Political Risk Mitigation

 

Instruments to mitigate political risk, in order to ease the access to financing for private infrastructure investments, are especially important in countries with high perceived political risks. In Southeast Asia, the main instruments employed include political risk insurance and joint venture/alliances with local companies, followed by risk analysis and consultations with governments and political leaders:

Main Risk Mitigation Instrument
PRI

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The main instruments applied to mitigate political risks are:

Political risk insurance and guarantees (PRI)

These enable investors and lenders to transfer political risks to a third party, in order to mitigate political risks such as expropriation, breach of contract, currency inconvertibility, political violence and arbitration award default. In 2012, insurance and guarantees covered around 6% of global FDI flows, including 14.2% of FDI flows to developing countries, reflecting the importance of PRI for foreign direct investment.

Political Risk Insurance
Political Risk Insurance can cover both equity investors and lenders against the default of a public or private entity resulting from a political event. The project’s risk level will determine coverage (generally limited to less than 100% of the investment), pricing, tenor and eligibility. Providers of PRI cover include bilateral agencies such as export credit agencies and export-import (Ex-Im) banks, multilateral agencies and private insurance companies.

Political Risk Guarantees
Political Risk Guarantees typically cover the full amount of debt owed to commercial lenders in private projects, if the debt default is caused by political risks specified under the guarantee. In general, the types of political events that may be covered are widely defined and may even include force majeure events.
The most common examples are Partial Risk Guarantees (PRGs) offered by multilateral development banks and a few bilateral agencies. These guarantees can cover up to 100% of debt service (principal and interest). PRGs generally require the government to provide a counter-guarantee or indemnity.

Credit Guarantees
Credit Guarantees are comprehensive instruments that cover losses in the event of a debt service default, with no differentiation between commercial or political causes. Credit guarantees can be classified into two types:

  • Full Credit Guarantees or Wrap Guarantees 
    Full Credit Guarantees or Wrap Guarantees cover the entire amount of the debt service in the event of a default. They are often used by bond issuers to achieve a higher credit rating to meet the investment requirements of institutional investors. Until the global financial crisis in 2007/08, private monoline insurers issued wrap guarantees for bonds issued by infrastructure project companies in the ASEAN region.
  • Partial Credit Guarantees (PCGs)
    Partial Credit Guarantees (PCGs) cover part of the debt service of a debt instrument, regardless of the cause of default. PCGs ease the borrower’s access to financing by reducing interest rates and/or by increasing the tenor. PCGs typically cover debt service for late maturities, which may be beneficial when lenders are unwilling or unable to provide a financing tenor long enough to match the cash flow of a project. Alternatively, PCGs can cover a portion of principal and interest payments payable throughout the term of a borrowing. PCGs are increasingly used by sub-national entities and private companies to borrow from commercial banks or to issue bonds.

Unlike other Risk Mitigation Instruments, political risk insurance and guarantees are tradeable. More information on the market for PRI can be found on the following pages:

 

Joint ventures or alliances with local companies 

These enable investors to collaborate with a local counterpart possessing a better knowledge of the local market, political system and specific risks, thereby enabling foreign investors to increase their knowledge of the market in question. Foreign lenders may similarly seek to co-finance large infrastructure investments with domestic banks.

Consultations with governments and political leaders

These enable investors and lenders to be informed on national development plans, infrastructure objectives and policy changes that might affect infrastructure investments. They allow private stakeholders to express their perspectives on public policies, in order to improve the investment climate.

Risk Analysis

This seeks to manage risks throughout the life cycle of a project, through analysing the risk profile of an infrastructure project, in order to identify the main risks and the optimal solutions to mitigating the negative impacts of these.

The following table presents the main political risks, selected risk mitigation instruments to mitigate each risk and typical providers of each instrument:

Main political risks and selected financial risk mitigation instruments
Risks* Selected risk mitigation instruments* Providers
Expropriation (plant & equipment) Comprehensive Contractors Plant and Equipment insurance Private insurers
Force Majeure (natural disaster) Natural Catastrophe cover
Business interruption cover
Private & public insurers
Private insurers
Contract frustration (vs private or public) Contract frustration cover Private & public insurers
Expropriation & Regulatory changes Expropriation cover
International or national (NY, SG, HK law) 
Arbitration courts (contractually defined)
Private & public insurers
(Arbitration) Courts
Political Violence Political violence cover (property damage) Private & public insurers
Currency inconvertibility/ Transfer restrictions Currency inconvertibility cover Private & public insurers
Breach of Contract & Non-honouring of financial obligations Comprehensive cover
Contract frustration cover
Private & public insurers
International or national (NY, SG, HK law) Arbitration courts (contractually defined)
Private insurers (few)
Private & public insurers (Arbitration) Courts
Not honouring an arbitration award Arbitral award cover Private & public insurers
Legal risk Denial of justice cover Private & public insurers
*The table is not comprehensive but focuses on selected risks and risk mitigation instruments with a focus on insurance and guarantees