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«CONFERENCE REPORT October 23, 2009 The Fletcher School of Law and Diplomacy, Tufts University Hosted and Sponsored by: Conference Summary Political ...»

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Focusing his discussion on political risk methodology, he argued that effective political risk assessment should not be limited to the macro or even country level of analysis. In fact, he posited that it should incorporate analysis of local economic and political conditions, as well as ethnic and religious issues. Dr. Howell claimed that this more granular approach is critical in today’s globalized world as ethnic factions, terrorist organizations, and other sub-national and regional entities exert a greater ability than in the past to affect cross-border investments.

Dr. Llewellyn Howell’s Main Points:

The units of analysis in political risk assessment should not lie at the country level, but should rather consider the interplay of various sub-state actors and their impact on the social, political, and economic environment.

The risk appetite of a given investor is dependent on firm-specific, industry, and macro

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It is important to calculate the probability of an event occurring, which implies a quantitative element of political risk assessment. The probabilities have to be calculated in a systematic way, so as to enable a comparative analysis of countries using the same

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The components of political risk assessment include government stability, socioeconomic issues, investment profile, internal and external conflict, corruption, law and order, and social and ethnic issues associated with economic risk.

Political risk assessment has transitioned from a focus purely on host governments to the incorporation of various actors and stakeholders that could affect the investment, such as ethnic groups, terrorist organizations, domestic and international civil society groups, and other sub-national and regional entities.

The Fletcher School of Law and Diplomacy | Political Risk Conference Report Panel III: Investment and Trade Finance in Conflict-Affected Countries Aiming to discern the chief risks to firms that invest and operate in environments characterized by ongoing conflict or lack of effective governance, the Investment and Trade Finance in Conflict-Affected Countries panel touched on several topics, including comparisons between trade promotion and investment, investments in ex-ante versus ex-post environments, and initial investment considerations versus real-time adjustments during a project. The

countries in question were defined as primarily failing or failed states and characterized by:

presiding conflict; a weak rule of law or even lawlessness; a lack of functioning capital markets and productive investment opportunities; rampant inflation; and controlled exchange rate regimes that contribute to black markets and informal economies. Due to the changing nature of conflict, products designed to protect firms’ interests have evolved to cover losses not only in cases of damage to assets but also business interruption. Panelists noted that risk-pricing models are project-specific, and take into account a range of objective and subjective factors in the host country in order to determine risk premiums, including the threat of the actor and the vulnerability of the particular business. Participants concurred that insurance providers have started to focus more on “comprehensive” guarantees.

Investment and Trade Finance in Conflict-Affected Countries Panelists:

John Greenwood, VP Credit & Agency Finance, Citigroup Jim Williams, Director, Insurance, Africa, the Middle East, and Southern Asia, Overseas Private Investment Corporation (OPIC) David Drysdale, Deputy Director for Trade, Finance, and Investment Negotiations, U.S.

Department of the Treasury Dominick Donald, VP Country Analysis, AEGIS Rashmi Nehra, Assistant VP PRI, Chartis Professor Laurent Jacque, Walter B. Wriston Professor of International Business, The Fletcher School (Panel Moderator) The Fletcher School of Law and Diplomacy | Political Risk Conference Report

Investment and Trade Finance in Conflict-Affected Countries Panel’s Main Points:

Threats posed by specific actors and the vulnerability of the given business must both be assessed in order to determine specific exposure to losses. The utilization of exposure fees is based on various elements, many of which are categorical or loosely defined. Most claims are categorized as being commercial, as opposed to political, risks.

It is often easier to define political risk in terms of what it is not (i.e. things that are not in

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Firms have started to focus more on “comprehensive” insurance guarantees that include “nonpayment” coverage. OPIC and other providers are responding to this demand through sovereign non-honoring provisions.

It is almost impossible for a bank to meet target hurdles when sovereign risk ratings are incorporated. There is generally little relief through PRI coverage, except via comprehensive coverage through an AAA-rated agency.

The questions insurers raise include what portion of an investment can actually be recovered and whether investors have the technical experience to undertake a commercially viable project. They also look to see whether the company attempts to mitigate some of the vulnerabilities itself. Insurance should simply be considered as a layer on top of other risk mitigation efforts.

Since the Cold War, civil and ethnic conflicts have proliferated in developing countries, and these can have a significant impact on a company’s operations. As a result of these changing circumstances, products have also evolved to cover losses not just stemming from damage to facilities and other assets, but also due to foregone income.

Risk premium pricing models are very project-specific, incorporating both objective and subjective factors and taking into account relevant events occurring in the host country

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In conflict zones, it is almost impossible to conduct transactions without securing revenue from export flows. It is much easier to work with projects that will generate trade flows, as they produce hard currency earnings which can be kept offshore and The Fletcher School of Law and Diplomacy | Political Risk Conference Report then used to make loan payments or dividend returns to asset owners.

For energy projects that experience windfall profits, the government often exerts pressure to renegotiate contracts, which can result in expropriation. Many international financial institutions are signing onto the “Equator Principles,” under which contracts are structured to ensure a more equitable division of revenues between the parties.

A recent trend observed in the context of global financial crisis is the wide fluctuation of commodity prices. This is important to consider, as it changes the perceptions of what the government should receive as a “fair” revenue allocation.

Panel IV: Political Risk Insurance and Investment Guarantees Topics of discussion for the Political Risk Insurance and Investment Guarantees panel included: a current overview of political risk insurance (PRI) products; the use of Basel II compliant PRI policies; and the outlook for the PRI market in the foreseeable future. The panelists noted that the current economic crisis has adversely impacted the PRI industry. With fewer projects being undertaken in emerging markets, there has been a drop-off in demand for PRI products. Globally diminished trade credit and project-lending volumes have exacerbated this issue. The panelists stressed that a distinction should be drawn between credit risk and political risk. Credit risk refers to the ability of counterparties to pay, while political risk includes considerations of sovereign entities’ willingness to pay. The panel and the conference concluded with the panelists identifying intellectual property rights protection as a potential area for PRI product development. The panel topics of discussion included an overview of PRI product offerings and a discussion on how to optimize PRI policies. Panelists also discussed the use of Basel II-compliant PRI policies, how PRI could eventually be extended to cover intellectual property rights, and a near-term outlook on the PRI industry.

Political Risk Insurance and Investment Guarantees Panelists:

Rod Morris, VP, Political Risk Insurance, OPIC Mac Johnston, Advisor, PRI Arbitration, Robert Wray PLLC Julie Martin, VP, PRI Brokerage, Marsh The Fletcher School of Law and Diplomacy | Political Risk Conference Report James Bond, COO, Multilateral Investment Guarantee Agency (MIGA), The World Bank Group Barker Keith, VP and Assistant General Counsel, Sovereign Risk Insurance Professor Jonathan Brookfield, Associate Professor of Strategic Management and International Business, The Fletcher School (Panel Moderator)

Political Risk Insurance and Investment Guarantees Panel’s Main Points:

PRI involves political events that can be clearly observed and measured. A partial list of coverage areas includes: war and civil disturbance; breach of contract; currency inconvertibility; and the non-honoring of a government’s commitment to an investor’s

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The current economic crisis has adversely impacted PRI business, with fewer projects in emerging economies leading to a decreased demand for PRI products. Also, many PRI providers are experiencing credit supply issues and are in turn reducing PRI availability.

Despite the current economic downturn, there is adequate capacity, and those companies seeking coverage can get it. PRI should, however, be the last line of defense in managing a company’s risks.

Three steps should be taken in order to prevent errors when writing and updating PRI

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2) Identify the proper underwriter. In political risk insurance, an underwriter who knows the industry and associated risks is more valuable than the firm’s

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3) Involve the project manager in the policy formation process.

Basel II-compliant PRI policies dictate two key points. First, credit risk indicates a counterparty’s ability to pay, while political risk considers a government’s willingness to pay. Second, for a product to be Basel II-compliant, it needs to mitigate credit risk, which means the policy cannot include specific exemptions; the policy needs to be “bulletproof.” The Fletcher School of Law and Diplomacy | Political Risk Conference Report There is discussion in industry circles for a potential new PRI product intended for intellectual property right protection. Before a firm’s intellectual property rights can be insured, they must be legally protected through patents and trademarks in the relevant

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The Managing Political Risk conference covered a comprehensive range of issues relevant to the political risk sector. The broad spectrum of panelist sectors and areas of specialty provided comprehensive perspectives on the state of risk management. Bringing together experts in business intelligence, political risk insurance, financial services, and energy, the conference reinforced the importance of political risk as an increasingly relevant factor as the world moves into the second decade of the 21st century.

The political risk industry has become highly specialized, particularly in business intelligence, where companies are compelled to find a unique competitive advantage over other industry contenders in order to set themselves apart. Awareness and understanding of political risk is an important component to scenario planning in the energy sector, which must be conducted on a regular basis while keeping in mind that forecasts do not always provide reliable predictions.

The rise and expansion of multinational corporations indicate that foreign investors now face a broader base of stakeholders; they must take into account perspectives of both local and national actors. The nature of risks when operating abroad has varied greatly, from the expropriation and nationalization risks in the 1960s and the19 70s to convertibility issues and damage due to civil strife. These developments have increased the need to understand, measure, and hedge against political risk.

The degree and the implications of political risk and political risk insurance are complex and cross conventional borders. It does not only affect corporate actors and their bottom line, but actors involved in nation-building in post-conflict environments. By partnering with the The Fletcher School of Law and Diplomacy | Political Risk Conference Report private sector, public risk insurance mechanisms, like MIGA and OPIC, can spread out risk and make these important investments possible, aiding to break the conflict-poverty cycle.

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Established in 2007, the Center for Emerging Market Enterprises at The Fletcher School, Tufts University, serves as one of the leading global hubs for research, study and networking devoted to enterprises in the emerging markets. Promoting understanding and engagement that contributes to global prosperity and stability, CEME draws on an extensive network of professionals in private, public, academic, and non-government enterprises in emerging and developed countries. Under its Emerging Market Enterprise Strategy and Emerging Market Local Capital Markets research programs, CEME plans to continue its exploration of political risk in the 2010/2011 academic year. Management and investment in emerging and frontier markets, particularly post-conflict environments, is becoming an increasingly prevalent challenge for global corporations. CEME’s upcoming programming will include examinations of bond markets, market valuation, management practices, and stakeholder relations—and their inclusion in risk assessments—in emerging and frontier markets.

Founded in 2008, the Fletcher Political Risk Forum (FPRF) is a graduate student organization at The Fletcher School, Tufts University, facilitating research and discussion amongst students with career and academic interest in political risk in the fields of finance, consulting, business intelligence, and business strategy and operations. FPRF student organizers created and coproduced the “Managing Political Risk” conference in 2009 to help fill a gap in the dissemination of political risk analytic methodologies and mitigation strategies that have applicability across business sectors.

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