Political Risk In Project Finance
Assessing Project Finance Political Risk In Emerging Markets
Assessing Project Finance Political Risk
Political Risks are characterized as the non-market challenges and complications that businesses, investors, and lenders face when they invest in emerging markets and developing countries. Project Finance Political Risk is the risk that applies to emerging market investments in project finance. While the risks may appear dormant from time to time, maybe even for extended periods of time, political risk in project finance exists continuously for the duration of the project financing. Regardless of how long political risks may have appeared dormant, they become active – and potentially dangerous to project financing – upon the occurrence of a triggering event.
Triggering events can range in severity from insignificant all the way up to armed insurrection. Nominally almost anything can be a trigger, like a political decision that advances new policies which are inconsistent with existing policies. A triggering event can also be any type of event that is in any way connected or related to political instability. These events include an act of terrorism, riot, coup, civil war, insurrection or sedition. When political risks shift from dormant to active due to the occurrence of a triggering event, they immediately become both more severe and more likely to negatively impact the outcome, profitability or even the viability of investments, business ventures, and project financings.
Political Risk 2016 Global Map
Quantifying Political Risk No Easy Task
Although it is widely believed that political risk can be quantified and managed, companies that invest in emerging markets do so because they generally believe they have adequately quantified the risk they will face to an extent which is sufficient for them to abdicate much of their ability to manage that risk.
For example, a company that is going to build a new facility must decide between two parcels of land for the location of the facility. One of the parcels is significantly less expensive than the other but it is located within the 100-year flood plain, which means it is susceptible to flooding every 100 years. The other parcel is not susceptible to flooding but is considerably more expensive. Because it is sufficiently less expensive, the company may decide to proceed with building on the flood-prone parcel because they believe they have adequately quantified the risk of flooding, even though in so doing they are abdicating their ability to manage future flooding.
Mitigating Geopolitical Risk In Emerging Markets
Similarly, the risk that political decisions, political conditions or political instability could materially affect the profitability, continuation or even the viability of their business is routinely faced by companies that invest in emerging markets. Until recently, companies interested in investing in emerging and frontier markets were limited to a binary choice. They could do the deal and accept the risk or pass on the deal and completely avoid the risk.
Neither, in this case, is a good option. Deciding on the first option may force the company to accept more risk than they are comfortable accepting, and the second option, while risk-free, absolutely guarantees they will make zero profits.
Fortunately, the marketplace developed a solution for Political Risk that creates a third option that is decidedly superior to those which were previously available. The introduction of Political Risk Insurance allows companies to more aggressively pursue the profits and growth potential offered by emerging market opportunities while substantially reducing the risks their investment will face.
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