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Foreign Direct Investment

and Political Risk

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FDI
FDI can be defined as investment made to
acquire a lasting interest in an enterprise
operating in an economic environment
other than that of the investor, the
investor's purpose being to have an
effective voice in the management of the
enterprise.

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It may involve the acquisition of property,
such as a factory or hotel, or all or a
substantial part of the shares in an
existing corporation in the host country.
FDI may also involve the establishment of
an entirely new business ("green field'
investment), and also includes the rein-
vestment of earnings in the host country.

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Form of Business Organization
Normally, FD is conducted through the
establishment of a branch, a subsidiary or
a joint venture. Other forms of business
organization are possible, managing risk
and local regulation and requirements will
usually be deciding factors.
Direct equity investment is also possible.

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A firm wishing to invest and carry on business in
another country must, of course, comply with the
laws of that country. For example, a foreign
corporation that carries on business in Canada
through a branch may be required by the laws of
the province where the branch is located to
obtain a license and to register certain
information. If it wishes to incorporate a
subsidiary in Canada it may be required to have
a majority of directors who are resident
Canadians.
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In the same way, a Canadian firm seeking to
establish a branch or subsidiary abroad
will have to comply with the local laws.
Some countries do not permit foreign
corporations to conduct business through
a branch. Others do not allow foreigners to
own a majority of the shares in a domestic
corporation. For example foreign
ownership of QANTAS is limited to 25%
by Australian law.
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Many countries insist on a local partner
having majority ownership (more than
50%), making the joint venture mandatory.

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Political Risk
possibility that political decisions,
conditions or events in a host country
will negatively affect business climate
(investors lose money or make less
than expected)

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Issues
• Major Events
• Government Actions

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Major Events
• war,
• civil war,
• terrorism,
• insurrection

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Government Actions
• Unwelcome Regulation
• Interference With Operations
• Expropriation
• Other Political/Legal Risks

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Unwelcome Regulation
- mandatory local equity, management
- profit reinvestment, repatriation restrictions
- limitation on employment and location
- exchange, price controls
- import restrictions
- restriction of intellectual property rights
- performance requirements
- workers councils (EU)
- complex , costly incorporation (civil law)

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Interference With Operations
- local majority on board of directors
- restricted access to local capital,
customers, distribution, advertising,
product lines

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Expropriation
government seizure of private assets,
with compensation (confiscation - no
compensation)

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Other Political/Legal Risks
- weak business law
- weak law enforcement
- corrupt bureaucracies, justice systems

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National Investment Regulations
- all countries have investment laws
- some offer foreign investment incentives and minimal
regulation
- some require local participation
- most require foreign investors to register with government
and obtain approval for venture
- many have laws guaranteeing compensation for
nationalization or expropriation, guaranteeing repatriation
of profits, nondiscriminatory treatment, and tax
stabilization
- developing countries more restrictive
- trend towards liberalization
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FDI into Canada
- 1974, Foreign Investment Review Act (FIRA)
- strict review of incoming FDI
- U.S., E.U. pressure

- 1985, Investment Canada Act:


- limited review of significant investments
by non-Canadians, to ensure net benefits
- review by Industry Canada
- transaction reviewable if:
- acquisition of 1/3 voting shares
- WTO/NAFTA investor - direct
acquisition only, assets over $160 m
- enforcement - orders to comply, divest, $10,000 /day penalties
- appeal to Federal Court possible but difficult

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International Laws
no global right to invest abroad

and

No assurance of protection of your


investment if you choose to go ahead
anyway

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Expropriation - International Legal
Principles
1/ - Traditional - up to 19th century
- foreign investors exempt or ‘strict liability’ of
expropriator
2/ - Calvo Doctrine - 19th C - Latin America,
20th C - Communist and newly independent colonies,
developing countries
- expropriation OK for any reason
3/ - Modern Theory - 20th C - developed countries
- expropriation OK if:
1/ for public purpose
2/ non-discriminatory
3/ prompt, fair market compensation

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Expropriation: Current Agreements
OECD - 1976 Declaration on International Investment:
- guidelines for OECD members only
- ‘national treatment’ once investment allowed
- capital movements (purchase, sale of shares, land, repatriation of dividends, profits, interest payments)
liberalized
- prompt and adequate compensation required if assets expropriated
1990’s Multilateral Agreement on Investment:
- GATT type rules for investment
- not implemented - political ‘hot potato’
WTO:- TRIMS and TRIPS
United Nations:
-contradictory policies on expropriation
- 1962 UN Resolution on Permanent Sovereignty:
- expropriation restricted, adequate compensation required
- OECD nations comply
- 1974 UN Charter of Economic Rights and Duties:
- expropriation a country’s right
- developing countries support
World Bank - 1992 (guidelines only)
- host country protection of private property
- rules re expropriation, business licensing
- not binding but can be used by arbitrators at International Centre for Settlement of Investment
Disputes (ICSID)
- arbitration procedures
Multilateral Investment Guarantee Agency (MIGA):
- insurance guarantees ( limited) if both home and host countries members
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Bilateral Investment Treaties (BIT)
- usually developed/developing countries
- right to invest
- reciprocal rights of firms to do business
- repatriation of profits
- guarantees against undue expropriation
- dispute settlement (ICSID)
- U.S. uses extensively
- Canada - e.g. ASEAN, China, Russia
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Strategies If Expropriated or Other
Losses
1/ Sue/Arbitration
- in home or host country (but Canada, many countries apply Act of State Doctrine and
recognize a country’s sovereign rights to expropriate)
- U.S.: - 1964 Foreign Assistance Act
- courts can ignore Act of State
Doctrine, sue for country’s assets in U.S.
- U.S Foreign Claims Compensation Co.
World Bank - ICSID

2/ Insurance:
- World Bank - MIGA
- private insurance -Lloyds of London, etc
- Export Development Canada:
- provides foreign investment insurance
for: - expropriation,
- war, revolution, insurrection,
- currency inconvertibility (not available for high risk countries)
U.S. - Overseas Private Investment Corp.
- similar to EDC but used as a political weapon by U.S. since U.S. firms
won’t invest in excluded countries

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Developing a Political Risk Strategy
1/ Gather Information - internal and external
2/ Develop Risk Assessment and Management
Process
- identify and evaluate risks
- develop “go/no-go” criteria
- if “go”, develop strategies to deal with
identified risks
3/ Implement Strategies
4/ Evaluate Success
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