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Political Risk Insurance at the Forefront of Carbon Finance

Hoda Atia Moustafa's picture

Reduce. Reuse. Recycle. Green is the new black. With all of us more aware of global warming and the need to save our environment, the big question we at MIGA are asking is: what can we as an institution do to contribute?

Political Risk Insurance at the Forefront of Carbon Finance

One answer is that we can continue to do what MIGA has always done: supporting private investors. Specifically, however, MIGA can support those investors in the now well-established market of certified emission reductions (CERs) that are freely tradable on the European market, but depend heavily upon activities undertaken in developing countries. Investors relying on CERs as returns on their investments (in lieu of dividends) want assurance that governments that have signed up to the Kyoto Protocol will not renege on their commitments. This is very much a political risk, and with the right structuring is potentially a powerful political risk insurance product line.

Here is how it works: under the Kyoto Protocol, the UN Framework Convention on Climate Change (UNFCCC) has created a Clean Development Mechanism (CDM), which allows industrialized countries to invest in emission reductions wherever it is cheapest globally, so long as this takes place in countries that are signatories to the Kyoto Protocol. Often the least expensive emission reductions occur in lesser developed countries. When approached by the investor, the host government issues a statement, called the Letter of Approval (LoA) validating that a particular activity will assist the country in its sustainable development objectives. Once the LoA is issued, and the investor receives the appropriate licenses and permits to undertake its activities, it quantifies its reduction of carbon emissions through an independent expert accredited by the UNFCCC. This expert verifies the reductions, which are then referred to as "Verified Emission Reductions" (VERs). The VERs are then taken to the country's UNFCCC body where they are officially certified and transferred into CERs where they are bought and sold in industrialized countries that are signatories to Kyoto. (Although Kyoto is set to expire in 2012, all indications are that the market for CERs will continue to exist thereafter). The CERs can be used by companies to offset activities that increase carbon emissions. This is sort of like controlling your energy bill by using less energy to heat one room in your house and using the energy saved to heat another.

So where does political risk insurance fit in? Since the CERs constitute an investors’ return on investment, they want certainty, just like with any other investment, that the government will not interfere with their ability to capture this return. This can include the risk of expropriation of the investment, revocation of the LoA, failure to allow the CERs to be transferred outside the host country, and war and civil disturbance that damages the underlying project. These are all traditional political risks that MIGA and other providers can cover; they just need to be fit into the CDM world.

MIGA has already received several inquiries regarding projects such as these. One contract was already issued for a project in El Salvador back in 2006, and projects in our pipeline include several in sub-Saharan Africa. These involve the flaring of methane in landfills, transforming the gas into carbon dioxide, which is 21 times less potent than methane, and will significantly reduce the landfills' emissions.

Hopefully, by putting our footprint in the CDM world, MIGA can manage our own carbon footprint on the global scene by actively supporting projects such as these.