Navigating Geopolitical Risks in Infrastructure Development

Infrastructure development is essential to supporting economic growth and connectivity, and improving people’s quality of life. However, macroeconomic factors, including monetary policy rate increases, greater economic volatility, and waning risk appetite among investors, have emerged as threats to the sector.

Given current trends, the world faces an infrastructure investment gap of US$5.2 trillion to 2030 between infrastructure needs and financial resources. This could reach as high as US$14.9 trillion by 2040, when the achievement of the UN’s Sustainable Development Goals (SDGs) is taken into account.

Urbanization, climate change, the energy transition, population growth, and economic expansion are some of the factors driving the urgent need for infrastructure investment. The greatest need for infrastructure investment is in emerging countries, yet these countries often lack adequate infrastructure investment structures, which can potentially hinder development opportunities.

According to Marsh's Political Risk Report 2024, organizations are facing a world made more volatile and riskier by macroeconomic and geopolitical changes. Increasing regionalization, export controls, and a growing number of barriers to trade and finance has made the infrastructure landscape more volatile and riskier.

This is further compounded by the fact that more than 60 countries, representing at least 40% of the global population and GDP, are holding elections in 2024. Businesses making investment decisions may have to consider how long-term uncertainty caused by geoeconomic competition and geopolitical insecurity may also be influenced by current events and electoral outcomes.

These concerns permeate the value chain for infrastructure development, with the potential to impact corporate and institutional equity investors, commercial and official providers of project debt, construction firms, and governments of countries that need such investments.

How does this relate to me?

Long-term, stranded investments in illiquid assets can be prone to outsize risks. This is despite opportunities for growth remaining plentiful across the globe. An investment deficit across emerging markets means there are opportunities to meet pressing needs for fast-growing populations, such as clean water, communications, electricity, food, transportation, and more. Additionally, the need to diversify supply chains to achieve greater food and energy security and build a sustainable future will continue to attract investment opportunities. However, in this context, one category of unpredictable risk can hold back infrastructure investors, stunt national development, and dash infrastructure investment returns: Political risk.

While business risks are often unavoidable for investors and businesses, they can be managed and mitigated. Political risk is the possibility of foreign investors suffering financial losses because of political decisions, conditions, or events in the host country or market where they have invested. Unmitigated, such risks may cause the cost of capital (the returns required by capital providers to invest in that country) to be higher than other locations, resulting in a country risk premium (CRP).

The potential impact of political risks for infrastructure assets and projects is wide. Political risk insurance (PRI) is one of a handful of tools available to mitigate the risk, from covering physical loss or damage of assets due to war, civil war, and terrorism to more complex events such as loss of a concession or permits due to government action, or non-remittance of profits being blocked due to government currency restrictions. PRI can also extend to insuring the project against breach of key contractual agreements that the government has entered into, such as a power purchase agreement or a fuel supply agreement.

Cover is provided by investment-grade PRI insurers in long-term, multi-year, fixed price, and non-cancelable policies. A study commissioned by Marsh and S&P Global shows that mitigating the key risk factors explaining the CRP can reduce the investors’ cost of capital, and thereby bolster project valuations and investment returns — even after accounting for the PRI cost.

Additional PRI benefits may include:

Mitigating the susceptibility of infrastructure projects to volatile risks, including the need to mark down project values to market.
Selecting investment opportunities that might otherwise not meet investors’ investment return hurdles due to country risk.
Raising investor capital and facilitating project exits.
Securing potentially more favorable financing terms.

For dedicated long-term owner-operators of infrastructure in emerging markets, as well as institutional equity investors such as private equity firms, pension funds, infrastructure funds, and sovereign wealth funds, PRI is an invaluable tool to facilitate investment.

Investors of infrastructure projects (including commercial lenders, pension funds, insurance companies, debt funds, capital market investors, and infrastructure funds) may face challenges ranging from project-specific risks such as country risk (with projects in emerging markets) to credit-specific issues (such as limited credit risk capacity for large transactions) and portfolio management concerns (such as risk concentrations by borrower, industry, or location).

The use of insurance risk capital, provided by investment-grade insurers, can help catalyze debt investment by way of matching term, multi-year, fixed price, and two types of non-cancellable policies:

Non-payment insurance for lenders

Non-payment insurance is increasingly used by banks and lenders as an unfunded credit risk transfer tool to mitigate the non-payment risk of a counterparty (a loan borrower or debt obligor). Basel III-compliant NPI policies can facilitate capital relief for regulated lenders and help project lenders make larger loans in support of infrastructure debt funding. NPI can solve limit management issues caused by “tall trees” and other risk concentration issues.

NPI is a powerful instrument for credit and portfolio managers (CPMs), allowing lenders to bolster their competitiveness while prudently growing their loan book. Using NPI can help lenders mitigate their risk by sharing a single transaction or credit portfolio exposure with a pool of natural, non-competing syndication partners (insurers) uncorrelated to the underlying risk.

NPI covers the failure or refusal of a counterparty to pay an amount owing under a financing agreement, for any reason. This includes commercial and political risks that private or sovereign borrowers may encounter. Coverage is non-cancellable and fixed-price and can cover short-, medium-, or long-term payment risk in both emerging and advanced economies.

Insurers’ risk appetite has broadened in recent years to include a variety of financing structures and asset classes. These include “mini-perm” and long-term project and infrastructure financings for both greenfield and brownfield assets such as quasi-merchant exposures and acquisition financings involving operational assets. A broad range of industries are covered, including power and energy (and renewables), waste and water treatment, transportation (airports, roads, and ports) and technology and telecommunications, including data centers and cell towers.

Political risk insurance for lenders

PRI is a variation of NPI that provides financial protection to lenders, investors, and businesses that could face losses due to political risks. It is used frequently in emerging market infrastructure finance, when the project lenders are comfortable with the project’s commercial and credit profile but may have concerns regarding jurisdictional risks.

PRI provides a means for lenders to share an infrastructure project loan’s political and country risks with insurers, while keeping exposure to the loan’s basic credit and market risks. PRI can help lenders navigate concerns regarding a government canceling critical permits and concessions, war and political violence risks, currency restrictions blocking debt service, expropriation of project assets, and breach of contract by the host government on critical project agreements (such as a power purchase agreements, gas transportation services agreements, and minimum revenue guarantees).

A key risk facing engineering, procurement, and construction (EPC) firms and equipment suppliers is political instability in the host country of the project. For instance, changes in government policies, civil unrest, embargoes, and currency controls. These challenges have the potential to negatively impact contractors and suppliers by causing interruptions in contract execution, non-payment of amounts due, calling of bonds, and confiscation of assets.

To help mitigate these risks, political risk insurance can help protect EPC contractors and suppliers against financial losses due to political events beyond their control.

In practice:

Contract frustration insurance

Contract frustration insurance can protect EPC businesses from financial losses resulting from political and credit risks. These risks may involve the frustration of a contract due to decisions or actions by the host government, license cancelation, or unilateral termination of the contract by a public buyer. Risks may also include the non-payment of invoices by the buyer, non-payment of termination fees according to the contract, or non-payment of amounts due following an arbitration award. Depending on the project, contract frustration can include protection against financial losses due to the fair or unfair calling of bonds (advance payment bonds, performance bonds, and bid bonds) by the beneficiary. This insurance is targeted at domestic contracts in OECD countries or cross-border contracts in emerging markets.

Contractor’s comprehensive plant and equipment insurance (CCPE)

CCPE can protect a contractor against loss or damage to mobile equipment used on-site for projects in emerging markets, for instance caused by political risks. It covers events such as the confiscation, requisition, seizure, and willful destruction of equipment by the government or due to political violence. Additionally, the insurance provides coverage for losses resulting from forced abandonment of the contract execution location due to insecurity and non-re-exportation prevented by the local government or license cancelation. The cover can be used to protect various types of equipment, such as cranes, trucks, diggers, and tunnel boring machines. It is targeted at cross-border projects.

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Navigating Geopolitical Risks in Infrastructure Development