Political risk tempers LP appetite for Southeast Asia

To foreign investors familiar with Southeast Asia, the intricate web of relationships that underpin commercial and political activity is no longer a surprise. European and US institutions, however, would still raise an eyebrow - and fret about the Foreign Corrupt Practices Act - on discovering that an Indonesian or Philippine fund manager or portfolio company executive is in bed with a local political party.

This might explain why a recent report produced by the Emerging Markets Private Equity Association (EMPEA) found that 23% of LPs regard political risk factors as a deterrent to investing in these countries. What is it about Indonesia and the Philippines, which have starkly different political environments, that provokes such responses?

Corruption in the run-up to a general election is one area of common concern. Candidates running for positions that carry responsibility for certain kinds of projects often expect their campaign chests to be funded by those who'll need their help in the future.

"You need to grease that hand with a very large sum of money in order to get your license, your final signature to begin operations" says Dane Chamorro, Asia Pacific director for global risk analysis at consultancy Control Risks. "As a result, big projects often just slow down and stop because Western companies are going to violate criminal statutes from their own countries if they make those payments, even if they wanted to."

Conflicts of interest
This scenario is particularly pertinent to Indonesia right now, as the nation is due to hold elections in 2014. The forthcoming poll is a prime example of the interrelationship between local political leaders and entrepreneurs, who are in many cases one and the same.

Take Aburizal Bakrie. Widely regarded as one of the most successful businessmen in Indonesia, Bakrie is also chairman of the country's largest political party, Golkar, and a strong tip to become the next president. Concerns about conflicts of interest are widespread because the Bakrie family controls companies across the breadth of Indonesia's economy, including the mining, oil and gas and property sectors, leaving any competing companies in these spaces highly vulnerable to capricious policy-making.

Such national level concerns are often even more intense among the localities, where officials ride roughshod over central directives in the pursuit of their own interests.

Jason Wright, associate managing director at risk consultancy Kroll in Singapore, says that the decentralization Indonesia underwent following the removal of the Suharto in 1998, only increased the power - and potential for corruption - at a local level. "There's a sense that you need a local partner in order to protect your investment, but that can amount to a form of corruption," says Wright. "You can end up being pressured into paying off local officials."

Local governments have also been known to void contracts or withdraw licenses, as Churchill Mining, a UK company backed by Pala Investments, found to its cost. In 2008 Churchill uncovered a giant coal deposit in the province of East Kalimantan, Borneo. Months after the discovery, a local government official revoked the company's licenses, saying it had cut protected forest illegally.

In certain localities of the Philippines, issues of corruption go hand-in-hand with threats to security. The more rural parts of Mindanao, home to a number of mining, logistics, telecoms, and infrastructure investments, is troubled by Marxist-inspired insurgent groups that not present safety concerns for companies on the ground, but also demand so-called revolutionary taxes from businesses operating within their stronghold.

"You get a political group, which is essentially operating as a sort-of mafia group, subjecting the mining companies to extortion. With that comes the potential for bribes, and if you're a US company, falling foul of US laws against terrorist financing," says Wright.

Yet despite the risks, appetite for investment in these countries continues to increase, with Indonesia in particular generating huge interest in the private equity community.

Local player Northstar Pacific last year raised $820 million for its third fund and then signed a share-swap agreement with TPG Capital that gives them an economic interest in one another's business. A host of other Indonesia funds, experienced GPs and first-time managers, are currently seeking capital.

It would appear that tales of corruption and unreliability are not enough to slow the groundswell of confidence that has greeted the emergence of a dynamic consumer market, a period of relative political stability and the country being elevated to investment-grade status.

Growth imperative
"You have much higher growth than in European markets, but you also have a higher risk that your investment could collapse because your competitors have a political advantage or a certain license you need is denied to you because you weren't paying the right people," says Wright. "There's a higher risk of large impact events but there's also more growth and potential."

Over in the Philippines, meanwhile, Eric Manlunas, managing partner of Siemer Ventures and a trustee of the Philippine Development Foundation, also points to a newfound stability in the commercial environment."The new administration has aggressively dealt with corruption issues by exposing and prosecuting corrupt officials which has inspired renewed confidence in the private sector," he explains. "LPs that continue to latch on to that legacy perception will risk missing out on the next emerging market performer."

Be that as it may, experts in risk mitigation advise caution to private equity investors as they review opportunities in these markets, as many inevitably will over the coming years.

"LPs are under a lot of pressure to put money in places with high rewards, high growth. They need to do their homework, but shouldn't lose sight of the forest for the trees," says Chamorro. "You are doing business in a place where the rules of the game can change very quickly."

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• Topics
• Southeast Asia
• LPs
• Siemer & Associates
• Emerging Markets
• Indonesia
• Philippines
• LPs