The Inter-American Development Bank is joining the brave new world of political risk insurance for the capital markets. Long known for its A/B-loan product designed to promote private sector projects in Latin America, the agency is now putting the final touches to an extension of political risk guarantees.

"Last February, our mandate was broadened to include helping to develop local capital markets," said Bernardo Friedman, deputy manager at the IDB. "And we thought that a good way to do so would be through a political risk product that would bring Latin fixed-income transactions up to investment grade."

The political risk guarantee will be very similar to the insurance policy for capital markets offered by the Overseas Private Investment Corp. and Zurich U.S. in the sense that all three policies cover convertibility and transferability risks. However, OPIC and Zurich have limits on their exposure for certain risks in certain countries and OPIC is not active in Mexico. In contrast, the IDB product focuses only on Latin America and the Caribbean.

"We realized that there was a growing demand for political insurance in Latin America," said Jack McDonald, a consultant helping to direct the initiative. "And that other market players have quite a bit of capacity constraint in countries such as Brazil, Mexico and Argentina."

The multilateral conducted a review of the political insurance market, which indicated that there was enough space for an additional player. "We did a survey of the market in order to assess where our product could fit in," explained McDonald. "The feed-back was very positive. Market participants thought that an additional player specializing in Latin America could bring more diversification and risk sharing to the sector. So we got the signal that our product would be well received."

The product is an extension of an existing IDB political risk guarantee that until now has only been on offer for infrastructure projects, in particular for bank lending. Now the multilateral is working on a standardized product suitable for bondholders. "We are working on issues such as claim periods, timeliness of payments and environmental and social covenants," said Friedman.

West LB recently closed the first capital market transaction to feature an IDB political risk guarantee. The $137 million deal provided financing for San Pedro de Macoris, a power project in the Dominican Republic. The guarantee will protect lenders against risks associated with currency convertibility and transferability and against premature termination of a 20-year power purchase agreement between the special purpose company and the state utility company. Duff & Phelps Credit Rating Co. rated the deal BBB.

"We are currently refining the guarantee we used for San Pedro de Macoris and looking at securitization deals," said Friedman. "We expect to start working on some deals this summer."

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