Potential implications of COVID-19 for the Singapore political risk and trade credit market, and initial steps for insurers
The rapid spread of the coronavirus (COVID-19) has led to widespread disruption of global trade and business operations. Government actions to contain the spread of COVID-19 are challenging businesses’ ability to fulfill their contractual obligations. Containment measures such as travel restrictions and work stoppages - first employed in China and now replicated in most developed countries - have halted manufacturing and disrupted supply chains. If global commerce continues to face these disruptions, companies across numerous sectors will experience heightened credit risk.
The pandemic is likely to have repercussions for underwriters of political risk and trade credit insurance. Most industries will be negatively impacted by COVID-19, and the effects will be exacerbated as the severity and length of the pandemic persists. Based on our prior experience, it is likely that insured losses will arise from: (1) falling commodity prices; (2) increased governmental intervention; and (3) rising insolvencies of businesses with insufficient capital to withstand enforced closedowns or supply chain disruptions.
With respect to political risk insurance, claims could emerge under contract frustration policies in particular. Broadly speaking, contract frustration insurance covers the risk of default under contracts with sovereign entities and state-owned obligors. As well as non-payment and non-delivery by the obligor, it can cover risks such as licence cancellation, import and export embargo and non-certification of invoices. The contract frustration market, both in Singapore and elsewhere, sustained heavy losses following the crash in commodities prices between 2014 and 2016. Many emerging market governments, particularly in sub-Saharan Africa, which were heavily dependent on revenues earned from the sale of commodities, started to default on their contractual obligations. As their national budgets shrank, those governments prioritised essential services over projects financed by international investors, which led to them failing to meet their payment obligations in respect of those projects.
The sharp contraction in demand caused by the pandemic, initially from China but now from Western economies as well, has led to another slump in commodities prices. The situation has been exacerbated by Saudi Arabia’s decision to increase oil production at a time of falling demand, which has led to a collapse in oil prices from around USD 60 per barrel in January 2020 to under USD 20 per barrel in April 2020.
The International Energy Agency warned in a report in March 2020 that the collapse in oil prices threatens to cut the revenues of oil producing states such as Ecuador, Iraq and Nigeria by between 50% and 85%. The IEA warned that Nigeria’s economy was less prepared to tackle a “price shock” than five years ago, because per capita GDP had shrunk by almost a third.
The single situation credit market also saw a large number of claims following the 2014-2016 commodities crash from commodities traders and banks following defaults under contracts with local traders and commodity producers. The steel sector in India and the UAE was particularly hard hit. We would again expect to see pressures in those sectors as companies struggle to cope with the impact of the demand shock and falling prices prompted by the COVID-19 pandemic.
The impact of the dramatic fall in commodity prices has already been felt in Singapore. In recent weeks, we have seen the fall of one of Singapore’s biggest oil traders, Hin Leong Trading, which in turn has raised the prospect of a severe liquidity crunch in the city-state’s commodities sector. The company admitted to $800 million in undisclosed losses, as well as the sale of pledged collateral, and is now the subject of a police investigation. It is the second high profile insolvency of a Singapore commodities trader in recent months, with Agritrade International also being accused of fraud by at least 20 banks following its collapse in February 2020.
As governments around the world take a more interventionist role in regulating commercial activity, we may also see an increase in claims under contract frustration and other political risk policies for losses arising from import or export embargos or other Government measures which prevent the performance of contracts. For example, in China, the government responded to the disruption to trade and supply chains by issuing force majeure certificates to Chinese companies to protect them from liabilities arising from their inability to perform contractual obligations. This has had knock-on consequences for traders supplying commodities to China and for their contracts with mining companies.
Trade credit insurers are also expecting an uptick in claims activity. Trade credit insurance policies cover the risk of private buyer default or insolvency. Despite aid packages for business announced by various governments around the world, it is expected that the shutting of service and manufacturing operations as a result of the pandemic will lead to a steep rise in insolvencies and, in turn, claims under trade credit insurance policies.
Initial Steps for Claim Professionals
It is imperative that claims handlers understand the insurers’ timing requirements for political risk and trade credit claims, as such timing requirements vary by policy. Although political risk and credit policies typically provide for insurers’ liability to be deferred until a specified ‘waiting period’ has expired, many such policies contain prescriptive timetables for the adjustment of the claim, including requests for further information and the provision of a coverage determination. We have seen policies issued to banks in which the insurer is required to notify the insured within as few as 14 days if it requires further information in connection with its review of the claim and to notify the insured of its coverage determination within 30 days after receipt of the claim or, if later, 14 days after receipt of any requested information. If the insurer fails to request information relevant to the claim within the specified timeframe, it may be at risk of waiving its rights to investigate the claim.
Thus, to ensure no rights are waived, it is important for claims handlers immediately to review and diarise the policy’s relevant deadlines. When faced with tight timescales, the insurer should consider appointing a loss adjuster as soon as possible. If potential coverage or validity issues are already apparent from an initial review of the claims materials, then it may be necessary for the insurer to impose a reservation of rights in order to protect its position.
It is also important for the claims handler to review the policy wording carefully to familiarise themselves with the scope of the cover under the insuring clause and any potentially applicable exclusions, conditions or warranties. For example:
- The policy will usually require that the relevant default or government action occurred within the policy period. In a claim for non-payment, for example, it will be important to check whether the relevant due date fell within the policy period.
- If the claim arises from an action of a government, it will be important to consider whether the alleged government act falls within the definition of one or more of the insured perils. Conversely, trade credit insurance policies sometimes contain political risk exclusions; careful thought will need to be given to the potential applicability of such exclusions in any particular case.
- Contract frustration and credit policies typically contain exclusions, warranties or conditions which seek to protect the insurer’s position in the event that the underlying transaction turns out to be illegal or unenforceable or if the insured has acted in breach of local laws. It can, therefore, be important to check whether, under the laws of the host country, the insured contract was properly authorised by the relevant government officials or parliamentary bodies. If it was not and the insurers proceed to pay the claim, this could adversely affect their ability to make recoveries if and when they and/or the insured seek to enforce the debt.
- Similarly, fraudulent activity often only comes to light following an economic downturn as parties who have engaged in fraud struggle to meet their contractual obligations. As Warren Buffett once famously said, “only when the tide goes out do you discover who has been swimming naked”. The trade credit industry is unfortunately susceptible to fraud, including fraudulent invoicing in the factoring sector and theft and fraud in relation to secured commodities, and so trade credit claims handlers will need to be alive to indicators of potential fraud in insured transactions. The recent collapses of Hin Leong and Agritrade amid allegations of fraud would appear to illustrate this point. As well as concealing hedging losses, Hin Leong is alleged to have sold oil pledged as collateral to raise cash. As for Agritrade, its lenders allege that it issued multiple bills of lading for the same shipments and raised financing on non-existent shipments of coal.
- Contract frustration and credit policies will often contain “disputes exclusions” which suspend the insurers’ liability under the policy until any dispute between the insured and the obligor in relation to the insured debt has been settled or resolved in the insured’s favor. Accordingly, it is always important to investigate whether the debt is disputed by the obligor and to obtain full details from the insured on the nature of any such dispute.
Given the scope of the potential economic impact of the COVID-19 crisis, insurers and claims professionals may face unique and challenging claim scenarios. As always, preparation and timely investigation will be key.
For more information, please feel free to contact Julian Wallace (Julian.Wallace@kennedyslaw.com) in Kennedys Singapore office, or David Chadwick (David.Chadwick@ kennedyslaw.com) or Andrew Westlake (Andrew.Westlake@kennedyslaw.com) in Kennedys’ London office.