What is Political risk?
By Melvin J. Howard
As difined by the enclopeida broadly stated, political risk refers to the complications businesses and governments may face as a result of what are commonly referred to as political decisions—or “any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives.” . Political risk faced by firms can be defined as “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).” Portfolio investors may face similar financial losses. Moreover, governments may face complications in their ability to execute diplomatic, military or other initiatives as a result of political risk.
A low level of political risk in a given country does not necessarily correspond to a high degree of political freedom. Indeed, some of the more stable states are also the most authoritarian. Long-term assessments of political risk must account for the danger that a politically oppressive environment is only stable as long as top-down control is maintained and citizens prevented from a free exchange of ideas and goods with the outside world.
Understanding risk as part probability and part impact provides insight into political risk. For a business, the implication for political risk is that there is a measure of likelihood that political events may complicate its pursuit of earnings through direct impacts (such as taxes or fees) or indirect impacts (such as opportunity cost forgone). As a result, political risk is similar to an expected value such that the likelihood of a political event occurring may reduce the desirability of that investment by reducing its anticipated returns.
There are both macro- and micro-level political risks. Macro-level political risks have similar impacts across all foreign actors in a given location. While these are included in country risk analysis, it would be incorrect to equate macro-level political risk analysis with country risk as country risk only looks at national-level risks and also includes financial and economic risks. Micro-level risks focus on sector, firm, or project specific risk.
Macro-Level Political Risk
Macro-level political risk looks at non-project specific risks. A common misconception is that macro-level political risk only looks at country-level political risk; however, the coupling of local, national, and regional political events often means that events at the local level may have follow-on effects for stakeholders on a macro-level. Other types of risk include government currency actions, regulatory changes, sovereign credit defaults, endemic corruption, war declarations and government composition changes. These events pose both portfolio investment and foreign direct investment risks that can change the overall suitability of a destination for investment. Moreover, these events pose risks that can alter the way a foreign government must conduct its affairs as well.
Research has shown that macro-level indicators can be quantified and modeled like other types of risk. For example, Eurasia Group produces a political risk index which incorporates four distinct categories of sub-risk into a calculation of macro-level political stability. This Global Political Risk Index can be found in publications like The Economist. Other companies which offer publications on macro-level political risk include Business Monitor International, Economist Intelligence Unit, and Political Risk Services.
Micro-Level Political Risk
Micro-level political risks are project-specific risks. An examination of these types of political risks might look at how the local political climate in a given region may impact a business endeavor. This type of risk includes project-specific government review (such as the Committee on Foreign Investment in the US (CFIUS) process in the United States), the selection of dangerous local partners with political power, and expropriation/nationalization of projects and assets.
So how do you go about minimizing political risk as a company entering a foreign country? There are a couple of ways first research this is what we did before deciding to enter the Canadian market in terms of riskiness by paying for reports from consultants that specialize in making these assessments. In fact we do this in every country that we may do business in. Then we went on the to the U.S. Department of State's background notes) and clicked on Canada. It goes on to talk about Geography, People, Government, Economy and US Canada relations. But what is totally absent from all of the publications is Canada’s health care system. Now you would think Canada a G-11 North American Country would not be considered political risk when it comes to health care. That’s what underwriters in London thought to when I first approached them to underwrite our project in Canada. After months on collecting data and me making presentations one of which me power pointing to the piece meal and Hodgepodge approach that Canadian provinces are dealing with Private delivery of medical services. I pointed out it was unorganized with no rules or regulation nor framework to go by. Also the constant bickering between the Provinces and the Federal Government in the media. Only served to cause more political turmoil in terms of private investment in health care. So after months of negotiations I was the first one to be granted Political Risk insurance for a health care project in North America. One of many milestones that I have managed to create for this project. At the bottom you may see sample terms of the insurance. Of course I took out the relevant names for confidential reasons.
So some thought that a NAFTA claim was going to be launched by a huge multi-national corporation. Once again that was short sighted the multi-nationals would not have to lay a claim for NAFTA at this point. Since I will deal with most of the multi-nationals in terms of banking, insurance, vendor relations, legal, etc. They would not have to do this direct. It’s not about how big the dog is in the fight. It’s about how big the fight is in the dog. This claim will not go away my colleagues and I am adamant that we be adequately compensated for breach in trade rules. So I ask you if insurance underwriters whom job it is to know about risks. Thought that health care in Canada was a risk in terms of Private Investment. What more evidence does the international tribunals need?
May 7, 2004
Mr. Melvin J. Howard Regent Hills Health Centre By Facsimile - 13 Pages
Dear Mr. Howard;
Re; Regent Hills Health Centre Political Risk Insurance
We are now in receipt of written terms for Political Risk Insurance, as provided by our colleagues at Political Risk in London. The terms are provided on the basis of "Leader only", and will require that additional Underwriters be canvassed in order to provide 100% support for the full limit of $50,000,000, Terms are subject to agreement by all participating Underwriters, and could change if other participants require higher rates,
Brief details of the lead Underwriter's terms are: Political Risk Insurance
United States Dollars
Eighteen (I8) months from date to be agreed
$280,000 in respect of 18 month term, inclusive of xxx xxx xxxx fees
ie accordance with specimen policy wording attached and amendments thereto as
determined by Underwriters,
We will require evidence of the land purchase and payment of the full amount of the premium prior to effecting coverage. We would also ask you to note the policy is non-cancelable by either party unless specifically agreed at inception, in accordance with Clause 2.8 of the policy wording.
We will confirm when other Underwriters have authorized their support, and the terms thereof, and trust you find the foregoing in order in the meantime.
SPECIMEN POLICY WORDING
EXPROPRIATION INSURANCE - PERMANENT INVESTMENTS
Conditions and Warranties
Endorsement for Currency Inconvertibility
RISK : EXPROPRIATION INSURANCE - PERMANENT INVESTMENTS
WORDING ATTACHING TO POLICY NO:
Whereas the Assured has made to Underwriters a written proposal, the representations, particulars and statements of which, shall form the basis of this Policy.
SECTION 1; INSURED EVENTS
In consideration of the premium payable hereunder Underwriters agree to indemnify the Assured for the Insured Percentage of its Ascertained Net Loss (as hereinafter defined) up to but not exceeding the Policy Limit, caused solely and directly in consequence of the occurrence during the Policy Period of one or more of the following Insured Events but subject always to the definitions, exclusions, conditions and warranties below :
Expropriation means an act occurring within the Policy period not limited to expropriation but including also confiscation, nationalization, requisition, sequestration and deprivation by law, order or administrative decree of the government of the Foreign Country which
i) expressly and permanently deprives the Assured of all or part of its shareholding in the Foreign Enterprise, or
ii) expressly and permanently deprives the Foreign Enterprise of all or part of its fixed and/or current assets, or
ill) expressly and selectively prevents or restricts the operation of the Foreign Enterprise so as to cause the permanent and total cessation of the Foreign Enterprise's activities.
1.2. Selective Discrimination
Selective Discrimination means the imposition within the Policy Period of any law, order, decree, regulation or import / export restriction by the government of the Foreign Country which is applied against the Assured but is not applied against other entities with similar interest and standing, and which is beyond the control of the Assured and which
i) expressly and selectively prevents or restricts the operation of the Foreign Enterprise, or
ii) legally prevents trie Assured from participating in the benefits of the joint venture agreement,
so as to cause the permanent and torn! Cessation of the Foreign Enterprise's activities.