In this interview, Stephen Kay of Marsh's Political Risk and Trade Credit Practice gives an overview of the current global political and credit instability, and how Marsh can assist their clients during these challenging times.
The continuing economic downturn and credit crunch are impacting political stability in some countries. Which countries are experiencing this trend and how is it affecting their economies?
SK: As we head into 2012, increased political and credit instability remains firmly entrenched as a new feature of the global economy. The trend began in 2008 with the onset of the economic crisis and has translated into political violence this year in what were superficially “stable” countries like Egypt, Libya and Thailand. This has turned the prediction of political risks on its head, because nobody saw these events coming.
Basically, populations suffering from conditions like food insecurity and income inequality (previously masked by economic growth and political repression) are now increasingly finding an outlet. The proliferation of technology and social media among unemployed youth has facilitated this trend. This new activism is global and isn’t limited to emerging markets only (as exemplified by the Occupy Wall Street movement in the U.S.). Recent casualties include actual or threatened convulsions in the Middle East and North Africa. As other closed regimes that host U.S. business operations react to this perceived threat, there are risks that the leadership will either resist violently or turn to populist policies that are unfriendly to foreign investment. Looking forward, it is important for U.S. businesses operating abroad to recognize this shift, which can impact the behavior of Host Governments from Venezuela to Saudi Arabia, China or Russia.
In summary, these are challenging and unprecedented times. In the last two decades, corporate risk managers got used to viewing emerging markets in a single dimension: as a source of growth, opportunity and reward. Today’s new reality is that they must reassess the developing world as a source of formerly unidentified political risks, which can severely and unexpectedly impact a firm’s balance sheet and profitability.
How does Marsh help clients, to identify potential risks?
SK: At Marsh, part of our job is to help companies recognize potential risks that may not have even fully materialized. Unlike other risks, political risk is not actuarially analyzable, which makes attempts at forecasting futile. We can’t predict what is going to happen in a given country, but we can help clients identify where potential risks may lie. This starts with a wide-eyed process of identifying the magnitude of the corporation’s exposures in risky countries and assessing the “what if” impact of scenarios which seem unlikely at the moment (like regime change in Egypt, or a break-up of the Euro).
We also encourage clients to think about where they lie in the continuum of industries that seem to be at higher risk. For example, the visible presence of famous U.S. brands operating abroad can offer targets for political violence. Additionally, resource investments in emerging countries often run into expropriation; the same goes for highly regulated industries like power and utilities, banking, and telecommunications, which are constantly in the public eye. These sectors — and surprising to many, also basic manufacturing and hospitality — are the most frequent targets of expropriation and government interference. However, this doesn’t mean that supermarkets or cement plants are immune (these sectors have also had political risk losses).
Once the firm’s political risk landscape has been surveyed, it’s easy for Marsh to explore and cost out the use of investment insurance. At that point, our client can assess the alternatives of keeping the risk, managing it internally or transferring it to a third party.
What are some other products/services that Marsh can deliver to help our clients doing business in these parts of the world?
SK: In this ongoing credit crunch, the availability of trade finance to fund exports and imports has declined because banks are not lending as they did in the preceding boom. This has, in turn, affected U.S. companies’ revenues because they have traditionally relied on banks to facilitate foreign sales (through letters of credit confirmations, or the purchase of client receivables, or giving credit directly to foreign customers).
The sudden void in trade finance creates a prime opportunity for a specialized Political/Credit insurance product called Contract Frustration (CF)coverage. CF insures an emerging country customer’s failure to pay on large and long contracts (on anything from capital goods to bulk commodities). It also responds to losses resulting from purely political events, such as when the seller's government cancels an export license, or war frustrates shipment of the goods. The insurance can then be used to facilitate bank financing for the contract.
We like to think of CF as an “offensive” tool because it helps our clients book additional sales. Unlike “defensive” insurance, the funds to pay for CF coverage comes from the sales contract itself not from a finite, fixed corporate insurance budget. It is built directly into the profit margin as a part of the contract’s variable costs. The insured’s sales people also like it because in the eyes of their foreign customer it improves their competitiveness against rivals who insist on tougher or costlier terms of payment.
Has there been an uptick of clients coming to Marsh for Foreign Investment Insurance?
SK: Yes. Interestingly, over several years, a significant segment of Marsh clients considered insuring the political risk of their foreign operations, then “ticking the box” after investigating the cost, and continuing as before, uninsured. This pattern might have gone on for several years.
In 2011, many of those same companies have suddenly “pulled the trigger,” obtaining political risk coverage for the first time. In some cases this is motivated by risk management’s own assessment of an increased risk environment (as discussed above). In others, we have observed that the firm’s senior management or even members of the board have mandated the firm to procure the coverage.
Unfortunately, in some extreme cases, obtaining coverage after the situation has apparently deteriorated (like Libya), can be costly and difficult, or even impossible. However, broadly speaking, political risk insurance capacity remains plentiful, and costs broadly affordable for most countries, on a global portfolio basis.
What value does Marsh bring to our clients who find themselves in these volatile locations and which Marsh differentiators come into play?
SK: Marsh has the best people and a depth of resources that is unmatched by any other broker. Marsh has gone out of its way to hire from diverse qualified backgrounds, such as government export credit agencies and banking, to assemble an amazing, unparalleled and joined-up global team. No other large broker or insurance boutique can match our spread of knowledge and capabilities.
This gives us the ability to pull together a lot of information quickly about the state of insurance market conditions anywhere in the world, and enables us to determine where we can obtain the best terms and conditions for insuring our clients’ risks — whether through the private insurance market, or government agencies, or whether placed in the U.S., London, Bermuda or Singapore markets. Finally, no other broker matches the level of political risk analysis tools that Marsh offers under our arrangement with Maplecroft, the independent U.K. risk assessment and mapping firm: Marsh clients can access Maplecroft’s analyses, including its country risk scorecards, on a fully complimentary basis, directly from Maplecroft’s website.