By Daniel Wagner
Trade & Investment Flows
Statistics regarding trade and investment flows are worth discussing because I believe they are a fairly accurate gauge of investor/trader sentiment. During the last 6 months of 2000, requests for trade-related PRI coverage (such as contract frustration, wrongful calling of on-demand guarantees, and non-honoring of letter of credit coverage) were roughly 2:1 over investment-related coverage (such as expropriation, currency inconvertibility/non-transfer, political violence and breach of contract). However, the situation changed dramatically during the first half of 2001. Requests for investment coverage outpaced trade coverage by a 3:1 ratio.
I believe that this change is attributable to the initial optimism that investors felt for the prospect of an improved investment climate in the region in 2001. In the 12 months between June 2001 and May 2002, requests for investment coverage continued to outstrip requests for trade coverage by roughly a 2:1 margin. By the middle of last year, it was evident that the economic gains and relative political stability that had characterized 2000 were not going to persist. I therefore believe that the statistics for this past 12-month period are indicative of a general trend toward caution about investing in Asia, even before the terrorist attacks of September 11 occurred.
Indeed, the project finance business in Asia has been slow since 1997—a result of the Asian financial crisis, of banks having generally reduced their lending levels in Asia, and of many infrastructure-related problems materializing in the 5-year period since the crisis began. This remains fresh in the minds of lenders and equity investors. As a result, relatively few projects are reaching the financial close stage, margins remain tight for banks, and many banks are chasing the same transactions. In fact, it is not uncommon for me to see requests for coverage for the same transaction from five or six different sources.
Conclusion: What Motivates Companies To Purchase PRI in Asia?
The conclusion to be reached is that investors and their partners are the driving force behind the majority of PRI submissions. Most of these submissions have been generated because of banks’ desire to satisfy internal credit committee lending requirements. This, in turn, is linked to the banks’ own risk management guidelines as well as a desire to reduce capital allocation costs and/or satisfy home office central bank lending guidelines. The pursuit of risk management techniques that remove the need to provision for cross-border exposure while simultaneously reducing capital allocation costs will continue to be a prime motivating factor behind bank lending guidelines.
Although it is less common for equity investors to pursue PRI without the involvement of a bank, investors’ own risk management guidelines often require that PRI be utilized to remove political risk from their balance sheets. Investors’ risk management guidelines generally fall into three categories: (1) purchase PRI for each overseas exposure; (2) do not purchase PRI for any such exposure; or (3) purchase it only for those transactions that exceed the company’s tolerance for political risk exposure. The most common approach appears to be the last one, with most investors pursuing coverage only for those exposures that are of particular concern. This creates a tendency for PRI providers to receive only adversely selected transactions from equity investors.
There can be little doubt that investor/trader/lender reaction to individual political events in host countries is a prime motivating factor in the purchase of PRI for transactions in Asia. The example of the dramatic jump in submissions for Singapore earlier this year is a good indication of this. I have seen similar rises in submission levels following other political events in the region, and indeed, globally. However, the interest levels tend to dissipate as quickly as they arose once the event in question subsides.
It is quite common for PRI purchasers to pursue PRI only after a political or economic event has occurred. PRI is ultimately a commodity that is sensitive to supply and demand. It would therefore be wise for purchasers of PRI to pursue coverage either well in advance or well after such events occur because, not only is it less likely that coverage will then be available, but the cost of coverage will undoubtedly be higher during the storm.
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