Alaco

02.05.2014 | Hidden risk in infrastructure projects

Understanding risks such as corruption and political exposure should be central to decision-making in major infrastructure projects.

Risk and reward is the axis that lies at the heart of all business decisions.  It is always a delicate balance.  But a lack of transparency, or an unfamiliar operating environment, can make a sound assessment of both risk and reward very difficult.  In many markets, corruption, social and political upheaval, and the weak rule of law can make the playing field anything but level.  Closer to home, new legislation, a strengthening regulatory environment, and greater scrutiny from NGOs, journalists and activists bring a considerable array of potential pitfalls that may have little to do with the specifics of the project itself.  Risk comes in many forms.

It pays to be well briefed.  Companies operating abroad should do their due diligence – not just financial, but political, regulatory and reputational.  A growing number of firms specialise in this kind of intelligence gathering, drawing on established networks of sources in the field, backed up by thorough analysis of local filings and other data.  Alaco has investigated several infrastructure projects recently which serve as good examples, in territories as diverse as Eastern Europe, Africa and Asia.

Allegations of corruption, cronyism and collusion have plagued separate multi-billion dollar road building projects in Poland and Russia.  A massive motorway infrastructure project in Russia has been characterised by tender manipulations designed to ensure the victory of a pre-determined winner.  Concessions have been awarded by agreement in advance, based on a quid pro quo arrangement under which the losing party was awarded a different contract of an equal magnitude elsewhere.  The whole project is a prime example of the mechanisms through which the ruling elite reward the loyalty of favoured associates and share between themselves the spoils of major government contracts.  International bidders have had little influence over the outcome of the tenders, regardless of the merits of their bids.  One European member of a successful consortium has found itself at the centre of major controversy when initial environmental concerns sparked wider scrutiny of the bidding process.  Tenders for remaining sections of motorway are still being held; foreign bidders should exercise caution.

In Poland, the outlook has been more positive.  A political football since the concession was first awarded in 1997, the highways project was very publicly smeared by various politicians with allegations of corruption in order to discredit their political opponents and the business elites associated with them.  This had serious ramifications for the international firms involved in consortia bidding for the project.  But as we explored the detail, and spoke to political analysts, journalists, civil servants and civil engineers associated with the project, it became clear that despite the regular political point scoring, the underlying integrity of the project was robust and unlikely to be the cause of any material reputational damage long-term, whichever party was in charge.

Politics is clearly always a risk.  Regime change across the Arab world, or in Ukraine, shuffles the deck and brings in a new cadre of ministers, each with their own advisers and vested interests.  Even subtle changes in the political landscape can have significant effects on foreign direct investment. 

Turkey’s $5 billion Public Private Partnership (PPP) healthcare programme, long touted as a national success story, saw the construction of numerous hospitals across the country.  The rapid development of the healthcare sector went hand in hand with the growth of the economy, creating a virtuous circle that led observers to overlook the extent to which contracts were awarded to supporters of the ruling AKP Party.  A nascent opposition has turned the spotlight on some of the PPP contracts, a scenario largely unthinkable even a year ago.  Fortunately, we had made it pretty clear to our client who their prospective local partners were and they had opted not to engage.

Companies considering infrastructure projects in the mining or energy sectors must be prepared to deal with a whole host of other risk factors.  In Uganda, for example, international mining companies are still struggling fully to understand the minutia of the 2003 Mining Act.  The Act effectively made it illegal for foreign companies or individuals to own mineral rights. The legislators’ intention was to encourage overseas investors to partner with local companies in order to exploit Uganda’s rich natural resources.  But selection of a local partner is a fraught process: some have the licences they say they have and obtained them in accordance with the law; others have no business whatsoever holding themselves out as potential partners. But they do, and it is no easy task working out which is which.  Add in an election in 2016, some succession issues surrounding the President and the uneven rule of law and you have a potentially rewarding business environment massively complicated by circumstances that are unique to Uganda.  We continue to monitor developments.

A similar picture has emerged across the globe in resource-rich Mongolia, where investors who flocked to the country several years ago, hoping to reap the benefits of the projected economic boom, have instead encountered a series of frustrating developments, from overnight revocations of mining licences to unfavourable amendments to the legislation on foreign direct investment.  In the turbulent election year of 2012, some foreign companies left Mongolia altogether.  Others were ejected.   Those who stayed continue to struggle to find a common language with the government. We visit Ulaan Baator regularly to keep channels of communication open.

Whatever the question, the only way to make an informed decision is to combine detailed insight on the ground with an overview of the commercial and political forces at work, and an ever changing cast of characters.  All of these cases required a combination of meticulous desk-based research and in-country investigation first to identify, then investigate and finally reach a judgement on the relevant issues.  Each case Alaco undertakes is unique.  However, the issues at stake can be remarkably similar.  Can the risks inherent in a project be identified, understood and managed?  If the right mix of resources and talent are brought to bear, we believe they can.