Managing Risk: Revolutions and the Asia CFO

As popular revolts erupt in Egypt, Tunisia, Libya, Iran, Jordan, Algeria, Yemen and Bahrain, global insurance broker Marsh is ready to dispense advice. The company works with the world’s insurance companies on behalf of corporates looking for the most cost-effective and appropriate insurance coverage as part of their risk management.

“Political risk insurance is there to be part of a prudent ongoing strategy when investing in fragile, or politically sensitive, or emerging economies,” says Richard Green, Asia Head of Marsh’s Trade and Political Risk Practice. “If you’ve got an oil and gas asset worth US$500 million and the next day you don’t have it anymore, that’s very expensive.”
He spoke to CFO Innovation’s Cesar Bacani about the impact of the disruptions on trade and investment in Asia, what the region’s CFOs can do to protect their company’s interests, and other issues. Excerpts:
Are you seeing increased levels of concern among your clients because of what’s happening in the Middle East and North Africa?
It’s definitely true that there’s been steadily increased concern across that region – Egypt, Tunisia, Algeria, Yemen, Jordan, Iran. The real concern is not so much that this will force a change in regime; it is more about the uncertainty of what the new regimes in each of these countries will actually look like.
There are different types of concern. One concern is for Asian companies that have assets in Egypt, oil and gas assets predominantly, possibly also hotels and tourism assets. There are concerns about those assets and the people [assigned there]
There are much broader concerns. A number of Asian companies, whilst they do not have assets in Egypt, are actively trading with that country. The concern is what’s going to happen to the Egyptian economy. Unemployment is very high, inflation is at nearly 12% and rising, the Egyptian pound is under a lot of pressure. You might start to see defaults on sovereign payment obligations, i.e., payments from the Egyptian government; or corporate payment obligations.
There is also some concern about how the Suez Canal will be affected, since it accounts for a substantial portion of world trade. If there’s a problem getting shipping through that canal, that will affect the world.
Are you beginning to see defaults or delayed payments?
Not as yet, but the concern is they may arise in the near future
Is it too late to buy political risk insurance or trade credit insurance? I imagine the premiums must be very high to protect against risks in Egypt.
To be honest, the underwriters that we’ve spoken to in Asia are taking a step back from Egypt and waiting to see what happens. Most of them have said that they are not actually writing new transactions in Egypt right now, because they want to see, in the coming weeks, what emerges.
Coverage is still available for some of the other countries. Prices will have gone up, but cover has not been completely withdrawn at the moment. The situation is pretty fluid, though; it can change from day-to-day.
You mentioned the Suez Canal. If it becomes impassable, surely there are alternative trade routes?
Our estimates are that about 4 million barrels of oil go through the Suez Canal every day. We have heard of certain shipping companies already re-routing their containers, and that could have an impact on trade. It’s a longer way round.
There is coverage called trade disruption insurance designed to address situations where, for natural peril reasons or for political reasons, a waterway is not navigable anymore. Whether that coverage would be available right now for that region, we’d have to check. None of our clients have asked for that.
That’s the irony of insurance, isn’t it? It’s abundant when you don’t need it, but when you do need it, you can’t get it.
That is obviously a popular perception, but political risk insurance is very much like other forms of insurance. Most of us insure our houses every year without really expecting them to catch fire, but every year you pay the premium because it’s prudent to do so. What we don’t do is wait till the basement’s on fire, and ring up saying, “Could we buy us some coverage?”
But when it comes to these types of insurances, they wait until protests erupt and then they say, “Could we buy a political risk insurance?”
Political risk insurance is there to be part of a prudent ongoing strategy when investing in fragile, or politically sensitive, or emerging economies.
I’m guessing one reason is because the premiums can be quite hefty.
If you’ve got an oil and gas asset worth US$500 million and the next day you don’t have it anymore, that’s very expensive. The premiums are sensible ones in the context of the risks that are being taken.
You have to decide upon a prudent level of coverage. But waiting for the country to implode and then buying is not the best strategy. It wasn’t so long ago when there was political violence in Thailand. A number of our clients were insured for port-to-place in Bangkok because it was part of their strategy to buy these types of insurances to protect their assets. And now we’re talking about Egypt, and Iran, and Algeria.
How much would it cost to buy political risk insurance?
Most political risk insurances are between 75 basis points to 250 basis points. It often just depends, as well, on the appetite of the market. The political risk insurance market in Singapore is very active. There are nine or ten companies offering political risk and credit risk insurances.
There are different political risk coverages, depending on the nature of your exposure. If you have a fixed investment like a factory or a plant, that’s one type of political risk insurance. If you’re trading with an overseas government entity, it’s a different type of insurance.
Basically you have the investment insurances, which would include confiscation, expropriation, nationalization, that’s when the host government takes your asset from you. In the political risk insurance market, there is a product called political violence, which covers [damage to assets from] riots, strikes, civil commotions, civil unrest, terrorism, and civil war.
Are there any economies in Asia that are regarded as carrying higher levels of risk?
There’s focus at the moment on Thailand, with the problems that we’ve had in the recent past there, and the continued uncertainty.
What about China? There was a failed attempt to start protests there, a change of leadership is due in 2012 and there are fears about runaway inflation and an overheating economy.
Actually outside companies investing in China feel that it is a safe place to make fixed investments, so we’re not seeing a great deal of demand for investment-type insurances, political risk insurances in China.
Where we are seeing demand is among companies that are trading in or with China, which are protecting payments [due them] against credit default risk. We’re seeing quite a lot of demand for domestic trade credit insurance in China, meaning a U.S. company, say, trading with Chinese buyers. There is also demand from companies exporting into China.
There is a concern that people are over-stretched, over-leveraged, and that could have an impact on payments in China. It has to be said that the Chinese government has taken action to take the heat out the economy by raising interest rates and so on. I think that’s going to help.
What about companies in China exporting to the US and Europe? Aren’t they concerned about counterparty risk because of the economic environment out there?
They do. One of the biggest things we’ve seen in recent years is the expansion of Chinese business overseas. Chinese companies obviously have huge exposures to Europe and the US, but also increasing exposures to Africa and South America. What puts China in a special category is that it has its own political risk and credit risk [insurance provider], a state-owned insurance company called Sinosure.
Foreign insurers are allowed to cover domestic credit in China, but they’re not allowed to cover export credit. Chinese companies exporting overseas that are looking for trade credit coverage have to get that from Sinosure. If it’s political-risk-type insurance that they require, there are private insurers that can provide that coverage, but they still have to compete with Sinosure, and Sinosure’s capacity premium terms are very attractive.
If I were an exporter, why would I buy trade credit insurance? Why can’t I require my buyers to buy a letter of credit?
You can. But liquidity in the banking system is not what it was before the global financial crisis. If you ask your buyer to open a letter of credit, it’s better for you because you’ve got a secure payment instrument, so you have solved your problem. But what you’ve done is create a problem for your buyer, because your buyer will have to go and get a letter of credit and that will use up his banking lines.
What you don’t want to do is make life too difficult for your buyers. If you do that, they’ll buy from someone else. What we are seeing in Asia is that people are using trade credit insurance to give them a competitive edge. They can then tell their customers: “We will supply to you without the need for an LC. When other people want LCs, we don’t.”
What most of our clients are trying to do is to make things as easy as possible for the buyer. If there is a way to not require letters of credit, not require corporate guarantees, not require advance payments, that helps in the sales process. Trade credit insurance allows our clients to be very flexible on their payment terms, but at the same time protects them.
Will the counterparty know that you have taken out credit insurance on the transaction?
No, absolutely not. It must be confidential. It’s not really a question of trust. The concern is that if the buyer knows that it’s insured, they might ring up the seller and say, “look, I can’t pay you this much, but you’re not going to lose any money because the insurer will pay anyway.” There’s what we call moral hazard there.
Would the buyer of the insurance pass on the cost of the insurance to the other party?
It may do so. Before the global financial crisis, credit was almost free. If you were selling to a buyer on credit terms, you wouldn’t charge them anything necessarily. But now that credit’s not free, if you’re taking credit risk, my view is you can and should charge for [insurance coverage].
Don’t some insurers provide credit reports on counterparties, giving a company some indication of whether a prospective buyer might default or not?
One of the advantages of taking on trade credit insurance is that you get much more than just an insurance policy. You get access to [the provider’s] intelligence on credit risk.
When you’re dealing with a new buyer, either domestically or overseas, you might not know that buyer at all, so you have no idea how to assess the credit risk on that buyer. But insurance firms might know that buyer, it might be a client of theirs, they might be covering them already. So getting access to the insurer’s view of the credit risk is very valuable.
Is this a service that is done by everyone, or is it just one or two of them?
It varies from company to company. Some of the credit insurers provide credit information services, which they sell [in the form of] a credit report. You don’t have to buy the insurance policy. Other companies don’t sell their credit intelligence. But if you have an insurance contract with them, you can submit the name of a potential buyer to them, and they will give you a credit limit on that particular buyer. How high or low that credit limit is will reflect their view of the buyer’s creditworthiness.

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