political risk is a type of risk faced by investors

8/8/2019 Political Risk is a Type of Risk Faced by Investors

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overall suitability of a destination for investment. Moreover, these events pose risks that

can alter the way a foreign government must conduct its affairs as well.

Research has shown that macro-level indicators can be quantified and modeled like othertypes of risk. For example, Eurasia Group produces a political risk index which

incorporates four distinct categories of sub-risk into a calculation of macro-level politicalstability. This Global Political Risk Index can be found in publications like The

Economist.[5] Other companies which offer publications on macro-level political riskinclude Business Monitor International, Economist Intelligence Unit, and Political Risk

Services.

Micro-Level Political Risk

Micro-level political risks are project-specific risks. An examination of these types ofpolitical risks might look at how the local political climate in a given region may impact a

business endeavor. This type of risk includes project-specific government review (such as

the Committee on Foreign Investment in the US (CFIUS) process in the United States),the selection of dangerous local partners with political power, and

expropriation/nationalization of projects and assets.

To extend the CFIUS example above, imagine a Chinese company wished to purchase a

US weapons component producer. A micro-level political risk report might include a fullanalysis of the CFIUS regulatory climate as it directly relates to project components and

structuring, as well as analysis of congressional climate and public opinion in the US

toward such a deal. This type of analysis can prove crucial in the decision-makingprocess of a company assessing whether to pursue such a deal. For instance, Dubai Ports

World suffered significant public relations damage from its attempt to purchase the US

port operations of P&O, which might have been avoided with more clear understandingof the US climate at the time.

Political risk is also relevant for government project decision-making, whereby

government initiatives (be they diplomatic or military or other) may be complicated as a

result of political risk. Whereas political risk for business may involve understanding thehost government and how its actions and attitudes can impact a business initiative,

government political risk analysis requires a keen understanding of politics and policy

that includes both the client government as well as the host government of the activity.

Political Risk MitigationCompanies may have a Chief Risk Officerwho is charged with managing political risk

or, in many cases, this job falls to theChief Financial Officer.

At the macro-level, political risk mitigation largely involves understanding political

uncertainties of the operating environment and the risks faced by all business operationsin individual countries. Such information can come in the form of customized analysis or
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in-depth subject matter reporting; information that can enable an investor or firm to

calibrate their risk appetite. Mitigation tactics involve both macro- and micro-level

strategies. A recent article on the subject suggested that political risk mitigation shouldnot simply revolve around the decision to enter or avoid a given countrys marketplace,

but should rather center on the pragmatic usage of contingency planning, intellectual

property safeguards, risk diversification, and sound exit planning to guard againstuncertainty.[6]

At the micro-level, political risk insurance and hedges play a larger role. MIGA and

OPIC provide project-specific political risk insurance. This type of insurance usually

outlines specific triggers, such as expropriation or breach of contract by a local party,which entitle the insured entity to a pay-out after relinquishing control of the insured

project to the insurer. Political risk insurance, however, often involves premiums which

must factor in considerable uncertainty and the threat that arbitrary decisions will affectthe value of insured property. Policies therefore can often be very expensive. Businesses

can also purchase hedges, which could be derivative instruments, which allow them to

reduce risk by selecting a level of return based on a given set of outcomes.

Political risk mitigation takes place before, during, and after an investment. Prior toinvestment, businesses can perform due diligence related to local partners and carefully

word and structure their contracts. While a project is on-going, the investor may benefit

from building local political leverage through community activities. After a risk has beenrealized, its effects may be mitigated through post-hoc litigation and retaliation, as well

as the implementation of a previously developed contingency plan, or exit from the

market.

References

Extended Bibliography

1. Ian Bremmer, Managing Risk in an Unstable World, Harvard Business Review, June

2005

2. Ephraim Clark & Radu Tunaru, The Evolution of International Political Risk 1956-

2001, http://econpapers.repec.org/paper/mmfmmfc05/37.htm

3. Eurasia Group and PricewaterhouseCoopers, Integrating Political Risk Into Enterprise

Risk Management,

http://www.pwc.com/Extweb/onlineforms.nsf/docid/F44B471C9D848314852570FF0069

BBCA?opendocument

4. Llewellyn D. Howell, The Handbook of Country and Political Risk Analysis, ThirdEdition, PRS Group, 2002
http://www.answers.com/topic/political-risk-1#cite_note-5http://www.answers.com/topic/multilateral-investment-guarantee-agencyhttp://www.answers.com/topic/overseas-private-investment-corporation-1http://www.answers.com/topic/political-risk-insurancehttp://econpapers.repec.org/paper/mmfmmfc05/37.htmhttp://www.pwc.com/Extweb/onlineforms.nsf/docid/F44B471C9D848314852570FF0069BBCA?opendocumenthttp://www.pwc.com/Extweb/onlineforms.nsf/docid/F44B471C9D848314852570FF0069BBCA?opendocumenthttp://www.answers.com/topic/political-risk-1#cite_note-5http://www.answers.com/topic/multilateral-investment-guarantee-agencyhttp://www.answers.com/topic/overseas-private-investment-corporation-1http://www.answers.com/topic/political-risk-insurancehttp://econpapers.repec.org/paper/mmfmmfc05/37.htmhttp://www.pwc.com/Extweb/onlineforms.nsf/docid/F44B471C9D848314852570FF0069BBCA?opendocumenthttp://www.pwc.com/Extweb/onlineforms.nsf/docid/F44B471C9D848314852570FF0069BBCA?opendocument


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5. Nathan Jensen Measuring Risk: Political Risk Insurance Premiums and Domestic

Political Institutions, Washington University,

http://www.sscnet.ucla.edu/polisci/cpworkshop/papers/Jensen.pdf

6. Martin Lindeberg and Staffan Mrndal, Managing Political RiskA ContextualApproach,

http://www.diva-portal.org/diva/getDocument?urn_nbn_se_liu_diva-1029-1__fulltext.pdf

7. Theodore H. Moran ed., International Political Risk Management: Exploring New

Frontiers (IBRD: Washington, 2001, pg. 213-214) Jeffrey D. Simon, A TheoreticalPerspective on Political Risk, Journal of International Business Studies, Vol. 15, No. 3.

(Winter, 1984), pp. 123-143.

8. Guy Leopold Kamga Wafo, Political Risk and Foreign Direct Investment, Faculty of

Economics and Statistics, University of Konstanz, 1998, http://www.ub.uni-konstanz.de/kops/volltexte/1999/161/

Footnotes

1. ^ Eurasia Group and PricewaterhouseCoopers, Integrating Political Risk Into

Enterprise Risk Management,

2. http://www.pwc.com/Extweb/onlineforms.nsf/docid/F44B471C9D848314852570FF0069BBCA?opendocument

3. ^ Kennedy, C. (1988): Political Risk Management: A Portfolio Planning Model,

Business Horizons, Vol. 31, p.21

4. ^ Ian Bremmer, How to Calculate Political Risk, Inc. Magazine, April 2007, p.101

5. ^ Ephraim Clark, Valuing political risk, Journal of International Money, andFinance, Vol. 16, No. 3, 1997, 484-485; Stefan H. Robock, "Political Risk:

Identification and Assessment." Columbia Journal of World Business, July-

August 1971, pp. 6-20; and Stephen J. Kobrin Political Risk: A Review and

Reconsideration, Journal of International Business Studies, Vol. 10, No. 1(Spring - Summer, 1979), pp. 67-80.

6. ^ Rolling with the Punches, Economist, October 1, 2007

http://www.economist.com/displaystory.cfm?story_id=9890890 (accessed05/06/2008)

7. ^ Ian Bremmerand Fareed Zakaria, Hedging Political Risk in China, HarvardBusiness Review84, no. 11 (2006)
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