Allocating risks to seal more deals
During the 1990s, East Asia was without doubt the ?flavour of the
decade? for foreign investors. But it is clear that the region is
no longer seen as the investment haven it once was.
Flows of foreign direct investment into developing countries in Asia fell by roughly a quarter in 2001. Preliminary figures for 2002 do not look much better. The reasons for this are several. Like the rest of the world, Asia is feeling the effects of the global economic downturn, brought on by negative growth in Japan and zero to low growth in other markets. As a result, banks have become less interested in financing projects in the region, and investors have all but tied a knot in their purse strings.
Asia is facing a number of regional challenges as well. Investors that are going ahead are steering clear of what they see as riskier markets, with the bulk of funds going to mainland China and Singapore. The opening up of China's economy is also impacting the exports of other countries in the region. And the region continues to deal with the lingering effects of the financial crisis of the late 1990s.
While the investment slowdown is primarily attributed to economic reasons, ongoing and potential conflict in the Middle East, concerns about North Korea, and unrest in other parts of the world are also having an impact. Investors within Asia have often tended to believe that proximity and common historical bonds provide adequate protection against political (noncommercial) risks, but this is no longer the case. The recent bombing of a Balinese nightclub and other terrorist attacks in the region have clearly shown that the risks in what were once considered safe investment destinations have not only changed in nature but have also become harder to predict. As a result, foreign and local investors are being forced to reassess risks, especially for larger projects, such as infrastructure, which are easy physical targets.
Trends such as the increasing decentralization of decisionmaking and control for the provision of key services (such as water), are also leading investors to pay more attention to risks at the municipal or sub-sovereign level.
Risky business
Political risks, real or perceived, deter not only investors but also project financiers and insurers. The insurance market has already taken a blow from the events of the past year, which negatively affected capacity and terms of financing. Reinsurers are focusing on more lucrative business lines where rates have been jacked up since 9/11, leaving many providers of political risk insurance, who rely on reinsurers to take on some of their contracts, high and dry.
Over the past few years, many of the underlying political risks have changed, with some types becoming more associated with economic crises and less with willful political acts of governments. At the same time, investors and insurers are questioning the effectiveness of traditional political risk insurance coverage and wanting more comprehensive products that include some portion of commercial risks. This blurring of commercial and political risks has led many insurers to rethink the nature of political risk coverage. In the infrastructure sector, breach of contract coverage is being especially scrutinized.
As a result, insurers are now operating in an environment where they need to be much more precise about the perils they are actually prepared to cover, at a time when project sponsors and lenders are demanding more coverage, for more risks. They are being asked to fill in the gaps left by property/casualty insurers, who now routinely exclude terrorism and sabotage coverage from their policies. The cumulative effect of these developments is that insurers and lenders have become less able and more reluctant to take on emerging market risks.
MIGA as a risk mitigator
In this environment, the Multilateral Investment Guarantee Agency (MIGA), a member of the World Bank Group, plays an important counter-cyclical role, encouraging FDI flows by mitigating perceived political risks in the ?riskier? markets and partnering with other insurers to increase the capacity of the industry as a whole.
Noncommercial risk insurance not only helps investors recover losses resulting from adverse government actions; it actually deters such actions. This insurance can cover the risks relating to breach of contract, expropriation, currency inconvertibility, and war and civil disturbance. As a member of the World Bank Group, MIGA is uniquely positioned to mitigate these risks and help resolve potential disputes between investors and host countries.
MIGA guarantees do more than increase investor confidence in the safety of their projects. They do more than give developing countries a better chance of breaking the cycle of poverty. MIGA's political risk insurance can help improve projects' risk and return profiles, close more deals, and creatively address some of the tougher issues facing certain sectors today.
Without political risk coverage, many investors simply would not be able to take advantage of business opportunities in emerging economies. Noncommercial risk insurance alleviates country risk, which increases a sponsor's ability to attract scarce loan financing for its project enterprise. Political risk insurance can also extend the tenor of financing, and in some cases even lower financing costs for the project enterprise. This is particularly significant for lenders, as it can help them manage tight country limits, primarily by reducing provisioning requirements. This allows banks to build safe assets in emerging markets.
Over the past 12 years, MIGA has offered $1.2 billion in gross insurance coverage for more than 70 projects in 11 Asian countries, providing protection against the risks of transfer restriction, breach of contract, expropriation, and war and civil disturbance (including terrorism). These guarantees have facilitated about $8.5 billion in additional FDI. The region currently accounts for 10% of MIGA's outstanding portfolio. Projects encompass a range of sectors, with the portfolio concentrated on infrastructure projects. Guarantees range in size from $.3 million for a Japanese manufacturing project in Pakistan, to $87 million for an infrastructure loan by a French lender for a project in the Philippines.
These MIGA-supported projects have had a high developmental impact, creating opportunities in host countries through job creation, export and tax generation, technology transfer, spin-off business development, and enhanced domestic competition.
One such project involves $10 million in guarantee coverage to France Cables et Radio Vietnam Pte. Ltd. for its nonequity direct investment, via a business cooperation contract, with the state-owned Vietnam Post and Telecommunications agency. The MIGA guarantee, issued in 2001, is protecting the investor against the risk of currency transfer restriction. The contract calls for the two companies to work together ? on a build-and-transfer basis ? to construct, install, and maintain at least 540,000 new fixed telephone lines in East Ho Chi Minh City over a 15-year period. The project aims to boost the number of phone lines per person by 2003, with an increase of 20,000 lines in the city's rural outskirts. Teledensity, currently at 5%, is expected to reach 21% by the project's completion in 2005.
Another project, the Manila North Tollways Corporation (MNTC), illustrates well the particular strengths that MIGA can bring to a country's development and to managing a project's risks. The project entails the expansion and rehabilitation of a toll road in the Philippines. MIGA provided $87 million in coverage against the risks of transfer restriction, expropriation, and war and civil disturbance. The refurbished highway is expected to improve traffic flows, allowing for the more rapid movement of goods and people between Metro Manila, economic zones, airports, and several other important industrial zones. A number of multipurpose complexes are already being built along the highway corridor to take advantage of the high traffic volume out of Metro Manila. The project will also contribute to the reduction of vehicle operating costs and provide increased road safety, in addition to creating employment.
MIGA's presence in this deal helped a number of commercial banks accept the country risk at a time when the political and economic conditions were less than ideal. The transaction also showed MIGA's ability and willingness to work with other multilaterals and bilaterals in securing what is best for the project enterprise and the country.
MIGA has also issued guarantee coverage for a project that involves the development, construction, and operation of a 76MW gas-turbine-diesel power plant in Nanjing City, the economic, social, and cultural center of China's Jiangsu Province. MIGA's insurance is covering a $22.9 million investment by Coastal Nanjing Power, Ltd. of the Cayman Islands against the risks of transfer restriction, expropriation, and war and civil disturbance. The project is working to alleviate acute power shortages caused by the city's fast economic growth and limited installed energy capacity. A reliable power supply during peak periods is also considered key to attracting companies to Nanjing's industrial zone.
Sharing the risks
A new distribution of risks among those who are best positioned to shoulder them is critical for sustaining flows of foreign direct investment (FDI) into developing countries. By making sure that risks, including those relating to political uncertainties, are managed by those most capable of doing so, a good investment can go ahead in even the riskiest of environments. Redistributing the risks will call for enhanced partnerships and collaboration among insurers and other risk mitigation entities. Developing countries too need to step up their efforts to promote FDI and minimize the risks to investors.
Public insurers could and should be at the frontier in terms of providing coverage for ?riskier? countries, re-examining certain coverages, such as expropriation and inconvertibility, and rethinking the approach to complex projects where sovereign performance risk is perceived to be high. This is especially true for infrastructure projects, where development needs continue to be huge. These projects ? which in the last decade have become more expensive, more difficult to finance, and more complex all around ? tend to involve both local and national governments. And with performance bonds being increasingly tied to the sale of operating licenses, the risk increases of local and national governments wrongfully calling the bond, or breaching the contract. There is clearly a need for public insurers to play a counter-cyclical role to help offset the drying up of private investment in this and other sectors. As political risk insurance capacity and tenors are reduced in the private market, the public agencies' role in maintaining large per-project limits and longer tenors will be critical.
With these issues in mind, MIGA recently partnered with the Asian Development Bank to support joint projects in which one or both will provide investment guarantees, in combination with ADB direct assistance, such as loans or equity investments. MIGA and ADB will also work together to increase awareness about political risk insurance and guarantees in Asia, in addition to supporting private sector development in other ways, such as providing technical assistance to governments and investment promotion boards.
The opening of MIGA's regional office in Singapore in September 2002 is another manifestation of its commitment to strengthen ties to insurers, investors, and other development agencies in the region. It is also a clear sign of the agency's resolve to focus on the many investment opportunities that exist in Asia and which are currently not moving forward.
One new project, originating in the Singapore office, is already underway. MIGA recently issued $2.4 million in guarantee coverage to MTU Asia Pte. Ltd. of Singapore for its investment in and shareholder loan to PT MTU Detroit Diesel Indonesia. The coverage is for the risks of expropriation, war and civil disturbance. The project involves the construction of a dealership in Jakarta for the distribution, sale and maintenance (as well as after sales service) of small diesel engines and spare parts, for use in commercial marine, small (captive) power generation, construction, and other industries. The supply of high-quality diesel engines is expected to help improve the quality and efficiency of products where diesel engines are installed, and thereby improve the lives of residential and business users. The project is expected to be coinsured by the Export Credit Investment Corporation of Singapore.
The pipeline of projects for the region is quite strong, with nearly a dozen deals, large and small, being considered in countries throughout the region.
Into the future
The ongoing prospects for FDI flows to Asia are excellent, but investors and lenders must be aware not only of potential political risks, but also of key ways to mitigate them. For those in the political risk insurance and development business, working to address these issues means closer collaboration with public and private partners to leverage combined strengths and capacity in support of sound developmental projects. It also means that continued efforts need to be made to help governments attract and retain FDI flows.
At the end of the day, change brings with it both risk and opportunity for all. Rethinking how political risks are managed, and what part investors, insurers, and host countries need to play, is not easy. It is important to stay focused on the fact that the potential returns are great, since there continue to be large numbers of good business opportunities in developing countries, especially in Asia. In a time of so much change in the process of globalization, the price of standing still is much higher than taking calculated risks.
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Flows of foreign direct investment into developing countries in Asia fell by roughly a quarter in 2001. Preliminary figures for 2002 do not look much better. The reasons for this are several. Like the rest of the world, Asia is feeling the effects of the global economic downturn, brought on by negative growth in Japan and zero to low growth in other markets. As a result, banks have become less interested in financing projects in the region, and investors have all but tied a knot in their purse strings.
Asia is facing a number of regional challenges as well. Investors that are going ahead are steering clear of what they see as riskier markets, with the bulk of funds going to mainland China and Singapore. The opening up of China's economy is also impacting the exports of other countries in the region. And the region continues to deal with the lingering effects of the financial crisis of the late 1990s.
While the investment slowdown is primarily attributed to economic reasons, ongoing and potential conflict in the Middle East, concerns about North Korea, and unrest in other parts of the world are also having an impact. Investors within Asia have often tended to believe that proximity and common historical bonds provide adequate protection against political (noncommercial) risks, but this is no longer the case. The recent bombing of a Balinese nightclub and other terrorist attacks in the region have clearly shown that the risks in what were once considered safe investment destinations have not only changed in nature but have also become harder to predict. As a result, foreign and local investors are being forced to reassess risks, especially for larger projects, such as infrastructure, which are easy physical targets.
Trends such as the increasing decentralization of decisionmaking and control for the provision of key services (such as water), are also leading investors to pay more attention to risks at the municipal or sub-sovereign level.
Risky business
Political risks, real or perceived, deter not only investors but also project financiers and insurers. The insurance market has already taken a blow from the events of the past year, which negatively affected capacity and terms of financing. Reinsurers are focusing on more lucrative business lines where rates have been jacked up since 9/11, leaving many providers of political risk insurance, who rely on reinsurers to take on some of their contracts, high and dry.
Over the past few years, many of the underlying political risks have changed, with some types becoming more associated with economic crises and less with willful political acts of governments. At the same time, investors and insurers are questioning the effectiveness of traditional political risk insurance coverage and wanting more comprehensive products that include some portion of commercial risks. This blurring of commercial and political risks has led many insurers to rethink the nature of political risk coverage. In the infrastructure sector, breach of contract coverage is being especially scrutinized.
As a result, insurers are now operating in an environment where they need to be much more precise about the perils they are actually prepared to cover, at a time when project sponsors and lenders are demanding more coverage, for more risks. They are being asked to fill in the gaps left by property/casualty insurers, who now routinely exclude terrorism and sabotage coverage from their policies. The cumulative effect of these developments is that insurers and lenders have become less able and more reluctant to take on emerging market risks.
MIGA as a risk mitigator
In this environment, the Multilateral Investment Guarantee Agency (MIGA), a member of the World Bank Group, plays an important counter-cyclical role, encouraging FDI flows by mitigating perceived political risks in the ?riskier? markets and partnering with other insurers to increase the capacity of the industry as a whole.
Noncommercial risk insurance not only helps investors recover losses resulting from adverse government actions; it actually deters such actions. This insurance can cover the risks relating to breach of contract, expropriation, currency inconvertibility, and war and civil disturbance. As a member of the World Bank Group, MIGA is uniquely positioned to mitigate these risks and help resolve potential disputes between investors and host countries.
MIGA guarantees do more than increase investor confidence in the safety of their projects. They do more than give developing countries a better chance of breaking the cycle of poverty. MIGA's political risk insurance can help improve projects' risk and return profiles, close more deals, and creatively address some of the tougher issues facing certain sectors today.
Without political risk coverage, many investors simply would not be able to take advantage of business opportunities in emerging economies. Noncommercial risk insurance alleviates country risk, which increases a sponsor's ability to attract scarce loan financing for its project enterprise. Political risk insurance can also extend the tenor of financing, and in some cases even lower financing costs for the project enterprise. This is particularly significant for lenders, as it can help them manage tight country limits, primarily by reducing provisioning requirements. This allows banks to build safe assets in emerging markets.
Over the past 12 years, MIGA has offered $1.2 billion in gross insurance coverage for more than 70 projects in 11 Asian countries, providing protection against the risks of transfer restriction, breach of contract, expropriation, and war and civil disturbance (including terrorism). These guarantees have facilitated about $8.5 billion in additional FDI. The region currently accounts for 10% of MIGA's outstanding portfolio. Projects encompass a range of sectors, with the portfolio concentrated on infrastructure projects. Guarantees range in size from $.3 million for a Japanese manufacturing project in Pakistan, to $87 million for an infrastructure loan by a French lender for a project in the Philippines.
These MIGA-supported projects have had a high developmental impact, creating opportunities in host countries through job creation, export and tax generation, technology transfer, spin-off business development, and enhanced domestic competition.
One such project involves $10 million in guarantee coverage to France Cables et Radio Vietnam Pte. Ltd. for its nonequity direct investment, via a business cooperation contract, with the state-owned Vietnam Post and Telecommunications agency. The MIGA guarantee, issued in 2001, is protecting the investor against the risk of currency transfer restriction. The contract calls for the two companies to work together ? on a build-and-transfer basis ? to construct, install, and maintain at least 540,000 new fixed telephone lines in East Ho Chi Minh City over a 15-year period. The project aims to boost the number of phone lines per person by 2003, with an increase of 20,000 lines in the city's rural outskirts. Teledensity, currently at 5%, is expected to reach 21% by the project's completion in 2005.
Another project, the Manila North Tollways Corporation (MNTC), illustrates well the particular strengths that MIGA can bring to a country's development and to managing a project's risks. The project entails the expansion and rehabilitation of a toll road in the Philippines. MIGA provided $87 million in coverage against the risks of transfer restriction, expropriation, and war and civil disturbance. The refurbished highway is expected to improve traffic flows, allowing for the more rapid movement of goods and people between Metro Manila, economic zones, airports, and several other important industrial zones. A number of multipurpose complexes are already being built along the highway corridor to take advantage of the high traffic volume out of Metro Manila. The project will also contribute to the reduction of vehicle operating costs and provide increased road safety, in addition to creating employment.
MIGA's presence in this deal helped a number of commercial banks accept the country risk at a time when the political and economic conditions were less than ideal. The transaction also showed MIGA's ability and willingness to work with other multilaterals and bilaterals in securing what is best for the project enterprise and the country.
MIGA has also issued guarantee coverage for a project that involves the development, construction, and operation of a 76MW gas-turbine-diesel power plant in Nanjing City, the economic, social, and cultural center of China's Jiangsu Province. MIGA's insurance is covering a $22.9 million investment by Coastal Nanjing Power, Ltd. of the Cayman Islands against the risks of transfer restriction, expropriation, and war and civil disturbance. The project is working to alleviate acute power shortages caused by the city's fast economic growth and limited installed energy capacity. A reliable power supply during peak periods is also considered key to attracting companies to Nanjing's industrial zone.
Sharing the risks
A new distribution of risks among those who are best positioned to shoulder them is critical for sustaining flows of foreign direct investment (FDI) into developing countries. By making sure that risks, including those relating to political uncertainties, are managed by those most capable of doing so, a good investment can go ahead in even the riskiest of environments. Redistributing the risks will call for enhanced partnerships and collaboration among insurers and other risk mitigation entities. Developing countries too need to step up their efforts to promote FDI and minimize the risks to investors.
Public insurers could and should be at the frontier in terms of providing coverage for ?riskier? countries, re-examining certain coverages, such as expropriation and inconvertibility, and rethinking the approach to complex projects where sovereign performance risk is perceived to be high. This is especially true for infrastructure projects, where development needs continue to be huge. These projects ? which in the last decade have become more expensive, more difficult to finance, and more complex all around ? tend to involve both local and national governments. And with performance bonds being increasingly tied to the sale of operating licenses, the risk increases of local and national governments wrongfully calling the bond, or breaching the contract. There is clearly a need for public insurers to play a counter-cyclical role to help offset the drying up of private investment in this and other sectors. As political risk insurance capacity and tenors are reduced in the private market, the public agencies' role in maintaining large per-project limits and longer tenors will be critical.
With these issues in mind, MIGA recently partnered with the Asian Development Bank to support joint projects in which one or both will provide investment guarantees, in combination with ADB direct assistance, such as loans or equity investments. MIGA and ADB will also work together to increase awareness about political risk insurance and guarantees in Asia, in addition to supporting private sector development in other ways, such as providing technical assistance to governments and investment promotion boards.
The opening of MIGA's regional office in Singapore in September 2002 is another manifestation of its commitment to strengthen ties to insurers, investors, and other development agencies in the region. It is also a clear sign of the agency's resolve to focus on the many investment opportunities that exist in Asia and which are currently not moving forward.
One new project, originating in the Singapore office, is already underway. MIGA recently issued $2.4 million in guarantee coverage to MTU Asia Pte. Ltd. of Singapore for its investment in and shareholder loan to PT MTU Detroit Diesel Indonesia. The coverage is for the risks of expropriation, war and civil disturbance. The project involves the construction of a dealership in Jakarta for the distribution, sale and maintenance (as well as after sales service) of small diesel engines and spare parts, for use in commercial marine, small (captive) power generation, construction, and other industries. The supply of high-quality diesel engines is expected to help improve the quality and efficiency of products where diesel engines are installed, and thereby improve the lives of residential and business users. The project is expected to be coinsured by the Export Credit Investment Corporation of Singapore.
The pipeline of projects for the region is quite strong, with nearly a dozen deals, large and small, being considered in countries throughout the region.
Into the future
The ongoing prospects for FDI flows to Asia are excellent, but investors and lenders must be aware not only of potential political risks, but also of key ways to mitigate them. For those in the political risk insurance and development business, working to address these issues means closer collaboration with public and private partners to leverage combined strengths and capacity in support of sound developmental projects. It also means that continued efforts need to be made to help governments attract and retain FDI flows.
At the end of the day, change brings with it both risk and opportunity for all. Rethinking how political risks are managed, and what part investors, insurers, and host countries need to play, is not easy. It is important to stay focused on the fact that the potential returns are great, since there continue to be large numbers of good business opportunities in developing countries, especially in Asia. In a time of so much change in the process of globalization, the price of standing still is much higher than taking calculated risks.
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