Violent conflict presents a serious challenge for businesses operating abroad. A large body of evidence shows that investments in conflict-prone countries, and the interaction with the dynamics of violent conflict at local and national levels that frequently follows, often lead to operational, reputational and even legal costs.
Political risk analysis and environmental and social impact (ESIA) standards as well as other approaches to managing risk have been evolving since the 1980s, complemented by increasingly sophisticated understandings of the appropriate relationship between business and host societies, and of ‘corporate social responsibility’ (CSR). Despite this, understanding of the interrelationship between particular investments and violent conflict has been limited.
Annex 1 provides a fuller discussion of the limitations inherent in current practice. Major gaps exist in:
- Capacity to understand accurately any existing or potential conflict in a country, its actors and their perspectives, and its causes and consequences.
- Ability to appreciate the spectrum of influence that an investment can have on such conflict, directly, indirectly and at varying levels.
Conflict risk – defined as the risk that a project’s development, construction or operations may impact negatively on and be negatively impacted by violent conflict – poses a major threat to an investment’s creditworthiness and viability. Demonstrations and blockades by local communities; sabotage of project installations or facilities; kidnapping or assault of staff; outbreak of violent clashes between armed groups; demands of payments by armed groups to project sponsors – all of these can impose direct costs on an investment.
At the same time, no project located in a conflict-prone area will be neutral in terms of its own impact on conflict. The interaction between a company investment and conflict is best understood as a two-way process: just as a project may be adversely affected by violent conflict at local or national levels, the project itself will have an impact on the conflict context within which it is located. Even where conflict appears to be geographically far from a project, the investment may become part of the conflict dynamic. If a government is party to a conflict, for instance, then payment of taxes, royalties, or profit-sharing with the government (if it is a partner) can be seen to support the state by boosting its access to resources to continue the conflict. The business’s mere presence can attract attention of warring parties, representing an influx of resources to an otherwise isolated region, stirring ambitions for autonomy or independence. And the business may become a source of heightened competition locally.
Decisions that project sponsors take regarding project location, design and management have the potential to impact and affect the severity and dynamic of the conflict. The way the company operates – in recruiting staff and distributing employment opportunities and community benefits, arranging security, interacting with political actors – has an impact. Each of these actions can, and often have, provided the trigger which may spark violence, due to preexisting structural causes and proximate conflict factors. Understanding pre-existing tensions, and how a project may impact upon them, is thus central and fundamental to improved management of conflict risk. Yet while companies are increasingly aware of the conflict-related costs that can accrue to them, the impact of project activities themselves on conflict dynamics remains only partially understood.
Direct costs clearly affect the project’s viability; indirect costs also have an impact, and banks supporting controversial projects may themselves face reputational risks.
Box1: Costs of conflict
Direct costs
- Security: Higher payments to state/private security firms; staff/contractor time spent on security management
- Risk management: Insurance, loss of coverage, reduced mobility and higher transport costs
- Material: Destruction of property or infrastructure
- Opportunity: Disruption of production, delays on imports
- Personnel: Kidnapping, killing and injury; recruitment difficulties; higher wages to offset risk
- Reputation: Consumer campaigns, risk-rating, share-price, competitive loss
- Litigation: Expensive and damaging law suits
Indirect costs
- Human: Loss of life, health, intellectual and physical capacity
- Social: Weakening of social, political and economic capital
- Economic: Damage to financial and physical infrastructure, loss of markets
- Environment: Pollution, degradation, resource depletion
- Political: Weakening of institutions, rule of law, governance
Some companies have actively engaged in the debate on business and conflict, which has climbed international policy agendas over the past decade. This is particularly true of companies in the extractive industries, who have participated in multi-stakeholder processes such as the Kimberley Process Certification Scheme4, the Extractive Industry Transparency Initiative (EITI)and the Voluntary Principles on Security and Human Rights (VPs)in order to seek out shared solutions to problems. To date, the financial sector has had limited involvement in these discussions and processes, although several leading banks have adopted the Equator Principles,and the UN Global Compact has had a special focus on finance.
Large-scale investment to build infrastructure, construct dams, or prospect for oil, gas of mineral resources is made possible because lenders, insurers and promoters come together and pool risks. The field of project finance is therefore well-placed to develop new and innovative approaches to assessing and managing risks associated with major investments in conflict-prone countries.
This briefing paper proposes better lending practice in conflict-prone states – defined as ‘conflict-sensitive’ project finance – is in the interests of all stakeholders. Such an approach would enable financial institutions to:
- Understand the conflict context in which a project is developed
- Recognise the two-way process that characterises the interaction between investments and conflict and assess the impact between the project activities and the conflict context
- Mitigate negative impacts that may result from such an interaction
- Harness opportunities to encourage project sponsors to contribute to a more secure operating environment
A conflict-sensitive approach to lending and insuring can provide project sponsors and investors with increased confidence that cash flow, reputation and relations with host countries and other actors will not be negatively affected by violent conflict. In turn, this approach may also assist multilateral development banks (MDBs) and others to improve their track record of supporting those projects that further developmental goals, as well as projects which ‘do no harm’ and contribute to the building of peace.
