Political risk: Dealing in the danger zone

Security and politics add to the complexity of investing in volatile regions, says Tony Levene
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There is invariably a positive correlation between risk and reward. But weighing up the equation in politically volatile areas – parts of the former Soviet Union, sub-Saharan Africa and especially parts of the Middle East, for example is about more than simply assessing potential profits or losses. Lives and corporate reputations might also be in jeopardy.

Assessing political risk can be complex. “Risk factors vary not just between countries but also within countries,” says Andreas Carleton-Smith, Middle East regional director for Control Risks, the security and political risk analysis consultancy.

“Doing business in the Kurdish part of Iraq, for example, is different from doing business in Baghdad, while Libya is fragmented by a tribal framework. Companies must be aware of this, but sometimes they can be too aware of risks that turn out not to be present.

“Also at stake is doing something that appears sensible in the area of business but proves to be legally or reputationally damaging in the UK or US.

“The overriding decision is understanding the risk and how, if possible, this can be mitigated. The advice is very individual and, for obvious reasons, totally confidential.”

Mr Carleton-Smith, who is based in Dubai, says anyone engaging in business in a volatile area needs to look at security risk, such as protecting facilities; political risk, such as the replacement of a UK-friendly regime with another; travel risk, including personal safety; and operational risk, such as how shareholders will be treated and how profits will be repatriated.

“In the Middle East, as elsewhere, we rate risks on a spectrum from extreme to low,” he says. “Syria is extreme: conditions are hostile; law is arbitrary, so contracts can’t be enforced, allowing companies to quote force majeure clauses; and both local and foreign personnel are in physical danger.

“At this level, we help by advising on how to evacuate employees and secure property. But in the United Arab Emirates, there is political stability, contracts are respected and there is personal and property security.

“Bahrain and Egypt are medium risk, while Iraq generally remains high. It is a complex and opaque region.”

The Arab uprising of 2011 has been politically popular, but it swept away business certainties built up over years. Enterprises, therefore, have had to recalculate their risks. Trading partners may have disappeared, for example.

Control Risks cites one company in a high-risk zone that heavily invested ahead of civil unrest only to find its business permit had been revoked and the contract re-awarded to friends of the former opposition.

In some cases, companies have to comply with regimes or quasi-governments blacklisted in the EU or quote force majeure and close down.

There is always the future, however. “Firms that plan ahead have an advantage in judging the time to re-enter jurisdictions,” says Mr Carleton-Smith.

“If you can understand and manage the risks, there are potentially big rewards. UK companies are now looking more closely at Iraq – construction, oil, telecoms, retailing and finance. There are substantial rewards for getting it right. Being fully aware of the situation means they can approach insurers with greater confidence.”

Some firms are also preparing for an eventual return to Syria, although when the opportune moment will be is anyone’s guess.

As a number of companies that moved back into Iraq between 2004 and 2006 found, post-conflict states can be chaotic, with contracts awarded more informally.

That is risk enough for many. But since that time, there has been the added complication of the UK’s Bribery Act, which came into force in July 2011. Companies that fall foul of the act face unlimited fines, and imprisonment for individuals of up to 10 years and/or an unlimited fine.

Clifford Chance, the law firm, says there has been only one successful UK Bribery Act prosecution to date (involving a court official receiving small payments to expunge traffic offences), but there are more in the pipeline.

Prosecutors such as Richard Alderman, former director of the Serious Fraud Office, have talked of “pushing the legislation to the limits” – a zero-tolerance warning for companies.

What may be seen as normal practice in the Middle East and other difficult jurisdictions – gifts, hospitality and so-called facilitation payments to overcome inefficiency or speed up bureaucracy, for example – is now outlawed for UK companies. This places them at a potential commercial disadvantage to rivals from Russia or parts of Asia that have no legal bans on what the UK considers to constitute bribery and corruption.

There is a particular risk under this legislation in dealing with “public officials” – a label for which there is a wide variety of interpretations in the Middle East – who demand payments for doing what they are required to do anyway.

Companies are moving towards zero tolerance of such questionable practices. Besides the reputational damage it might cause, a bribery probe is expensive.

“Organisations may be tempted to cut corners to win business,” says Clifford Chance. “But those that have been investigated know this is not a cost-effective approach.”

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