Political risks over the project life cycle

Political risks can arise from the actions of governments, public authorities or civil society at large, in the form of legitimate and/or illegitimate and discriminatory actions. These may include interventions to prevent the transfer of payments, cancellation of a license or events such as war, civil strife, revolution and other disturbances that may prevent the exporter from performing under the supply contract, or the buyer from making a payment. Physical disasters such as cyclones, floods, and earthquakes may also fall under this banner.

Political risks influence a project’s revenue stream, or the value of the asset or company. It can also influence domestic and foreign investors’ and lenders’ perspectives on a country’s attractiveness for investment, as well as investors’ access to regional and international capital markets. The latter is of particular importance for capital-intensive infrastructure projects in countries with a shallow domestic capital market.

A project’s life cycle can be separated into a construction phase and operational phase, each of which is susceptible to political risks:

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Construction Phase

  • Expropriation
  • Work permit requirements for skilled labour

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Operational Phase

  • Confiscation, Expropriation, Nationalisation (CEN)
  • Transfer and convertibility restrictions
  • Political violence, unrest or war
  • Breach of contract
  • Adverse regulatory changes
  • Creeping expropriation
  • Non-Honouring of Sovereign Financial Obligations (NHSFO)
  • Arbitral Award Default (AAD)

The likelihood of political interference in infrastructure projects is greater than for other types of projects, due to the social and environmental impacts of infrastructure projects. In addition, project cycles of 20 years or more exceed political cycles: this increases the risk of political intervention of new governments or their potential reluctance to honour financial obligations. According to interviewed experts, private partners often refrain from PPP contracts with public counterparts at a municipal level.

Definitions of main political risks in private infrastructure projects
Political Risk Definition
Adverse regulatory changes, or creeping expropriation A series of events – mostly regulatory changes – by the host government (or a sub-sovereign entity or regulatory agency) that results in the deprivation of an investor's rights to the use of the property or revenue stream, even when the property has not been seized and the legal entitlement to the property has not been affected.
Arbitral Award Default (AAD) Losses arising from a government’s non-payment, when a binding decision or award by an arbitration or judicial forum cannot be enforced.
Breach of contract (BoC) Losses resulting from government termination or rescission of contracts (e.g. a concession or a power purchase agreement) without compensation for existing investments in a product or service.
Civil disturbance Property or income losses from domestic political violence, including hostile actions by national forces, civil war, revolution, insurrection, or politically-motivated terrorism or sabotage.
Confiscation, expropriation, nationalisation (CEN) An action whereby a government seizes property or assets of the foreign investor without full compensation to the investor. This is also referred to as 'ownership risk' or nationalisation.
Non-Honouring of Sovereign Financial Obligations (NHSFO) Losses resulting from the failure of a sovereign, sub-sovereign, or state-owned enterprise to make a payment when due under an unconditional financial payment obligation or guarantee related to an eligible investment.
Sub-sovereign risk Losses related to a breach of contract, non-payment or other actions or inactions by a sub-sovereign host government or contractual counter-party.
Transfer and convertibility restrictions Arising from the inability to convert domestic currency into foreign currency, or to transfer funds outside the host country, due to the actions of the host government.
Source: Author’s compilation based on OECD (2008) and MIGA (2013)