Underlying Danger: avalanches of political risk can surprise even the most secure foreign investment contracts

By Ron Doyle

I spent two weeks in March 2012 skiing in the Canadian Rocky Mountains, during which time it snowed nearly every day. The new fresh snow was mounded up on every slope. The sights were amazing, as every surface and tree was coated in white. It was hard to believe that anything so beautiful could be so dangerous.  The warnings of high avalanche danger were quickly proven, when several skiers and snowmobilers were caught in avalanches and killed. Apparently, the new spring snow was heavier and had more moisture than the existing snow cover, thus creating a very unstable situation.

When I returned to the office, one colleague reported that during the recent International Credit Insurance and Surety Association meetings, members indicated that more companies were buying Single Buyer policies largely to protect their larger exposures from political risks. Another colleague advised that our clients had experienced non-payment situations on sales covered under Irrevocable Letters of Credit.

The danger of avalanches in the mountains is a very good analogy for the political risk dangers underlying even the most secure of export sales or foreign investment contracts.

As an example, let us look at a very secure transaction in a relatively low risk country. Historically, such a country could have been Kuwait before the invasion by Iraq or Egypt prior to the Arab Spring. Looking for such a country in March 2012, it could be Mali.

The example seemingly secure transaction is this: the sale of electric generating equipment to a new foreign client covered by a Confirmed Irrevocable Letter of Credit payable at sight, confirmed by a major international bank in the UK. Many companies would not think to insure such a transaction as it seems safe as fields of snow. All of the risks have been covered.

Yet, there is a good reason for insurance in the example above. Like the field of snow, the risk lies below the surface out of sight. If shipment of the equipment is to take place when a major political event occurs and the shipment is delayed and can’t take place until after the expiry of the Confirmed Irrevocable Letter of Credit, the contract is frustrated and the costs are at risk of never being recovered. Even if a down payment and progress payment had been received before the event, these payments likely would have been covered by on-demand performance bonds, which most probably would have been called.

A contract can be frustrated by “avalanche” and costs can be at risk of never being recovered.

The biggest political risk losses always occur in countries deemed to be lower risk because exporters or investors feel safe. If the country was perceived as higher risk, the exporters and investors would need to take more precautions in order to find suitable financing. In the Kuwait situation, all involved were seeking coverage for all risks in Iraq and Iran because of ongoing hostilities, but it was impossible to sell political risk coverage in Kuwait, even at exceptionally low premium rates. because the risk was perceived to be so low. Billions of dollars of uninsured contracts were frustrated.

Political events affecting contracts are occurring with more regularity. They can be insured at reasonable premium rates, but most companies still choose to overlook the catastrophic impact, if a highly improbable, but possible risk occurs.

How much uninsured exposure does your company have to political risk, when you consider investments, mobile equipment, payment on sales contracts and cash in local bank accounts? Are you going to consider how to mitigate it? Call your ICBA broker to discuss counter-avalanche political risk insurance tactics!

(Ron Doyle is a founder of Millennium CreditRisk Management – credit and political risk insurance specialists – www.mcm.ca. ICBA is the world’s largest team of independently-owned, specialist trade credit insurance brokerages. Partners combine local service with global coordination to provide credit and political risk insurance solutions for multinational companies.)