As populism threatens more protectionist trade policies and currency volatility and questions longstanding institutions and agreements from Nafta to Nato, investors and companies are preparing for the new face of today’s risk, writes Sarah Rundell.
Political risk insurance (PRI) is usually associated with safeguarding trade in emerging markets, where uncertainties like expropriation, political violence and sovereign debt default can endanger investment. But in recent months, demand for PRI has jumped in developed markets where the new Trump administration, the Brexit vote and the rise of populism in Europe pose new uncertainties for global trade.
“Across the board, people have underestimated political risk in developed markets because they have been more concerned about emerging markets. Yet political upheaval in developed markets, linked to populism, has created real uncertainty,” says Kade Spears, divisional head of specialty at The Channel Syndicate, who links a record number of enquiries and a spike in premiums in the first quarter of 2017 to general concerns about political risk. “Imagine the impact on trade if security in Europe was undermined by the rewriting of Nato. The risk isn’t immediate – it’s medium to long-term – but populism has created a unique set of circumstances and people are talking about redrawing or rewriting the rules of international engagement.”
Protecting against protectionism
During his campaign, US President Donald Trump threatened to impose 45% tariffs on Chinese imports, scrap important trade deals and introduce border taxes to reduce imports into the US, sounding alarm bells for cross-border trade. He has backed down from his original threat to tear up the North American Free Trade Agreement (Nafta) between Canada, the US and Mexico, but uncertainty about what a revised Nafta will look like is still fuelling demand for PRI. This is not surprising given that trade in goods among its three partners has more than trebled since the agreement took effect in 1994, with 14% of world trade in goods now taking place under its rules.
Mexican companies in particular are feeling the uncertainty, says Lila Rymer, head of US underwriting for credit and political risks at Beazley in New York, who reports “strong demand” across Beazley’s political and credit products such as expropriation risk and non-payment cover by government counter-parties and corporate entities.
“If Trump revises Nafta, will companies in Mexico that rely on the US export market adapt and survive? The risks we cover include future non-payment by Mexican companies,” she says.
Some 70% of Mexican exports go to America, and the US accounts for more than 50% of Mexican imports. Today’s uncertainty is putting pressure on specific industries such as Mexico’s car manufacturers, which President Trump has threatened with a 35% tariff. Head north, and Canadian exporters are facing similar unknowns, including a new duty of up to 24% recently slapped on Canadian lumber imports into the US.
As with Nafta, so too with Brexit. Uncertainty for UK-based businesses that benefit from trade with Europe means many are now mulling restructuring their supply chains to address potential disruptions to their manufacturing and retail operations. “The UK’s decision to leave the European Union has spiked uncertainty at home,” says Spears at The Channel Syndicate, which has a significant UK client base. “Many of our clients are proactively looking at ways to set up subsidiaries or branches in Europe in the event that there is no interim trade deal. We are hearing a lot of comments from clients with significant client bases in continental Europe that they need to be there to support them.”
Many of our clients are proactively looking at ways to set up subsidiaries or branches in Europe in the event that there is no interim trade deal. We are hearing a lot of comments from clients with significant client bases in continental Europe that they need to be there to support them.
Kade Spears, The Channel Syndicate
Protectionism in the US – or even the EU where some commentators predict that without the UK in the trading bloc, the protectionist instincts of some member states will come to the fore – will add fuel to the fire of broader economic nationalism. It has affected companies involved in cross-border trade with countries such as Russia, Turkey and India for a while. These governments may not share Trump’s particular brand of populism, but are nonetheless behind the rise in protectionism that experts believe is one of the contributing factors to the slowdown in global trade, forecast by the WTO to expand by just 2.4% in 2017, half of pre-financial crisis levels.
European agricultural exporters felt the sting of protectionism in 2014 when Russia banned a range of products including meat and dairy in response to sanctions over Ukraine. Valued at around €5.2bn, or 4% of overall EU agri-food exports, the ban left exporters looking for alternative markets and those with shipments already halfway to Russia facing losses.
“Companies stuck with shipments to Russia relied on political risk and credit insurance to cover those losses,” recalls Pierre Lamourelle, deputy global head of transactional cover at Euler Hermes, who says that demand for PRI cover rose by 25% in 2016.
He points to the emergence of 2,300 new “protectionist measures” over the last three years from ountries across the globe to protect local champions. Some of the measures include trade barriers like punitive taxes and quotas, and he names India, Brazil, Argentina and Turkey as regular offenders. But developed nations are increasingly in the mix.
“One in seven protectionist measures has beenimposed by the US . We have also found countries like Japan and the UK in there,” he says, quoting Euler Hermes economic research.
He also notices growing protectionism in services, as governments change licences and regulatory frameworks to favour their own industries. Here, Euler Hermes scores Indonesia, China, India, Russia and Brazil as the worst.
It all adds up to an environment that Andrew Underwood, regional product leader of political risk, credit and bond at XL Catlin, links to an uptick in demand for pre-shipment policies to cover risks that occur before goods are dispatched, ranging from a change in legislation, to an embargo or licence cancellation. Non-delivery policies that protect buyers who have paid in advance for goods and require insurance to cover policy changes affecting a delivery obligation are also on the rise, he says.
There is a risk that emerging markets might revert to nationalism. It could lead to a heightened number of expropriations.
Lila Rymer, Beazley
The number of insurance providers and insurance products is growing in response to changed demand. It reflects a growth trajectory that consultancy KPMG predicted last year, when it forecast that uncertainty would see the value of the global political risk and crisis management insurance market exceed US$10bn by 2018.
“We have increased our capabilities,” says Underwood, referencing XL Catlin’s decision to increase the headcount of its London underwriting team to eight, and boost the global headcount to 50. “We can now insure up to 20-year policies with a line of up to US$200mn dollars. It enables us to support more project finance transactions and, more importantly, offer the full spectrum of products across a wide range of countries and industries to our partners.”
It is an expansion that will particularly position the company to benefit from the growth in large-scale, longerduration infrastructure projects, a sector set for a boost under Trump’s US$1tn infrastructure promise.
Lamourelle at Euler Hermes notices an extension of the PRI covers on offer with the inclusion of propertylike covers such as business interruption or contingent business interruption to the traditional confiscation products. But identifying specific risks is becoming evenmore complex for insurers in riskier counterparty markets and, by extension, so is matching risks with products.
“It is a game of catch-up. We are seeing situations where it is no longer straightforward confiscation actions, but more forced abandonment and creeping expropriation often linked to protectionist measures where investors are being de-possessed of their assets. Or local governments are imposing higher taxes for foreign investors and reviewing agreements that have been put in place by former governments,” he says.
This ties in with Rymer’s observations that emerging markets might become more nationalist in “a trickle-down” response to nationalist policies in developed markets.
“We cover the expropriation and confiscation of US and European investments abroad, and there is a risk that emerging markets might revert to nationalism. It could lead to a heightened number of expropriations.”
Some insurers are warning of a spike in emerging market sovereign credit risk, and a jump in investor exposure to non-payment risk, as US multinationals invest more at home rather than overseas in line with US domestic policy. Carrots, like lower taxes, and sticks, like border charges hitting supply chains, are likely to see more US companies invest at home. Carmaker Ford, for one, cancelled a new plant in Mexico.
Couple this with massive domestic infrastructure opportunities and likely rises in US interest rates, and less money could flow to emerging markets. “If capital flows back to the US, emerging markets will suffer. Will governments and companies in such markets be able to pay and service their debt if there are changes in US interest rates?” asks Rymer.
Not just populism
It’s not just populism behind demand for PRI. The oil price is a key source of uncertainty. “What will the oil price look like in one year, five years or 10 years and how will this affect countries’ and companies’ ability to pay for projects and goods that they have committed to?” says Rymer.
Terrorist attacks in Europe are also adding to the climate of uncertainty and demand for insurance that goes beyond property damage to include business interruption.
In a 2016 report on the insurance market, KPMG found that the cost of business interruptions exceeded the bill for property damage in the wake of the Paris terrorist attacks. “Asset damage was limited whilst the estimated cost of business interruption, according to various economists, might reach US$12bn,” the report said.
Furthermore, PRI demand is being driven by banks. “Indeed, an increasing number of banks are also using insurance for capital relief purposes, on one-off transactions or developing a portfolio approach with insurers,” says Lamourelle.
So far, Trump’s rhetoric hasn’t been matched by policy in many areas. But the steady demand for political risk insurance and the spike in premiums speak to the uncertainty out there.
“My biggest concern is that the political establishment doesn’t listen to wider concerns about their policies, and populism gains ground. Macron won the French election but 35% of the population voted for Le Pen, and that is a significant threat to the establishment,” Spears says.