When it comes to following the rules of a host country involved in FDI, companies are advised to ‘go by the book’. But what if the book changes? Governments rise and fall and so does the legislation they introduce. Yet changes at the top are not necessarily bad for business. What is bad for business is the unknown. 

Election years are a nervous time for the market and for direct investors. And 2012 is a bumper year on the political merry-go-round: France has held its presidential election, which pitted the socialist Francois Hollande against Nicolas Sarkozy; the US presidential race between president Barack Obama and Mitt Romney will finish in November; and in the same month on the other side of the Pacific, the 18th national congress of the Chinese Communist Party will bring president Hu Jintao’s leadership (under the country's rules) to an end. 

Professor Scott Moeller, director of the M&A research centre at Cass Business School, argues that the unknown is one of the greater challenges to crossborder M&A and investment. "It is a confidence game and you are making some big bets with a lot of money. You need the board on side and maybe shareholders on side, and you need to be certain that an investment is going to pay back in the long term as well as enhance the reputation of the company. This is going to be a hard sell to shareholders if they are unsure as to the future,” he says.

Political winds

But given the length of time it takes to make investments, a change in government is inevitable at some point for any investor, as Sir Michael Arthur, a partner at ADRg Ambassadors, an organisation that offers corporate diplomacy and dispute resolution to companies operating in foreign jurisdictions, points out: “Legal uncertainty is crucial, and any business doing FDI has to factor in that there will be political change over the life of an investment.”

Clearly, however, some countries are more vulnerable to the effects of political instability. So far, France appears to have changed little from an investment viewpoint since its election, particularly when compared with the regime changes emerging out of the Arab Spring.

Of course, the developed West is by no means immune to the confluence of business and politics. In 2006, when Dubai Ports World was ready to buy the port management contracts owned by P&O, the deal had been approved by the US government but became part of a political punchbag between the House of Representatives and the then president, George W Bush. Or consider also in the US what the impact would be on the healthcare sector if Mr Obama were to lose the election. 

In developing countries, the effects can be far greater. In Venezuela, president Hugo Chavez’s government has played hot and cold with the rules on foreign interest and ownership of the country’s oil industry (and, coincidentally, Venezuela also has an election this year when Henrique Capriles, a young centrist lawyer, will challenge the left-wing Mr Chavez). 

In China, where government policy is not a matter of public record, the effect of a change in premier is an unknown. What is known is that Mr Hu must step down (and also other members of the central committee will inevitably change, too). What is not known is what the impact will be on FDI. “China is anyone’s guess,” says Mr Moeller. “Anyone who says they know [what is happening] is just hypothesising. Nevertheless, China does need to access foreign markets. And most people would be surprised if the slow liberalisation didn’t continue. But that’s no guarantee.”

Energy worries

The effect of politics and changes in political leadership is greater in certain sectors, with mining and energy being two of the most acutely political. This partly reflects the high importance of these industries in terms of GDP to the countries in question. This in turn makes them vulnerable to attempts at renationalisation (which has recently happened in Bolivia and Argentina) or, if mining or energy companies have been privatised, a government may not wish to renationalise but may retain a so-called golden share, which means that it can intercede in the business of the company. 

A sector such as mining will also fall prey to political change simply because of the long lead time of mining investments, which will outlive many different governments. But it is also because of the intense regulatory environment that mining requires: if there are a lot of laws governing a sector then companies operating in that sector are more likely to see those laws change. 

Of course, it is not only regime changes that can cause a government to change its mind on policy or pursue a change in direction that has significant consequences for foreign companies. Recently, Vodafone’s Indian operations have become embroiled in an argument with the Indian government over the latter's proposal to introduce retrospective tax laws that would cost Vodafone more than $2bn in relation to its acquisition of India’s core mobile business back in 2007.

Damage control

Political fluctuations are a reality and companies cannot avoid them. Those that cope with them the best tend to have a mechanism for coping with them. Sir Michael says that many problems can be resolved by influencing a new government and its policies at a high level. “We can use the argument very strongly to a new government that it shouldn’t retract or change things too much because it will be bad news for the country. We can show it that [the country] needs FDI, that if [the government] changes its rules, that FDI will go somewhere else, perhaps to the neighbouring country that will reap the benefits,” he says. 

Sir Michael has tangible examples where influence has helped unlock difficulties that political change has brought, but he also warns that sometimes such tactics do not deliver. “We can’t be [naive] about this. It doesn’t always work,” he says.

Perhaps there are also some opportunities to be had from political uncertainty such as on price. As Mr Moeller puts it: “At times of change in a country, prices may well be lower so you could get lucky and pick up a bargain.”