Executive Summary

This chapter discusses methods of mitigating political risks, including political risk insurance products. Such products are of great importance to investors, are offered by a diverse group of entities, and include varying forms of coverage. This chapter also provides guidance as to the selection of methods to mitigate political risks.

1.0 Introduction: Type of Risks Faced by International Investors

International investors inevitably face a number of risks, commercial and political, when investing overseas, particularly in emerging markets. These risks include: (1) market risks, (2) credit/default risks, (3) operational risks, (4) liquidity risks, and (5) political risks.1

Political risks stem from government actions that may adversely affect the value of foreign investments in that country.2 They include: expropriation, nationalisation of assets in an industrial sector or a geographic region, war, civil disturbance, terrorism, discriminatory regulations, and currency inconvertibility and transfer restrictions. Some political risks may be company-specific, such as discriminatory regulations or expropriation. Other risks are country-specific, such as mass nationalisations or currency inconvertibility. Political risks can present themselves in numerous ways, such as in connection with the issuance, renewal, and revocation of licences and permits; changes in regulatory and tax environments; responses to natural disasters, and actions to address public health and safety.3

Certain events increase political risks. For example, falling prices for energy products, such as oil and coal, can place greater pressure on government finances, affecting the ability of a government to pay its debts, which, in turn, may lead to not honouring its sovereign obligations, as well as other risks.4 Political events in recent years,5 including the “Brexit” referendum and the protectionist statements of the Trump administration, have increased concerns about political risks, leading to an increased demand for new products from both public and private political risk insurers.

2.0 Tools to Manage Risks Faced by International Investors

In part, commercial risks traditionally have been mitigated prior to investment by due diligence and proper planning.6 Mitigation of political risks, however, presents unique challenges, as the risks are unpredictable and difficult to manage.

Some mitigation methods are aimed at prevention. For example, a basic tool to mitigate political risks at the national level exists in the form of international treaties, discussed in Chapter 6 and other chapters in this volume. Although the scope and content of bilateral investment treaties (BITs), multilateral investment treaties (such as the Energy Charter Treaty), and free trade agreements containing investment provisions vary considerably, many contain similar substantive protections.7 Another tool to protect against political risks is an agreement with the host state relating to the specific investment. The host state in such agreements frequently agrees to “stabilise”

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the regulatory and fiscal environment for the project, either by freezing regulations or setting parameters for changes in regulations.8 Stabilisation clauses are discussed in Chapter 7.

Insurers and various institutions have developed financial methods, such as political risk insurance and guarantees, to protect against political risks. These methods are not necessarily aimed at prevention; rather, they provide assurances to an investor that compensation will be received if a loss occurs as a result of a political risk event.9 In many instances, financial methods of addressing political risks can be a faster and more reliable means of obtaining redress than dispute resolution or treaty protections. In other instances, the costs imposed by political risk insurance — including both direct costs and indirect costs (such as time) to meet the providers’ policy requirements — may lead investors to implement other strategies for mitigating risk.10

A comprehensive political management approach aims to minimise exposure to political risk effectively and efficiently. When tailoring their approaches to managing political risks, businesses should consider the protections available under a variety of risk management tools and the ways different tools may supplement each other. When selecting a proper tool to manage the political risks described above, businesses should consider the historical actions of the host country, the entities that are participating in a project or with whom a dispute may arise, and the scope of disputes and/or government conduct at issue. Of course, the appropriate mix of protections remains to be considered and selected on a case-by-case basis.

3.0 Types of Entities Offering Political Risk Insurance Products

Approximately 90 public and private institutions underwrite political risk insurance.11

3.1 Public Insurers

Public insurers come in many forms;12 export credit agencies and multilateral development banks are two types of public institutions that provide assistance (such as credit, guarantees, or insurance products) for international investments.13 Examples of such institutions include the World Bank, which makes available political risk guarantees through the Multilateral Investment Guarantee Agency (MIGA), whose mission is to promote foreign direct investment in developing countries,14 and the Overseas Private Investment Corporation (OPIC), the principal government-backed political risk insurance provider in the United States.

3.1.1 MIGA

Eligibility requirements for a MIGA guarantee include:

  • Investors must be citizens or entities of a MIGA member making an investment in a developing MIGA member;
  • The host country must have an agreement on investment protection with the home state of the investor, protection for the investment through local laws, or a protection agreement with MIGA; and
  • The investment must meet environmental and developmental goals.15

As of September 2017, MIGA has paid only eight claims.16 The small number of claims paid by MIGA could be a testament to the agency’s ability to work with investors and host countries to find amicable pre-claim solutions.17 Such a deterrent effect, arguably inherent in public insurance from governments or under multilateral agreements, is an advantage of purchasing coverage from a public insurer.18

3.1.2 OPIC

OPIC insures investments up to US$250 million (with the exception of oil and gas projects, which may receive cover of up to US$400 million), and up to 90% of the investment loss.19 OPIC has funded, guaranteed, or insured more than US$200 billion of investment in more than 4,000 projects,20 and has made 300 insurance claim settlements totalling US$977.4 million.21

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OPIC makes political risk insurance available for currency inconvertibility, expropriation, and political violence.22 Other specialised coverage is available for certain kinds of breaches of contract or arbitration agreements or failure to enforce arbitration awards. OPIC restricts its services to only US investors, contractors, exporters, and financial institutions involved in international transactions.23 Moreover, like MIGA, OPIC considers economic and social development criteria, such as whether the contemplated project will benefit the host country.24 These eligibility requirements and conditions may be viewed by some as a disadvantage of pursuing public insurance.

3.2 Commercial Insurers

Commercial insurers also offer political risk coverage to investors. One advantage to pursuing private insurance is that private political risk insurers have greater flexibility than public institutions to tailor policies to a specific company and its contemplated risk.25 Private insurers also have the ability to tailor policies more quickly and efficiently, with more favourable (and likely more costly) coverage.26 There are a number of private political risk insurers — such as AIG Global, Chartis, Meridian Finance Group, Zurich Emerging Market Solutions, Aon Sovereign Risk Insurance, Ltd., and Lloyds of London — offering a variety of products, including insurance for investors with existing (rather than new) investments.

When selecting a political risk insurance product, businesses should consider each insurer’s specific criteria (for example, MIGA requires that a project meet certain environmental and development goals), as well as the type of coverage offered. It may behove an investor to interview several commercial insurers to understand each insurer’s track record and ability to design innovative solutions to mitigate a wide range of risks.

4.0 Types of Coverage and Measure of Loss

Insurance companies are built on the principle of subrogation — that is, insurance policies give an insurance company the right to “step into the shoes” of the insured after it has been indemnified for its loss. Subrogation rights can be found in concession agreements, investment contracts, and BITs, and the protections available in these agreements may have a direct impact on the value of the insurer’s subrogation rights.27

Further, political risk insurance policies set forth the events that give rise to a loss — i.e., what constitutes an event of loss — and the measure of damages in the event a loss occurs.28 Generally, damages are measured as the net book value of an insured investment. What constitutes an “event of loss” is a more difficult question, however, and the types of incidents covered are often quite limited.

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4.1 Traditional Products

Political risk insurance typically covers three main categories of risk: (1) inconvertibility, (2) expropriation, and (3) political violence.

  • Currency inconvertibility (CI) coverage typically protects investors against restrictions preventing the conversion or transfer of investment returns into US dollars.32 This type of coverage has been relied on during foreign exchange shortages and cases of sovereign default.33 CI coverage typically precludes recovery for losses arising out of currency devaluations.
  • Expropriation coverage protects investors against state actions that deprive an investor from effectively exercising its fundamental rights in the project or investment.34 Expropriations can be the result of a direct act of taking, such as nationalisation or confiscation, or an indirect or “creeping” taking, such as a series of acts that, over time, have an expropriatory effect.35 Expropriation is discussed in Chapter 8.
  • Political violence coverage compensates investors for losses to income, property, or assets as a result of political violence in the host country. The political motives of the person(s) engaged in the violence are vital considerations, as this type of coverage does not cover criminal or non-political violence.36

4.2 Specialty products

In the mid-to-late 1990s, OPIC and MIGA (and some private insurers) began offering coverage to insure arbitration outcomes under two scenarios: (1) failure to pay an arbitral award (“Arbitral Award Default Coverage”), or (2) failure to participate in an arbitration called for by an investment agreement or a treaty (“Denial of Justice Coverage”).37 A threshold requirement for such coverage is that the investor’s contract or agreement provides for arbitration as a method of resolving disputes. Under Arbitral Award Default Coverage, if a final award is unpaid after the insured has made reasonable efforts to enforce it, the insured can seek payment for the loss.38 Under Denial of Justice Coverage (which is not readily available and the terms of which are often heavily negotiated),39 if the government should have gone to arbitration, but refused to do so, then an investor may only need to demonstrate that reasonable measures have been taken to pursue and preserve remedies and minimise losses.40

Globalisation poses opportunities and challenges for political risk insurers, leading to refinement of products to address global financial crises, terrorism, and environmental change.41 For example, MIGA, OPIC, and certain private insurers offer coverage for “non-honouring of financial obligations” (NHFO).42 Commercial lenders that provide loans to public sector entities (such as sovereign entities and state-owned enterprises) for infrastructure and other developmentally beneficial projects are primary

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beneficiaries of NHFO coverage.43 NHFO coverage protects the lender against losses resulting from a sovereign’s failure to make a payment when due under an unconditional financial payment obligation or guarantee.44

Terrorism insurance makes available coverage for violence perpetrated by a foreign or global entity, and not otherwise related to a host state. It can be difficult to distinguish, however, between what events are considered political violence (including riots, strikes, civil disturbances, revolutions, war, civil war, rebellion, insurrection, sabotage, coup d’état, and looting), and terrorism (including the use of force or violence, of any person or group, committed for political, religious or ideological purposes including the intention to influence, overthrow or sustain any government).45 For example, in 2010, nearly 100 people were killed and more than US$1 billion in property was damaged in Bangkok during political protests against the Thai Government. Although the Government declared these events acts of terrorism, some insurers claimed that the demonstrations fell instead under the definition of political violence.46 This is an important example of subjectivity when determining whether an event qualifies as political violence or terrorism. The decision may depend on whether terrorists take claim for the attack, on whether local governments refuse to acknowledge the event as terrorism, or on how insurance companies’ interprete the contractual language.

Businesses should note that standard terrorism policies may not insure against cyber-terrorism, although there are now bespoke products being developed to protect against this increasing threat.47

Finally, climate change, and more specifically actions (or failures) to address climate change, are increasingly recognised as “political” risks facing international investments. Thus, both public and private insurers have responded by broadening the use of their risk mitigation products to focus on energy efficiency, carbon offsets, and renewable resource projects.48 For example, OPIC offers political risk insurance for REDD (Reduced Emissions from Deforestation or Forestry Degradation) projects, which use market incentives to promote sustainable forest development.49

5.0 Coverage Issues

Even with political risk insurance, an insured cannot be entirely certain that its claims will qualify as an insured event. Often, an insured must choose between fighting the insurer or the host country, both of which can be lengthy and cumbersome fights. For example, MIGA’s breach of contract coverage requires a determination, through an arbitral proceeding or a local court judgment, that the contract has in fact been breached in order for a claim to be paid.50 Coverage for expropriations often requires investors to “take all reasonable measures”, which may include pursuing legal action, to preserve their rights before claims will be honoured.51 Moreover, other types of coverage present complicated issues of proof, as most insurers require a sworn “proof of loss” statement with supporting documentation in a specified time period, which may be difficult with respect to investments in emerging markets.

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Investors in infrastructure projects in developing countries have faced complex and lengthy problems trying to recoup their investments, notwithstanding the existence of political risk insurance policies. Therefore, investors should pursue a variety of contractual and financial strategies concurrently to mitigate commercial and political risks — such as entering into investment agreements (with arbitration clauses), careful structuring of their investment, and purchasing political risk insurance.

Notes

1
1. A. Berlin, “Managing Political Risk in the Oil and Gas Industries,” 1 Transnational Dispute Management, Issue 1 (February 2004) (“Berlin”).

2
2. See Robert Wray PLLC, Vol. XI “RW Political Risk Newsletter”, Issue 2 (November 2015) (“Wray”).

3
3. See M. Nolan, T. Canning, E. Culbertson, E. Hogwood, and P. Kinnimont, “Dispute Resolution in Project Finance Transactions”, in John Dewar (ed.), International Project Finance: Law and Practice, (2nd ed. 2015) (“Nolan 1”) pp. 573-74, 584.

4
4. See Wray, supra note 2, at 6. Factors that political risk insurers take into account when constructing models are often referred to as “correlations”.

5
5. In recent years, conflicts in countries such as Libya, Ukraine, Yemen, Ivory Coast, and the Central African Republic have led to an increased number of payments to customers with political violence coverage. See B. Huber, “The Evolution of Political Violence Losses,” Zurich Emerging Markets Solutions (8 March 2016), https://www.zurichna.com/en/knowledge/articles/2016/03/the-evolution-of-political-violence-losses. The Arab Spring also is a reminder that vulnerable regimes merit careful analysis of risks and opportunities. See Wray at 8.

6
6. See Nolan 1 supra note 3, pp. 573-74, 584; see also Berlin, supra note 1, at section III.

7
7. Id. p. 587.

8
8. See Nolan 1, supra note 3, pp. 585-86.

9
9. See Berlin, supra note 1.

10
10. M. Nolan, F. Sourgens, and M. Rockefeller, “Political Risk Insurance and Guarantees from Public Providers,” in M. Audit and S. Schill (eds.), Transnational Law of Public Contracts (Bruylant 2016) (“Nolan 2”), p. 743.

11
11. These include the 50 members of the Berne Union (the global organisation of public and private investment insurance and export credit insurers), as well as 27 separate individual syndicates of Lloyds of London, and approximately 20 private sector providers (including AIG, Ace, Sovereign, Zurich, Starr, FCIA, and others.) See ttps://www.opic.gov/blog/uncategorized/why-political-risk-insurance-is-critical-to-the-global-economy.

12
12. A survey of 13 OECD and three non-OECD countries conducted by the OECD Investment Division found four general categories of public insurers and guarantors: (i) government departments funded through the state budget process (Turkey); (ii) self-financed government agencies (Australia, Belgium, Japan, Korea, UK and US), (iii) public limited companies or limited liability public agencies (Canada, India, Italy and South Africa), and (iv) private providers of publicly-sponsored insurance cover (Austria, France Germany, Netherlands). See Nolan 2, p. 740 (citing K. Gordon, Investment Guarantees and Political Risk Insurance: Institutions, Incentives, and Development, OECD Investment Division Working Papers 2009/1, 6).

13
13. See Nolan 2, supra note 10, pp. 740-41.

14
14. See MIGA, Who We Are, https://www.miga.org/who-we-are.

15
15. See MIGA, Investment Guarantees; Eligibility, https://www.miga.org/investment-guarantees/overview/eligibility.

16
16. These claims were with respect to: (1) a power project suspended in Indonesia by a presidential decree in response to the country’s economic crisis; (2) war and civil disturbance relating to a power project in Nepal; (3) a project in Argentina at the time of the country’s financial crisis; (4) losses incurred in the violence following Kenya’s disputed election in 2007; (5) losses resulting from political violence in Madagascar; (6) war and civil disturbance events in Burkina Faso; (7) war and civil disturbance events in Central African Republic; and (8) war and civil disturbance events in Mali.

17
17. See MIGA, https://www.miga.org/who-we-are/frequently-asked-questions.

18
18. J. Waters, “A Comparative Analysis of Public and Private Political Risk Insurance Policies with Strategic Applications for Risk Mitigation,” 25 Duke Journal of Comparative & International Law (2015) (“Waters”), pp. 361, 376-77.

19
19. See http://opic.pfsfinance.com/pdf/OPIC_Handbook.pdf.

20
20. OPIC, 2012 Annual Report, p. 5, https://www.opic.gov/sites/default/files/files/OPIC_2012_Final.pdf.

21
21. See https://www.opic.gov/what-we-offer/political-risk-insurance/claims-and-arbitral-awards.

22
22. See, e.g., OPIC Handbook 16 (2013 version).

23
23. See http://opic.pfsfinance.com/pdf/OPIC_Handbook.pdf.

24
24. See 22 U.S.C. § 2191(1)-(3) (2006).

25
25. See Wray, supra note 2, p. 2 (May 2015).

26
26. See Waters, supra note 18, pp. 379-30.

27
27. See, e.g., R. Ginsburg, “Political Risk Insurance and Bilateral Investment Treaties: Making the Connection”, The Journal of World Investment & Trade 14 (2013) 943 pp. 968-69. For example, in a recent arbitral decision, a tribunal decided that the political risk insurance payment the Claimant received under its insurance through the German Government should not be deducted from the amount due to Claimant from Respondent because the insurance payment was “a benefit which Claimant arranged on its own behalf.” The Tribunal, however, recognised that under the relevant insurance policies “the protected investors may be obliged to hand over to the insurer all or part of any sums recovered as damages.” See Hochtief AG v Argentine Republic, ICSID Case No. ARB/07/31, Decision on Liability, 29 December 2014, at para. 309.

28
28. See Berlin, supra note 1.

29
29. Sempra Energy v Nat’l Union Fire Ins., No. 06-cv-6107, 2006 WL 3147155 (S.D.N.Y. 31 October 2006).

30
30. Sempra Energy v Marsh USA, Inc., No. 07-cv-05431, 2008 WL 4981206 (C.D. Cal 27 October 2008).

31
31. Sempra Energy v Marsh USA, Inc., Nos. 09-55022, 09-55290, 390 Fed. Appx. 754 (9th Cir. 3 August 2010).

32
32. See, e.g., OPIC Handbook, p. 18. Often such coverage is available for both “active” blockage — which occurs when the host State affirmatively denies conversion of funds into US dollars—and “passive” blockage — which occurs when the host State does not affirmatively deny conversion, but fails to make available foreign exchange in a timely manner.

33
33. See Nolan 2, supra note 10, pp. 746-48.

34
34. See, e.g., OPIC Handbook, p. 18.

35
35. See, e.g., MIGA Investment Guarantees, https://www.miga.org/investment-guarantees/overview/types-of-coverage, For example in Siemens v Argentina, ICSID Case No. ARB/02/8, Award (6 February 2007), Argentina had taken a series of adverse measures, including postponements and suspensions of the investor’s profitable activities, renegotiations, and cancellation of the project, which the Tribunal found amounted to a creeping expropriation.

36
36. See Nolan 2, supra note 10, p. 749.

37
37. OPIC has extended its Breach of Contract/Arbitral Award Default coverage to insuring debt instruments in Capital Markets and Bank Syndicates. Under this coverage, the insured investor is required to secure a favourable arbitral award against the host government obligor. Important facets of this coverage also include “fast-track” arbitration on the debt agreement and a requirement that arbitration is binary in its assessment, essentially based on payment or non-payment on the debt. See https://www.opic.gov/blog/uncategorized/why-political-risk-insurance-is-critical-to-the-global-economy.

38
38. See Robert Wray, “Insuring Arbitration Outcomes,” October 2005, http://www.robertwraypllc.com/insuring-arbitration- outcomes/ (“’Reasonable efforts’ calls for the insured to seek enforcement in the local courts, and depending on the circumstances may also require the insured to seek enforcement elsewhere.”).

39
39. Id.

40
40. See, e.g., Construction Aggregates Corporation, Memorandum of determinations, IIC 1058 (1977), 8 September 1977, Dominica (OPIC) at p.12 (arbitration proceedings were commenced but not pursued when the government failed to participate in the arbitration proceedings); see also Id. p.14 (finding no allegation and no reason to suspect that the failure on the part of the Government of Dominica to arbitrate was caused as a result of Claimant’s provocation, instigation, fault or misconduct).

41
41. See, e.g., Nolan 2, supra note 10, pp. 741-42.

42
42. OPIC’s coverage, titled Non-Honouring of a Sovereign Guaranty (NHSG), protects investors if a sovereign government fails to meet its contractual guaranty of a debt obligation.

43
43. Examples of projects involving NHFO cover include a power project in Angola, a transportation project in Panama, and an infrastructure project in Senegal.

44
44. The “unconditional” requirement means that the financial payment obligation cannot be subject to any defences. Importantly, NHFO coverage typically does not require an investor to obtain an arbitral award in order to file a claim for compensation. See, e.g., http://treasury.worldbank.org/bdm/pdf/MIGA_NHSFO_brief.pdf.

45
45. Willis Towers Watson, “Guide to Political Violence and Terrorism Insurance for Financial Institutions,” 30 November 2015, http://blog.willis.com/2015/11/guide-to-political-violence-and-terrorism-insurance-for-financial-institutions/.

46
46. See E. Freely, “What’s Covered? Distinguishing Among Political Risk, Political Violence, and Terrorism Insurance”, 1 July 2015, https://www.marsh.com/uk/insights/risk-in-context/distinguishing-among-political-risk-violence-terrorism-insurance.html.

47
47. See, e.g., Construction Aggregates Corporation, Memorandum of determinations, IIC 1058 (1977), 8 September 1977, Dominica (OPIC) at p.12 (arbitration proceedings were commenced but not pursued when the government failed to participate in the arbitration proceedings); see also Id. p.14 (finding no allegation and no reason to suspect that the failure on the part of the Government of Dominica to arbitrate was caused as a result of Claimant’s provocation, instigation, fault or misconduct).

48
48. See, e.g., V. Micale, G. Frisari, and F. Mazza, “Mapping the World Bank Group Risk Mitigation Instruments for Climate Change,” Climate Policy Initiative (September 2013), https://climatepolicyinitiative.org/wp-content/uploads/2013/09/World-Bank-Group-Risk-Mitigation-Instruments-for-Climate-Change-Brief1.pdf.

49
49. As of September 2017, OPIC had not paid any claims involving renewable resource products.

50
50. See, e.g., MIGA Investment Guarantees, https://www.miga.org/investment-guarantees/overview/types-of-coverage.

51
51. See, e.g., OPIC, Memorandum of Determinations, Expropriation Claim of Caterpillar Financial Services Corp., Contract of Insurance No. F314, 31 May 2013 (contract required insured to “take all reasonable measures to pursue available administrative and judicial remedies and to negotiate in good faith with the foreign governing authority and other potential sources of compensation”).

52
52. M. Kantor, “International Project Finance and Arbitration with Public Sector Entities: When Is Arbitrability a Fiction?” 24 Fordham International Law Journal 1122, note 30 (2001) (“Kantor”) citing OPIC’s Memorandum of Determinations: Expropriation Claim of MidAmerican Energy Holdings Company (formerly CalEnergy Company, Inc.), Contracts of Insurance Nos. E374, E453, E527, and E759 (10 November 1999).

53
53. Id. pp. 1136-37.