Political Risk: Insights For Your Firm
Today, as many businesses wonder how to thrive amid political uncertainty, companies with experience in emerging markets can offer insights to help with the changing business environment. One common solution chosen by companies operating in emerging markets is political risk insurance. Political risk insurance both helps protect businesses against the risk of losing investments and helps companies secure funds for new ventures at more favorable interest rates.
Which strategies can help multinational companies grow globally with greater confidence? What are some of the risks that multinational companies should prepare for as political uncertainty escalates? In this interview, Alison Ramsay, Vice President of Global Credit Lines at AIG, explains how political changes can relate to political risks in emerging markets and provides insights to help businesses seize global opportunities in 2017.
In emerging markets, we often see regime changes. If a company operates in an emerging market, how could a regime change affect its business?
In general, the impact of regime change is greater in emerging markets because they may not have the same underpinning of civil societies or government institutions. The legislative and judicial systems may be underdeveloped, and existing laws are not always consistently applied. So there is more potential for negative effects on foreign investors because they can’t count on “the system” to protect their interests.
When government policies change, the company’s business plan might have to change quickly as well. A contract made with the government might be invalidated, or a subsidy might be taken away. Which other factors could be risky for businesses?
Those could be some of the risks. A new administration may have won an election on a platform of cleaning up past real or perceived corruption. Contracts put in place by the previous government may be reviewed, amended unilaterally, or even cancelled.
An area where we see this happen more frequently is in the natural resources sector. There is often a lot of local passion around natural resources because agricultural, oil, gas, and mining projects have a strong impact on the local community. So there may be a lot of pressure on politicians to respond to those local concerns.
If a multinational company operates in an emerging market, what could be the consequences of rising nationalism and protectionism in that country?
Those issues do come up in emerging market countries as well. For example, many companies have manufacturing operations overseas, and those operations may in turn rely on imported inputs from third countries. The result of protectionism could be higher import taxes or other forms of pressure to “buy local.” Domestic sales in the emerging market country could also be negatively affected if new rules favor local competitors.
When nationalism and protectionism are on the rise, the desire to improve national security and shape economic development might lead to new policies that limit foreign investment. Is there an example of how anti-foreign investment sentiment could impact business in a developing country?
Going back to the topic of natural resources as an example, there are instances in which countries have nationalized the oil and gas industries in the name of protecting the national interest. In these cases, operations owned and run by foreign companies have been expropriated, and these companies have had to leave their assets (and future profits) behind. Many countries’ constitutions allow for expropriation.
On another note, when anti-foreign investment sentiment rises, the government might increase regulatory involvement in industry sectors with high levels of foreign participation; this may lead to higher operating costs or perhaps restrictions on certain activities. One example of a sector that may be impacted is utility companies, where there may be a cap imposed on prices charged to local customers.
So those regulated sectors may have higher risks when it comes to a new administration?
You could think of it that way. Another significant risk is change in the economic situation of the country. Whether there’s a change in government or not, a weakening economy could lead a government to decide that it’s not in the public interest anymore to provide subsidies, say, for clean energy. So the government may want to, or need to, revisit those contracts. That has happened in a number of countries: Spain a few years ago would be one example.i
In emerging markets, civil unrest and political violence can be prevalent. How could these risks affect a multinational business?
It generally depends on what the business is doing, and on the location. Is the company operating in a high-profile industry sector? This is sometimes the case for large European and American companies.
Location is also key; if the company is in a city, there might be more potential for political violence. Businesses should take into consideration the potential for both asset damage and business interruption losses.
How can companies act proactively to help reduce political risks in times of unrest?
Being a good corporate citizen can have a significant impact. Are you contributing to the economy? Are you providing jobs? Are you being environmentally responsible? Are you investing in the community? I think those things are particularly important.
What about companies who want to protect themselves against the risks associated with new governments, new policies? What proactive steps can businesses take to help reduce regulatory risks?
The details of the investment contracts are really important. A deal should be fair to all parties. If an agreement is too favorable to the investor and doesn’t provide a good deal for the host country government, then that might invite scrutiny later on.
Dispute resolution provisions in the investment contracts are also important. Ideally the agreements should call for international arbitration in a neutral location, under a system of laws other than that of the host country, to improve the chances of a fair outcome.
With uncertainty rising around the globe, how can political risk insurance help companies in 2017?
I like to think of political risk insurance in terms of the opportunities it can help open up for companies. Not only can political risk insurance help protect against loss of the company’s assets, but it also can help companies finance new opportunities. When a company is looking to expand overseas, generally speaking, that can make their lenders a little nervous. Political risk insurance can be a risk mitigating factor there.
A political risk insurance policy can be provided to the investor or to its financial institution; knowing that if one of these risks does happen, the loan will still be insured under the policy. This can help make banks more open to helping their clients make investments in new markets.
To clarify, political risk insurance can help companies grow and expand overseas with more confidence. It not only can help companies receive the loans they need, but also can protect the banks in certain ways.
Yes—and political risk insurance is not just for large investments like infrastructure or manufacturing. We have a number of clients who insure their mobile assets—for example, drilling rigs, high-value electronic equipment, or inventories. Political risk insurance is helpful for companies with mobile equipment because it helps them take advantage of business opportunities, wherever they’re available. For companies with distribution facilities in various regions of the world, political risk insurance helps keep them close to their customers while minimizing the risk to their assets.
It sounds like political risk insurance may help companies be more flexible so that they can take advantage of opportunities around the globe more quickly. It makes sense in this new era where the world is more interconnected. It’s a mobile age, right?
i “The cost del sol.” The Economist: the Economist Group, 20 Jul. 2013, http://www.economist.com/news/business/21582018-sustainable-energy-meets-unsustainable-costs-cost-del-sol. Accessed 12 May 2017.
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* The content contained herein is intended for general informational purposes only. Companies and individuals should not solely rely on the information or suggestions provided in this article for the prevention or mitigation of the risks discussed herein.