Political Risk In Project Finance
Assessing Emerging Market Political Risk In Project Finance
Overview of Political Risk in Project Finance
Political Risk is 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.
Project Finance Learning Center
Project finance was first used in 1299 when an Italian merchant bank provided the project financing to finance the development of English silver mines. England repaid the Italian merchant bank who funded the project with the output from the mines. Project financing has been used to finance thousands of projects since those silver mines, including such notable projects as the Panama Canal and North Sea oil platforms. Our Project Finance Learning Center includes information we hope will improve understanding of this type of finance.
Definition of Project Finance
Project finance is not as well understood than it should be due largely to the fact that there is no consensus definition of project finance. Perceptions of what constitutes project financing vary depending on the definition of project finance you first learned. We list three of the most widely accepted definitions below.
A financing of a particular economic unit in which a lender is satisfied to look initially to the cash flow and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan.1
The raising of funds to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and a return on their equity invested in the project.2
The financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project.3
Project Finance Questions & Answers
Project Finance Lexicon
Accounts Receivable
Accounts Receivable is money owed to a company by a customer for products and /or services sold. Accounts receivable is considered a current asset on a balance sheet once an invoice has been sent to the customer.
Accounts Receivable Factoring
Accounts Receivable Factoring is a method of Trade Financing where a company sells their accounts receivable in exchange for working capital. The purchaser of the receivables relies on the creditworthiness of the customers who owe the invoices, not the subject company.
 For details go to Accounts Receivable Factoring »
Advance Against Documents
Advances Against Documents are loans made solely based on the security of the documents covering the shipment.
Asset Based Lending
Asset Based Lending is a method of Trade Financing that allows a business to leverage company assets as collateral for a loan. Asset-based loans are an alternative to more traditional lending which is generally characterized as a higher risk which requires higher interest rates.
Cash Against Documents
Cash Against Documents is the payment for goods in which a commission house or other intermediary transfers title documents to the buyer upon payment in cash.
Cash in Advance
Payment for goods in which the price is paid in full before shipment is made. This method is usually used only for small purchases or when the goods are built to order.
Cash with Order
Cash with Order is the payment for goods whereby the buyer pays when ordering and in which the transaction is binding on both parties.
Commercial Finance
Commercial Finance is defined as the offering of loans to businesses by a bank or other lender. Commercial loans are either secured by business assets, accounts receivable, etc., or unsecured, in which case the lender relies on the borrower’s cash flow to repay the loan.
Confirmed Letter of Credit
A Confirmed Letter of Credit is a Letter of Credit issued by a foreign bank, which has been confirmed as valid by a domestic bank. An exporter whose form of payment is a Confirmed Letter of Credit is assured of payment by the domestic bank who confirmed the Letter of Credit even if the foreign buyer or the foreign bank defaults.
Consignment
Consignment is a delivery of merchandise from an exporter (the consignor) to an agent (the consignee) subject to an agreement by the agent that the agent will sell the merchandise for the benefit of the exporter, subject to certain limitations, like a minimum price. The exporter (consignor) retains ownership of and title to the goods until the agent (consignee) has sold them. Upon the sale of the goods, the agent typically retains a commission and remits the remaining net proceeds to the exporter.
 For details go to Consignment Purchase »
Cross-Border Sale
A Cross-Border Sale refers to any sale that is made between a firm in one country and a firm located in a different country.
Factoring
Factoring is the selling of a company’s invoices and accounts receivable at a discount. The lender assumes the credit risk of the debtor and receives the cash when the debtor settles the account.
 For details go to Accounts Receivable Factoring »
Invoice Discounting
Invoice Discounting is a type of loan that is drawn against a company’s outstanding invoices but does not require that the company give up administrative control of those invoices.
factoring invoices
factoring invoices is one of the most common methods of trade financing. Your company sells their invoices to a factor in exchange for immediate liquidity. The factor who purchases the invoices relies on the creditworthiness of the customers who owe the invoices, not the subject company.
For details go to factoring invoices »
Irrevocable Letter of Credit
Irrevocable Letter of Credit is a Letter of Credit in which the specified payment is guaranteed by the bank if all terms and conditions are met by the drawee.
Letter of Credit
Letter of Credit or LC is the most common trade finance solution in the world. A Letter of Credit is a document issued by a bank for the benefit of a seller or exporter, which authorizes the seller to draw a specified amount of money, under specified terms, usually the receipt by the issuing bank of certain documents within a given time.
For details go to Letters of Credit For Imports »
Open Account
Open Account is a trade arrangement in which goods are shipped to a foreign buyer without guarantee of payment. The obvious risk this method poses to the supplier makes it essential that the buyer’s integrity be unquestionable.
 For details go to Open Accounts »
Pro forma Invoice
Pro forma Invoice is an invoice provided by a supplier prior to the shipment of merchandise, which informs the buyer of the kinds, nature and quantities of goods to be shipped along with their value, and other important specifications such as weight and size.
Receivable Management
Receivable Management involves processing activities related to managing a company’s accounts receivable including collections, credit policies and minimizing any risk that threatens a firm from collecting receivables.
Revocable Letter of Credit
Revocable Letter of Credit is a Letter of Credit that can be canceled or altered by a buyer after it has been issued by the buyer’s bank.
Structured Trade Finance
Structured Trade Finance is cross-border trade finance in emerging markets where the intention is that the loan gets repaid by the liquidation of a flow of commodities.
Trade Credit Insurance
Trade Credit Insurance is a risk management product offered to business entities wishing to protect their balance sheet assets from loss due to credit risks such as protracted default, insolvency, and bankruptcy. Trade Credit Insurance often includes a component of political risk insurance, which ensures the risk of non-payment by foreign buyers due to currency issues, political unrest, expropriation, etc.
Project Finance Documents
› EPC Contract
› O&M Agreement
› Loan Agreement
› Offtake Agreement
› Supply Agreement
› Intercreditor Agreement
› Tripartite Deed
› Common Terms Agreement
› Concession Deeds
› Shareholder Agreement
Project Finance Participants & Stakeholders
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