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Political risk and international business

by Steven E. Hendrix*

Business executives sometimessay that overseas transactions aresimply more complex versions ofdomestic operations. One ele-ment that makes these transac-

tions more complex, however, isthe increased presence of "politi-cal risk." This article explores (1)what constitutes political risk, (2)how exporters can avoid politicalrisk, and (3) what legal problemsgenerally arise with the documen-tation of political risk insurance.

Political risks defined

Political risk, sometimes called"sovereign risk," has several ele-ments. First, it is found whenevera government prevents a privatesector debtor from repaying itsobligations. Second, it occurs

* Steven E. Hendrix, Esquire, aUniversity of Wisconsin LawSchool graduate, is an attorneylicensed to practice law in Wiscon-sin, Pennsylvania, and the Districtof Columiba.

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when the foreign government is it-self a debtor and defaults on itsown obligations due to its ownvolition. Third, political risk ispresent when a government repos-sesses the assets of a private entity(sometimes referred to as "confIs-cation," or "expropriation").Other examples of political risksinclude imposition of new controls(such as trade restrictions, ex-change limitations or monetarycontrols), and war, revolution orinsurrection. Ultimately, the exactdefInition of "political risk" will belisted in any insurance or guaran-tee documentation.

Interestingly, political risk isnot limited to foreign countries.For example, the United Statesfroze Iranian fmancial assetsduring the hostage crisis in Iran.This may have been considered aconfIscation by the U.S. Govern-ment of Iranian assets. However,despite domestic political riskthreats such as this, most busi-nesses are much more concernedabout political risks initiated byforeign governments.

In theory, whenever a businesssuffers a loss due to the occur-rence of a political risk, it canreceive compensation from thatforeign government. However,most countries have adopted theidea of "sovereign immunity." Thisdoctrine asserts that a governmentis not liable for its actions in courteither in that nation or abroad,unless the government submitsvoluntarily to any such lawsuit. Itis easy to understand why notmany business executives areeager to discover the limits of thislegal doctrine. Therefore, mostcompanies prefer to avoid politi-cal risks when possible by insuringagainst that class of risk.

Insuring against political risks

There are several methods foravoiding political risks, dependingon what type of transaction is in-volved.

Investments: The OverseasPrivate Investment Corporation(OPIC), a U.S. Government agen-cy, provides political risk in-surance and loan guaranteeprograms to facilitate U.S. privateinvestment in some less-developednations. To qualify for OPIC in-surance, investors must meet cer-tain eligibility requirements.Interested investors should con-tact OPIC's offices in Washingtonto apply for its programs.

Foreign sales: The ForeignCredit Insurance Association(FCIA) offers political risk in-surance policies to protect ex-porters from foreign governmentintervention in selling theirproducts/services abroad. Typical-ly, FCIA coverage is short -term innature, usually 180 days or less,occasionally up to one year. TheFCIA "New to Export," "Umbrel-la," "Short-Term Single Buyer,""Medium-Term Single Buyer,""Financial Institution BuyerCredit" and FCIA "Lease" in-surance policies offer 100% politi-cal risks protection, as well as90% or more commercial riskscoverage. FCIA "Bank Letter ofCredit" insurance policies areavailable to approved commercialbanking institutions in the UnitedStates to insure against bothpolitical and commercial risks.Coverage under the Letter ofCredit policy is 100% protectionwith sovereign banks, 98% for

Wisconsin International Trade -May/June 1991

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bulk agricultural sales, and 95%for all other banks and sales.

The FCIA Multi-Buyer In-surance Policy offers two coverageoptions. First, 100% coverage forpolitical risks is available, but onlyif commercial risk is limited to90% coverage and a deductible isincluded for commercial risks.The second option provides for upto 95% cover for commercialrisks, but limits political riskscoverage to a maximum of 95%.Past 180 days, however, both com-mercial and political risks drop to90%. AIG, a New York private in-surance company, also offerssimilar short-term coverageagainst political risks.

For medium- and long-termcoverage, exporters should con-sider the Export-Import Bank ofthe United States (Eximbank),another U.S. government agency.Eximbank offers a guarantee ofrepayment on 85% of the value ofan export transaction, either inU.S. dollars or in readily convert-ible foreign currencies. After adownpayment of 15%, medium-term (implying a loan of $10 mil-lion or less and repayment termsof one to seven years) coveragewould guard against 100% of thepolitical risk and 98% of the com-mercial risk. For long-termobligations (defmed as having aloan amount of greater than $10million or a repayment term ofgreater than seven years), the Ex-imbank guarantee may extend to100% of both political and com-mercial risks, after a 15% cashdownpayment.

Eximbank also offers a "Politi-cal Risks Only" guarantee, cover-ing only political risks ofnonpayment of principal in trans-actions with private or non-sovereign public buyers. Anonsovereign public buyer is agovernment -owned or controlledentity which does not carry the"full faith and credit" of the con-

trolling government. Thus itsobligations are not fully backed bythe guarantee of a sovereignpublic entity. In cases where theU.S. exporter is related to theforeign purchaser, this may be theonly type of guarantee Eximbankis willing to offer.

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No matter what type of Exim-bank guarantee is sought,coverage of interest charged onthe loan is not covered 100%automatically. Normally, Exim-bank covers interest on fIXed-rateloans at the lesser of the rate onthe note, minus 50 basis points(112%), or the Treasury rate at thetime of the loan plus 50 basispoints. For floating rates, Exim-bank uses a similar formula todecide coverage.

Legal problems associated withpolitical risk coverage

Debate concerning thecoverage of political risk in-surance generally occurs in twoareas : (1) exchange availabilityversus devaluation in currency,and (2) the issue of causation.

Exchange availability: The onepolitical risk that businesses mostoften confront is that of foreignexchange availability, sometimesreferred to as "transfer risk."Transfer risk occurs when the ap-propriate government authority

Wisconsin International Trade -May/June 1991

fails to transfer (or allow thetransfer ot) a buyer's qualifyinglocal currency deposit into U.S.dollars. Under Eximbank guaran-tees, any default due to the failureof the buyer to make the local cur-rency deposit within 90 days of thedue date is considered a commer-cial risk -- not a political risk.

Causation: Whenever agovernment does not directly in-tervene in the operations of asingle business, but, for example,drafts new regulations broadly, toaffect an entire industry, it be-comes more problematic todeclare that an insured politicalrisk has occurred. For instance, anew tax on newsprint leviedagainst all newspapers in thecountry is probably not govern-ment intervention in one par-ticular business. But, if there wereon~ one newspaper in the.country, the new regulation wouldbegin to look a lot like direct in-terference in that company.

As an additional example, it islikely to be argued in the comingmonths that the U.S. Government,via its policies in the Middle East,"caused" many Iraqi businesses tolose their access to credit. Indeedthe purpose of the U.S. policy wasto cut off funds to Iraq for politi-cal reasons. Thus, it will be ar-gued that the non-payment ofdebts owed by private entities inIraq was a foreseeable conse-quence of the U.S. Government'spolicy in the region. Of course theU.S. Government's response willlikely be that it did not directlyprevent any single entity fromrepaying its debt. In the end,though, for this event or any eventto be considered an occurrence ofan insured political risk, thepolicyholder has to show that thegovernment's action constituted acovered political risk, and that thisevent caused the loss in question.Continued on page 27

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you--baggage handling, groundtransportation, local multi-lingualguides, changes in air carrier rout-ing, classification upgrades, etc.Non-business group dinners andoutings which try to capture thetrue cultural flavor of the countryare also within the scope of thetravel assistants. The 1990 Asianmission had a number of fIrst-timePacifIc Rim travelers, all of whomexpressed their appreciation athaving someone available to worryabout the details. Group dinnersat Happoen in Tokyo, an authen-tic Mongolian barbecue, a guidedtour of Snake Alley in Taipei, anda dinner cruise on Singapore Har-bor can certainly contribute to theenjoyment of any business trip.

. Proximity

Although the telefax machinehas become one of the most im-portant pieces of equipment inany international business opera-tion, there still is nothing likebeing there. One of my calls wascorrective in nature. Being able tosit across a table and present myconcerns and receive real-timeresponses from my counterpart ismore valuable than 50 fax trans-missions.

Picture the scenario of walkinginto a group appointment at TheSingapore Manufacturers' As-sociation, an organization similarto Wisconsin Manufacturers andCommerce. In the hall were per-haps 100 Singaporeans. We tookthe group to be a number of inter-ested on-lookers of our meeting.However, they were all buyers!All had been given advance wordof our visit, our products and ser-vices, and all had "shopping lists."We were literally inundated withSingaporeans looking to buy ourproducts or talk about investmentpossibilities. When we broke intogroups, I had six individuals wait.ing to talk to me about distribu-

tion of my product lines in Sin.gapore and neighboring areas. Ofcourse, you would be able to setsomething like that up on you ownfrom thousands of milesaway wouldn't you??

Enough said. As a small Wis-consin business we have benefItedfrom our pa,rticipation in the trademission program. Working withthe Governor and DOD staff hadbeen a real pleasure for us inevery facet. Is participation costeffective? I believe so. In the twoAsian missions we have accom-panied, both have yielded long-term sales far in excess of theactual costs of the trips. I stronglysuggest that when the nextbrochure comes along announcinga state-sponsored trade and in-vestment mission, give it morethan the obligatory 10 secondglance before it sails into thewastebasket. Small business orlarge, the opportunities are avail-able, and the Department ofDevelopment may be just thevehicle to get you there--to SnakeAlley and back again, that is.

The next Wisconsin Trade and

Investment Mission to be led byGovernor Tommy G. Thompsonwill be to Toronto and Montreal,Canada, September 8-12, 1991.Details are available from theDepartment of Development attelephone (608) 266-1480 or telefax(608) 266-5551.

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Political risk cont. from page 9

For further information, con-tact:

Eximbank811 Vermont Avenue, N.W.Washington, D.C. 20571Telephone: (800) 424-5201or (202) 566-8990

Wisconsin International Trade -May/June 1991

FCIA40 Rector Street, 11th FloorNew York, NY 10006Telephone: (212) 306-5000or (212) 513-4707

OPICInformation Officer112920th Street, N.W.Washington, D.C. 20527Telephone: (800) 424-0PIC

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Costa Rica cont. from page 19

With a stable democraticgovernment, a well-educatedpopulation, and a well-developedinfrastructure of communications,electricity, and transportation,Costa Rica also offers one of thebest investment climates in theCaribbean basin. The Govern-ment of Costa Rica maintains apositive attitude toward foreigninvestment, and is especially inter-ested in agroindustry and specialtyagriculture. Food processing,light assembly operations, andother labor intensive activities alsooffer attractive investment oppor-tunities. There are no legal profItor repatriation restrictions or jointventure regulations that couldpresent barriers to direct foreigninvestment in Costa Rica.

For further information aboutexporting to Costa Rica, contact:

Bureau of InternationalDevelopment

Wisconsin Department ofDevelopment123 W. Washington AvenueP.O. Box 7970Madison, WI 53707Telephone: 608/266-1480Telefax: 6081266-5551

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