Foreign Direct Investment and Political Risk


FDI can be defined as investment made to acquire a lasting interest in an enterprise operating in an economic environment other than that of the investor, the investor's purpose being to have an effective voice in the management of the enterprise.


It may involve the acquisition of property, such as a factory or hotel, or all or a substantial part of the shares in an existing corporation in the host country. FDI may also involve the establishment of an entirely new business ("green field' investment), and also includes the reinvestment of earnings in the host country.

Form of Business Organization
Normally, FD is conducted through the establishment of a branch, a subsidiary or a joint venture. Other forms of business organization are possible, managing risk and local regulation and requirements will usually be deciding factors. Direct equity investment is also possible.


A firm wishing to invest and carry on business in another country must, of course, comply with the laws of that country. For example, a foreign corporation that carries on business in Canada through a branch may be required by the laws of the province where the branch is located to obtain a license and to register certain information. If it wishes to incorporate a subsidiary in Canada it may be required to have a majority of directors who are resident Canadians.

In the same way, a Canadian firm seeking to establish a branch or subsidiary abroad will have to comply with the local laws. Some countries do not permit foreign corporations to conduct business through a branch. Others do not allow foreigners to own a majority of the shares in a domestic corporation. For example foreign ownership of QANTAS is limited to 25% by Australian law.

Many countries insist on a local partner having majority ownership (more than 50%), making the joint venture mandatory.


Political Risk
possibility that political decisions, conditions or events in a host country will negatively affect business climate (investors lose money or make less than expected)


• Major Events • Government Actions


Major Events
• • • • war, civil war, terrorism, insurrection


Government Actions
• • • • Unwelcome Regulation Interference With Operations Expropriation Other Political/Legal Risks


Unwelcome Regulation
- mandatory local equity, management - profit reinvestment, repatriation restrictions - limitation on employment and location - exchange, price controls - import restrictions - restriction of intellectual property rights - performance requirements - workers councils (EU) - complex , costly incorporation (civil law)

Interference With Operations
- local majority on board of directors - restricted access to local capital, customers, distribution, advertising, product lines


government seizure of private assets, with compensation (confiscation - no compensation)


Other Political/Legal Risks
- weak business law - weak law enforcement - corrupt bureaucracies, justice systems


National Investment Regulations
- all countries have investment laws - some offer foreign investment incentives and minimal regulation - some require local participation - most require foreign investors to register with government and obtain approval for venture - many have laws guaranteeing compensation for nationalization or expropriation, guaranteeing repatriation of profits, nondiscriminatory treatment, and tax stabilization - developing countries more restrictive - trend towards liberalization

FDI into Canada
- 1974, Foreign Investment Review Act (FIRA) - strict review of incoming FDI - U.S., E.U. pressure - 1985, Investment Canada Act: - limited review of significant investments by non-Canadians, to ensure net benefits - review by Industry Canada - transaction reviewable if: - acquisition of 1/3 voting shares - WTO/NAFTA investor - direct acquisition only, assets over $160 m - enforcement - orders to comply, divest, $10,000 /day penalties - appeal to Federal Court possible but difficult

International Laws
no global right to invest abroad and No assurance of protection of your investment if you choose to go ahead anyway

Expropriation - International Legal Principles
1/ - Traditional - up to 19th century - foreign investors exempt or ‘strict liability’ of expropriator 2/ - Calvo Doctrine - 19th C - Latin America, 20th C - Communist and newly independent colonies, developing countries - expropriation OK for any reason 3/ - Modern Theory - 20th C - developed countries - expropriation OK if: 1/ for public purpose 2/ non-discriminatory 3/ prompt, fair market compensation

Expropriation: Current Agreements
OECD - 1976 Declaration on International Investment: - guidelines for OECD members only - ‘national treatment’ once investment allowed - capital movements (purchase, sale of shares, land, repatriation of dividends, profits, interest payments) liberalized - prompt and adequate compensation required if assets expropriated 1990’s Multilateral Agreement on Investment: - GATT type rules for investment - not implemented - political ‘hot potato’ WTO:- TRIMS and TRIPS United Nations: -contradictory policies on expropriation - 1962 UN Resolution on Permanent Sovereignty: - expropriation restricted, adequate compensation required - OECD nations comply - 1974 UN Charter of Economic Rights and Duties: - expropriation a country’s right - developing countries support World Bank - 1992 (guidelines only) - host country protection of private property - rules re expropriation, business licensing - not binding but can be used by arbitrators at International Centre for Settlement of Investment Disputes (ICSID) - arbitration procedures Multilateral Investment Guarantee Agency (MIGA): - insurance guarantees ( limited) if both home and host countries members


Bilateral Investment Treaties (BIT)
- usually developed/developing countries - right to invest - reciprocal rights of firms to do business - repatriation of profits - guarantees against undue expropriation - dispute settlement (ICSID) - U.S. uses extensively - Canada - e.g. ASEAN, China, Russia

Strategies If Expropriated or Other Losses
1/ Sue/Arbitration - in home or host country (but Canada, many countries apply Act of State Doctrine and recognize a country’s sovereign rights to expropriate) - U.S.: - 1964 Foreign Assistance Act - courts can ignore Act of State Doctrine, sue for country’s assets in U.S. - U.S Foreign Claims Compensation Co. World Bank - ICSID 2/ Insurance: - World Bank - MIGA - private insurance -Lloyds of London, etc - Export Development Canada: - provides foreign investment insurance for: - expropriation, - war, revolution, insurrection, - currency inconvertibility (not available for high risk countries) U.S. - Overseas Private Investment Corp. - similar to EDC but used as a political weapon by U.S. since U.S. firms won’t invest in excluded countries


Developing a Political Risk Strategy
1/ Gather Information - internal and external 2/ Develop Risk Assessment and Management Process - identify and evaluate risks - develop “go/no-go” criteria - if “go”, develop strategies to deal with identified risks 3/ Implement Strategies 4/ Evaluate Success