Healy, C. 2015. The higher returns of development: MIGA's catalytic role. GREAT Insights Magazine, Volume 4, Issue 5. August/September 2015.
The returns on investing in developing economies are high, but perceived risks are inhibiting many from entering these markets, to the loss of both countries and investors. The Multilateral Investment Guarantee Agency (MIGA) can assist.
The private sector is recognised as a critical driver of economic growth, contributing to poverty reduction and higher living standards across the globe. It is responsible for around 90 per cent of employment in the developing world, providing critical goods and services, ensuring the efficient flow of capital, and delivering the largest portion of tax revenues.
Despite the continuing importance of official development assistance (ODA) and other public sector funds, the Multilateral Investment Guarantee Agency (MIGA) sees huge opportunities for private finance and investment to take an ever increasing role, particularly with higher growth rates and yields in many developing economies compared with their more established counterparts. For example, in the case of Africa’s infrastructure development, ODA has declined, while private investment has surged to over 50 per cent of external financing. Here, as elsewhere Public-private Partnerships (PPPs) are increasingly mainstream and tested.
In particularly fragile states, involvement of the private sector—especially foreign companies—can help reduce the risk of conflict recurrence by providing increased economic opportunities, helping to jumpstart domestic economies and integrate them into the global economy. Indeed, the private sector offers the opportunity for a virtuous circle within the fragile context—creating new opportunities to escape political and economic deadlock.
Yet, the agenda of the July’s Addis Ababa Conference on Financing for Development explicitly recognized that, despite improvements in their investment climates, many developing countries have not attracted sufficient private investment to diversify their economies. It stressed that an enabling environment must be paired with an appropriate regulatory framework, development of local markets, and incentives to align private investment with public goals. It also drew attention to how, despite some progress, these risks—as well as the perceptions of these risks—have inhibited private investment to well below potential or optimal levels. Hence the need to harness the energy, capital, and expertise that the private sector is providing.
In 2013 the Economist Intelligence Unit conducted a survey of multinational investors that assessed their risk perceptions in the short and medium term. It found that breach of contract and regulatory risks top respondents’ political risk concerns — based on actual experience as well as perception (see Figure 1). Additionally, it found that investors continued to rank political risk as a key obstacle to investing in developing countries. While concerns about the risks of instability and expropriation persist, there is also huge opportunity in these markets. Key constraints remain the availability of prepared projects, intermediation services, and risk guarantees, especially by multilateral banks. A critical factor in infrastructure is also the disconnect that often exists between the pay-off to the private investor/financier and the outlay. Uncertainty about political and commercial risk in these environments contributes to an often dramatic mismatch between the preparedness to lend and the need.
Investors use a variety of approaches to mitigate political risk. Some include using phased investment, local partnerships, engagement with the host government and local communities, and political risk insurance (PRI). There is a continued increase in the use of PRI —from private providers as well as export credit agencies and multilateral institutions — as a risk-mitigation tool.
Countries receiving private investments also face risks, including a lack of symmetry in negotiating power, signing contracts with reputational risks if they need to be renegotiated later, social dislocation in project areas, environmental degradation, increased corruption, undermining of democratic politics, and loss of economic value through transfer pricing and tax avoidance.
MIGA is central to the World Bank Group’s role in catalysing private sector finance for development. MIGA does not provide credit directly – rather, it is focused on providing investment guarantees and credit enhancement to foreign private investors and lenders.
This ‘crowding in’ of private sector finance in support of projects with high development impact is the Agency’s core mandate.
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MIGA provides PRI and credit enhancement for projects in a broad range of sectors in its developing member countries around the world. It covers a variety of cross-border investments including debt and equity. Under its PRI suite, MIGA covers four traditional risks: transfer restriction, expropriation, war and civil disturbance, and breach of contract. Under its non-honouring of financial obligations (NHFO) product line, MIGA can also cover commercial bank financing and capital markets transactions for public sector projects. NHFO protects a lender against losses resulting from a failure to make a payment when due under an unconditional and irrevocable financial payment obligation or guarantee.
One advantage that MIGA has over private-sector PRI providers is its ability to extend long tenors —in some cases up to 20 years. This means MIGA’s cover can generally match the term of project loans, even for large infrastructure investments. As a result, MIGA insurance is increasingly seen by governments as an effective way to enhance PPPs or quasi-PPPs. Additional benefits accrue to host countries because MIGA ensures that projects are aligned with their development strategy and meet high environmental and social standards as a condition of coverage. MIGA also seeks approval from the host country to cover any investment. These measures help the investor’s position with the host country government should a dispute arise.
In addition to helping countries attract project finance for strategic infrastructure deals, MIGA offers other instruments that can help mobilize capital. For example, MIGA is able to provide coverage for private equity funds under a master contract of guarantee that reserves capacity and provides up-front pricing for a specific period. The fund managers may use this contract to raise funds from institutional investors that are interested in taking commercial risks (and returns) associated with the investments but are concerned about political risks. MIGA has used this master contract model with several private equity funds that invest in sub-Saharan Africa.
MIGA’s status as a member of the World Bank Group significantly strengthens its ability to resolve potential disputes between investors and host countries, and is an important asset in the insurance marketplace. Since its inception 27 years ago MIGA has issued more than US$36 billion in guarantees for nearly 800 projects in over 100 countries—with an incredibly low claims ratio.
MIGA’s overarching ambition is to continually adapt to the ever-growing need for investments into developing markets, cater to the needs of new investor types, and complement and enhance the products being offered by existing PRI providers. The agency aims to optimize the opportunities presented by its expanded product line and its broader client base – including equity investors, lenders such as banks, and capital market investors – and carry on its work in infrastructure, power, transportation, finance, manufacturing, and agriculture. Top priorities will continue to be supporting investment into the lowest-income countries and fragile and conflict-affected states where the need is greatest.
For example, in Côte d’Ivoire MIGA stepped in very quickly after the country’s civil conflict with project guarantees underpinning some US$2 billion dollars in foreign direct investment. The projects included the Henri Konan Bedié toll bridge in Abidjan, the introduction of combined cycle technology to the Azito thermal power plant, and the construction and operation of an offshore oil and gas facility. The support for investors in the immediate post-conflict moment was essential for ensuring a smooth transition back to democracy, as well as for assuring investors that they could take advantage of the high investment potential after years of underinvestment in the country. Greater stability and very high growth levels have subsequently only borne out this support.
MIGA’s evolution over the next few years is likely to reflect and drive developments within the PRI market more generally. Examples of recent developments include:
MIGA’s credit enhancement products can now cover private loans for a public project. This is the case for the Cambambe hydropower plant in Angola that will increase the country’s power capacity by 30 per cent. In this case, MIGA’s US$512 million guarantee improved the tenor and the terms of the financing.
MIGA will look at public money (bilateral or multilateral) as a risk mitigator rather than a principal provider of funds. Governments are more motivated to resolve disputes when there are public funds involved. In addition, they are inclined to identify and deal more systematically with environmental, social, and integrity risks when public money is involved.
The agency has also begun working with pension funds and is actively seeking out new ways to look to institutional investors to get capital where it is needed. This is the new horizon in financing for development.
MIGA will continue to offer new products, increase its volume, and enter challenging markets in support of investors into developing economies. It will work alongside its World Bank Group partners, other bilateral and multilateral institutions, and private reinsurers to maximize the leverage of its product and underpin investments so critically important for development.
Strong growth in the PRI market is indicative of the benefits investors see in this type of risk mitigant as they increase their presence in markets that historically they may have considered more marginal, but whose high growth rates and potential now make it ever harder for them to ignore. MIGA already plays a unique role within the PRI space, and its product and position will allow it to expand further supporting private investment, as well as the valuable development impact that can come with it.
About the author
Conor Healy, Senior Risk Management Officer, Multilateral Investment Guarantee Agency (MIGA).
Photo: National Cement Share Company, Ethiopia. Credits: Gavin Houtheusen/DFID.
This article was published in GREAT Insights Volume 4, Issue 5 (August/September 2015).