seed inventories,” explains Anastasia Usacheva, CFO of Kernel. “While the facilities were always satisfactory to the company, once the company reached a certain size it became harder to manage them. Although we have always been open with all of our lenders, inevitably each bank did not have the full picture regarding other banks’ credit lines and the goods pledged against them.” In 2008 Kernel decided to improve transparency for all its lenders by creating a syndicated facility. Working with ING and another bank as arrangers, it developed a syndicat-

ed financing facility to meet its financing needs. The new facility, which totalled USD 255 million, had a one-year tenor. It combined the best features of the existing bilateral facilities, with improved security for lenders (because of greater transpar-ency of inventories and other details) and simplified reporting for the company.“Pre-export facilities of this type had been used before in CEE but not for agricultural companies or in a syndicated format,” explains Pieternel Boogaard, Head of Agricultural Finance, CEE at ING. “The challenge was to find a balance between making the facility administratively simple for Kernel and ensuring syndicate banks were comfortable with the risk. Inevita-bly, Kernel is hampered by perceptions of Ukrainian macro-economic risk, although the company’s strong management and listing in Warsaw provided comfort to lenders.”

One important feature of Kernel’s USD 255 million facility – which is absent in deals for the oil and metals and mining sectors where syndicated pre-export finance is common – is that it could be varied in size on an annual basis depending on Kernel’s need for working capital. “Flexibility was an important characteristic of the new fa-cility,” says Usacheva. “While our business has grown, our financing needs vary sig-nificantly depending on the world price of sunflower oil and the crushing capacity.”Given its tenor, the facility had to be re-newed annually and ING acted as Co-Man-dated Lead arranger on each occasion. “Changing financial conditions from 2008 onwards meant that some of the partic-ipants in the syndicated facility changed from year-to-year,” explains Usacheva. “But ING was consistently responsible and reliable in ensuring the facility was fully supported.”

Flexible financingBy 2011 Kernel had grown significantly and its financing needs were greater. Ker-nel required acquisition finance for a new storage and refinery plant near Illichevsk on the Black Sea in Ukraine. Using this new production and distribution facility, Kernel

had further increased its global export of sunflower oil and meal. “In addition, Kernel’s size had become sufficient to warrant a longer tenor tranche as part of the facility,” adds Usacheva.

With ING again acting as Co-Mandated Lead Arranger and Agent, Kernel signed a new USD 500 million pre-export facility that enables it to fully – and flexibly – fi-nance its sunflower seed crushing business. Of the total facility, USD 280 million has a tenor of three years while USD 220 million has a one-year tenor, which can vary in size on an annual basis. “The facility is unique because of its size and tenor – a three-year tranche is unusual for a syndicated deal in this sector and country,” says Usacheva. “The three-year tranche gives us stability and greater certainty over our working capital while the one-year tranche ensures we have the flexibility we need to adapt to market conditions.”

Working with INGING is a core bank for Kernel and man-aged its IPO in 2007. “We have known the company for a decade and have supported it with corporate finance, general lend-ing, project finance and M&A advisory as well as day-to-day cash management, FX and documentary credit,” explains Oleg Kababchian, Head of Sector, Corporate Clients division at ING. “Our longstanding relationship with ING made it a natural choice when we sought an arranger for the syndicated facility,” noted Kernel’s Us-acheva. She said that ING’s team are easy to work with because they have a deep knowledge of the sector and the region and an understanding of the company, its needs and its goals. “That means we can speak to them as a partner,” she said. “Di-alogue is efficient because we don’t need to explain everything and they always ask the right questions. They understand the risks we face and how to mitigate them. We’re in daily contact with ING and always include it in any discussions about future plans and projects. As we continue to grow, we hope that we can work together further.”

55kernel

poland

WARSAW, POLAND 7.03 PM

POLAND

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

Business as usual

57

Source: ING

estimated average growth 2014/ 2015

More information on ING CB in Poland visitingcb.com/poland

energy finance

SOURCE OF OPPORTUNITIES energy finance

Countries in CEE must work on increasing their energy supplies if their emerging markets are to grow. At the moment the emphasis is still on expanding domestic production, for exam-ple with the help of coal and nuclear energy. Eventually these countries will also invest more in other sources such as renew-able energy. And they will have to invest in their gas pipeline infrastructure. Expanding inter-connections between countries is a precondition for competitive and affordable prices. - by Rodolphe Olard - Global Head of Natural Resources Advisory at ING Commercial Banking and Alexander Alting von Geusau - Head of Utilities, ING Corporate Finance

The one thing that is crucial for future energy supplies is having a mix. Countries would be wise to not put all their eggs in one basket of en-ergy sources, such as natural gas, coal or nuclear energy. Instead they should make use of multiple sources, including sustainable sources. Having a mix is also important when it comes to the infrastructure. Countries that want to benefit from favourable prices in the future must see to it that they import from more than one country. Working together is necessary to achieve this mix. This is a hurdle that should not be hard to overcome for countries in the CEE region. After all, Bulgaria, Romania, Hungary, Poland, Slovakia and Czech Republic are used to wheeling and dealing with their neighbouring countries as a result of their geographical location.

59

Self-sufficiencyNevertheless CEE countries have not really made much headway when it comes to working together in the field of energy. For the time being the countries seem to be mainly focusing on national concerns when it comes to energy security. After the fall of the Berlin Wall the countries naturally focused on their own independence. Countries in the CEE region did not want to become too dependent on Russian gas. Their drive for independence is visible in the investments they have made and are still are making in the energy sector.

ING’s Global Head of Utilities Alexander Alting von Geusau explained that CEE countries have invested a great deal in thermal power plants such as coal and lignite. “Poland is a good example. The country wants to be as self-sufficient as possible and not have to depend too much on Russia or Western Europe for their energy supplies. Around 90% of the power production in Poland is derived from coal. They have huge coal reserves that can provide cheap fuel to their power plants. The balance of the power production mainly comes from biomass and wind energy.” The security of power supplies is also a priority in other CEE countries although differences do exist in the choice of energy sources. Countries south of Poland like the Czech Republic and Slovakia secure their energy supplies mainly through a mix of coal, hydro, nuclear energy and a limited amount of gas. Governments in CEE countries are encouraging investment in new nuclear power plants to secure future energy independence.

The fact that this need for independence is as prevalent as ever is also visible in recent M&A activity. Alting von Geusau: “Local and regional players dominate the market and keep consolidating further while large Western European energy giants are leaving. Vattenfall, for instance, sold its assets to the Polish play-ers Tauron and PGNiG, and we are seeing the emergence of new energy players such as EPH Group (Energetický a prČmyslový holding) in the Czech

energy finance

Republic. That company was created through a large number of acquisitions over a period of eight years, and ING played an important role in the transfor-mation of EPH into a major player in the CEE region.

Renewable energyRenewable energy is also an option worth considering for countries that want to be self-sufficient. After all, renewable energy sources are not only less polluting and risky than coal, lignite and nuclear energy; they also ensure that a country is less dependent on imports of raw materials and electricity. A number of CEE countries have laid a good foundation for this with the help of hydropower. Although they want to continue to expand in this area, the subsidies required for constructing renewable energy projects will add a significant amount to energy prices. This is difficult to justify at a time of economic slowdown. In the medium term this growth in these Eastern European countries will mainly have to come from biomass and wind energy. The target for wind energy is a massive 17.5 gigawatt. Various countries already have experi-ence in this area, including Poland and Romania (ING has supported wind energy projects in both countries).

Economic powerhouse Germany can serve as an example when it comes to investing in renewable energy. The country is proof that targets can be met if the government supports private investment with predictable subsidies. The cost to the consumer and industry, however, is very high as evidenced by every increasing power prices driven by the generous subsidy system. Therefore is has been very difficult for CEE countries to follow Germany’s lead in the current economic climate. It started off well. CEE countries had ambitious growth targets of 20 percent for renewable energy. These targets have now been relaxed and lowered in nearly every country (with the exception of Romania). And it still remains to be seen if these less ambitious targets will be met.

According to Alting von Geusau subsidy schemes in CEE countries, as in many Western European countries, have often proved to be unreliable. “Governments unexpectedly changed the subsidies in a number of countries, sometimes even retroactively for existing projects. This has made investors wary and with the uncertainty of future subsidies in most countries it is very challenging to finance renewable projects in CEE.” This is aggravated by the euro crisis and the low prices of coal and CO2 as well as the fact that not all the grids are ready for supplies from sustainable sources (that are less stable and dependent on the sun and the wind). The example set by Germany shows that this is a serious issue that needs to be resolved because the grids in this West European country are already struggling to cope with energy excesses during extremely sunny or windy weather.

InfrastructureThat brings us to another aspect of energy supplies that the CEE countries will have to invest in in the not too distant future: the infrastructure - not only for electricity transmission, but also gas transport. The interconnection is this region is still quite limited for both gas and electricity supplies. When it comes to the gas infrastructure Russia in particular has been working hard on a web of pipelines including Nord Stream and South Stream. Russia and Gazprom are making significant investments to increase the number of routes supplying the European gas markets. The South Stream project in particular is aiming at improving security of supply to Eastern and Southern Europe. It is a long term investment that is supported by a number of countries in the CEE as well as by some of the largest European oil and gas and energy companies. ING is assisting in this endeavour through the provision of financial advisory services for the offshore section of the pipeline system across the Black Sea as well as for the onshore section in Hungary. A number of other pipeline projects are seeking to provide supply routes from Azerbaijan via onshore Turkey. It is fair

to say that debt markets tend to respond well to such projects, as demonstrated by the success of Nord Stream financing.

InterconnectionA great deal can also still be achieved when it comes to the electricity infrastructure in the CEE region. Dozens of billions of euros are needed to adapt grids to modern-day requirements. Hefty financial injections are required not only for maintenance and improvement but also to increase the interconnectivity between countries. The electricity grid in Europe can be divided into seven power islands (two of which are in the CEE region) within which energy is predomi-nantly exchanged. According to Alting von Geusau many more connections are possible and necessary to achieve a level playing field with fairer price setting. “The development of this interconnection in the CEE region is progressing slowly. That is because of this previously mentioned focus on energy security. Local ‘monopolists’ are of course also not applauding cheaper imports.”Alting von Geusau believes that interconnec-tivity should be a priority in European politics and investments could be promoted through a reliable European subsidy scheme. “The European Investment Bank could create incentives for this. That would encourage large investors to commit. Right now the electricity transmission market is still quite domestically orientated. This could be different. A grid operator like TenneT in the Netherlands and Elia in Belgium have proven that cross-border European transmission companies can be created and efficiencies can be achieved if countries work together.”

ING’s Global Head of Utilities believes that interconnection can be further improved with the support of the European Commis-sion and banks such as the EIB. ING can play a useful role in financing infrastructure projects and improvements across Europe. “We know a lot about how the global energy market works. We view the situation through pan-European glasses. We work together with large energy companies. And we have a wealth of experience in local markets where ING is present. This, combined with our knowledge about the region, makes us an ideal partner for financing energy projects in Central & Eastern Europe.”

61energy finance

KIEV, UKRAINE 4.42 AM

UKRAINE

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

Business as usual

63ukraine

Source: ING

estimated average growth 2014/ 2015

More information on ING in Ukraine visitingcb.com/ukraine

FX HEDGING TO THE FORE

Corporates’ use of hedging – most notably of FX – has risen markedly since the financial crisis began. While regulatory change looks set to sig-nificantly increase hedging costs, the adoption of new market practices could ensure than that it remains affordable. - by Arek Szperna, Head of Financial Markets for CEE at ING.

financial markets

financial markets

Corporate clients active in CEE – whether they are local or international firms – must manage three principal risks: foreign exchange (FX) risk, commodity risk and interest rate risk. Of the three, FX risk is by far the most important. With the exception of Slovakia (which is a member of the Eu-rozone) and the countries with a currency peg, most countries in the region have free-floating exchange rates that create the potential for companies to have huge FX exposure.

The scale of that exposure has been vividly displayed in recent years. During 2008 and 2009, the Polish zloty weakened by up to 50% in just six months. More recently, in 2011 the Hungarian forint lost up to 20% of its value in five months, while in 2012/2013 the Russian rouble lost about 15% against the US dollar. Such huge swings are not beneficial for anyone. However weak, a local currency can create opportunities for some companies: for those that manufacture in the region and distribute elsewhere, such a decline in costs can be a boon. On the other side, for international companies distributing prod-ucts or services in the region, devaluation on such a scale can rapidly price them out of the market.

Before 2008, many corporates were reluc-tant to hedge long-term FX risk because the economic backdrop was relatively stable and there were few negative con-sequences of failing to hedge. Since the onset of the financial crisis, awareness of FX risk has necessarily grown – CFOs and treasurers rapidly increased their knowl-edge as volatility spiked – and demand for longer-term hedging solutions has therefore risen.

Local presence is crucialThe market for hedging corporate FX risk is dominated by local and regional banks, according to central bank statis-tics from across CEE. For international banks without an onshore presence it is more difficult to develop the relationships needed to win business: generally FX and risk management business is awarded to banks willing to make their balance sheet available to clients.

In addition, given the complexity and diversity of local markets in CEE it is difficult for banks without a local pres-ence to develop the appropriate expertise or knowledge necessary to adequately address the dynamics of FX in the region and hedge risks accordingly. ING is well

positioned in each local market and offers expertise, execution and research locally. It is also heavily committed to supporting its clients and deepening its corporate re-lationships. While a local presence remains essential, many companies are increasingly centralising their corporate treasury at a regional or global level. To reflect this ING also operates global emerging markets FX desks in Amsterdam, Brussels and London to provide coverage at head office level: clients can access local know-how and still execute globally – which can prove to be more cost effective.

A new second risk factorWhile FX has undoubtedly become the most important risk factor facing CFOs and treasurers in the past three years, the significance of commodity risk has also increased over the same period. Indeed, commodity price risk has become suffi-ciently elevated to overtake interest rate risk as the second most important risk facing companies.

Large local companies in the natural resources sector, such as local refineries or gas distributors, are used to buying a product based on a price formula that differs from the formula used to set a selling price. Similarly, some companies may have a long lag between production and sales. Given commodity price volatility, such companies can face significant dis-crepancies in these prices. As a result they have increasingly hedged the gap between their buying and selling price or tried to guarantee forward prices. At the same time, many logistics clients have reacted to the increase in diesel fuel prices by using commodity derivatives to hedge their expo-sure (see box on commodity derivatives for more details).

Interest-rate hedging has historically been relatively unimportant to companies in CEE as most countries in the region have benefited from a downward movement of interest rates. Even as the cost of funding has fluctuated, it has been offset by this downward trend. Naturally CFOs and treas-urers are aware of interest rate risk, but it is not a primary concern. After all, a 50% movement in FX has a much greater effect on a company than a 100 basis point increase in interest rates.

The impact of regulatory changeThe torrent of regulatory change – most notably Basel III – will have a significant

impact on banks and major knock-on effects for corporates in all regions seeking to hedge FX risk, commodity risk or inter-est rate risk. Basel III is already impacting the pricing of derivatives to end clients such as corporates as banks are consider-ing the credit risk of the corporate client, expressed as a Credit Valuation Adjustment (CVA), and the market liquidity risk in order to allocate capital for potential negative valuation of the contract more accurately.

Historically, credit risk has not been fully reflected in derivatives pricing, which was instead determined primarily by a bank’s ability to provide a particular hedge. Under Basel III the rating of individual clients and the sector they operate in will have a major bearing on the price they pay to hedge their risks. For highly-rated companies the expectation is that hedging costs will remain similar to those previously incurred. For lower-rated companies, which include many domestic companies in CEE, costs could increase considerably.

There is, however, a way for such compa-nies to mitigate the potential increase in hedging costs associated with CVA. Long-term hedging contracts are covered by the International Swaps and Derivatives Association documentation that includes a Credit Support Annex. This annex states that if a contract is negatively valued by the market, then the client owes money to the bank (in compensation for the increase in credit risk). So should a certain pre-agreed value be reached, collateral must be posted. The Credit Support Annex can work on a bilateral basis.

To date the Credit Support Annex has been rarely used – most obviously be-cause clients have not been aware of it and have never had to consider using it. Among those companies that were aware of it, there has been a concern that the requirement to post collateral could trigger a liquidity problem. Also, in some countries – including in CEE – it has been unclear whether the existing legal framework sup-ports the use of the Credit Support Annex and whether it is enforceable for corpo-rates. Given the importance of ensuring access to hedging for CEE corporates, it seems certain that these challenges will be overcome and the use of the Credit Support Annex will increase as non-collat-eralised hedging prices increase.

65

Commodity derivativesThe prevalence of heavy industry in CEE (compared to western Europe) means that corporates in the region have greater com-modity exposure. Consequently, interest in – and the use of – commodity derivatives is growing. The appetite for commodity derivatives is increased further by the fact that CEE gas prices, on which many manufacturers depend, are not linked to oil prices (unlike in Western Europe) and are therefore potentially more volatile and subject to unexpected changes by major producers. Historically hedging has been seen by many in CEE not as a risk management tool, but as an opportunity to make a financial profit. However, as familiarity with hedging strategies increases, a cultural change is occurring among many corporate treasuries in the region. Increased volatility in energy prices in particular has put producers’ margins under pressure and prompted many to implement risk reduction strategies and consider commodity derivatives in a new light.

Commodity derivatives are used to hedge energy (oil and oil derivatives such as gas and coal), base metals (including aluminium, copper and zinc) and soft commodities (such as corn and wheat). By far the largest commodity derivatives market – at around 70% of the total across CEE – is energy-related as large manufacturing companies’ cost structures have a large energy compo-nent. Metals hedging represents around 25% of ING’s CEE commodity derivatives hedging; the remainder is soft commodities. Geographically the greatest interest in hedging is in Poland and Russia, the region’s largest economic powers.

In the post-financial crisis period, clients have turned to simple products for hedging, with swaps typically used. More specifi-cally, an Asian swap structure is employed where the payoff is determined by the average price of the underlying asset over a certain period of time as opposed to at maturity. Such a structure is advantageous for commodities because they tend to be produced and consumed on a continuous basis. Alternatively, some clients want more flexibility and choose a collar, which limits the range of possible positive or negative returns on an underlying asset to a specific range. Documentation across CEE is the standard ISDA agreement, except in Russia where RISDA documentation is used.

ING takes a unique approach to commodities derivatives. Rather than taking proprietary positions in derivatives (as some banks do), ING’s goal is always to help its clients achieve their risk management objectives. In doing so, ING acts as an intermediary and connects the value chain between producers and consumers. Consumers of a commodity retain the ability to specify the quality and delivery of the physical commodity they need. However, by using a derivatives contract they can ensure price stability of that commodity.

Given its broad strength in commodity derivatives – ING has desks in Amsterdam, New York and Singapore – and wide range of customers, the bank is able to lay-off most of its risk internally: only residual risk is laid off in the market. Moreover, ING’s commodity derivatives clients are also typically clients of other ING businesses, including lending. Consequently, the credit risk associated with exposures can be more fully assessed. ING’s network of country offices across CEE also enables the bank to understand how clients operate and the challenges they face, as well as checking their suitability for derivatives products and arranging credit lines where necessary.

financial markets

Securities financeCEE remains an emerging market for securities finance and trading structures with limited volumes in most countries, with the exception of Russia – by far the largest market in the region – Poland and the Czech Republic. There is also increasing activity in Turkey. Activity is typically focused mainly on fixed-income markets in the region, which tend to have greatest liquidity, although more established markets also have equity activity.

CEE corporates use of an array of structured solutions, ranging from repo structures to derivatives with a linear payoff (such as contracts for difference) for a wide variety of reasons such as generating short-term liquidity or optimising balance sheets. For example, a company may have a significant amount of cash on hand ready to be put to use as part of its capital expenditure programme. Rather than simply investing that money in bank deposits, corporates in CEE are increasingly interested in investing in the repo market as an alternative.

Corporates may also seek strategic solutions to hedge existing exposure. One notable trend in CEE is the common use of ex-isting collateral for financing requirements. This reflects the nature of shareholding structures in CEE, which are typically more concentrated than in Western Europe with a family or individual acting as controlling shareholder. Rather than forfeiting that control, owners often want to use their shareholding to generate leverage.

Typically different types of financial institutions (FIs), such as banks, pension funds, insurance companies and hedge funds, have different requirements in CEE. For example, hedge funds may seek leverage to enhance their returns by trading on margin, need market access or need securities lending to cover short selling. There is also growing interest in contracts for difference. Banks may want financing to achieve balance sheet relief and meet regulatory goals: ING’s A+ rating (from Standard & Poor’s) ensures that it can offer competitive financing across a wide range of asset classes.

ING Global Securities Finance offers an integrated fixed-income and equity platform that meets the needs of a range of FIs and corporates across CEE. Given ING’s global footprint and local market presence and knowledge, it can offer access to both devel-oped and emerging markets. The bank offers a broad product range including linear equity derivatives, securities borrowing and lending, repo, and synthetic portfolio solutions. Moreover, rather than simply presenting a list of possible solutions, ING aims to engage with clients at an early stage of their decision-making so a tailored solution can be structured.

67

ISTANBUL, TURKEY 1.37 PM

TURKEY

GDP change %

Private consumption % change

Investment % change

CA balance in % GDP

Fiscal balance in %

CPI average % YoY

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

Business as usual

69turkey

Source: ING

estimated average growth 2014/ 2015

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71

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