CHAPTER 6
Sovereign Risk and Political Risk: New Challenges Anne Marie Thurber and Samit Shah
This chapter describes what is meant by nonhonoring insurance coverage, why it is useful for insureds, how the market has changed over the years, what issues are important to underwriters and buyers of the coverage, and what recent developments have occurred in the aftermath of the global economic crisis. It then comments on several key considerations.
What Is Nonhonoring Coverage? Essentially, nonhonoring coverage protects an insured against the failure of a government entity to honor its payment obligations. These obligations can arise as a result of commercial contracts or financing arrangements from lenders or capital market investors. In addition, a government entity can be the sovereign itself, a subsovereign (province or municipality), or a state-owned enterprise (SOE). The payment obligation can arise directly where the borrower is the sovereign federal government (usually through the ministry of finance), from a guaranty by the sovereign on behalf of another borrower, or from the obligation of a subsovereign (SS) or SOE. When referring to nonhonoring coverage, the most straightforward structure is that in which a bank lends money to a sovereign borrower to fund the purchase of goods or services. Although the transaction is a key component, the obligation to repay the bank exists regardless of the results of the underlying contract. In this manner, the loan is “delinked” from the performance of the contractor or supplier. Thus, the obligation to repay is constant, but the resulting performance risk shifts to the sovereign because the loan proceeds were used to pay the contractor or supplier directly. If a problem arises with the underlying contract, because the contractor or supplier has already received the funds, the government must rely on other mechanisms to resolve the problem, such as calling on performance guaranties.
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