How to protect my company from political risks?

By November 23, 2018 Law, Trade News
Mapa riesgos politicos- Dos Aguas Blog

Political instability in a country has a direct impact on its trade. In recent years, there have been many elements that have affected trade relations at an international level. As a consequence, global trade protectionism has increased and the position that the President of the United States has been defending has marked a wake of uncertainty in global markets. In Europe, the UK’s negotiations to leave the European Union continue to appear on the region’s political-risk scenario. Likewise, as the negotiations continue, the risk of the UK leaving without a satisfactory agreement increases, and companies may need to be prepared for such an event.

Political risk is defined as the risk arising from the political and economic circumstances of the country with trade interests. In this way, the level of political risk will vary depending on the country. This risk is mainly caused by the political measures of the country’s authorities, which may affect the ability of its residents to carry out transactions, or even to breach the contract.[1] This situation raises the question, how to act in the face of a political risk?

From a business point of view, the types of action against these risks are classified into two different models: active and non-active.

Active modes of action

Active action implies, for example, hiring export credit insurance. This instrument is a hedging mechanism that protects exporters against both ordinary and extraordinary risks arising from international trade. They shall, therefore, be compensated for the damage caused by events which may impede the collection or recovery of credits agreed abroad. For example, in Spain, the Spanish Company of Export Credit Insurance (in Spanish, Compañía Española de Seguros de Crédito a la Exportación-CESCE) offers a wide range of products that enable companies to cover the political and commercial risks they have in their business operations and international investment (export operations, sales on the domestic market, foreign investment, resolution of contracts, work abroad, implementation of securities clearing operations, etc). CESCE covers the short-term commercial risks, both inside and outside Spain, as well as the state long-term commercial and political risks in all its periods, in relation to the external activity of the companies.[2]

Another instrument to take into consideration is forfaiting operations which is a modality of export financing, that consists of the commercial discount that the exporter receives to implement the deferred payment of commercial purchase/sale operations. These are instruments that are likely to be financed such as letters and promissory notes, both with the endorsement of front-line banks. The time allowed is usually between 6 months and 5 years.[3] The virtuality of this instrument is that it implies the assurance of the collection of the export by the exporter.[4]

Non-active modes of action

The non-active mode of action is the observance and analysis of the country risk, that is to say, the study of the country’s qualification with regard to its political risk. Thus, the types of risks to be analyzed are the following:

  • Sovereign risk. The risk of the creditors of the States or of entities guaranteed by them, since any legal action against the borrower could be ineffective.
  • Transfer risk. This is the risk that foreign creditors have against residents in a country when they unable to cope with their debts because they do not have enough currencies for that debt.
  • Risks arising from the international financial activity. These are the risks that can be covered by the export credit insurance.[5]

It must be pointed out that this analysis will always depend on the institution that performs it and the variables that it uses. For example, after the economic crisis of 2008 and the fall of Lehman Brothers (which had obtained the highest qualification), these agencies suffered a great loss of credibility and proved that they may not work as an instrument against the risk generated by Economic and/or political instabilities.

However, beyond big companies, there are also other companies and agencies that are dedicated to the analysis and localization of political risks such as MARSH, which makes a map and detailed study of all countries worldwide. Here we can see the map of the year 2018:

https://www.dosaguasconsulting.com/wp-content/uploads/2018/11/Political-risk-index-MARSH-Dos Aguas Blog

Source: MARSH

In conclusion, these instruments are useful for identifying and mitigating the effects of political risks on international trade operations, and for providing security in our international activities. Do you have any doubts? Don’t hesitate to contact us!

Sources:

[1] Guillermo Rivas-Plata Sierra et al.  (2008) ¿Cómo operar en el Comercio Internacional?, Agroleader+, page: 79. Available online (link) [Last accessed: 22.11.2018]

[2] Ministerio de Industria, Comercio y Turismo (2018) Cobertura por cuenta del Estado de los riesgos de la internacionalización de la economía española: CESCE, Gobierno de España’s website. Available online (link) [Last accessed: 22.11.2018]

[3] Fermín Pérez Aguilera (2017) Manual. Puesta en marcha y financiación de pequeños negocios o microempresas, Editorial CEP, page:91.

[4] Consejo Superior de Cámaras de Comercio. Plan Cameral de las Exportaciones (2018) ¿Qué es el Forfaiting?, Cámaras’ website. Available online (link) [Last accessed: 22.11.2018]

[5] Consejo Superior de Cámaras de Comercio. Plan Cameral de las Exportaciones (2018) ¿Cuáles son los instrumentos de cobertura del riesgo político y comercial?, Cámaras’ website. Available online (link) [Last accessed: 22.11.2018]

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