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An introduction to performance bonds

China General Interest

by John Earwaker

In this challenging world there is a need for certainty, possibly more now than any other time before. None more so than in the construction, manufacturing and or export industries.

To ensure certainty and manage financial risk, principals, when considering bids and awarding contracts, demand of the appointed contractor or manufacturer, performance bonds to guarantee promised and satisfactory performance.

Performance bonds in turn add value to the contractor’s bid by assuring principals of their performance.

In China, performance bonds are issued for 10% of the contract value and are often extended to include any retention. The biggest issue is whether the bond provider’s paper is acceptable. Thankfully, notwithstanding the huge financial upset worldwide, performance bonds are being accepted in China as before. Where there is an issue, the rated paper issuer has local bank representation. Principals in the United States of America, on the other hand, expect performance bonds to be as high as 200% of the contract value. As a performance bond is effectively an on demand cash instrument, the issuers of performance bonds understandably require collateral from the contractor/manufacturer to offset the financial risk. To date, trading banks have been the usual and accepted source of performance bonds.

Interestingly enough, this has not always been the case, up until the early 1960’s Insurance underwriters were the main source of performance bond guarantees. Now the worm has turned and the international insurance industry has turned their hands to providing Surety Subsidiary Companies. Companies like QBE, VERO, CHUBB, COFACE and US RISK are now very much in the market for surety products, of which performance bonds are the most common.

Whilst the end product, between what the trading banks and surety underwriters provide, is the same, there are differences in the application process. Trading banks require collateral, in order to support the additional credit required, whereas Surety Underwriters do not generally demand collateral, relying on their ability to underwrite a risk. The effect of this difference can make a substantial difference to the balance sheet and working capital of an applicant.

In New Zealand, the Surety Underwriters now have a recognised distributor with the ability to provide performance bonds on contracts, manufacturing and infrastructure projects in China as well as in Indonesia, India, the Middle East, South America, Europe, Australia, Pacific Islands, New Zealand and now USA. In most situations the performance bonds can be issued directly by the Surety Underwriter without the need for intermediary handling of foreign trading banks.

John Earwaker is a Director of Bonded NZ, a specialist insurance broker offering surety bonds for projects in China.