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Issue 07 / October 2015

Why construction contractors must work harder to manage risks in emerging markets

At a glance
  • Contractors must analyse worst-case scenarios and possible disruption to their project’s supply chain
  • Companies often fail to coordinate the human resources department with their risk management team
  • Political hotspots extend far beyond the Middle East and include Africa, Asia and Latin America
As Europe-based construction contractors increasingly tender for projects in emerging markets, they must consider supply chain, human and political risks from the offset. By Willis Global Construction

It is increasingly common for European construction contractors to search out new markets in foreign countries. Whereas the supply of construction projects at home was once steady and partners consistent, several factors are now forcing contractors to look further afield.

Construction and real estate are an integral part of emerging markets’ growth.

Globalisation and the increased mobility of workforces are driving this trend across many business sectors. However, in construction these developments are being exacerbated by increased foreign investment into European construction and significant new opportunities in emerging markets.

China is leading the way for foreign investment in Europe and, more generally, is set to dominate the global construction market by 2020, with a projected 21% share worth $25 trillion. According to a report published by law firm Pinsent Masons, the potential scale of Chinese investment into UK infrastructure will be more than £100 billion over the next 10 years. Increasingly, Chinese construction businesses and workforces will deliver these major Chinese investments.

These firms see the UK as a springboard into the wider European market and we can expect players from the rest of the BRICS economies to follow suit. The Shanghai-based New Development Bank (NDB) could play a leading role in increasing the influence of these nations by acting as a competitor to the International Monetary Fund (IMF) and the World Bank, and by providing capital for infrastructure projects to developing countries. 

Public private partnerships in emerging markets

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Public private partnerships in emerging markets

One of the fundamentals of public-private partnerships (PPP) is the transfer of risk from the public to private sector; appropriate allocation of accepted risks among the private sector partners is also vital to successful project delivery.

The central principle that each risk should be allocated to the party best able to manage it remains true. Political and economic risks will be fundamental to a private partner’s engagement in PPP in emerging markets and may present risks that require consideration beyond the traditional risk allocation methodologies and additional guarantees to build confidence.

The structure of PPPs means that insurance is a key risk acceptance tool used by the private sector and its funders. Insurance in PPP projects must satisfy the requirements of all the project parties. Parties to PPP contracts in developed markets will be familiar with requirements of ‘authority’ and ‘lenders’ in relation to responsibility for maintaining comprehensive insurance cover at acceptable levels.

Insurance considerations for PPPs in emerging markets tend to be even more complex as one must contemplate additional issues like legislation, which restrict placement of cover and availability of reinsurance. Finally, in many cases local insurers and advisors may be unfamiliar with the insurance requirements of PPP contracts. 

Clients engaging in PPP in emerging markets should look to insurance advisers with strong specialist PPP expertise in all sectors and international territories to support their bid and provide advice on optimal risk allocation and transferability of risks, as well as strong local networks to support implementation and management of their programmes.

Willis’s PPP Solutions’ team of PPP specialists and the Willis/Gras Savoye network of 131 countries can provide support at every stage through bid, construction, operation and secondary market activity. 

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Global change

Increasing competition in Europe is combining with significant new opportunities in emerging markets.

The global shift towards an urban population is particularly pronounced in emerging markets. Fast-growing cities across the developing world are contributing to remarkable growth rates in emerging markets. Construction and real estate are an integral part of emerging markets’ growth, driven by a demand for investment in more housing and infrastructure. These regions already account for 52% of all construction activity – a figure that is increasing all the time.

These trends present both tremendous opportunity and significant risks for the construction industry and increase the importance of the risk management function exponentially. In addition to the traditional construction risks, such as CAR liability, risk managers must now consider a host of new, expansive and often vaguely defined risks. 

The construction industry is particularly exposed to delays, increased wage rolls and lack of materials.

The construction industry is particularly exposed to delays, increased wage rolls and loss of profits from a lack of materials, whether they are caused by adverse weather or a project manager’s lack of strategic planning. Unforeseen incidents or commodity shortages can cripple the profitability of a project. Issues are likely to be amplified in new and emerging markets.

Understanding of the nuances of a new market takes time but is necessary in order to understand the local subcontracting market, to get the right quality of product and the required health and safety standards.

In Latin America these issues are exacerbated by poor transport infrastructure, civil unrest and natural catastrophes. This is especially important when considering that many industrial construction projects, which are critical to Latin American economies, are in remote locations such as mining and energy projects.

Supply chain

The principles that apply to contractors working in Europe often apply to those working elsewhere, including Latin America. Contractors must conduct due diligence assessments on the parties involved in their projects, including main suppliers, sub-contractors and consultants by analysing worst-case scenarios and possible disruption to the project supply chain.

The project teams also need to pay attention to the allocation of contractual risk. There may only be a couple of suppliers in a Latin American country for what they need and, if they fail to provide a critical component, the owner will see it as the contractors’ problem. So, the project teams must ensure that mechanisms are in place to avoid contract default on either side.

The Middle East also has its unique challenges with supply chain management. Potential resource scarcity must be carefully managed to avoid potential delays or bottlenecks, particularly for projects working to the 2020–2030 deadlines.

Saudi Arabia’s construction industry has recently taken great measures to address this issue. Some construction firms in Saudi Arabia, with ongoing or upcoming Mecca projects, have procured Italian quarries to ‘exclusively secure’ the quantities of marble required for construction in the holy city.

It is vital that material availability is managed from the outset of projects to avoid delay in start-up costs and potential advanced loss of revenue. Materials are often imported and contingency planning for delays should be calculated with analytical and strategic due diligence.

Contractors must conduct due diligence assessments on main suppliers, sub-contractors and consultants.

Human capital

The adage that a firm’s people are its most valuable asset is particularly true of the construction industry. However, in Latin America there is a limited pool of qualified engineers who have the knowledge and relevant experience to meet project requirements. Many European contractors have been using expat talent to meet the shortage of skilled workers.

The use of expats to address a skills shortage is a viable solution, if somewhat short term. It also adds complications, with expats prone to move between companies and projects, adding pressure to healthcare costs and doing little to sustain long-term growth in the local construction industry. There are also often significant restrictions on cross-border labour movement, which could hinder growth in emerging markets.

In the past companies have often failed to coordinate the functions of the human resources department and the risk management team. Risk managers tend to want to use their own corporate insurance for protection. However, when contractors are paid to export their technical expertise to a new market it is often wise to utilise their insurance know-how and ability to assess the risks they face as well.

Claims handling is one area where very often the only way to learn is from experience – whether that be good or bad. Preparations can be made in good faith but it is only practice that ultimately reveals what works and what does not. This underlines the importance of having an international broker, who not only benefits from your own experience but also from the experience of your peers.

Political risk

Construction in the Middle East continues to boom. Some of the most expansive and audacious construction projects in the world are being fuelled by rapid urbanisation in the region, which, according to the UN, will see another 110 million people moving to MENA’s cities over the next five years.

But while it is hard to overlook the opportunity that these global trends are presenting to the construction market, it is impossible to ignore the threat of political risk.

Expropriation, exchange transfer risk, sovereign default, and broader corruption are very real concerns.

In regions such as Saudi Arabia, where the trend of expropriation risk, exchange transfer risk and sovereign default risk remain medium-low and not likely to increase, there has been a flood of interest and capital into this country from Western construction companies. However, a note of caution is necessary due to an increase in the threat of terrorism and political violence. There is no doubt that Sunni/Shia tensions will not dissipate and the threat from ISIS is very real.

Political Risks are not confined to the Middle East, however: Africa, Asia and Latin America all register on the map of political hotspots below.

Political Risks are typically difficult to predict and can be triggered by relatively low-key event such as the bus fare rises in Brazil that led to riots in 2013. These events can bring critical transport links to a standstill and disrupt business operations.

Foreign contractors are not just exposed to political violence, terrorism or civil war. Expropriation, exchange transfer risk, sovereign default, and broader corruption are also very real concerns.

Latin America is no stranger to political uprising, and there have been several examples over the last decade of direct government intervention in the private sector, such as the expropriation of the 51% Repsol held in YPF in 2012 by the Argentinean government and the nationalization of Empresa Transportadora de Electricidad (TDE) in Bolivia – the subsidiary of the Red Electrica de Espana – also in 2012.

Africa continues to exhibit heightened political risks even in those countries that are moving in the right democratic direction. For example, Cote D’Ivoire’s National Development Plan is devoting $22 billion to investment, of which 60% come from the private sector. Even exchange transfer risk and sovereign default risk have both been trending downwards as Cote D’Ivoire has grown to around 40% of the GDP of the West African CFA.

Yet, despite all this, a recent history of civil war, unrest and economic uncertainty results in a situation where international donors and foreign investors continue to express misgivings about the lack of political reconciliation and long-term stability. 

New partnerships

Emerging markets have a vast requirement for infrastructure, and financing these infrastructure requirements can present major challenges.

Public Private Partnership (PPP) is an established method of procurement for infrastructure projects. PPP can assist governments in raising the initial capital necessary to fund infrastructure requirements, spread costs over time and allow emerging markets to benefit from the experience and expertise of the private sector.

In various regions there are differences in the stages of development of utilisation of PPP and the drivers for its use as well as the definitions of partnering and the level of commitment and expertise.

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In order to be viable PPP transactions must be ‘bankable’. The barriers to attracting financiers for PPP projects in emerging markets include project and country risk as well as the availability of political commitment, viable legal and political frameworks and local expertise (see box). 

The opportunities for European contractors who work abroad are significant as are the risks, which must be properly mitigated. Expat contractors must be aware of differences not only between regions, but also the countries within those regions.

In Latin America, for example, countries may share a common language but maintain a distinct cultural and business identity. Recognising such differences and being able to adapt a business model to the local business environment is the first step towards securing a market share in the growing construction sector.

Against this backdrop the role of the risk manager becomes increasingly valuable. And equally as important will be the broker partners chosen to help navigate through these often-unchartered territories. A broker partner with international expertise, experience on the ground, a longstanding history in the construction sector, and a highly flexible model can help a Western European contractor working abroad not only mitigate risk but contribute to the overall health and financial success of the company.  

Find out more

Photo of John  Roberts
John Roberts

John.Roberts@willis.com | +44 (0)2031248431

John has been heavily involved in the UK Power Industry for 35 years, carrying out statutory examinations and offering technical support on legislation to companies. He was also involved for an extended period at Sizewell ‘A’ Nuclear Power Station in the South East of England on a major boiler repair programme.

Photo of Charles Clarke
Charles Clarke

Charles.Clarke@willis.com | +44 (0)2031247506

With 14 years in the industry, Charles has extensive experience in multinational mining, contractors, manufacturing and leisure clients, leading the placement design, broking and ongoing client relationships. He has specific significant experience in employers, pollution and construction & contractors liability.

Photo of João  Pedro Búzio
João Pedro Búzio

buzioj@willis.com | +44 (0)2031248470

For 11 years João has successfully worked closely with clients’ project teams and has significant experience identifying and responding to the specific risk management and insurance requirements of large and complex construction projects globally. His construction project experience includes placement of projects ranging from oil and gas to mining, power generation, infrastructure and property development projects.

Photo of Kathryn  Harb
Kathryn Harb

harb_ka@willis.com | +1 (212) 915-8244

Kathryn’s experience within the Construction Industry began in 2011 when she was asked to assume the leadership of the North American Construction Project Insurance Team. In 2013, after forming part of the core team that developed the Willis Global Industry model, Kathryn was appointed director of strategy for the Global Construction Industry working directly under William Creedon, head of Willis Global Construction.

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Photo of John  Roberts
John Roberts

John.Roberts@willis.com | +44 (0)2031248431

John has been heavily involved in the UK Power Industry for 35 years, carrying out statutory examinations and offering technical support on legislation to companies. He was also involved for an extended period at Sizewell ‘A’ Nuclear Power Station in the South East of England on a major boiler repair programme.

Photo of Charles Clarke
Charles Clarke

Charles.Clarke@willis.com | +44 (0)2031247506

With 14 years in the industry, Charles has extensive experience in multinational mining, contractors, manufacturing and leisure clients, leading the placement design, broking and ongoing client relationships. He has specific significant experience in employers, pollution and construction & contractors liability.

Photo of João  Pedro Búzio
João Pedro Búzio

buzioj@willis.com | +44 (0)2031248470

For 11 years João has successfully worked closely with clients’ project teams and has significant experience identifying and responding to the specific risk management and insurance requirements of large and complex construction projects globally. His construction project experience includes placement of projects ranging from oil and gas to mining, power generation, infrastructure and property development projects.

Photo of Kathryn  Harb
Kathryn Harb

harb_ka@willis.com | +1 (212) 915-8244

Kathryn’s experience within the Construction Industry began in 2011 when she was asked to assume the leadership of the North American Construction Project Insurance Team. In 2013, after forming part of the core team that developed the Willis Global Industry model, Kathryn was appointed director of strategy for the Global Construction Industry working directly under William Creedon, head of Willis Global Construction.

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