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
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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.
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.
- 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.
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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:
- Usage of PRI in Southeast Asia
- Demand for PRI for infrastructure investment in Southeast Asia
- Supply of PRI from public and private agencies
- Constraints in accessing PRI cover
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.
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.
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The following table presents the main political risks, selected risk mitigation instruments to mitigate each risk and typical providers of each instrument:
| 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 |