Canadians Go International

In an era of rapid European expansion, some of the most dominant British and French enterprises of the 17th century ruled the fur trade via negotiated treaties with Canadian First Nations communities. But beaver scarcity caused northward migration from Iroquois communities into the more fur-rich areas occupied by the Hurons, resulting in The Iroquois Wars and leading to trade slowdowns within the Canadian fur industry.

Today, the location of raw materials has caused many companies to venture into politically unstable regions of the world, as commodity dependency and increasing global demand from emerging markets have made it lucrative for companies to take on additional risk.

Canada’s mining companies are no exception, seeking exploration opportunities in challenging geographies to increase revenues and profits.

Statistics Canada reports that about 67% of the $225 billion worth of assets owned by Canadian mining companies are located in foreign jurisdictions where political risks can potentially threaten the viability of operations, especially in regions that pose considerable geopolitical instability.

Corporations must address the wide array of threats that may negatively affect their balance sheets. Types of risks can range from seizure of assets, licence cancellations, regulatory changes, tax increases, forced sales, bribery, currency restrictions, labour disputes, riots, war and acts of terrorism.

Unlike other industries that have the flexibility to decide where a project is domiciled, mining companies must go to where the resources are situated and mitigate the risks inherent to that part of the world. Although not all of these risks are insurable, an increasing number of these companies are seeing credit and political risk insurance as key tools to help mitigate some of the more catastrophic and unpredictable hazards.

POLITICAL RISKS TODAY

One risk that has become increasingly prevalent is resource nationalism, in which foreign governments change the deal to which foreign natural resource companies sign up, often through increased taxation and royalties, or reduced foreign ownership percentages after the investment is made. Sometimes, these acts reach the extreme of expropriation, an insurable risk wherein the host government takes an investment and does not compensate the investor.

Resource nationalism can originate from different sources in different countries, but some contributing factors can include countries with troubled colonial histories, economic recession or income disparity, negative past experiences with foreign investors, or deep cultural beliefs surrounding the resources themselves.

This risk is often more prominent in emerging markets or regions of the world where mining revenues often account for a relatively higher proportion of gross domestic product.

Democratic Republic of the Congo

Consider, for instance, that Canadian-owned mining companies are responsible for two-thirds of copper and cobalt output within the Democratic Republic of the Congo, where mining accounts for approximately 50% of gross domestic product.

However, in its 2013 annual ranking of 96 political jurisdictions for mining investment, the Fraser Institute puts the Democratic Republic of the Congo at 87 for “uncertainty concerning disputed land claims,” 90 for “legal system” and 90 for “political stability,” demonstrating a jurisdiction with an extreme level of political risk.

Middle East and North Africa

Acts of political violence pose another serious risk to Canadian corporations with operations in developing regions. Political violence in the Middle East and North African (MENA) region has created chronic challenges for businesses engaged there, including severe disruptions to production and supply chains resulting from damage to assets, and the threat to worker safety and security.

China

The 2013 trade figures between Canada and China – which last year became the world’s largest trading nation – lie in the range of $70 billion, positioning China as Canada’s largest trading partner after the United States.

Although China represents a large and potentially lucrative market for exporters, its economy is slowing and there remains a great deal of uncertainty with regard to regulatory risk and a still-evolving judicial system. Intermittent protests throughout the country, most recently in Hong Kong, could create still more uncertainty moving forward.

Moreover, although credit information services are available to exporters, the degree of information quality can vary significantly.

In the current Chinese regulatory environment, it is important that exporters know their clients well, keep terms and conditions in documents of sale simple and easy to understand, and select collection agencies based on past performance. Exporters also need to consider that Chinese law will govern legal outcomes since Canadian court orders cannot be enforced in China.

Social unrest can fuel business interruption

Operations in a foreign country are also often affected by disruptions aimed at a specific project and a company’s lack of awareness and engagement with the surrounding community. Sensitive issues ranging from local land rights to social, labour and environmental considerations can quickly lead to protests that impact production, cash flows or, in extreme circumstances, the viability of a project altogether.

A project that operates in a challenging political or security environment is far more likely to be successful if it has implemented local hiring programs and social investment programs that ensure benefits accrue to the local community.

As an October 10 analysis article from Reuters noted, “Measuring political risk in emerging markets,” street protests, ethnic violence and labour unrest “are factors that have increased chances of business disruption in emerging markets by 20% over the past three months.”

INSURANCE AWARENESS

Beyond just a developing awareness for political risks in the mining sector, ongoing conflicts such as those in Russia, Ukraine, Syria and Iraq have contributed significantly to increased political risk awareness among risk managers, chief financial officers and chief executive officers, prompting corporations to seek ways to further manage investment risk for their international business.

With this in mind, it is vital for Canadian corporations with an international footprint to fully understand the entire spectrum of risk associated with pursuing opportunities in a foreign country.

This can often be addressed through prudent and responsible country risk management, which should entail consultation with the Canadian government, including its local export credit agency, Export Development Canada, as well as with the private credit and political risk market in Canada.

Still, unforeseen political shifts can leave even the most well-informed corporations vulnerable to political threats. Political risk insurance is one way for Canadian firms to grow with a safety net against some of the worst risks they face in emerging markets.

No sectors face these risks more frequently than energy and mining.

These companies need to carefully consider appropriate trade credit and political risk insurance coverage to ensure their assets are protected and their lending secured, while at the same time making it easier to attract investors and lenders to complex projects.

• Expropriation coverage offers protection in the event of confiscation, expropriation, nationalization and other acts by a host government that deprive the company of its fundamental rights to its venture, mined material, equipment or other assets.

• Political violence coverage offers protection against the damage or destruction of assets resulting from events such as war, revolution, insurrection, civil unrest, terrorism and
sabotage. Coverage for business interruption is readily available in Canada, as well as the forced abandonment of a project due to political violence.

• Currency inconvertibility and non-transferability coverage helps protect against the inability to convert local proceeds to hard currency and repatriate the currency and is particularly useful against government decrees that force companies to bring trade revenues back onshore to local accounts.

Political risk insurance policies can include any combination of relevant political risk coverages on a single policy with the ability to manuscript to meet the specific needs of each company. Having coverage terms for 15 years or longer will be important for companies that are undertaking a long-term venture and that want to make sure their assets are protected for the duration of the investment.

It is also important to note that some providers of political risk coverage offer non-cancellable terms where the premium rates may be fixed for the duration of the coverage. This will allow a company to lock in coverage for the entire length of its investment.

During the fur trade, great conflicts came with the extraordinary profits. Corporations have learned much about investing abroad since then, but are still confronted with the challenges of dealing with new, growing markets with great uncertainty.

With prudent country risk management, firms can plan for and prevent many of these risks from derailing a project.

However, recent history has shown that the emerging markets will occasionally present foreign investors with unforeseen challenges, and credit and political risk insurance are useful tools to have in place should some of the worst events unfold.