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Business /23 Apr 2017
04.23.17

GM and Lessons in Surviving Tit for Tat Political Risk

It stands to reason that rising populist sentiments combined with economic and social turmoil, particularly in single-cylinder economies, will give rise to economic nationalism. This tendency naturally coincides with a greater likelihood of traditional political risks, such as the recent expropriation of GM’s assets in Venezuela. This case, like many other examples of political risks to corporate assets, raises a series of important questions – ones likely to dominate board rooms and strategy planning for quite some time as we are firmly in a period of “tit for tat” economic reprisals.

Looking at the GM case more closely, it follows all the hallmarks of classical political risks. At once aimed at sending a signal to an iconic American brand and domestic labor groups, this expropriation carries a message to the world – namely, Venezuela is not a safe place for cross-border investors or its beleaguered people. While any seasoned global professional with the ability to read the headlines could have made this determination given the unravelling social cohesion in the country, deeper analysis reveals that when it comes to country risk, industry sectors matter nearly as much if not more than market factors. This subtle truth is often missed by many political risk analysts and market data providers, who often paint an entire country red as a no-go area the second the country appears in the headlines.

When was the last time you heard about Unilever or Proctor & Gamble having their assets seized by government action? While the risk is certainly not 0, it is comparatively lower than the exposure to political risk in the automotive, energy, extractive and transport industries, which have historically been associated with a country’s military-industrial base. Besides, these industries generally rely on marquee assets and host government concessions or guarantees to successfully run their operations.

When conditions sour at a national level or when we enter a period of diplomatic and trade disputes, these types of assets fall into sharper focus in the crosshairs of government reprisals. These conditions only worsen when you add in organized labor, which tends to plague the manufacturing industries and natural resources, which tend to plague the energy and extractive sectors. When the euphoria wears off of breaking ground or cutting ribbons on a new plant, sectors with “heavy assets” are among the first to pay a heavy toll through nationalization, expropriation and asset seizures – all carried out by host country officials with conveniently short memories.

While the expropriation of GM’s assets may feel good in the halls of power of Nicolás Maduro’s state house, it is in every respect a pyrrhic victory that will do more harm to Venezuela than GM. GM enjoys a fortress balance sheet and near perfect geographic diversification. As such, the loss of market access and an already moribund facility that has not produced a car since 2016 is a rounding error, albeit an annoying one, to the world’s third largest automaker. Venezuela, on the other hand, adds another industry sector to its long list of more than 1,400 private businesses it has seized since 1998, making it one of the worst countries to do business as a cross-border investor, particularly in exposed industries such as energy and now, with GM’s setback, the automotive sector.

Against this backdrop, should all investment flows cease in Venezuela? Should investors across all sectors back away from this important gateway market, which is home to 31.5 million people and the world’s largest proven oil reserves? While the knee-jerk reaction in the political risk industry is to run for the hills and provide reams of backward-looking analysis and anodyne economic forecasts, complex market conditions, such as those found in fragile, conflict-ridden and violent states (or what development institutions term FCV states), can also present unique market opportunities. Counter-intuitively under FCV conditions, business leaders and investors do not need to worry nearly as much about an even greater threat to their enterprises, namely competition. Clearly the erosion of the “business commons” and general market demand depresses all segments of an economy. But the ability to appropriately anticipate and hedge the type of adverse government action that affected GM is neither widely understood nor leveraged, particularly among skittish investors who might like certain industry sectors, but shy away from geographic market expansion for all its attendant risks – real or perceived.

For this class of well-heeled but geographically timid investor, the 21st century will increasingly become an uncomfortable time, with fewer places to shelter from the long-arms for risk and uncertainty. The future has always been set by risk-takers. Today, the future belongs to those who adopt an invest now or pay later thesis, which will not only grant them greater market access to the majority of the world’s consumers, it will enable them to shape outcomes, including in situations as dire as Venezuela’s. A detailed report on Venezuela’s market outlook and political risk factors may be somewhat helpful to an investment committee doing pre-investment due diligence on a project in the country. This same report, however, is of little comfort when protesters and riot police have taken to the streets, all with a backdrop of hyperinflation that would make Zimbabwe’s Robert Mugabe proud. In situations of extreme market stress, there is no such luxury as operating normalcy.

Just like with a burning house, only the comfort in the financial ability to rebuild and restart will make a difference. Just as we cannot purchase insurance when our house is on fire, it is similarly difficult to obtain political risk coverage when a market reaches widespread turmoil or panic. Instead, investors must adopt a portfolio-level approach to insuring their cross-border investments and activities. In this manner, the likelihood of becoming collateral damage to rapidly changing market conditions or being lulled by the false comfort of a low risk rating in an analyst’s report or the hubris of an investment committee with “political connections” are greatly reduced. Rather, just like GM’s operational spread of risk can help offset the occasional setback, the advent of portfolio-level political risk insurance can confer similar shock absorption to companies and investors lacking GM’s fortress balance sheet. More importantly than the ability to withstand shocks, this type of strategic risk transfer can open entirely new markets, investment opportunities and industry sectors by putting a fixed price on geographic uncertainty.

Beyond the all-important financial comfort provided by these policies, which can cover a broad series of unfortunate events, they also serve to remove other noisome aspects of being a multinational investor or firm. The ability to shift the legal domicile for disputes and arbitration for example, or the operating comfort of having coverage denominated in the same currency as a hedge against fluctuation or inconvertibility are but a few qualitative attributes of this coverage. Likewise, attempting to mirror the length – or tenor – of coverage to the investment horizon of a project can help reduce the mismatch between long range planning and risk hedging strategies. Ironically, this is one of the areas where cross-border investors falter most often and it is largely due to a combination of human factors and model error. All too often investors compensate for increased country risk by raising their economic discount rates in their financial simulations. This, or so the theory goes, will improve risk-adjusted returns by delivering greater sums to investors over an investment horizon.

As Murphy’s Law would have it, not only will risk rear its ugly head at an inopportune time, it is very likely that setbacks will occur well before an investment breaks even or reaches “maturity.” Again, political risk insurance can help mitigate this liquidity trap, although the claims process and “cooling off” periods can be prolonged. Leveraging this approach, investors can buy into the fortress balance sheet of the insurance industry as they navigate increasingly turbulent waters in the search for yield. Doing so with the confidence of a GM can greatly change attitudes and risk appetite for geographic expansion, while giving global consumers the products, services, capital and opportunities they deserve.

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