Security personnel keep vigil in the wake of post election violence in Kenya. Pic: Nation Media Group

Olkaria III Geothermal project in the Rift Valley of Kenya– a project which ATI reinsured MIGA against transfer restriction, expropriation, war and civil disturbance. The plant will provide 35MW of additional power. Pic: Rebecca Post, MIGA

Concerns over political risk continue to loom large as businesses slowly gain appetite for investment in emerging markets. Investors now have a better grasp of political risks, placing the global political risk insurance (PRI) industry in a position to grow. TradeInvestAfrica looks at the opportunities and challenges in Africa’s developing PRI industry.  

Among the first things the Orascom Group chief executive, Samih Sawiris, looks at when scouting for new investment opportunities is the sustainability of a country’s legal system and how often the rules of the game change.

Sawiris knows first-hand what he is talking about - the Egyptian business group has successfully invested $3-billion in the Middle East and Africa’s telecommunications, tourism, manufacturing, construction and ICT sectors over the past few decades. ‘The best way to offset risks is to deal solely on legal terms. Be tough in initial negotiations and make sure it’s all covered by the country's laws.’

Sawiris handed the advice to business people attending the Common Market for Eastern and Southern Africa (COMESA) investment forum in April, where the term political risk came up repeatedly during the discussion on obstacles facing the region’s ability to attract and maintain investments.

Investment opportunities and returns abound in Africa, but it comes with risks. Stories of woe are plentiful - in May 2010 First Quantum Minerals Ltd lost a licence for one of its mines in the Democratic Republic of Congo because the government handed it to another party. Rio Tinto Group had its assets stripped by the former government of Guinea. African Consolidated Resources Plc has been in dispute with Zimbabwe over the cancellation of its permit to mine in the Marange diamonds fields since 2006.

Foreign companies mainly consider two things before investing in a developing country: the rate of return on the investment and the risk associated with it. Assessing the rate of return is easy but the latter is more complicated. Investors are very concerned about the risks to their businesses that they cannot control.

Among these are inadequate business regulations, poorly defined ownership rights, failure to enforce the rule of law, exchange control restriction, limitations on repatriation of funds, war, civil disturbance and terrorism.

Foreign investment expected to grow

The financial crisis may have reduced the global appetite for risk and shelved many companies’ investment plans. Yet the Multilateral Investment Guarantee Agency’s (MIGA) latest World Investment Outlook and Political Risk Report predicts the trends that sustained the expansion of Foreign Direct Investment (FDI) before the downturn, such as the growing consumer markets, intensified competition and increasingly open investment regimes, are expected to boost the revival of FDI.

‘There are signs of economic recovery, with a slow increase in FDI having become evident in the fourth quarter of last year,’ says MIGA’s operations director, Edith Quintrell.

Rebounding Chinese demand for commodities and a surge in commodity prices are among the factors contributing to the upswing in FDI into Africa. More foreign businesses are now looking to increase their presence on the continent and hope to match the already significant Chinese and Indian presence.

‘Africa offers huge investment opportunities in energy and infrastructure and the growing intra-trade should help reposition the region,’ says Kato Mukuru, the head of research for Renaissance Capital. The investment bank published a report in April giving 10 reasons why Africa is now a great destination for FDI. Huge natural resources, strong growth in the equities market, relatively high GDP growth performance and attractive valuations of banks on the back of limited liquidity, are some of the top reasons outlined in the report.

The opportunities appear alluring, but the exposure for investors, who are now expanding into more countries, has never been greater. 

Investors’ approaches, when it comes to factoring political stability into their risk assessment of potential projects, vary. There is diverse opinion on whether high-risk investments have the potential of high returns, or they are just a dangerous gamble.

Zimbabwe-based Kingdom Financial Holdings' chief executive officer Nigel Chanakira says in terms of consistent returns, stable countries such as South Africa attract higher FDI, unlike Zimbabwe, which he thinks glows an angry red on Africa’s political risk map.

‘However, for me, high risk means high returns.  Investments in Zimbabwe can prove highly profitable,’ says Chanakira.

Orascom’s Samih Sawiris calls this ‘gambling’, saying the main reason FDI levels are low in sub-Saharan Africa is because of the lack of stability in some countries. ‘Domestic investors have a better chance to live with these risks and react in a way that mitigates them.’

Chris Kirubi, chairman of Kenya-based property development and management company, International House Limited, says its foolish to take media reports on the continent at face value. Instead, business people need to conduct thorough due-diligence.

‘We have to become competitive. Once you remove borders, it will bring automatic challenges. Countries will want to attract investments so they'll want to do better,’ says Kirubi.

Pressure on African governments to improve regulatory and legal frameworks, in order to help change perceptions and encourage further FDI, has never been greater. Another challenge is to effectively market available opportunities.

According to Quintrell, the nature of investments will be different going forward, with investors cautious and more realistic of both the political and financial risks involved.

That said, political risk management has to be a core process in the way emerging market investors run their businesses and has indeed become a normal part of corporate decision-making, although the process sometimes tends to fall between stools.

 ‘Political risk management still needs to be better integrated with strategic planning and decision-making processes. We are talking about someone from one place needing to understand that the place where they are going is different and many managers are close-minded in getting their heads around totally different environments and new value systems,’ says Robert McKellar, a political risk analyst and director of Harmattan Associates.

Political risk consultants intimately know the scenarios that are likely to cause a nightmare for their clients, and make a living from giving advice. ‘People and reputation are critical assets - the rule is: do not sacrifice either in pursuit of profit. Either provide foreign operations with the means to protect these assets and then play by the rules, or abstain from a high risk location,’ says McKellar.

 But does danger necessarily mean one should not invest?

‘To me, risk equals uncertainty. In other words, if a risk is foreseen and understood, it is not a "risk" but rather a "factor" and as such can be taken into account when considering the projects viability. Unforeseen issues such as regime change can be ameliorated by a number of mechanisms, one of the most efficient being political risk insurance cover,’ says Stewart Kinloch, the acting chief executive of the Africa Trade Insurance Agency (ATI), Africa’s biggest player in the continent’s political risk industry.

MIGA, which provides guarantees against political risk to protect cross-border investment in developing member countries, predicts a significant increase in demand for investment insurance.

‘At this time, the global credit crunch has reduced the "global" appetite for risk, both political and commercial. The challenge for Africa is to compete against the likes of Asia and South America when it comes to attracting FDI and bringing the political risk insurance industry along with the investors,’ says Kinloch.

No risk, no gain

Investing in countries that are tainted by years of conflict or even sporadic unrest can cloud perceptions of risk despite the fact that potential rewards abound and particularly in areas such as infrastructure rebuilding. If risks in such hot spots are managed properly, investors need not overlook the potential high returns that are achievable. Political risk insurance has been crucial in supporting large and complex projects in countries such as Mozambique and the Democratic Republic of Congo, where there has been prolonged conflict.

One way of mitigating is through Political Risk Insurance (PRI). In Africa, the PRI industry is still developing. Insurers are now calling for the exploitation of credit and political risks that have been on the rise, impacting negatively on business operations. The take-up for such risks by the insurance sector has been slow because the losses resulting from them are usually too large to bear and cumulatively they can result in the collapse of an insurance company.

‘The political risk insurance industry is minimal in Africa and no matter how well travelled or educated the industry outside Africa is, the lack of local "flavour" will always count against underwriting Africa from a distance,’ says Kinloch.

‘This "local flavour” is one of ATI's major deliverables when it comes to African risk and assisting our reinsurance partners in London and elsewhere,’ adds Kinloch.

Political risks have therefore been traditionally covered by special political risk insurance.

Some of the providers include:

African Trade Insurance Agency (ATI) (http://www.ati-aca.org)
ATI has a membership of 16 countries as well as several other institutions. In terms of country demand, deals underwritten in DRC, Malawi and Zambia amounted to 65% of the agency's total volume of business, which increased by 123% in 2009. The agency mainly underwrites investments in the extractive, infrastructure, telecommunications and agri-business sectors, and has partnered with insurance companies in East Africa to provide political risk insurance cover.

Export Credit Guarantee Company of Egypt (ECGE) (http://www.ecgegypt.net/)
ECGE provides guarantees to exporters of commodities and services on a number of risks, including non-payment and political risk. The company recently entered into an agreement with ATI, which will facilitate more domestic and foreign investment and exports into Africa.

Multilateral Insurance Guarantee Agency (MIGA) (www.miga.org)
With a membership of 175 countries, MIGA’s outstanding exposure stands at $7.5 billion worldwide, with about 11% of that exposure focused on FDI initiatives in Africa. The agency primarily underwrites investments in the agri-business, manufacturing and infrastructure sectors.

Export Development Canada (www.edc.ca)
The Canadian government established the EDC to foster export and international trade. It provides insurance for export non-payment and political risk.

The Export Finance and Insurance Corp (www.efic.gov.au)
The Australian government's corporation provides exporters and investors with, among other services, export finance guarantees and political risk insurance.

The Overseas Private Investment Corporation (www.opic.gov)
Opic is the United States' version of Canada's EDC and Australia's EFIC. Since its start in 1971, it has facilitated over $70 billion in exports.

*See a comprehensive list of political risk insurance providers.

Proactive choices

Even political risk insurance has its own drawbacks. While companies have to deal with the fear of disputed claims, insurers also recognise that political risk policies should ideally be a tool of last resort.

Although ATI’s policy rarely has an “off cover” country or industry, it has a number of “non-negotiable” exclusions such as nuclear, military, child labour, drugs or corrupt practices.

‘Research the risks before you invest. I recall a case of alleged "forced abandonment" in Tanzania. In short, it was alleged that the Tanzanian authorities stood by when a family was illegally driven from their farm property. If there is a history of such activities then it is probably better to seek a different project than to try to mitigate the risk with insurance or any other solution,’ says Kinloch.

The jury is still out on the effectiveness of mitigating political risks with other proactive methods such as taking on a local partner or establishing a strong corporate social responsibility programme aimed at getting the local community on your side.

References

Political Risk Insurance Centre
Multilateral Insurance Guarantee Agency
Llyods Insurance
AON risk map 2010
Risky Business: Corruption, fraud, terrorism and other threats to global business (Book authored by Stuart Poole-Robb and Alan Bailey.)