Parker Norfolk: Trade Opportunities and Risk Mitigation
Parker Norfolk’s Richard Bishop discusses best practices for capitalizing on trade opportunities while simultaneously ensuring sound risk mitigation.
Global uncertainty, trade wars, Brexit, and economic volatility. Any company considering becoming an exporter could be forgiven for having to think long and hard about whether the aggravation and hassle involved are really worth it. However, once the opportunities are understood, there are many compelling reasons to engage in international trade, and to work with trusted partners and advisors to exploit these opportunities whilst others hold back.
Successful trade requires many things but essential to any transaction is working with specialised and experienced legal, banking, and insurance professionals to assist in the management and mitigation of the risks involved and to keep the cost of doing so to an economically acceptable level.
It is a common misconception that insurers will provide cover for any risk so long as the price is right. However, only the best risks attract support. Risks are regularly declined for a multitude of reasons, whether it is for territorial concerns, the nature of the counterparties involved, through a lack of available capacity, or even if the size of transaction is too small. Given the market’s highly selective nature, how do you go about making your risk as attractive to insurers as possible?
Whilst insurance for export transactions can be purchased to cover the default risk associated with payments due from contracting parties (Trade Credit Insurance “TCI” ) and for a multitude of politically motivated exposures that could lead to a transaction failing leaving the exporter significantly out of pocket (Political Risk Insurance “PRI”), there is a scarcity of capacity available for transactions in multitude of overseas markets, so, when it comes to transactions in these more challenging locations, it will be only the very best structured and managed that obtain economically viable insurance solutions.
An organisation’s approach to risk retention plays a vitally important part. TCI and PRI insurers commonly offer indemnities of up to 90% of the limit required leaving 10% of the risk retained by the policyholder but sometimes it plays better to take a higher retention. Many banks and major traders, who regularly use the insurance market to mitigate their own risk exposures, have long understood that a greater retention demonstrates that they are working in partnership with their insurers rather than being just buyers. Whilst insurers understand that small commercial organisations do not have the same financial resources available to them that a bank or large trader might, expecting insurers to take the majority of the financial pain of a transaction going wrong is necessarily in that organisation’s best interests. Regular buyers of TCI or PRI understand that sometimes it is necessary to demonstrate their confidence in a transaction by opting to take much greater retentions of the risk that might generally be expected. This can be especially true for new buyers of insurance. The insurance market, rightly or wrongly, gives great credence to recognised buyers with proven track records. New buyers have to work hard to demonstrate their credentials.
Another area for any buyer to address is the structure of their transaction. Working closely with lawyers and financiers that have experience of trade is essential and gives confidence to insurers. Making transactions overly complex will always make an insurer take a cautious approach and a lack of experience will only heighten concerns. Ensuring that insurers understand that the structure is not designed to absolve the insured party from its responsibilities to manage and control the risk it wants to share with them is essential. Utilising risk participation structures, commonly seen in Islamic Finance for example, can be a useful way to demonstrate this to an insurer’s satisfaction.
Having the right approach to risk retention and transaction structure are not the only issues as there are many other factors that can impact on insurers’ appetites. Even experienced buyers of insurance can run into issues when dealing with overseas markets that are less than stable and for the inexperienced, these markets can prove even more challenging. Many developing economies do not have the same respect for the payment of debts or for recognising legal title to commodities or other material goods as in more developed economies. So, ensuring property is stored in secure locations, is monitored regularly by a trusted and experienced agent or representative and is transported through trusted ports and depots are all essential risk mitigants as is ensuring that counterparty payments are guaranteed by well established and financially secure banks. Too often these parties are chosen on cost with little thought given to their acceptability to insurers.
Whilst many parties bring discipline and structure to the management and mitigation of risk in a transaction, it is the actions taken by insurance buyers that can be the true risk mitigant and make trade a profitable and sustainable business opportunity. A good insurance broker helps too!
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