Navigating regional political and security risk

17 August 2014

Investors face a widening and complex web of risks in the Middle East and North Africa region

Monitoring political and security risks should be part of any company’s investment plan, particularly when dealing with the Middle East and North Africa (Mena) region, where the operating environment is becoming increasingly risky. 

The death toll from Syria’s brutal conflict is rising, the jihadist Islamic State in Iraq and Syria (Isis) group is seizing control of major cities and oilfields in Iraq, and the Israel-Gaza conflict is having a destabilising effect on the region. In such a volatile environment, investors are faced with a complex web of risks and dangers.

Risk opportunities

Yet the perceived level of risk in any country is in the eye of the beholder. Some countries with very high security risks can still promise good returns for the right investor. Many companies are happy to deal with security risks, but will avoid countries with high operational or corruption risks.

“Managing corruption in Iraq is much more difficult than security,” says Jan Kamphuisen, Dubai-based head of analysis at UK-headquartered consultancy Control Risks.

Political Risk Ratings*
 ScoreCategoryGlobal ranking
Saudi Arabia5.85Medium101
*=As of third quarter 2014. Source: Maplecroft

Iran, for instance, is considered a low-risk country from a security point of view, says Kamphuisen, yet most Western companies steer clear of the country due to legal and reputational risks linked to sanctions.

For a few, the risks of doing business in the Mena region are too high, but for many others it is more a case of unravelling the interconnected risks, understanding them and working out how to manage them.

The increasingly high-risk environment in the region is driving up risks globally, according to the latest quarterly political risk index released in July by UK-based risk consultancy Maplecroft.

Over the past three years, the proportion of countries globally that Maplecroft rates in the highest risk categories have grown, primarily due to events in the Mena region. The firm says 36.6 per cent of the countries it rates worldwide are now considered as having an ‘extreme’ or ‘high’ risk rating, compared with 32 per cent in 2012.

Out of the top 10 highest-risk countries, the Mena region dominates, with Syria ranked the second-most risky out of 197. Libya, Iraq and Yemen also appear in the top 10.

Impact of conflict

The ongoing violence and conflicts are the most obvious risk to businesses currently operating or thinking of investing in the region. 

Syria’s civil war has brought the country’s economy to a standstill, while the exodus of refugees is placing a huge burden on Jordan and Lebanon.

The violence is also fuelling extremism, providing fertile ground for Isis’ expansion through Iraq.  

The advance of Isis has already had a direct impact on regional and international businesses, with a rising number of airlines changing their flight routes to avoid Iraqi airspace due to security concerns. Fears were exacerbated by the downing of a Malaysian passenger jet in July by rebel forces in Ukraine.

Changes to routes often result in extending flight times, increasing the amount of fuel used, which inevitably places added pressure on carriers’ profits.

Elsewhere, Libya is embroiled in fighting between various militia groups. The violence even reached Tripoli airport in June, where planes were set alight and international airlines cancelled routes to the country.

Security knowledge

Despite the headline-grabbing and harrowing violence seen in some states, analysts say security is not the most difficult challenge facing companies active in the region. 

“Out of all the risks, security risk is the most easily managed, except in extreme examples. It is much more difficult to manage political risks, such as non-payments or contract renegotiation,” says Kamphuisen.

He says many clients working in or entering a high-risk state will initially want to understand security risks, such as knowing when and how to evacuate a country. Yet it is running day-to-day operations that can be more challenging in the longer term. Political instability and conflict make it far harder and slower to secure approvals from local authorities, for instance.

Corruption risk is another major concern, while complex international sanctions, such as those imposed on Iran by the US, leave companies increasingly vulnerable to large fines and reputational damage.

“There is definitely increased focus on corruption issues from companies being increasingly aware of [the need to] strengthen their compliance programmes when considering hiring a third party,” says Dalia Yazbak, senior consultant, corporate investigations at Control Risks in Dubai. “When renewing existing contracts, they are becoming stricter on ensuring integrity issues. Retrospective due diligence is something we are coming across a lot, too.

“There is an increasing focus on sanctions, money laundering, links to high-risk countries such as Syria and Iran, and screening for criminal links. There is a greater awareness locally and regionally among clients that this is something they need to focus on,” she adds.

Interest in the opportunities to do business in Iran is also growing in light of the negotiations surrounding the possible easing of some sanctions.

Gulf markets

Even in the low-risk, politically stable Gulf countries, the need to understand your regional business partner is of increasing importance.

Indeed, the Gulf is one of Control Risks’ biggest markets. “The UAE, Saudi Arabia and Qatar are some of our busiest markets and the concern is mainly reputational,” Yazbak says, adding that companies are carrying out more pre-transaction due diligence now.

Companies are keen to understand the financial standing of their Gulf partners and how they are funded and to ensure they do not have links to countries such as Syria and Iran, which would expose them to sanction risk.

They are also keen to have a greater understanding of how Gulf businesses are founded, their company structures and their business connections. Such knowledge will help investors avoid a future breakdown in relations that could see businesses fail and projects grind to a halt.

The use of insurance in the Middle East is also growing as a means of mitigating risks.

“Until relatively recently, the Middle East was one of the most underinsured regions in the world, but this is rapidly changing and demand is unquestionably on the increase,” says Darren Jacobs, head of global corporate, Middle East, at Zurich Insurance, based in Dubai. “By far the two biggest markets in the region are the UAE and Saudi Arabia.”

Election risk

This year has also exposed investors to risks surrounding changes in government, with elections having taken place or due to take place in several countries in the region.  

The widely predicted appointment of ex-army chief Abdul Fattah al-Sisi as Egypt’s new president in June was seen by many as a step towards improving the country’s operating environment. 

Al-Sisi is generally perceived as a military strongman with the right leadership skills to put the country back on track.

Yet Kamphuisen says the new regime has engineered a “false sense of security”, with not enough done yet to tackle the socio-economic problems that fuelled the last two revolutions.

“There has been a security crackdown and a form of police state has been reinstated,” he says. The underlying tensions between the secular parts of society and the Muslim Brotherhood-supporting population persist.

“Our outlook for Egypt is not that positive. Clients will also be interested in such a large market, but interest has not been as great as we thought,” he adds.

Tunisia is preparing for parliamentary and presidential elections at the end of the year, but its shift to democracy could be thrown off course by problems such as high unemployment and strikes.

The threat of terror attacks also persists, particularly after the assassination of two politicians last year.

Social malaise

Social disparity and unemployment are also factors to be considered by investors, as they can indicate the likelihood of civil unrest.

Widening gaps between rich and poor fuelled the discontent that led to the 2011 uprisings.

Unemployment in Egypt is running at about 13.4 per cent, with most of those without work aged between 15 and 29. In Tunisia, joblessness is about 15 per cent. A lack of jobs is also a major problem in the GCC, with Saudi Arabia’s unemployment rate estimated at 11.5 per cent.

The Washington-based IMF warned in its regional outlook for 2014, released in April, of the importance of creating jobs in the private sector.  

“On current trends, there may only be enough private sector jobs in the GCC for one third of nationals entering the labour market,” the report read.

According to the World Economic Forum’s annual Global Risk Report, released earlier this year, unemployment is one of the biggest global risks that could cause a significant negative impact on countries.

The Mena region is ridden with complex, intertwined risks, from the obvious threat of terrorism and war to the hidden dangers of corruption and bribery. Sometimes it is the less evident risks that require the greater attention.

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