Companies operating in conflict-affected states face a host of entrenched and interconnected risks, from direct security threats to personnel and assets, to those rising from an unpredictable legal and regulatory environment, including extreme levels of corruption, writes Charlotte Ingham, principal political risk analyst at Maplecroft.
Many of the world’s leading growth economies suffer from high levels of political instability and political violence. For example, Nigeria, Colombia, the Philippines and India are all categorised as ‘extreme risk’ in Maplecroft’s Political Violence Index (which assesses a combination of conflict and political violence, terrorism and human security risks). It is therefore essential that businesses develop robust risk management systems so that they can operate effectively in these key markets.
KEY POLITICAL RISKS
The first step in navigating risks in conflict-affected states is to identify the key challenges facing business operations in these countries.
1. Persistent risk of political violence, including armed conflict, terrorism and civil unrest
The most obvious risk facing investors operating in conflict-affected states is violence, which presents companies with a host of operational, legal and reputational challenges. Conflict is a key component of the overall political risk environment. Indeed, of the 10 highest-risk countries in Maplecroft’s Political Risk (Dynamic) Index 2014-Q3, eight of these countries were categorised as among the highest risk in the Political Violence Index. These are: Iraq (1st out of 197 countries in the Political Violence Index, where 1 is the highest risk), Syria (2), Afghanistan (3), Somalia (4), Yemen (6), Libya (7), Central African Republic (9) and Sudan (10). See figure 1, above.
The most pressing concern for companies operating in countries with high levels of political violence is to meet their duty of care to ensure the physical safety of their personnel. Risks to employees may emanate from them being inadvertently caught up in the violence, such as that which occurred in the Upper Nile region of South Sudan in February 2014, necessitating the evacuation of staff from the China National Petroleum Corp, India’s Oil and Natural Gas Corp and Petroliam Nasional Bhd.
Foreign workers may also be the direct targets of political violence, particularly terrorism, as areas frequented by expatriates, or indeed the facilities of international companies, represent high-profile targets for militants. The attack on the In Amenas gas facility in Algeria in January 2013, in which 39 foreign workers were killed, was the most high-profile example of such an act of terrorism in recent years.
Beyond the security of personnel, the risk to assets can incur significant cost to business operations. This cost is the result of the direct damage to assets and also interruption to a company’s own production and that of its suppliers. Disruption to key infrastructure as a result of political violence also creates a significant cost burden due to business disruption. Illustrating the latter, in June 2013 Rio Tinto was forced to temporarily suspend coal exports from Mozambique’s Tete province after Renamo militants threatened to disrupt the Sena railway line, the only track leading from the coal fields to the port of Beira.
Companies operating in countries with high and growing political violence risks – such as Nigeria, which, according to Maplecroft’s Terrorism and Security Dashboard saw almost 3,500 people reported killed in terrorist attacks in the period July 1, 2013 to June 30, 2014 – also face increased costs due to the need to make provisions for additional security, and elevated insurance premiums. Although the threat posed by militant group Boko Haram remains largely constrained to the north of the country, attacks in Abuja and Lagos in June 2014 demonstrate the ability of the group to carry out attacks in the central or southern regions of the country. These attacks, combined with the apparent inability of the Nigerian government to form a coherent strategy to address security risks throughout the country, are likely to lead to a further loss of investor confidence in addition to heightened security costs for the foreseeable future.
2. Legal and regulatory uncertainty will persist in the long term
Violent conflict has consequences far beyond the physical security of personnel and assets. Legal and regulatory uncertainty is one of the leading political risks characterising the business and investment environment in conflict and post-conflict states. Conflict seriously jeopardises the viability of long-term investment projects. Reflecting this, almost 90% of countries ranked ‘extreme risk’ or ‘high risk’ for political violence are similarly categorised in the Maplecroft’s Legal Regulatory Risk Index 2014. In particular, this presents significant challenges for the extractives sector – which, according to the World Bank, is one of the primary investors in conflict-affected states – as its investments are typically predicated on decades-long timelines. In particular, adverse government interventions, such as resource nationalism or the introduction of currency transfer restrictions, are a key source of concern for the sector.
Corruption risks are typically higher in conflict-affected states, due to a host of factors including the increased scarcity of goods and services, a breakdown in order, and a lack of enforcement capacity. Of the 37 countries categorised as ‘extreme’ or ‘high risk’ in Maplecroft’s Political Violence Index 2014-Q3, only Israel is categorised as ‘medium risk’ in the Corruption Risk Index 2014-Q3, with the remaining countries all assessed in the highest risk categories. Businesses operating in conflict-affected states generally face increased legal risks emanating from corruption, including demands for bribes from militias, the payment of which may further fuel the conflict, creating significant reputational risks in addition to the legal challenges. Even if local judicial capacity is insufficient to prosecute incidents of corruption, companies will face compliance obligations under extraterritorial anti-corruption legislation in their country of origin, such as the US Foreign Corrupt Practices Act or the UK Bribery Act.
3. Lack of infrastructure and skilled labour increases costs and constrains growth potential
A further characteristic of conflict and post-conflict states is the dearth of infrastructure, either as a result of a lack of initial development, or due to the destruction of roads, ports, hospitals and schools during the course of the violence, and the lack of investment to renovate or rebuild them. Illustrating this trend, 70% of countries categorised as ‘extreme’ or ‘high risk’ in the Political Violence Index are also assessed in the highest categories in Maplecroft’s Transport and Communications Index. This lack of infrastructure significantly increases operating costs for business both directly – as they put in place their own provisions to transport goods and people – and indirectly through the inflationary pressure it creates throughout their supply chain.
Businesses in conflict and post-conflict countries may also face operational constraints created by a lack of available skilled labour, due to the killing, wounding or displacement of people of working age, and also the long-term consequences due to the disruption to education.
4. Increased vulnerability to external shocks, including cross-border security risks, pandemics and natural hazards
Conflict-affected states are typically blighted by a mix of political violence, extremely poor governance, high levels of corruption, persistent regime instability and the risk of societal unrest.
These are combined with structural challenges such as the destruction of key infrastructure and the undermining of societal resilience. In addition to the internal challenges this creates, they are also extremely vulnerable to the destabilising impact of external shocks.
These cross-border shocks may take the form of pandemics and infectious disease, natural hazard events, regional or global economic crises or the spill-over of security risks, including the inflow of fighters and weapons due to porous borders. The latter is clearly evident in the Mena region in the wake of the Arab Spring, with the further destabilisation of Iraq (ranked highest risk in the Political Violence Index) due to the operations of the Islamic State militant group, illustrating the vulnerability of conflict affected states to external forces.
STEPS TO MITIGATING RISKS
It is possible for companies to operate in countries experiencing conflict or in a post-conflict state, provided that they manage risks proficiently.
1. Assessing risk at the sub-national, national and regional level
A key component of this process, beyond the initial risk assessment, is maintaining situational awareness through the continuous monitoring of events at sub-national, national and regional levels. The intensity of political violence, for example, typically varies significantly throughout a country. Therefore, companies should assess the risk posed in their specific area of operation and take steps to monitor them accordingly.
However, as the knock-on impact of the Arab Spring highlighted, it is also essential to assess the regional risk of conflict and instability. In particular, countries already afflicted by conflict are vulnerable to further destabilisation. This was aptly illustrated by the manner in which the conflict in Libya in 2011, which displaced fighters and weapons elsewhere into North Africa, contributed to the coup in Mali.
2. Sector-specific risk assessments
Key to mitigating the risk to a particular company is assessing the degree to which different sectors are exposed to political risks in varying degrees. The extractives sector for example may be comparatively less vulnerable to security risks than the manufacturing sector, as the operations of the former are typically localised, making the sub-national risk of political violence far more pertinent.
Extractives are also less reliant on local supply chains and labour, which, as outlined earlier on, are more vulnerable to the impact of conflict. However, despite these apparent advantages relative to other sectors, warring factions are likely to attempt to control the sites of extractive operations, as they can often be kept operable with relatively few workers and the output sold to further fund conflict. In addition, the scale and duration of extractives sector investments makes them more vulnerable than other sectors to legal and regulatory changes.
3. Monitoring structural risks to identify emerging risk hotspots
A key component of risk mitigation is the evaluation of the structural, long-term political risk environment, which can provide a leading indicator of the potential for conflict and unrest. By monitoring the development of these indicators, companies can take steps to limit their risk exposure should a country show signs of increased instability. Assessing the root causes of regime change in Ukraine in early 2014 provides insight into the role key structural risks can play in identifying emerging political risk hotspots. During the period 2011 to 2014, the undermining of civil and political rights and judicial independence and a significant increase in human rights violations by the security forces combined with ‘extreme risk’ levels of corruption contributed to the conditions conducive to the overthrow of the government of President Yanukovych.
Conversely, monitoring structural risks enables the identification of countries which are on a positive trajectory which presents significant opportunities