Despite political tensions, Sub-Saharan Africa’s rise as a hotspot for inward investment over the past decade continues apace. Roddy Barnett, political risk underwriter and Emma Whiteacre, country risk analyst at Lloyd’s underwriter Beazley examine the opportunities and threats impacting companies and investors and the protections available.
The Africa growth story is ever more compelling, and rising foreign investment is reflected in rising demand for political and credit risk cover. Despite the notable constraint of surplus capacity in the Lloyd’s insurance market, Beazley’s overall exposure to political and credit risks in Sub-Saharan Africa has risen by 40% in less than two years. A combination of factors is influencing this increase.
Economic activity burgeoning
In part it reflects the higher levels of economic activity in the region, which (before the outbreak of the ebola epidemic) saw net foreign direct investment (FDI) inflows increase by 9.3% in 2013, according to UNCTAD. But it also reflects companies’ rising appetite for participation in the exciting growth story and alongside that, their caution over the political and economic risks that are so present in the region. And as awareness among risk managers of the availability of tailored political and credit risk products continues to rise, more investors and traders are taking advantage of the opportunity to expand their business interests while offsetting risk.
The exploitation of Africa’s extensive natural resources – oil and gas, minerals, agricultural products – has historically been the primary driver of the continent’s strong foreign investment appeal. While this remains true, the economic development that has been engendered by rapid growth from these sectors, coupled with population growth and the rise of a new middle class, is creating greater demand for broader economic assets. These include everything from power generation, transmission and distribution facilities, through to advanced telecoms networks, transport infrastructure such as ports, roads, railways, bridges, airports – and burgeoning domestic consumer markets.
Consequently, political risk and trade credit insurance exposure in the region is increasingly diversified across industries. In addition to the heavy industry and natural resources staples of hydrocarbons and mining, other sectors that feature strongly include telecoms, utilities, construction, food distribution and consumer goods.
Current areas of demand for cover include, for example, capital intensive road-building projects in Ethiopia and Ghana, airports in Angola and Côte d’Ivoire, water treatment plants in Cameroon and Uganda, and telecoms infrastructure construction in Zambia and Zimbabwe.
Diversification is standard prudent risk management, and underwriters naturally seek to avoid hefty exposure concentrations, but such a broad swathe of activity is also indicative of unprecedented strong external participation in the development of local economies.
And these trends are certainly set to continue. The IMF’s most recent Regional Economic Outlook for Sub-Saharan Africa finds that for most countries, infrastructure investment remains predominantly financed domestically. But, as the report notes, and Beazley’s own book corroborates, foreign investment inflows are becoming increasingly important. Moreover, the imperative for greater private investment – following the successful model of the telecoms industry – could lead to greater liberalisation of typically state-dominated sectors. Many an inefficient state monopoly across the region that survives only by virtue of its absolute centrality to the functioning of the economy could attract huge and transformative interest from foreign investors under the right conditions.
Political risks remain substantial
The political risk environment, however, is, in many places, on a less positive trajectory. Caution remains the watchword among financiers and contractors as recent history illustrates the challenges of operating in the region. For example, investors have been burnt by high-profile government expropriations of mining concessions in the Democratic Republic of Congo and Guinea, strikes at South Africa’s platinum mines, and large accumulations of unpaid obligations by state-owned entities to their suppliers in Nigeria, Cameroon and Côte d’Ivoire. These are exactly the kind of problems that encouraged the market to develop political risk cover back in the 1970s.
Broader political and economic developments have, on occasion, been similarly discouraging, exposing investors to greater potential political violence-related losses, sovereign credit weakness and contract cancellations. 2014’s economic crisis in Ghana resulted in capital controls that raised currency inconvertibility and transfer risks. The recently-concluded rebel insurgency in Mozambique has made the operating environment unpredictable.
Likewise the post-election violence in Kenya and Côte d’Ivoire created huge problems for exporters of these countries’ agricultural produce. Coups in Mali, Niger and Burkina Faso further substantiate an image of instability across the region. The death of President Sata in Zambia left the country in a state of limbo for some time, but succession risk will be felt even more acutely in authoritarian regimes such as Angola, Sudan, Zimbabwe, Cameroon, Uganda and Equatorial Guinea, where power struggles and business environment turmoil are almost inevitable following the death of their long-standing leaders.
Companies would not be able to contemplate investment in such volatile environments were it not for the financial safety net offered by political and trade credit risk insurance.
The cover available to mitigate such risks varies according to the specifics of a deal. Insurance can be offered against, for example, the risk that contracts are disrupted by unforeseen government action or that physical assets are expropriated or put beyond use by government action. Protection can also be bought to mitigate the risk that operations are decimated or stocks spoiled by acts of terrorism, industrial action or civil unrest. Many companies also seek protection against the imposition of capital controls that would prevent the repatriation of profits, or look to offset concerns regarding the repayment of financing, failure by governments to meet their payment obligations or that trade credit or delivery commitments sour.
Generally speaking, these are relatively long-tail – unlikely, but devastating – risks. The impact of any one of them could be enough to entirely scupper a project or bankrupt a company, in the absence of the critical financial backstop of an insurance policy. And there are plenty of claims from the region in the market that attest to the need.
Underwriters must be selective
Inevitably, then, underwriters are selective in the risks they take. Insuring activities that are ill-conceived or politically toxic is in no-one’s interests and typically this is the first test that insurers apply. Enabling such projects to happen against, for example, the best interests of the local population, is only likely to breed civil unrest down the line – contrary to the interests of the country, investors and insurers too.
Upon passing an initial, intuitive “does this deal make sense?” test, underwriters and analysts submit any request for cover to a process of due diligence. Given the non-uniformity of these kinds of transactions and contracts, there will always be a laser focus on developing a clear understanding of what’s involved. Underwriters will seek to understand the creditworthiness and political exposure of an obligor, its track record, the location of the risk, the obligations entailed, the flows of goods, services, money, the key relationships and the level of government involvement, if any.
The result of this due diligence means that gaps will inevitably arise between what investors would like covered and what insurers are able to cover. Figures 1 and 2 show Beazley activity “heat maps” contrasting political risk and trade credit enquiries against exposures underwritten in 2014. Angola, South Africa and Côte d’Ivoire currently have the greatest level of exposure, and the map illustrates just how broad-based demand – and our appetite – for cover is across the region. In fact, the Central African Republic, Swaziland and Somalia are the only countries in the region with no current exposure. On the enquiry front, the countries we have seen most enquiries for in 2014 are Nigeria, Ghana, Côte d’Ivoire and Angola. Ethiopia and Cameroon also feature high up on the list.
Information is improving
Our experience in providing cover right across the region and our expertise in interpreting events and understanding their implications enables us to make sound judgements – on the whole – but in this region nothing is straightforward.
The availability of data on political, economic and business activity in Sub-Saharan Africa, particularly in the smaller countries, has tended to be quite limited. However, this is gradually changing as greater internet penetration and, again, the incentives of investment, are driving local research, quality journalism, informed activism and the collection of data series that conform to global standards.
Once the initial due diligence is successfully completed, usually, investors’ and traders’ own experience and information are sufficient to enable underwriters to get comfortable with new risks, and for this reason, long-standing relationships can be reassuring. But occasionally, in cases of particular complexity or financial significance, underwriters conduct their own due diligence visits to assess a risk in greater detail. Crucially, the terms of the policy act as in-built risk mitigants by holding insured agents to high standards of disclosure and legal compliance, and promoting good governance and corporate behaviour, to minimise the risk of losses arising from the actions of the company being insured.
Risk is always risky
Of course, even the most exacting risk assessments cannot preclude the forces majeures and popular uprisings of the world. And for that reason insurers take great care to manage their exposures. On an aggregated basis, exposures to countries and to individual obligors are monitored and limited, to prevent systemic risk. Needless to say, insurers’ own credibility and financial stability – and hence ability to provide the service they do – are predicated upon conservative loss ratios and prudent exposure management.
The provision of political risk insurance is not a charitable exercise, but when circumstances are right it serves to facilitate economic development by supporting important trade and investment projects that might otherwise never get off the ground. In Sub-Saharan Africa, such provision is particularly significant, as investment into infrastructure is central to support sustainable economic growth, and local economies tend to lack the capacity and capital to drive the necessary investment forward.
At Beazley we have great hopes that the region can continue to make progress towards achieving its enormous potential – its domestically-generated potential, not just the allure of its exceptional natural resources endowment. Infrastructure, undoubtedly, will be an ever more important investment theme for the region. So too will a move up the value chain through resources processing, and the rise of intra-regional trade. Painful setbacks will occur, undoubtedly, but the overall momentum will be positive.