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Although commercial risks such as non-payment and bankruptcy have been causing the greatest headaches for those investing in the emerging markets in recent months, a new report has suggested that political risks are still a high priority.

The report has been released by the World Bank’s Multilateral Investment Guarantee Agency (Miga) and suggests that as foreign direct investment in emerging markets begins to increase post-crisis, the need to mitigate political risks will rise. According to Miga, political risk currently ranks as one of the top three concerns among investors, causing more angst than issues surrounding macroeconomic stability and access to financing.

“Even before the economic crisis hit, issues such as resource nationalism, the increased prominence of sub-sovereign entities and concerns about political violence were on the minds of investors,” explains Izumi Kobayashi, Miga’s executive vice-president.

“The economic crisis has further exacerbated concerns over the ability to convert and transfer currency, especially in countries where the crisis has severely undermined liquidity,” she adds.

With this trend in mind, the report suggests that interest in political risk insurance will grow. This type of risk mitigation was historically used for only a small proportion of foreign direct investment, with only 14% of those surveyed saying they used political risk insurance (PRI), although at least twice this number used it when entering the riskiest markets. However, 40% of the respondents have now said they would consider using insurance in the future.

The industry itself is relatively strong despite the financial downturn. The number of claims has not as yet been as high as expected and both private and public insurers have reported relatively strong financial figures, despite a decline in new business streams.
The emerging markets are also demonstrating some resilience compared to the developed world. While the economies of their industrialised neighbours are expected to contract by 3.2% in 2009, developing countries’ GDP is still expected to grow by 1.2%, states Miga’s report.

The multilateral’s survey also reveals how the growth in the number of emerging market or south-based investors is beginning to shape the market for PRI. Between 2003 and 2008, FDI outflows from developing countries into other emerging countries increased more than eight times, reaching an estimated US$198bn in 2008, of which 73% came from BRIC countries.

The share of south-based insurers in the Berne Union (the association for both public and private insurers) members’ new business increased from 2.5% in 2005 to over 9.1% in 2008.

Traditionally, emerging market investors would tend to use more informal methods of mitigating political risk rather than take out insurance. Such methods would include engaging with local governments and setting up joint ventures.

Yet, Miga reports that over half of those surveyed, and particularly those in China and India, would consider PRI as an option in the future, presenting vast opportunities for the PRI industry to adapt and increase the scope of their insurance products to a new market.
“At Miga we’ve seen a substantial growth in south-based investors in our existing portfolio and our pipeline,” comments James Bond, Miga’s chief operating officer.

“The PRI industry is adapting to these needs by tailoring its products, such as shariah-compliant insurance.”
The report was launched in London in December at a Financial Times summit on managing global political risk.