Sovereign Risk and Political Risk: New Challenges
attempted to accommodate these requests while keeping within the principle of insurance (a contingent obligation to pay) and the individual risk appetite. The vast majority of the requested changes related to actions or outcomes that are within the insured lender’s control. Basel III recommendations have been released, although the requirements will be phased in over eight years. As with Basel II, each banking regulator will have to interpret how the banks under its control must implement the new recommendations. Along with other forms of lending, the potential exists for a significant effect on lending to emerging market borrowers.
Recoveries Recoveries play a key role in any underwriting decision. When an underwriter agrees to accept a risk, it is making an educated bet that no losses will occur on the policy. However, equally important is the determination that in the event a loss is paid, the underwriter will recover amounts paid through subrogation. In many cases, these recovery efforts involve rescheduling. After rescheduling, the underwriter can decide to sell the debt or to wait for the loan to be repaid over time.
Privatization When offering coverage on an SOE, the underwriter and the insured need to consider what happens to the coverage in the event of a privatization. Several years ago, the approach was to include an endorsement agreeing to, in effect, renegotiate the policy to convert the coverage to currency inconvertibility and expropriation. As insureds have demanded more certainty in their coverage, the strategy of addressing the privatization “when and if it happens” is no longer acceptable. The underwriter needs to make its own assessment of the likelihood of a privatization during the policy tenor and include that factor as part of its risk appetite.
Case Examples The three entities principally involved in cross-border sovereign debt restructurings are the IMF, the Paris Club, and the London Club. The IMF has extensive experience, given that many of the distressed countries are recipients of World Bank funding. When invited, the IMF arrives in the country with a team of economists for a period of time to assess the level and composition of debt and the economic and financial risk factors and to provide recommendations on what policy changes could be implemented to alleviate the situation. Once the IMF has given a “reorganization plan,” the country can then approach the representatives of the creditor countries, also collectively known as the “Paris Club,” to negotiate a restructuring. This Paris-based forum of representatives from finance ministries and treasury departments of member
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