What is political risk in business?
Clarke Ricks
School of Business, Liberty University
BUSI 690: Policy and Strategy in Global Competition
Dr. Hicks
April 6, 2022
What is political risk in business?
Political risk is the possibility that your business could suffer because of instability or
political changes in a country: conflicts and unrest, changes in regime or government,
changes in international policies or relations between countries, as well as changes that
occur in a country's policies, business laws or investment regulations.
Other influential factors contributing to political risk include any other situation which
may have an influence on a country’s economy, such as commodity price volatility, liquidity
crises and sectoral downturns. Think of conflicts in the Middle East, the Arab Spring
recurrent coups, confiscation of assets by local governments, and disputes over natural
resources among nations. These may sound like unique political risks to international
business, but they can still affect your local business and you may not see them coming.
“When it comes to political risk, we say it could be defined to a certain extent by
its unpredictability,” says Pierre Lamourelle, Deputy Global Head of Specialty Credit within
Allianz Trade for Multinationals and a 25-year veteran of political risk assessment and
management. “Contrary to most other types of insurance, it’s not always possible to model
this type of risk based on historic data.”
Types of political risk
There are many kinds of political risks which can affect business: potential political and
economic instability, labour problems, local product safety and environmental laws. Here
are the key political risks.
War, terrorism, and civil unrest
Some geopolitical risks result from war, terrorism and civil unrest – a kind of political
risk map. “Look at what happened during the Arab spring in 2011 or in Ukraine in 2013-
2014,” says Pierre, referring to the Russian invasion of its neighbour. “Political unrest in
Ukraine at the end of 2013 led to a very volatile environment for companies with interests
in the region. They faced the potential for damage to assets through political violence and
possible broader expropriation measures.”
Unilateral decision made by a state-owned entity
Another typical political situation is a unilateral decision made by a state-owned
entity (‘le fait du prince’) to unilaterally terminate a contract signed with a foreign supplier
in retaliation for an unfriendly decision made by the government of that supplier.
Geopolitical decisions made by governments
On a less violent but still disruptive geopolitical note, there are a variety of geopolitical
decisions governments make at all levels that can create political risk and affect individual
businesses: foreign trade policies, tariffs, legal and regulatory constraints, tax regulations
and currency controls. “The embargo of Qatar by its neighbours and the commercial
tensions between the US, China, and Russia are also examples of what political risk is for
business,” Pierre points out.
Sanctions
Sanctions are another political risk in international business. “Typically, we expect our
insured to comply with international laws, so were they to breach a sanction, that would not
be covered,” Pierre points out. “And on top of that, if an insurer were to pay out on a
sanction contract, the insurer would also be exposed to those international sanctions.”
Jurisdictional risk
Jurisdictional risk is also a major political risk in international business, whether your
company is an SME looking to expand or a global multi-billion-dollar company. “Jurisdiction”
refers to the laws that will govern the agreement you sign with your partner. When that
partner is in another country, difficulties can arise should the terms of the contract begin to
unravel.
For instance, a European company contracting with an African company under local law
would not be exposed to the same legal framework as it would under English or French law
or if the contract is subject to international arbitration for the resolution of disputes
between the parties. “If you chose the local law, you could be exposed to unexpected
changes in the local law regulation or difficulty to enforce a decision made by a local
tribunal,” Pierre points out. “The choice of the law governing the commercial contract is
often the responsibility of the insured and is not an insurable risk as such. However, it is
worth mentioning that non-respect of an international arbitration award can be included as
a cause of loss, and therefore could be covered under certain political risk insurance
policies.”
Having the knowledge of how to deal with the complexity of the local legal
environment can make a big difference in your ability to withstand and manage political
risks. International risk insurers such as Allianz Trade have people on the ground in more
than 40 countries dealing with political risks of all types: check out our political risk map.
How political risk can affect your business
“What has changed in the 25 years since I started in this business is that we are living in
a more connected world today,” says Pierre. On the upside, that means business is easier to
conduct on a global scale. Almost everybody now has the ability to reach out to emerging
countries or to conclude a contract and to secure a sale in a foreign country.
On the downside, this means that when something goes wrong in one part of the
world, you can feel the impact halfway around the globe – directly, if you are dealing with
the country in question, or indirectly because of your diverse supply chain. Remember when
the 20,000-tonne container ship “Ever Given” got stuck in the Suez Canal in March 2021,
shutting down international trade for a week?
Another good example is when your own government decides to ban sending people on
the ground to the country where you are executing your contract. “You would have to stop
the performance of your contract,” says Pierre, “and you would be exposed to additional
expenses and not be able to keep on performing or to keep invoicing and receiving payment
from the customer in that specific country. This ban would clearly translate into a loss for
the contractor.”
As a last illustration, let’s take a change of law or a regulation that is super-selective and
targets only foreign companies. “That could be seen as a soft discriminatory measure and
could be covered as a political risk,” says Pierre. “But only if it’s a discriminatory measure.
Any governmental decision that would impact all the companies located in a country is not
captured by a political risk insurance policy. These are risks that all business owners are
facing when running a business.”
Political risk management is essential in these situations in order to assess the risks and
define actions to protect your company.
Political risk management
Some risks may be worth taking for the exposure to new markets at opportune
moments. But it is always important to keep your eyes and ears open because political risks
in international business aren't always well-identified. Sometimes the risks may be just
rumours – events that one could deem as not material with little or no substance behind
them.
Some of the early signs of political risk are political, economic and social instability:
The political situation in the country: how is the country behaving with its
neighbours? You want to be prepared if there’s an escalation of tensions or a war.
The economic conditions: what are the macro-economic imbalances? How stable is
the economy? What is the ability of the country to honour its payment obligations or debt
over the period of your project?
The social conditions: is youth unemployment or underemployment high (think:
Arab Spring, Sudan, Algeria etc.)? Are social tensions erupting into violence? Riots can also
impact trade transactions or performance of commercial contracts. For example, there is a
strong correlation in countries whose economies are heavily dependent on natural
resources such as oil and gas. “You know that in these countries if the price goes below a
certain threshold, there are going to be fewer resources to finance social programs and that
can lead to some social instability or even the inability to honour debt obligations,” Pierre
points out.
Do you need political risk insurance?
Political risk insurance is not a “mandatory” insurance product. It is a niche market,
originally used by large exporters, international contractors or banks facing the risk of
contract interruption, or the risk of non-payment or non-repayment of a loan.
However, political risk is no longer the exclusive domain of emerging countries. It can
directly impact all businesses due to the increased interconnection of economies. Political
risk insurance, targeted to your specific engagements by an insurer with a global reach,
can secure your economic and business interests.
“For companies, political risk insurance can cover, for example, non-payment of a cargo
or the non-performance of a contract,” explains Pierre. “When it comes to banks, we cover
their full spectrum of transactions from export finance to trade finance, to infrastructure
finance, asset-based finance and structure-trade finance. So, it’s a highly-customised
solution.”
What about recovery? “The destruction of an asset… there’s no recovery potential for
that,” says Pierre, “but if you insure against non-payment or non-reimbursement by a state
or local government entity, you have the ability to make a claim against the government
and get recoveries.” Or the debt may be rescheduled.
Credit and political risk insurance: what’s the difference?
Trade credit and political risk insurance (or structured trade credit insurance) are not
mutually exclusive, they are compatible. Trade credit insurance covers risks to your
company’s short-term portfolio of receivables. Structured trade credit or political risk
insurance covers a specific transaction, with risk horizons that can vary from very short-term
risks to long-term ones. Trade credit and political risk insurance, therefore, go hand-in-hand
to secure your business transactions.
“We design the political risk insurance policy transaction by transaction, for a specific
loan for a specific contract,” explains Pierre. “Discuss with your insurer or specialised broker
and check where you are really exposed and whether there is a need for political risk
cover.”
As a conclusion, Pierre reflects on his 25 years in risk management and points out: “You
can have a very strong transaction in a very complicated and sensitive country, but you
could also have a very bad transaction – if it’s not well structured – in a developed country.
I’ve seen lots of transactions performing very well in emerging economies, and conversely
claims that have been made on supposedly strong counterparties."
