CHAPTER 8 TRENDS IN MANAGING POLITICAL RISK

• Jurisdiction: United States

International Resources Law and Projects
(Apr 1999)
CHAPTER 8
TRENDS IN MANAGING POLITICAL RISK
Margaret B. Cole ¹
White & Case
London, England

Introduction

In past years at the Rocky mountain Mineral Law Foundation conferences papers have been given discussing methods of managing political risk. Most recently Andrew Seck delivered a very detailed paper pointing out the difficulties in managing these risks. This paper concentrates particularly on the risk arising out of the uncertainty associated with the legal systems in many emerging markets. While sometimes included in the general definition of political risk, for purposes of this paper I consider this particular risk as "legal risk" rather than political risk.

Legal risk is thus the very real risk inherent in doing business and carrying out a project in a jurisdiction where the legal system is new or undeveloped or where there is little, if any, experience in adjudicating commercial disputes such as those which may typically be encountered in the context of a major project financing. Mr Seck's paper was focused particularly on the problems in the Former Soviet Union, however, the problem is not limited to such jurisdictions. Legal risk is equally problematic in jurisdictions which may have well developed legal systems, but where there simply has not been the experience of major financings or other major commercial transactions and so no need to develop the jurisprudence to address these disputes. I think, for example, of some of the African countries which have inherited the legal systems of there former colonial rulers. Often those legal systems have not developed much beyond their status at independence, as there has been little major investment in those countries over the last few years which could have given rise to a development of laws, and perhaps the enactment of new laws.

In many respects this risk is one of the most important risks facing investors in emerging markets, yet it is one which traditional methods of mitigating political risk do little to address.

This paper will look briefly at those more traditional means of addressing political risk and at recent developments in managing those risks, and also offer some observations on management of legal risk.

Political Risks

Let me then turn to political risk. This risk can materialise at any point in the project cycle. While most often considered as an issue in emerging markets, it is worth the comment that emerging markets do not have a monopoly on political risk. Nationalisations have occurred in Britain, and tax rates that most project developers would characterise as creeping expropriation have been imposed in the past in some Scandinavian countries.

The Risk: political risk is typically thought of as encompassing the following risks

• expropriation (note this need not be outright expropriation but can be "creeping" for example, increasingly onerous taxes)

• political violence (terrorism, sabotage, declared or undeclared war, civil war)

• inconvertibility of currency

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• non-transferability of currency

• exchange rate fluctuation

• change in law

• government breach of contract (sometimes also included within exporpriation)

Keep in mind also

• restrictions on import of supplies or on the use of foreign labour

• production quotas and price fixing

Managing the Risk. Political risk can be one of the most difficult risks to manage. Traditionally, political risk is managed, or perhaps mitigated through political risk insurance from bilateral or multilateral agencies including export credit agencies. In addition, where a project is to be financed it may often be possible to include within the financing loans from institutions that either will agree to bear the political risk, or whose presence in a transaction (whether by virtue of such loans or an equity stake) generally mitigates political risks (or at least some of them). In fact, in countries viewed as involving a high degree of political risk, it is unusual for commercial lenders to be prepared to lend to a project unless some form of political risk support is provided, either through these means or directly by the sponsors.

Direct assurances from host governments may also be sought to...