Political Risk Insurance and Bilateral Investment Treaties covers are both risk mitigation tools for foreign investors. Though they are similar, Mr Ian Roberts and Ms Vanessa Kilner of Clyde & Co Clasis Singapore point out the crucial differences between them.
In March 2014, Indonesia announced its intention to terminate its Bilateral Investment Treaty (BIT) with the Netherlands, and is rumoured to be considering terminating all 67 of its BITs.
This follows moves elsewhere to limit the rights of foreign investors to resort to international arbitration; for instance, steps taken by South Africa since 2012 to terminate its BITs with certain EU countries, and similar action taken by a number of Latin American countries before that.
These developments highlight the necessity for foreign investors to consider alternative risk mitigation instruments in today’s investment environment, and the increasing role that Political Risk Insurance (PRI) may therefore play in this connection.
Sovereign risks, or political risks, are those risks associated with the actions of a host-government which deny or restrict the right of a foreign investor to use or benefit from its asset.
Broadly speaking, this can occur on two levels: first, the risk of government action against a specific entity, which might include discriminatory regulations applied by the host-country against a particular investor or project, creeping expropriation, or breach of contract; second, country-level risks that apply to all investors in that host-country, or in a particular sector, including war, revolution, mass nationalisations, regulatory changes, and currency inconvertibility.
Bilateral Investment Treaties
BITs are inter-governmental treaties which contain protections for investors from a wide range of host-government actions and interference.
The protections provided by a particular BIT will be determined on its terms in each case, but will typically cover a broad range of investments and oblige the host-country to provide at least the following standard of protections: adequate compensation in the event of expropriation; fair and equitable treatment for foreign investors; treatment that is at least as favourable as that provided to other foreign nationals and its own nationals; law enforcement services with respect to the investor/investment; and the right to free currency transferability and convertibility.
Crucially, most BITs provide foreign investors a direct right of international arbitration against the host-government for breach of these obligations. This means an aggrieved investor with recourse to a BIT can take action for damages directly against the host-country before a third party arbitral body, rather than being required to pursue local remedies in the host-country.
Political Risk Insurance
PRI (be it provided by the private insurance market, export credit agencies (ECAs) or multilateral agencies) is an (usually bespoke) insurance product designed to cover political risks.
Standard coverage under PRI may include cover for: expropriation; breach of host-government contracts and sovereign debt default; political violence; and currency transfer and convertibility risk. PRI therefore acts to indemnify foreign investors on the occurrence of a covered political risk.
The role of BITs vs PRI
Both BITs and PRI provide foreign investors legal protection against the occurrence of political risks and might appear to be interchangeable risk mitigation tools for investors. Notwithstanding the ostensible similarities between the two, however, there are crucial differences to be aware of in terms of the rights and protections afforded.
PRI insurers would also be well advised to familiarise themselves with BITs and to take note of any applicable BITs when underwriting a risk, as an investor’s rights under a BIT will form part of the recovery rights to which insurers will be subrogated should a PRI claim be paid. In many jurisdictions, bringing a claim under a BIT in the name of the affected investor will be the best chance insurers have to secure a recovery.
All foreign investors are entitled to exercise the remedies available to them under a BIT, if one exists between the host-country and the country in which the investor is located, provided that nationality requirements of that BIT are satisfied.
It may be that some time and expense is spent up-front taking advice on and structuring an investment vehicle in order to benefit from a particular BIT, but the costs of doing so could, depending on the circumstances, be less than the annual PRI premium.
However, whilst the cost of purchasing PRI might, in such circumstances, be considered prohibitive, particularly by smaller investors, a purchaser of PRI acquires certainty that its policy has specifically been taken out to insure its investment and need not be concerned with the validity or applicability of a BIT, or nationality requirements, later down the line. This is especially pertinent given the changing landscape with respect to BITs.
(b) Scope of protection
Whilst both protect against a broadly similar range of political risks, PRI can provide additional cover for political violence or war, which would not come under the scope of a BIT. Further, each country’s BITs will contain different terms, reservations and exceptions which may alter or limit the scope of protection ultimately offered to the investor and which will need to be considered closely to identify exactly what recourse is available.
Conversely, PRI does not tend to provide specific coverage for many common political risks such as discrimination, protectionism or unfair treatment, although such actions may ultimately constitute ‘creeping expropriation’ and fall for cover in that way.
In addition, there is no limit on what might be claimed under a BIT – in 2012 the largest ever BIT award of US$1.7billion was handed down in the case of Occidental v Ecuador – whereas an investor’s loss will only be indemnified by PRI to the extent of the policy limits purchased. Furthermore, coverage under PRI may be limited to just 90% of the investment which would leave the investor to bear a proportion of his loss.
With PRI, an investor’s claims are made against the insurer instead of the host-government. This provides straightforward recourse for the investor; covered claims will be settled after a waiting period, usually 180 days, has lapsed, without the need for arbitration or other legal procedures to prove that the host-government has breached its
Claiming under PRI may not necessarily be clear-cut, however, and the investor would still need to prove that an insured risk has occurred, as well as satisfy all the terms and conditions under the insurance policy before a claim will be paid.
By comparison, bringing legal proceedings under a BIT will be a costly and lengthy process. Furthermore, winning an award against a host-country does not mean getting paid; in Argentina, to date nearly US$2 billion worth of awards granted to foreign investors have been withheld.
A final observation to be made is that of the deterrent effect that BITs may have. Having a BIT in place can be said to encourage host-countries to exercise a level of care towards those investors who carry the support of their home-government.
In this respect, PRI backed by ECAs or multilateral organisations may also carry the backing and credit of those countries, which can have similar risk mitigating effects.
It remains to be seen whether the BIT landscape will continue to be eroded, and the extent to which PRI will be increasingly relied upon as an alternative risk mitigation tool going forward.
Given the differences between the two, however, it may be prudent to regard both mechanisms as complementary, rather than competing, tools. Certainly, the extent to which BITs can be utilised to complement PRI should be keenly regarded by insurers when it comes to considering recoveries.
Mr Ian Roberts is Partner and Ms Vanessa Kilner is Associate, both at Clyde & Co Clasis Singapore.