Companies with more than 20 percent of operations overseas are vulnerable.
As previously stable governments including Egypt, Libya, Yemen, Jordan and Oman began experiencing civil unrest earlier this year, corporate executives around the world started to feel a chill of uncertainty as the political winds in the Arab world suddenly shifted without warning. Any company with operations in the Middle East and North Africa, or even a strategic plan for entering the region, was now on high alert, trying to determine what type of disruption they were likely to suffer, how much damage would be done to their bottom lines and whether or not they should continue to conduct business in the region at all.
In late February, SNC-Lavalin, an $8.2 billion Montreal-based engineering and construction firm, evacuated 4,000 employees from two major construction projects in Libya as rebel forces clashed with Libyan leader Muammar Gadaffi. The company was building water treatment facilities and pipelines in the Libyan desert and had a contract to construct the Benghazi airport.
With those projects stalled, the company was determined to limit the damage. Denis Jasmin, SNC-Lavalin’s vice president of investor relations, recalls that while the phones were ringing constantly at the height of the crisis, the company was focused on finding a strategy to deal with investors’ questions about its future.
In 2010, Libyan revenues represented $400 million, or about 7 percent of SNC-Lavalin’s total revenues. Jasmin says that given the uncertainty of the situation, the company simply told investors that it would be removing Libyan revenues from all future projections. While quickly acknowledging the loss of business was difficult, these are some of the realities of political risk, an inescapable part of the global economy that all businesses must learn to manage. Political risk is becoming more important for companies, and for those that have spent billions of dollars building operations in foreign lands, the stakes are incredibly high.
Unfortunately, political risk is a concept that’s hard to get one’s head around, mainly because it assumes so many different forms – and it appears to be on the upswing. At one extreme is the risk of expropriation, or a foreign government nationalizing resources that a public company has developed. Instances of expropriation are relatively rare, but have occasionally occurred in Venezuela and other countries.
At the other extreme are risks from garden-variety problems such as corruption. Simon Whistler, senior consultant, global risk analysis, for independent specialist risk consultancy Control Risks, points out that corruption and local crime can fall into the category of political risks. With increased enforcement of the Foreign Corrupt Practices Act in the US and the 2010 UK Bribery Act, doing business with foreign governments increases risk exposure. ‘Companies have to be aware at all levels of their business how bribery, solicitation payments and internal fraud can impact their operations,’ Whistler says.
Assessing and protecting against risk
Historically, companies have not been particularly savvy about assessing political risk. ‘Many studies have shown that companies outside of the extractive industries don’t necessarily monitor political risk on a regular basis,’ says Jennifer Oetzel, associate professor in the international business department at American University. ‘And there’s not as much coordination as you’d imagine between headquarters and subsidiaries experiencing high levels of risk.’
Stephen Kay, senior vice president and US practice leader for political risk and structured credit at insurance broker Marsh, notes that companies’ awareness of political risk tends to be cyclical. Before the recent global financial meltdown, political risk didn’t seriously register for most public companies, but over the past two or three years, Kay says, ‘political risk has appeared on many companies’ radar screens.’ He notes that companies with more than 20 percent of their operations overseas are now actively planning how to manage – or offload – the political risks they face.
In some cases, companies are looking at ways to insure against political risk. The Overseas Private Investment Corporation (OPIC) is the US government’s development finance institution. OPIC insures against everything from currency inconvertibility (instances where governments impose new restrictions preventing companies from converting or transferring investment returns) to political violence (property and income loss from politically motivated unrest).
OPIC also offers standalone terrorism coverage, or protection against violent acts committed for a political purpose by individuals or groups who aren’t part of a country’s armed forces. Standalone terrorism coverage protects against chemical, biological and radiological weapons or other weapons of mass destruction.
The amount of time and resources companies devote to analyzing political risk usually varies by industry. ‘Oil companies have had much more sophisticated in-house competencies around assessing political risk,’ says Oetzel. ‘They often operate in countries with the highest political risk, and they have less choice about where they operate.’ Manufacturing or service companies don’t typically consider political risk with the same urgency.
Risk on a case-by-case basis
While the so-called social media revolution that started in Egypt and moved across the Middle East has elevated political risk to the top of many corporate secretaries’ and boards’ list of concerns, that region is not the only place in the world where political risk is high. Going forward, Whistler identifies Venezuela, Russia and Iran as examples of countries where the prevailing levels of political risk are highest. He recommends companies evaluate each country’s risks on a case-by-case basis.
Many countries have policies that will present risks for certain industries but provide opportunities for others. In Russia, for example, Whistler notes that ‘a lot of companies in the manufacturing sector are welcome because they create jobs and economic growth. ’ But, he adds, ‘If you look at foreign companies operating in the oil and gas sector, they’ve gotten into trouble with groups of oligarchs and power struggles within the highest levels of the Russian government.’
Specifically, Whistler says that BP encountered problems in Russia when a recent deal with Rosneft, the state oil company, angered its other local joint venture partners. In May, the BP/Rosneft deal collapsed.
Whistler also advises companies to look beyond the possibility of coups d’état or other large, sensational events. ‘We don’t focus on the headline risks,’ he says. ‘Companies have a generally good picture of who the political leaders are and what their inclinations are towards foreign investment. It’s the micro-issues around making sure tax payments are made on time and the trends around corruption that matter most.’
Additionally, some companies are finding managing political risk difficult because these risks often cut across many different departments within the company. At many large companies, legal counsel may be monitoring certain political risks while the board of directors oversees others. Whistler believes that companies can – and should – do a better job of looking at political risk holistically so that potential problems don’t fall through the cracks and warning signs don’t go unheeded.
Putting plans in place
Dealing properly with political risk requires that companies take the time to conduct scenario and contingency planning in order to have an actionable operations plan ready in the event that things go wrong. Here, the point is to ask the tough questions. As an example, Kay says, ‘If we’re sourcing from a third-party supplier in Mexico and that supplier is suddenly not able to deliver because of political events, what can we do? Can we move manufacturing quickly to another location?’
Oetzel also encourages companies to envision the worst-case scenario and tentatively plan a response: ‘Companies need to think: how severe would a shock have to be in a particular country for the company to actually withdraw? And is there a way to relocate certain parts of the investment?’
Corporate secretaries need to investigate political risks and how best to mitigate them, with the understanding that avoiding these risks altogether may not be possible. ‘Identifying the relevant political risks can be very difficult, and it’s hard to find out information – some of the relevant information might not be known by anyone,’ Oetzel laments. ‘Companies really need to prepare on an ongoing basis for risk events that they could never anticipate, and that’s obviously very challenging.’
Although researching and understanding political risks can be a monumental task, there are some resources to turn to. Consultants can be a source of critical information, providing detailed, case-by-case country analyses and assessments. Corporations can use services like the Economist Intelligence Unit to keep abreast of political risks simmering around the globe, and teaming up with a local partner can also provide valuable information and access. Some public companies will only invest internationally if they are working with a local joint venture partner, because a native usually has his or her finger more firmly on a nation’s pulse than a foreigner does.
After doing all the research, a company still has to actually execute effectively. There must be plans to keep things operational in a crisis so that a company can take care of its employees and keep doing business if appropriate.
During the recent upheaval in Libya, Jasmin underscores that he and other executives ‘never lost communication with our local employees there at the site’. Keeping a direct pipeline of information open is critical for evaluating any situation involving extreme political risk.
After seeing what happened in Libya, Jasmin has turned his attention to other operations in the region. He is now closely monitoring the political climate in Algeria, where SNC-Lavalin has a major engineering project involving a gas treatment plant. ‘Right now it’s business as usual in Algeria,’ he says. ‘There are some protests, but I don’t expect anything to happen because the people of Algeria went through a civil war in the 1960s and 1970s. The people don’t want to go back to that, and the president has already announced that he will retire.’
Is political risk insurance right for your company?
‘Trying to predict risks is sort of a fool’s game that’s fraught with difficulty and the potential for error,’ says Stephen Kay, senior vice president and US practice leader for political risk and structured credit at insurance broker Marsh.
For this reason, Kay notes that companies with more than 20 percent of their operations overseas often purchase political risk insurance policies from companies like ACE, Chartis and Zurich. ‘Political risk insurance,’ he explains, ‘has gone from a tiny, almost insignificant specialty to a major offering that most insurers provide.’
Often, Kay notes, companies buy political risk insurance because a board member reads a newspaper article and gets panicky. ‘Someone on the board may see that there’s an election coming up in Peru, and it looks like one of the frontrunners is a leftist guy who tried to take over by way of a coup ten years ago and is now purporting to be friendly to business,’ he says. ‘The director might say, 'We have operations in Peru; aren’t we worried about this?’
Kay cautions that event-driven inquiries can spur a company to buy the wrong kind of political risk insurance. Too often, he says, ‘companies will insure operations in Egypt and the policy will cover the risks of expropriation of the business by the government. But guess what? That’s not the risk that happens. It’s civil commotion bordering on civil war.’ For this reason, Kay advises companies to consider buying broad political violence coverage rather than more narrow policies that attempt to predict world events.
Although political risk insurance may be the right strategy for some companies, Jennifer Oetzel, associate professor in the international business department at American University, cautions about the cost of covering risks ‘that are difficult to predict from an actuarial point of view. Life insurance is predictable and can be accurately priced, but political risk insurance is very expensive, and companies don’t always read their policies. They may not realize that they’re not covered for what they thought they were covered for. What often seems like an easy fix really isn’t a fix at all.’
