In recent years, local companies in Asia, particularly in Hong Kong and Singapore, have realised that their limited domestic market can hinder their growth. In an effort to drive profits up, various firms have expanded all over the region – and some even as far as the Latin American and African regions.
But expanding overseas poses many risks. Civil strife, labour issues, and unstable governments can adversely affect both sales and production. Conflicts also have the potential to destroy warehouses and factories owned by these firms.
The unfortunate existence of these issues, however, is not pushing investors to look for solutions to insulate their businesses from political risks. In fact, many businesses are not familiar with the ways in which they can minimize the impact of these risks.
Furthermore, there is also a certain perception that these conflicts are manageable and will never occur. As the events of 9/11 have proven, this is far from the truth. The ‘black swan theory’ has illustrated that negative, unexpected events leave the most impact on society and business.
Asia’s companies should be aware that political risks are part of doing business abroad. It is important to plan well and consider the worst case scenarios. They should find ways to mitigate these potential occurrences and be prepared in case they do occur.
There are several ways for enterprises to manage risks and protect themselves from potential payment defaults during times of conflict. Three risk mitigation methods are particularly relevant for Asian companies: internal assessment and review, engagement of risk consultants, and political risk insurance coverage.
Internal Assessment and Review
The nature of the transaction or the type of goods involved is a very important factor to consider when dealing with companies domiciled in politically-high risk countries.
An environmentally-friendly project, for example, will create employment, improve resident livelihood, and generate foreign exchange. Political leaders will tend to be more receptive to these types of projects, in contrast to ones that have negative environmental impacts and deplete the country’s natural resources.
Similarly, if a company is selling essentials such as food or oil, it is more likely to be paid as opposed to those selling luxury or consumer goods.
The country’s political climate and attitude to foreign and local private-sector investment are also important. In Venezuela, the government is actively behind efforts to nationalize companies. It has taken over ranch lands, oil companies, fertiliser firms, cement makers, retail stores, and steel mills. The frequent government takeover of oil companies has sent jitters among industry stalwarts, who frequently speak of cancelling contracts.
At the same time, however, the country offers very attractive oil trading opportunities. As the leading oil exporter in the Americas, Venezuela has the largest petroleum reserves in the world.
Other countries in Latin America which have a high risk in expropriation or nationalisation are Bolivia, Ecuador, and Argentina. Investors should also be aware that this risk also exists in Zimbabwe, Sudan, the Democratic Republic of Congo, and Kazakhstan. These countries’ mining, oil, and gas industries face the threat of being nationalised.
Companies should conduct regular reviews and assessments of countries where they have moved their operations as well as countries which they are eyeing as potential new markets.
For example, if it comes to light that a particular country could be facing severe shortage of foreign currency and there is a possibility of foreign exchange control, it may be wise for the company to switch payment mode or terms when trading with buyers in said country. A good example is Argentina, which has been initiating a series of exchange control measures to stem the outflow of US dollars and bolster the central bank’s reserves.
Companies can also obtain political and country risk reports researched and produced by independent think tanks and various information providers. By getting hold of country risk reports, local companies can then ascertain if doing business in their desired locations is worth it in the long run.
Engaging Risk Consultants
For simple review and analysis, companies can purchase an off-the shelf type of report which may cost US$1,000 to US$2,000. A more in-depth and detailed report could run into several thousands of dollars. They can also choose to employ a risk consultant, the services of whom can cost in the tens of thousands of dollars and is typically done when companies are involved in signing multi-million dollar contracts.
Despite the high cost, it is highly recommended to engage consultants. This is especially true when performing due diligence and conducting feasibility studies before the signing of major long term contracts with new buyers in emerging markets, particularly involving the exports of capital goods and equipment.
The input provided by risk consultants affords companies a better understanding of the political and economic climate in which they will operate, as well as the potential risks and opportunities they will face. Consultant selection should be based on track record, intelligence network, and geographical coverage.
Political Risk insurance
Political risk insurance protects the balance sheet of businesses, thereby avoiding catastrophic financial loss due to business interruption and non-payment arising from political conflicts such as strikes, riots, civil commotion, terrorism, sabotage, war and/or civil war, embargo and currency inconvertibility, etc.
Having such a policy shields companies from risks that may strain their financial operations and hinder their overall financial growth. It also enables companies to have easier access to financing when the transaction is enhanced with such coverage.
Companies may initially be wary of purchasing political insurance for a number of reasons: lack of familiarity, the perception that political risks are manageable and that there is a low probability of occurrence, high insurance premiums, inconsistent coverage in high risk countries, concerns over the insurer’s willingness to pay, and finally, lack of specific coverage from the insurance provider.
However, political risk insurance should still be purchased as a risk mitigation tool.
Insurance premiums can go from hundreds and thousands of dollars to millions, depending on the duration and amount of the investment made. While it can be expensive, the costs do not outweigh the benefits.
Political risk insurance is especially crucial in emerging economies frequently threatened by political instability. Even the ‘safest’ countries can erupt in chaos. Should any conflict arise, it is essential for companies to prepare themselves beforehand.
They should remember that during the Arab Spring in the Middle East, firms were unsuccessful in getting political insurance coverage because most insurers were tight on capacity or had ceased coverage in certain countries. Seeking coverage should be done ahead of time, before conflict arises.
In general, political risk insurance providers cover most countries except for the following 16 jurisdictions:
- North Korea
- Sierra Leone
The benefits of using political risk insurance as a risk mitigation tool for companies venturing and expanding overseas markets has not eluded the eyes of the Singapore government.
It recently initiated a political risk insurance scheme through the statutory board IE Singapore. The programme will support up to 50% of insurance premiums paid by qualified Singapore-based companies for approved political risk insurance policies incepted with Singapore-registered credit insurers.
While expanding overseas can be very profitable, companies must always take political risks into consideration when conducting business abroad. No corporation wants to take the time to expand only to end up in the thrall of political turmoil such as unstable governments or labour issues.
Internal assessments and reviews should be conducted, businesses should confer with risk consultants, and investors should be aware of risk insurance options when trying new markets. Should coverage be unavailable when the situation deteriorates or takes place, the pre-meditated nature of insurance will not be there to protect against payment defaults.
About the Author
Andrew Loh is Head of Special Products, Asia Pacific, at the Atradius Group, which provides trade credit insurance, surety and collections services worldwide.
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