(a)        Introduction

MDBs are institutions such as the World Bank, African Development Bank and the European Bank for Reconstruction and Development or other of the international agencies established to assist in the development of economies. MDBs will support governments in the development of projects through risk mitigation products such as political risk cover, or in other ways (e.g. direct lending, providing funds for government support).

DFIs are bilateral, regional or multilateral institutions that are supported by developed countries with a mandate to provide finance to private sector participants to promote economic growth and support social development. These are institutions such as the International Finance Corporation and European Investment Bank.

ECAs are institutions (often public or quasi-public) that provide government backed support (loans, guarantees and insurance) to encourage the export of goods from their home country. For example, JBIC (the Japanese ECA) may lend to a PPP project for the supply of Japanese built trains.

These institutions play a vital role in securing the required funding for infrastructure projects in emerging markets. They are catalytic, attracting further private investment from commercial banks.

The involvement of these types of entity is advantageous in project finance transactions for a number of reasons:

(i)         their interest rates are generally lower than those of commercial banks and the tenor of the loan may be longer;

(ii)        they may be able to lend to projects which commercial banks cannot;

(iii)       the presence of one of these institutions may attract further private finance from commercial banks because of:

(A)       the nature of the support e.g. guarantees given to commercial banks covering all or part of their loan; and/or

(B)       indirectly, because their involvement engenders confidence in other potential lenders due to the expertise of these institutions in the project finance market; the political pressure that can be brought to bear on the government if any issues arise; or, in some cases, because of the preferential status that may be afforded to certain lenders by virtue of the involvement of these institutions (e.g. mitigating transfer and convertibility risk in the event of a foreign exchange crisis).

A full examination of these institutions and the support they provide is outside the scope of this guide but we will briefly look at political risk mitigation products below, which feature in African infrastructure PPP projects.

(b)        Political risk

Commercial risk is the inability of a borrower to meet its payment obligations due to performance issues with the project or if an offtaker has become insolvent.

Political risk is the failure of a borrower to meet its payment obligations because of the actions of the government or because of war or civil unrest in the jurisdiction of the project. Political risks typically include:

(i)         damage or destruction of assets, business interruption or forced abandonment of a project resulting from events such as war, revolution, insurrection, civil unrest, terrorism and sabotage;

(ii)        confiscation, expropriation, nationalisation (CEN) and other acts by a government that deprive the project company of its fundamental rights to the concession, equipment or other assets. “Creeping expropriation” – a series of acts that ultimately have an expropriatory effect. Selective discrimination, forced divestiture, and losses arising from breach of contract by the government or the non-honouring of a government payment obligation under an off-take agreement or other commercial arrangement;

(iii)       currency inconvertibility and non-transferability – the inability to convert local proceeds to hard currency and repatriate the currency.

There is an element of political risk in any project financing, even projects in the UK, but the risk is likely to be greater in emerging markets jurisdictions. Political risk is an issue in project finance transactions because:

(i)         the project may be the first project of its kind in the country in a sector which was previously government controlled;

(ii)        the project is likely to require some form of governmental concession whether to transfer hard currency outside the host country or merely just to operate and, if this is revoked, the project will fail; and

(iii)       the project will be very important to a country’s infrastructure (roads, hospitals) or for security reasons (airport, port).

(c)        Mitigation

The lenders to the project will seek to mitigate the political risk inherent in a project. They can do this in a number of ways:

(i)         by including “stabilisation” provisions in the concession agreement (promises not to adversely change legislation or to indemnity the project company if adverse legislation is implemented);

(ii)        an undertaking from the central bank to ensure the availability of foreign exchange;

(iii)       political risk insurance provided by commercial insurers or from ECAs or MDBs (see further below), although this can be very expensive or not available to cover the relevant risk;

(iv)       rely on the involvement of MDBs, DFIs and ECAs as part of the lending group to exert political pressure if political risks materialise; and

(v)        include the government as a shareholder in the project company.

(d)        Political risk insurance

Political risk insurance (PRI) policies are insurance contracts that offer coverage for the “political risks” excluded under typical commercial insurance contracts. PRI provides coverage for investors making direct equity investments in projects and to those lending to emerging markets borrowers.

As with other insurance contracts the coverage trigger hinges on a loss occurrence connected with a specified insurance peril. Particularly in relation to political violence and CEN cover, it can be difficult to determine the trigger for a claim. How can the insured prove that a loss was directly caused by political violence?

PRI policies are bespoke and the definition of each peril will be different for each insurer. Likewise, the exclusions, deductions etc. will all depend on the nature of the project, the country, and other factors to be considered at the time of policy inception.