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Home > Operations Management Best Practice > How to Manage Emerging Market Risks with Third Party Insurance

Operations Management Best Practice

How to Manage Emerging Market Risks with Third Party Insurance

by Rod Morris

Executive Summary

  • Emerging markets present significant noncommercial political risks.

  • Political risks can be mitigated through insurance products known as political risk insurance (PRI).

  • PRI is a vehicle designed to help both equity investors and financial institutions to mitigate the losses that can result from a foreign government’s substantive violation of the terms and conditions that originally attracted the foreign investment.

  • More than 40 insurers, both private and public sector, offer such coverage.

  • This article gives a comparative overview of the features of the public and private sector approaches.

Introduction

There are numerous issues that investors and companies must consider when contemplating an investment in a foreign country. Take for example, cultural differences, the tax regime, foreign currency exchange restrictions, the regulatory and legal environment, the judicial system, and security requirements for both assets and employees. For emerging markets in particular, each of these factors can be further complicated by the potential for politically motivated interference, or changes in the government’s attitude to foreign investment.

Foreign governments, especially those without an effective system of checks and balances, can create a favorable investment climate and then reverse or alter it quickly and dramatically. The results can be devastating to a foreign investor’s ability to survive. A government’s abrogation or unilateral alteration of an investor’s licenses or agreements, new and onerous regulations or taxes, confiscation of property, and so on can happen, do happen, and will continue to happen, even if an investor hires an entire team of international and local lawyers and does everything right. None of that will matter when the local political environment takes an abrupt turn, which can happen for any number of reasons, including financial crisis, coup, or regime change. Nor will it be much use if terrorists or organized crime factions create an untenable atmosphere of insecurity.

There is also a growing trend known as “resource nationalism,” in which governments have tried to grab a bigger share of the control and profits derived from diminishing supplies of, or increasing demand for (and therefore increasing prices of), their country’s commodities such as tin, gold, and oil. Some governments are forcing unilateral restructuring of contracts and concessions, or even forcing a change in ownership that flips the foreign investor from a majority to minority position. The trend is particularly notable in Russia, Latin America, and Africa. Even if an investment is experiencing no problems with the sovereign government, there is no guarantee that it will be safe from interference from increasingly militant local governments, local judges interpreting local laws, or activist community organizations, which can frustrate or destroy a project just as effectively as an outright confiscation.

It is therefore essential that any potential investor makes a study of the current and likely economic and political risks of a country. Countries with developing or struggling economies and immature or undemocratic political structures can offer significant opportunities but at the same time pose significant risk. Much of that risk can be described as political, and many of these political risks can be mitigated through insurance products, known generically as PRI (political risk insurance). Assessing these risks may require some outside assistance, and there are a number of organizations that can help (see the More Info section).

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