One of the fundamental principles of finance is that with greater risk comes the possibility of greater returns. This can certainly be true for companies looking to invest outside of the markets that they are familiar with, such as in the fast-growing economies of certain developing regions. Unfortunately, the downside to this strategy is the need to manage the uncertainty and potentially disastrous consequences of political risk.
The Multilateral Investment Guarantee Agency, a member of the World Bank Group, defines political risk as the negative consequences arising from the adverse actions or inactions of governments. These risks are often unpredictable and hard to quantify.
If a company is looking to invest in an environment where political risk is a concern, political risk insurance (PRI) is a tool that can mitigate some of that risk. In fact, according to Export Development Canada, a major Canadian political risk insurance provider, PRI can insure a company for up to 90 per cent of its losses resulting from:
- breach of contract by a foreign government;
- expropriation by a foreign government;
- political violence in a foreign country;
- currency conversion or transfer problems;
- difficulty repossessing or re-exporting physical assets; and
- a foreign government's default on financial obligations.
For companies considering a foreign investment, qualified legal counsel should always be retained for advice and assistance with the transaction, and thorough due diligence must be performed. Also, Representation and Warranties (R&W) insurance can be used to minimize risks arising from the transaction that may affect the buyer or seller. However, for political risks, which by their nature are out of the parties' control, PRI should be considered as a possible tool to ensure continued success once the transaction has been completed.
(For a more detailed review of R&W insurance, see Laura Johnson's post on this blog.)
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