Political Risk Rises But Risk Experts, Insurers Face Crunch Too

November 11, 2008

Fear of conflict, instability, crime and increasing state intervention arising from the financial crisis might sound like good news for political risk consultancies that have sprung up in recent years — but in reality the industry is feeling the crunch, too.

Former diplomats, soldiers, politicians, spymasters and academics have all earned lucrative fees from companies and investors keen to protect their interests from terrorism, war and government seizure particularly in emerging markets.

“To an extent, bad news is good news for these guys,” said political risk specialist Theodore Moran, professor at Georgetown University.

But he warned the risk advisory and insurance industry was “like the froth on top of a wave,” and would suffer too.

While many believe the recent global markets collapse will increase political risk globally, investors have been fleeing those very same markets and enthusiasm or finance for ventures with any degree of risk has dropped sharply.

“A lot of the big mergers and acquisitions are simply no longer happening and hedge funds and financial houses are also cutting back on working in these markets,” said Richard Fenning, chief executive of London-based business risk consultancy Control Risks.

Financial firms made up around 10 percent of Control Risks 110 million pound a year business, he said. That’s far less than the mining and energy companies that made up around 20 percent, given their greater need for advice due to the volatile areas in which they work.

The fastest-growing area of the business, he said, was its fraud detection wing.

“It’s not because fraud itself is increasing,” he said. “It is more that when companies are pressured they start taking a closer look at the books.”

Facing a squeeze, some firms that had done their political risk consultancy in house were now outsourcing it to firms such as Control Risks, he said.

Some of the world’s largest banks and insurance companies have turned to those who were formally the world’s most powerful people to give them a steer on political trends and keep them ahead of the curve using their ongoing contacts.

NO RESTFUL RETIREMENT

Earlier this year, ex-British Prime Minister Tony Blair signed a lucrative deal to advise the board of U.S. bank JP Morgan as well as taking another role with the insurer Zurich.

Those from the shadowy world of intelligence gathering are also particularly in demand. Former British Secret Intelligence Service (MI6) chief Richard Dearlove advises the board of world’s largest insurer AIG.

“There was a time when retired intelligence officers went off to grow tomatoes,” he told an emerging markets conference in September. “That doesn’t happen to many of us any more.”

In general, Control Risks’ Fenning says events such as the September 11, 2001 attacks have tended to boost business — as have major corporate governance scandals such as Enron. At present, he is most worried about the risks of falling commodity prices or an emerging economies recession hitting his clients.

The problem is that while consultants are adept at advising companies on the ground in volatile regions such as the Middle East on physical security, protecting financial investments against political risk is much harder.

“It’s hard to see how we can avoid an increase in political risk, not just in emerging markets but also in the G7,” said Dresdner Kleinwort head of emerging markets research Arnab Das, pointing to part-nationalisation of banks as well as the risk of protectionism and tighter regulation.

Some investors will be able to buy either conventional insurance or protection through the credit default swaps market, which protects bondholders against default but has seen premiums soar in recent week on default fears and worries the unregulated contracts might not pay out.

ICELAND EXAMPLE

“If you are looking at a global increase in political risk… you have to take a more protective stance and ultimately that means buying more treasuries and cash.”

For pure financial investors, the political risk that scares them most is not war, riots or bombings but of government controls or officially sanctioned interference taking their investments off them or stopping them getting their money out.

When the tightening credit crunch pushed Iceland’s highly indebted banking sector to destruction in September, taking its crown currency along with it, the government imposed stringent capital controls. That helped cut savers and investors — including British official bodies such as councils and police forces — off from their billions.

In retaliation, Britain used counterterrorism laws to seize Icelandic bank assets in United Kingdom — the sort of behaviour that would terrify investors in an emerging economy.

Iceland was certainly not a country particularly associated with political risk, even though the troubles in its banking sector were known. In its 2007 “risk map”, Control Risks rated it one of the safest countries alongside its other Nordic counterparts, safer than Britain or the United States.

“It has really helped to draw attention to unknown or unexpected political risks,” said Danske Bank head of emerging markets research Lars Christensen.

But simply knowing such risks may be rising only gets the savvy investor so far.

“Investors need to be aware, have contingency plans, be diversifying and not have all their investments in one place,” said Control Risks’ Fenning. “But there is nothing you can really do to avoid “unknown unknowns”.”

(Editing by Toby Chopra)

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