Emerging market bonds backed by political risk insurance (PRI) lost a lot of friends following Argentina’s debt default in 2002, as investors discovered that events they thought were covered were actually outside PRI’s scope.
Since then traditional providers such as the Overseas Private Investment Corporation (OPIC) and the Multilateral Investment Guarantee Agency (MIGA) have introduced new products that expand the scope of these policies, according to a report by Fitch Ratings.
Traditionally, PRI covers non-commercial risk such as currency transfer and convertibility, expropriation and other forms of local government interference; adverse regulatory changes; and political violence, among other hazards.
But now there are products that hedge credit risk, such as non-payment of an arbitral award and non-honoring of financial obligations known as NHFO.
"New PRI products that cover not only political risk but also certain credit risks typically related to a sovereign obligation could help select EM issuers to access international capital markets," said Cinthya Ortega, director in Fitch's Latin America structured finance group, in the report.
Indeed, it already has.
In October of last year, the Hungarian Export-Import Bank issued a $400 million bond with a senior tranche of $380 million backed by PRI from MIGA. That policy covered sovereign nonpayment, helping the senior notes achived a triple-A from Fitch.
Under the contract, MIGA agrees to cover payments on the senior notes should the Republic of Hungary fail to make payments when due under its own funding guarantees.
This could be another way for PRI to gain the momentum it had before the Argentine crisis.
In early 2003, the prognosis for PRI looked grim. Argentine deals that had the policy attached defaulted anyway, leaving some investors wondering what exactly it was supposed to cover if not a sweeping pesification of the economy.
Sources said they appeared to have conflated PRI with sureties that cover credit risk. Bondholders that filed claims on defaulted PRI deals in the MBS and utility sectors in Argentina came away with nothing.
In hindsight, investors in crumbling PRI paper misidentified the Achilles' heel of what they were buying into. When the Argentine government imposed a comprehensive pesification of the economy and the peso plummeted against the dollar, greenback-denominated paper of every stripe tumbled like dominoes, regardless of what sovereign interference there might have been in the actual payment.
While the desperate government did half-heartedly tamper with capital flows in the post-devaluation climate, that intervention was beside the point for the PRI deals, at least given the scope of the insurance policies back then.