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Political risks in Africa and PRI mitigation 10 Nov 2015

The world seems an increasingly unstable and risky place at the moment, especially in terms of political risk. Wars and civil unrests seem to constantly be in the news (Ukraine, Syria and Libya are currently hitting the headlines) with tragic human and social consequences. In Africa, conflicts include Boko Haram in Nigeria, rebels in the Central African Republic, the Lords Resistance Army in Uganda, coups in Burundi and Burkina Faso, civil war in DRC (with Uganda and Rwanda covertly involved), the conflict in Mali, Al-Shabaab in Somalia and East Africa, the South Sudan border conflict and various groups trying to seize control of post-Gaddafi Libya.
    
Yet in many ways, these are probably the most peaceful times in African history – and certainly when compared to the post-Cold War mayhem of the 1990s. Which brings me onto this month's topic of political risks and how to mitigate them.

The good news

According to an Ernst & Young report, between 1960 and 1990, there was only one instance of an African leader or ruling party being voted out of office. Between 1990 and 2013, over 30 ruling parties or leaders have changed through a democratic process.

Most recently, Nigeria successfully and peacefully transitioned power from Goodluck Jonathan to Muhammadu Buhari – who became the first Nigerian politician to unseat a sitting leader at the ballot box. That is not to say that political risks in Africa are no longer a concern.

What is political risk?

Political risk is a very wide term and the Wikipedia definition is a good starting point:

“the risk of a strategic, financial, or personnel loss for a firm because of such nonmarket factors as macroeconomic and social policies (fiscal, monetary, trade, investment, industrial, income, labour, and developmental), or events related to political instability (terrorism, riots, coups, civil war, and insurrection).”

The key thing to note is that political risk covers not just government action but also the actions of almost any organisation or person with political aims that could affect an investment.

Just because a country is stable, does not mean that there are no political risks. Authoritarian regimes can be very stable but political risks could surface on regime change or attempted regime change. The key issues for investors and lenders is that manifestation of a political risk can result in injuries to personnel and loss of life. This can have serious impacts on a company in terms of morale, repatriation costs, etc. Also, there are direct costs, such as damaged assets, lost production and criminal penalties (e.g. for bribery and corruption), and indirect costs and loss of reputation through adverse media and other criticism. In all cases, shareholder value is likely to be adversely affected.

Political risks today

In the “old” days, the biggest concern for investors in emerging markets was the risk of nationalisation or “expropriation risk” by governments. The reality of the world today is that most governments do not seriously consider taking this drastic step, primarily because such steps can result in claims for compensation (under contract and/or bilateral investment treaties) and can also irreparably damage the “investment brand” and FDI prospects of a country.

Increasingly, political risks are emanating from sub-state or transnational entities, with “creeping” expropriation becoming the key risk. Creeping expropriation covers a host of scenarios where a government (read this to cover sub-state and other similar entities) acts in a way that reduces investors' financial returns by (for example) discriminatorily changing the laws, regulations or contracts governing an investment. This is also sometimes referred to as policy risks. The reality is that more value can be extracted from investors with less impact on the economy by using these mechanisms than outright expropriation. For example, as recently as September this year, Nigerian National Petroleum Corporation (NNPC) said it would be reviewing the fiscal terms of its existing deep offshore Production Sharing Contracts with some international oil and gas companies (IOCs) operating in Nigeria.

Beware of political risks

Protecting one's assets and reputation from the variety of political risks whilst growing your bottomline needs careful management – especially in emerging markets. But there is no silver bullet solution. What is required is an array of strategies, instruments and third-party help to mitigate against these risks. For example by:
•    adopting and adhering to strong corporate social responsibility (CSR) policies;
•    finding suitable local partners whilst understanding and harnessing the local social and economic environment;
•    carrying out regular political risk assessments and monitoring;
•    putting in place suitable political risk insurance (PRI);
•    identifying and putting in place other country-specific strategies; and
•    structuring transactions to take advantage of bilateral investment treaties.

I am not going to talk about CSR, political risk assessment or bilateral investment treaties, primarily because the word count does not allow me but also because there is so much information out there on these subjects (e.g. see my article on http://myndff.org/policy-dialogue/investment-treaties-pri-and-doing-the-deal-structures-and-relationships-2/). Also political risk assessment is a dark art, best left to others more qualified than me.

The local scene

One key way to manage political risk is by understanding and tying into the local, social and economic environment. This is not a simple task because it requires intelligence gathering; analysis of the attitudes, opinions and positions of all local stakeholders; building relationships with suppliers and customers, government agencies etc. finding a suitable local partner for your business who is also able to mitigate against adverse political action being taken; and using the internet and social media.

Investing locally, employing and training local personnel and respecting local traditions and culture are not only good business practices but also can be a foil against political interference. If local people see the business as their business and have a stake in the success of that business, governments are less likely to politically interfere in that business.

Finding the right local partner needs careful consideration and requires appropriate due diligence to be undertaken before signing up. A politically connected local partner may not be the most appropriate person since he can fall out of favour in a change of government. In addition, if your local partner is a “politically exposed person,” (PEP) this can result in greater scrutiny from authorities as a potential compliance risk (e.g. for money laundering or terrorism). Having a PEP as your partner can also hinder raising finance from lenders.

Political risk insurance (PRI)

PRI is often a prerequisite for project-financed transactions and can help investors access finance (often on better terms). Lenders will often insist on PRI being taken out by the sponsors of a project. However, equity providers are also known to take out PRI in certain circumstances, although some equity investors self-insure. This is especially the case for large companies such as IOCs who have the confidence that they can manage the risks and have large enough balance sheets to take these risks on.

PRI providers can be divided into public multilateral agencies and private companies. The former include:
•    the Multilateral Investment Guarantee Agency (MIGA) which is affiliated with the World Bank;
•    national agencies of various OECD companies that provide companies from their country  with export credit and political risk insurance (e.g. OPIC (U.S.), NEXI (Japan), SINOSURE (China), ONDD (Belgium), EDC (Canada), ECGD, (Britain), COFACE (France) and EFIC (Australia).
    
The private political risk market has been around since the mid-1970s having been established by several underwriting syndicates at Lloyd's of London and the American International Group (AIG). The private market has grown significantly since these early days and now includes several major providers of political risk insurance, including Lloyd's, Sovereign, Chubb and Zurich.

Political risk pricing

The good news on PRI is that it is a growth market with significant competition as more and more insurers have moved into this market. This, combined with the lack of profitability in other traditional insurance markets, has resulted in PRI pricing being at an all-time low. So get a good adviser and shop around on price. However, as always, it's not just price but the insurance coverage that is important.

To state the bleeding obvious, a cheaply priced policy that does not cover the relevant political risks you are concerned about will be a total waste of money.

What does PRI cover?

Risks that can be covered by PRI include:
•    non-payment and various forms of breach of contract;
•    confiscation, expropriation or nationalization;
•    currency inconvertibility and non-transfer;
•    loss of assets or income due to political violence (including war, revolution, insurrection, politically motivated civil strife, terrorism and sabotage);
•    contract frustration due to political events;
•    payment default; and
•    wrongful calling of on-demand contract guarantees and bonds.

The key issue when taking out PRI is to identify what type of risks you or your lenders want the policy to respond to. Then get your advisers to check that the wording will respond to those risks. To the extent they don't, policy wording may be adapted and changed to match your requirements.

What to do in the event of a claim

Time is of the essence if you have losses that are potentially covered by a PRI policy. Among other requirements, an insured must file an application for compensation on time, as well as provide any additional supporting information required by the insurer.

Many political risk insurance policies have strict deadlines in which to file a claim (e.g. the standard OPIC policy requires an insured to apply for expropriation or political violence compensation within six months of the loss). Be prepared to litigate to claim under a PRI policy if an insurer disputes a claim notice (and get a good lawyer.)

The internet and social media

The rise of the internet and social media has put a different twist on political risk. For example by acting as a brake on governments and authorities taking arbitrary and unfair actions against investors (and individuals); accelerating political protests and civil unrest (e.g. the uprising in Egypt in 2010 when social media was credited with the massive demonstrations on the streets of Cairo and in Tahrir Square); and investors using social media as a tool to protect their investments by disseminating stories to counter any threats from government.

As a country's “investment brand” becomes increasingly important, the use and control of the global perception of a country as an investment destination becomes increasingly important. So whilst NNPC has said it wishes to renegotiate the IOC contracts, Mr Ibe Kachikwu (new head of NNPC) also stated that care must be taken not to create an anti-investment atmosphere, as that may be counterproductive to the industry.

As Warren Buffet said: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.”

Finally, a small plug from me. Want to hear about political risks and the oil and gas sector? I will be speaking on this subject at the Project Financing in Oil & Gas Conference in London on 23rd and 24th November - Project Financing in Oil and Gas. Hope to see some of you there.