Repsol, not to mention the Spanish government, would probably not describe the nationalisation of its Argentinean operations as “reassuringly familiar”. But political risk insurers describe this type of expropriation as one of the most obvious risks against which a foreign investor should insure – foreign-held resources assets provide the most tempting targets for governments hungry for the populist vote.

Critics of Argentina’s move against Repsol suggested that it would cost it access to foreign investment. In truth, and aside from scattered financings for resources companies and high-yield bond financings for utility restructurings, the country never recovered the access that it lost when it defaulted in 2001. In the intervening period former president Nestor Kirchner, and the incumbent, his widow Christina, have ignored any judgements that disgruntled creditors might obtain in foreign courts.

No innovation in expropriation

Latin America, despite its hard-won recent reputation for political stability and impressive resilience in the face of the post-2008 financial shocks, remains the home of “classic” expropriations. Venezuela’s Hugo Chavez has restructured heavy oil concessions in favour of state oil company PDVSA, and nationalised the telecoms and electrical utilities for Caracas, though in most instances he made all debt, and part of investors equity, contributions whole. In Bolivia, president Evo Morales makes a habit of nationalising a piece of infrastructure every May Day. This year, in an unhappy coincidence, it was Spanish grid operator Red Electrica’s turn to lose its Bolivian transmission network.

In March, UK-listed developer Rurelec lodged a claim of $142 million at the permanent court of arbitration in the Hague against the Bolivian government over the nationalisation of the Guaracachi generating project. Rurelec will be hoping that Bolivia takes arbitration court judgments more seriously than Argentina.

Insurance against host governments not honouring arbitration judgments is one of the oldest of an increasing number of specialised risks that insurers are willing to cover. The actions of Morales, Chavez and Kirchner aside, straightforward expropriation is increasingly rare, though war and civil disturbance remain ever-present risks. Adverse actions against foreign infrastructure can be much more subtle and opaque, and insurers have tried to keep up with these actions with newer products.

New risks need new products

Insurance against ignored arbitration judgements predates the Kirchner administrations’ actions. According to Ruth Ann Nicastri, a senior director in the political risk department at the US Overseas Private Investment Corporation (Opic), “the development of this product dates back to the mid-1990s, when there was a wave of investment by US corporations in overseas infrastructure assets. Their concession agreements included language specifying the use of arbitration in the event that these were terminated, so it made sense to develop this product.”

Newer products have tended to be more reactive in nature, however. Opic recently launched a product specifically insuring against retroactive changes to feed-in-tariffs for renewables projects. The product is designed to increase investors’ willingness to invest in emerging renewables markets. But it also recognises the uproar that retroactive changes to Spain’s solar tariffs created among renewables sponsors and lenders.

As Opic’s Nicastri notes, the standard political risk insurance contract, which covers “any taking by a host government that affects an investor’s fundamental rights”, should cover such actions. But many investors, and particularly lenders, have less use for such blanket coverage. Lead arrangers of mining deals in the more challenging jurisdictions still offer it to potential participants, though the response from lenders is often minimal. One reason for declining enthusiasm among lenders is that such coverage does not always provide cost effective benefits in terms of internal risk weighting or exposure limits, but a bigger recent obstacle is that their deteriorating access to dollar funding is reducing their ability to do any cross-border project financings.

According to Edith Quintrell, the director of operations at the World Bank’s Multilateral Investment Guarantee Agency (Miga), “we have seen increased demand in the wake of the events in the Middle East, as well as on concerns about Europe.” The impact of the Eurozone crisis is more indirect. “The European banks that have been affected by the debt crisis have pulled back from the market,” notes Quintrell, “and some of them were big users of our products, though newer lenders from places like Asia and South Africa have stepped up.”

According to Quintrell, the agency has experienced larger volumes of applications from sponsors located in jurisdictions like India and Turkey. These might approach investment decisions differently to western sponsors, but still tend to look to agencies like Miga for political risk mitigation.

Backstops for backstops

Miga’s most recent product introduction has been coverage for non-honouring of sovereign financial obligations. This covers a sovereign government refusing to “make a payment when due under an unconditional financial payment obligation or guarantee.” The product, introduced in 2009, and with a maximum term of 15 years, does not require a sponsor to win an arbitration award. Miga has so far issued five of these policies, with a sixth near signing. The product might cover a strong sovereign guarantee for a power purchase agreement with a state-owned utility, but a more straightforward obligation, like an availability payment, would qualify more easily. Emerging markets governments, moreover, have been wary of providing unconditional guarantees to state-owned utilities.

The government of Kenya, for instance, has issued a letter of comfort in support of state-owned Kenya Power & Lighting Corporation’s obligations under its power purchase agreement with the 300MW Lake Turkana wind project. The World Bank’s International Development Association is contemplating a backstop of the Kenyan government’s undertakings, while Miga may provide debt cover. The involvement of the World Bank agencies has required some amendments to the project’s power purchase agreement, but the sponsors, led by Aldwych International, hope to issue an information memorandum to lenders in June.

The same 2009 initiative that resulted in the non-honouring of sovereign obligation product also expanded Miga’s ability to cover breach of contract by standalone state-owned entities, even where the state does not have a financial obligation for these entities. This type of coverage is closer to Turkana’s situation than the non-honouring of sovereign obligation product.

Ahead of the curveballs

Staying ahead of government attempts to undermine project agreements can be a difficult job, and domestic legal proceedings do not always produce the outcomes for project sponsors that they expect. Joel Moser, a partner at Kaye Scholer in New York, notes that the Russian government’s move against the former owners of Yukos was accomplished with all the appearance of obvious legal forms and that all attempts by these owners to seek redress have failed. “Ultimately,” notes Moser, “there will always be unforeseen risks, and portfolios have to be diversified to minimise the impact of these risks.”

But Moser believes that sponsors in mature markets do not always take account of the products available to mitigate the risks of investments in emerging markets. “The allocation of political risks such as expropriation and breach of contract have traditionally been assigned to public agencies such as the World Bank Group, export credit agencies and other development finance institutions. But there’s a growing suite of products available on the private market. Insurers are increasingly able to offer bespoke products that only insure against specific risks that sponsors want to see covered.”

Agencies like Opic and Miga tend to offer broadly-defined coverage, but projects have to meet their eligibility criteria and have a positive developmental impact. Private insurers are not guided by policy considerations, though they struggle to extend coverage beyond ten years, and have traditionally confined themselves to shorter-term credit insurance policies. “Private insurers and their reinsurance backers have long ago learned the hard way to shy away from certain projects such as power and water which can easily become politicised public interest issues,” says Stephen Kay, senior vice-president and US practice leader for structured credit and political risk at Marsh. “The agencies are natural homes for these policies, provided they can get them past the enhanced and fortified environmental scrutiny which is required these days.”

But as their most dependable customer base, European trade finance lenders, has shrunk, they have tried to roll out more creative niche offerings that might appeal to infrastructure investors, Kay notes. According to Kay, trade disruption insurance, under which a sponsor might seek coverage for the risk of disruption to a project’s supplier from a political risk event, even if its asset is not expropriated, is a promising new product.

Sometimes, suggests Kay, sponsors might wish to only insure against a concession being cancelled, as opposed to other risks like expropriation and convertibility. “Many insurers are sensitive to convertibility, so if a project is earning revenues that are less vulnerable, then a sponsor can see real savings in premiums.” Given the complex intermingling between commercial and political factors in a concession termination, a sponsor might have to go through an arbitration proceeding first.

Secondary step-ups

The private market has fulfilled a crucial role in providing reinsurance capacity to primary political risk insurers, both other private entities and even public agencies. Miga and Export Development Canada have engaged in portfolio reinsurance for some country risks. Opic’s Nicastri says it tends to lay off project-specific risks with facultative insurance , but has not, since a 1980s decision from the US Office of Management and Budget, engaged in portfolio reinsurance.

Opic, for instance, recently applied to Miga for $150 million in reinsurance of its exposures to Apache Corporation’s Egypt operations. Opic provided Apache with $1 billion in standard political risk insurance, against confiscation, nationalisation, and expropriation risks and currency inconvertibility, and another $300 million in coverage against non-payment of arbitration awards and expropriation of production from its operations that it is allowed to export. Governments in the Middle East will be very tempted to revisit the agreements that underpin the exploitation of oil resources, because discontent about the distribution of the proceeds has been a major factor in the revolts.

Sponsors, however, will increasingly be looking for coverage that protects against the diversion of pledged revenues by government. The sponsors of the Peru Payroll Deduction Finance securitisation, which involved a forward sale of payments from Peru’s EsSalud social security administration, considered taking out Miga coverage against the risk, among others, that the Peruvian government might seek to divert the payroll deductions that fund EsSalud. In the end Bank of America Merrill Lynch, advised by DLA Piper, closed the $230 million zero-coupon bond issue without this enhancement.

Political risk insurance has even allowed for a minimal revival of the fortunes of monoline insurers in project finance. MBIA provided limited reinsurance to Opic on its Ps2.77 billion local-currency guarantee of a bond issue from Mexico state’s property registry in 2010. In December 2011, Assured Guaranty provided a partial wrap of Opic’s $131 million loan to the T-Solar Peru project. Assured’s wrap featured carve-outs that effectively let Opic retain political risks associated with Peru, and allowed the project credit to meet Assured’s underwriting criteria.

Some private credit insurers, including such names as AXIS and Catlin, which do not use treaty insurance to lay off risk, are now offering structured credit insurance that looks fairly close to a full financial guarantee, and for banks that buy it may be comprehensive enough to offer capital relief for Basel III purposes. The product is not cheap, typically covers no more than 60% of a bank’s exposure, and requires that the insurer has full access to a borrower’s financials. At ten years in maximum duration, it works best for shorter-dated resources deals, but where DFIs and ECAs, whether for exposure or policy reasons, cannot participate in these deals, such guarantee products might allow constrained project lenders to arrange cover with minimal fuss.

Political risk insurance will continue to evolve, as sponsors and lenders refine their demands on insurers’ resources. Miga recently issued a $207 million guarantee of the investment that Eramet and Mitsubishi, through joint venture Strand Minerals, have made in pre-feasibility studies at the Weda Bay nickel project in Indonesia. The three-year policy is the first that Miga has issued to such an early stage investment.

Kaye Scholer’s Moser suggests that simpler project payment structures, not to mention front-loading payback periods on infrastructure concessions, might allow for private insurers to take a larger share of primary business and encourage greater cross-border flows into emerging markets – without requiring complex collections of diverse credit enhancements. “Simple is better for investors. You get a wider audience.”