Foreign Direct Investment in Developing Countries/Emerging Markets The Role of Political Risk...

Foreign Direct Investment in Developing Countries/Emerging Markets The Role of Political Risk Insurance

Frank Linden, Senior Risk Management OfficerCenter for Integrative Leadership/Carlson School of Management, University of MinnesotaApril 20, 2010

MULTILATERAL INVESTMENT GUARANTEE AGENCYWORLD BANK GROUP

1. An overview of MIGA2. FDI and political risk pre- and post financial crisis3. Outlook and MIGA’s positioning


MULTILATERAL INVESTMENT GUARANTEE AGENCY WORLD BANK GROUP 4

1988 MIGA Multilateral Investment Guarantee Agency

MIGA …. A member of the World Bank Group

1944 IBRD International Bank forReconstruction and Development

1960 IDA International Development Agency

1956 IFC International Finance Corporation

1966 ICSID International Center for the Settlement of Investment Disputes


MIGA’s Mandate

MIGA's mission is to promote foreign direct investment (FDI) into developing countries to help support economic growth, reduce poverty, and improve people's lives

We do this by providing political risk insurance for cross-border investments into our developing member countries

Every dollar MIGA guarantees is estimated to facilitate $4 of foreign investment

Promote research and knowledge on FDI and political risk insurance World Investment and Political Risk report Online investor information services: www.fdi.net and www.pri-center.com

http://www.fdi.net/

http://www.pri-center.com/


Risks covered by MIGA

Currency inconvertibility and transfer restriction Expropriation War, terrorism, and civil disturbance Breach of contract (BOC) Non-honoring of sovereign financial obligations


Risks covered by MIGA (1)

1. Currency Transfer Restriction and Inconvertibility Protects against losses arising from:

Inability to convert local currency into foreign exchange within the host country Inability to transfer funds out of the host country

NB: Currency depreciation not covered

2. Expropriation Protects against losses arising from:

Nationalization and confiscation Creeping expropriation Partial expropriation (expropriation of funds)

NB: Non-discriminatory measures not covered, unless such measures have a confiscatory effect

3. War and Civil Disturbance Protects against losses arising from:

Damage/disappearance of tangible assets (including revolution, insurrection, coups d'état, sabotage, and terrorism)

Short-term business interruption - new

NB: Acts must have a primary intent of achieving a political objective


4. Breach of Contract Protects against losses arising from:

Breach or repudiation of a contract between the investor/project company and the host country authorities

Denial of Justice Non-enforcement of an arbitration/judicial award, or no recourse to judicial/arbitral forum, or

decision by forum not rendered in reasonable time

May cover sub-sovereign obligations and obligations from SOEs

5. Non-Honoring of Sovereign Financial Obligations - new For unconditional financial payment obligations of sovereign No arbitration required

Risks covered by MIGA (2)


Areeba Afghanistan LLC

(the project)

Government of Afghanistan

MTN

South Africa

License

EquityUSD 80 million

Fee

MIGA Guarantee

MTN – Afghanistan – Project Structure


Types of investments covered

Equity Shareholder loans Loan guarantees Loans from financial institutions Non-shareholder loans Non-equity direct investment and other forms of investment such as technical assistance and management contracts,

asset securitizations, capital market bond issues, leasing, services, franchising and licensing agreements


MIGA’s Financial Highlights

Gross exposure, $ billion

6.5

FY08

5.30

FY07FY06FY05FY04FY03

5.36

5.09

5.19

5.08

7.3

FY09

Key Figures Issued 952 guarantees for 600 projects

for a total of $20.9 billion during 1990-

2009 Portfolio: $7.3 billion in FY09 Issued $1.4 billion during

July 2008-June 2009

MIGA’s Strengths Total subscribed capital: $1.9 billion as

of June 2009 Strong capital base and ability to pay

compensation in the event of large-

scale losses Implied AAA by major credit rating

agencies


Top Investors and Host Countries as of June 30, 2009

Investor Country Exposure % Host Country

Exposure %

$M

Austria 30.0 Russian Federation 14.3 1,044.0

France 12.8 Ukraine 13.9 1,012.9

Belgium 10.2 Turkey 8.4 611.8

Spain 6.4 Djibouti 5.6 407.4

United Arab Emirates 5.4 Uruguay 4.1 301.2

Finland 4.1 China 3.4 248.2

South Africa 3.7 Brazil 3.4 244.2

United Kingdom 2.8 Kazakhstan 3.1 224.7

Netherlands 2.6 Mozambique 2.7 196.4

Switzerland 2.6 Costa Rica 2.2 158.5

Total 80.6 Total 61.1 4,449.3


Claims history

Of the 600+ projects MIGA has supported in its history, more than 60 instances when a project has gone into pre-claim status but then the dispute was resolved and it was not necessary to pay a claim

MIGA has successfully facilitated the settlement of disputes in all currency transfer/inconvertibility issues

Since inception MIGA has never denied a claim and has needed to make claim payments in just 5 cases:

Indonesia ($15 million for expropriation in FY00) Nepal ($144,600 for war and civil disturbance in FY05) Argentina ($558,311 for expropriation in FY05) Kenya ($491,100 for war and civil disturbance in FY09) Madagascar ($12,824 for war and civil disturbance in FY09)

All other cases have been resolved (before or after the claim was filed) or the claim was withdrawn


Before the Financial Crisis

Source: World Bank. Note: 2008 figures based on staff estimates

Net Private Capital Inflows to Emerging Markets 2005-2008, billion USD


Pre-crisis: A Fairy Tale World?

Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-070

200

400

600

800

1000 EMBI Spread

EMBI Spread


October 2008: The World Erupts

Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-080

200

400

600

800

1000

EMBI Spread

EMBI Spread


The Fallout … and Start of Recovery

Jan-02

Apr-02Jul-0

2

Oct-02Jan

-03

May-03

Aug-03

Nov-03

Feb-04

Jun-04

Sep-04

Dec-04

Mar-05

Jun-05

Oct-05Jan

-06

Apr-06Jul-0

6

Oct-06

Feb-07

May-07

Aug-07

Nov-07

Mar-08

Jun-08

Sep-08

Dec-08

Mar-09

Jul-09

Oct-09

0

200

400

600

800

1000

EMBI Spread

EMBI Spread


Impact of the Financial Crisis

The crisis ended the four-year global FDI boom

Collapse of demand and volatility of commodities prices

Dramatic changes in capital structure of projects - debt capital market not fully open

Increasing cost of capital and equity requirements

Delays with projects in infrastructure, oil, gas, mining, and energy sectors


The Impact of the Crisis on FDI

Global FDI – declined to $1.5 trillion in 2008 and to $850b in 2009; sharp decline in cross border M&As

Emerging markets capture increasing share of FDI


ECA Region Hardest Hit by the Crisis

Largest reversal in economic growth 2010 expected to be particular difficult

with GDP growth forecast between 2-3%

Foreign capital flows declined more than in any other region

GDP Growth (%)


MIGA’s Response to the Global Financial Crisis

Support private investment and bolster confidence in government commitments through credit enhancements by MIGA

Joint IFI Action Plan IFC, MIGA, European Bank for Reconstruction and Development, European

Investment Bank mobilize up to €24.5 billion to banking systems and lending to the real economy in Central and Eastern Europe

€2 billion of MIGA’s PRI capacity to support banking sector recapitalization (€1.8 billion signed by December 2009)

Guarantee Framework for Private Equity Funds to help clients raise financial capital for multiple investments into emerging

markets


Impact of the Financial Crisis on Political Risk

Degradation of perceptions: political risk score increased for 52 countries out of 126 from June 2008 to June 2009 (EIU’s Risk Briefing 2009)

Biggest escalation of political risks in Eastern Europe, Latin America and developing Asia Top concerns: social unrest, violent demonstrations, and the imposition of capital

account controls

Need for contractual political risk management products

Increasing FDI into EMs Political risk as top investment constraint


Landscape for Political Risk (cont’d)

Major constraints on foreign investment in emerging marketspercent of respondents

Source: MIGA-EIU Political Risk Survey 2009.Note: Percentages add up to more than 100 percent due to multiple selections.


INVESTOR CONCERNS ABOUT POLITICAL RISK

Political Risk Mitigation: Views and Practices

Use of a wide range of mechanisms, including informal means, for managing political risk

About 6 percent of investors reported that they do not mitigate political risk at all


Risk mitigation tools by sector: all emerging markets




Outlook for Political Risks

Types of political risks of most concern to investors in emerging marketspercent of respondents

Source: MIGA-EIU Political Risk Survey 2009.Note: Percentages add up to more than 100 percent due to multiple selections.




The crisis has made investors in Eastern Europe much more aware of risks and seek risk mitigation

Proportion of respondents that consider that the crisis has increased their willingness to contract risk mitigation going forward

Interest in PRI – in different regions


The Role of Multilateral Providers of PRI

Multilaterals are better able to maintain capacity, prices and tenors in times of crisis, and can fill the gaps in the private market

Higher selectivity, stricter underwriting conditions and reduced capacity in the private insurance market

Banks unwilling to lend without PRI; view multilateral involvement as a positive indicator High deficit countries perceived to be at a higher risk for transfer restrictions

Facilitation of high development impact investments and investments into underserved markets

Not subject to shareholder pressures for profitability


Why Investors Choose MIGA: Our Value Added

MIGA’s PRI is particularly suitable for complex projects PRI coverage may facilitate financing: lower costs of borrowing, longer tenor of loans

(up to 15-20 years) MIGA’s transfer and convertibility cover is seen by the banks as an effective mitigant of

country risk Credit enhancement and mobilization of reinsurance capacity Environmental and social risk mitigation Honest broker between the government and investor

Strong track record of ensuring continuing viability of investments in times of stress: Venezuela, Argentina, Russia

Prompt claims payment Access to World Bank Group expertise and resources


MIGA’s Comparative Advantage

More risky Environments

Costs

MIGA’s comparativeadvantage

Private PRI providers’ costs

Less risky Environments

MIGA’s costs

MIGA has a higher administrative cost than private PRI providers


Conclusion

Financial and economic crisis was an adjustment from unsustainable trends

FDI prospects remain optimistic and awareness of political risk is more in line with reality

Political risks will remain a major concern for investors in the medium term given the growing economic weight of the "South" both as a source and destination for FDI

Conflict-Affected and Fragile States remain a challenge for PRI providers


Working at MIGA

I N S U R I N G I N V E S T M E N T S E N S U R I N G O P P O R T U N I T I E S

for more informationwww.miga.org


Agribusiness, manufacturing and services

MIGA guarantees can cover a project’s physical assets or losses incurred by temporary business interruption in the event of civil disturbance, cover the inability to repatriate locally earned currency, and mitigate concerns related to unclear laws on property ownership

$300 million guarantee (expropriation, war and civil disturbance, and breach of contract) to Oy Metsä-Botnia Ab of Finland for its equity investments in a greenfield pulp mill, a free trade zone, and plantations in Uruguay – the largest ever foreign investment in the country’s history

$13.7 million in guarantees (expropriation, transfer restriction, and war and civil disturbance) supporting the development of a greenfield sugar mill in Kenya

MIGA’s Small Investment Program particularly relevant to this sector - $4.3 million in guarantees (transfer restriction, expropriation, and war and civil disturbance) supporting the installation and operation of a vegetable oil refinery in Boma, Democratic Republic of Congo


Telecommunications

MIGA’s cover can address concerns related to regulatory issues, licensing and frequency allocations, conversion of locally earned currency, performance-related clauses, and protection of assets (such as cell towers) in conflict-affected environments

Guarantee of $76.5 million against the risks of transfer restriction and expropriation to the MTN Group of South Africa, backing its $85 million investment in Afghanistan’s telecommunications sector (installation, operation, and maintenance of a 100 percent digital GSM technology network via its Afghan subsidiary, Areeba Afghanistan LLC).

Guarantees of $25.9 million (transfer restriction, expropriation, war and civil disturbance, and breach of contract) to Senegalese telecommunications operator Sonatel for its $25.8 million equity investment in, and shareholder loans to, its subsidiary in Guinea Bissau.

Guarantee of $37.9 million (transfer restriction, expropriation, war and civil disturbance, and breach of contract) to Orange Participations S.A. of France for the installation, operation and maintenance of a telecommunications network in Central African Republic operating on 100 percent digital GSM technology


Infrastructure (water and transport)

MIGA’s cover can address investor concerns related to tariff adjustments, license modification, creeping expropriation, sub-sovereign regulatory and contractual risks, and other issues

Dominican Republic Toll Road – MIGA guarantees of $107.6 million (transfer restriction, expropriation, war and civil disturbance, and BOC) resulted in higher rating of bond issuance allowing financing gap to be filled

Deqing Darco Producing Water Co. Ltd project in China – $7.1 million cover against risks of transfer restriction, expropriation, war and civil disturbance. MIGA helped resolve a dispute between the investor and a municipal authority in which each party claimed breaches of the joint venture contract by the other party.

MIGA issued guarantees of $427 million ($5 million for equity and $422 in Islamic project financing) backing a project funded under an Islamic financing structure – Doraleh Container Terminal in Djibouti. Mitigated against key risks of asset damage/business interruption due to conflict and risk of non-payment of a final arbitration award against the government for BOC of the concession agreement.

Foreign Direct Investment in Developing Countries/Emerging Markets The Role of Political Risk...

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