oversight

Overseas Investment: Issues Related to the Overseas Private Investment Corporation's Reauthorization

Published by the Government Accountability Office on 1997-09-08.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                   United States General Accounting Office

GAO                Report to the Chairman, Committee on
                   International Relations, House of
                   Representatives


September 1997
                   OVERSEAS
                   INVESTMENT
                   Issues Related to the
                   Overseas Private
                   Investment
                   Corporation’s
                   Reauthorization




GAO/NSIAD-97-230
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      National Security and
      International Affairs Division

      B-277618

      September 8, 1997

      The Honorable Benjamin A. Gilman
      Chairman, Committee on International Relations
      House of Representatives

      Dear Mr. Chairman:

      The Overseas Private Investment Corporation (OPIC), an independent
      government corporation created to promote investment in emerging
      market economies, has been the focus of debate in recent months. Unless
      Congress reauthorizes it, OPIC’s charter expires September 30, 1997.
      Among the issues subject to debate on whether to reauthorize OPIC are
      questions relating to public sector investment support, OPIC’s cost to the
      government, and the potential liabilities OPIC subjects the government to in
      pursuing foreign policy objectives by making investments in developing
      countries.

      As you requested, we reviewed (1) trends in private sector investment in
      developing markets and the role of the public sector in these markets;
      (2) OPIC’s risk management strategy and the steps that OPIC may take, if it is
      reauthorized, to further reduce portfolio risks while pursuing U.S. foreign
      policy objectives; and (3) the issues to be addressed and the time it would
      take to phase out OPIC if it is not reauthorized.

      In conducting this review, we analyzed private investment trends and
      surveyed a judgmental sample of 34 U.S. firms that had made investments
      overseas within the last 5 years in the power and telecommunications
      sectors—two of the four largest investment sectors in emerging markets.
      (See app. I for a list of companies surveyed.) We also analyzed OPIC’s risk
      assessment policies and financial reports and discussed risk mitigation
      strategies with private and public providers of project finance. Project
      financing involves lending for major projects where the assurance of
      repayment is provided through the project’s structure and anticipated
      future revenues rather than through sovereign (that is, national
      government) or other forms of guarantees. In some cases, the public
      sector provides investment support to investors in these projects. Further,
      we reviewed and discussed laws and regulations governing an agency
      shutdown with cognizant government officials.




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             OPIC was established by the Foreign Assistance Act of 1969 (P.L. 91-175,
Background   Dec. 30, 1969) to pursue the U.S. foreign policy of mobilizing and
             facilitating the participation of U.S. private capital and skills in the
             economic and social advancement of developing countries. In carrying out
             this responsibility, OPIC took over the investment guarantee and promotion
             functions of the U.S. Agency for International Development. In the early
             1970s, the U.S. approach to foreign assistance began to shift from one of
             providing government aid for infrastructure building and large capital
             projects to providing assistance to meet basic human needs. OPIC’s role
             was to support market-oriented private investment in various sectors.

             More recently, the World Bank has estimated that $200 billion would be
             needed annually over the next 10 years to meet the infrastructure needs of
             developing countries. Obtaining this level of private investment will be a
             major challenge given the economic and political characteristics of
             emerging markets and the unique risks inherent in each project. Project
             financing is emerging as an important component in infrastructure
             development.

             OPIC’s programs are designed to promote overseas investment and assume
             some of the associated risks for investors. Specifically, OPIC offers direct
             loans and loan guarantees to U.S.-sponsored joint ventures abroad,
             supports private investment funds that provide equity for projects abroad,
             and provides political risk insurance to U.S. investors. The political risk
             insurance covers investors for up to 20 years against losses due to
             currency inconvertibility, political violence, and expropriation.1 OPIC
             collects premiums and fees from the private sector for insurance and
             financing services. OPIC finance and insurance activities are backed by the
             full faith and credit of the U. S. government and are limited to a total
             exposure of $23 billion in fiscal year 1997. OPIC services are available in
             some 140 developing countries, although OPIC does not operate in some
             countries, largely for U.S. foreign policy reasons.

             Projects eligible for OPIC assistance include new investments,
             privatizations, and expansions or modernization of existing plants. The
             sectors OPIC supports include power, financial services,
             telecommunications, and oil and gas. To obtain OPIC support, investors
             must meet specific criteria, including U.S. ownership requirements.


             1
              Currency inconvertibility is the deterioration in the ability to convert profits, debt service, and other
             remittances from local currency into U.S. dollars. Loss due to political violence results from damage to
             assets caused by war, revolution, insurrection, or politically motivated civil strife. Expropriation is the
             loss of an investment due to expropriation, nationalization, or confiscation by a foreign government.



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                       Over the years, Congress has placed various requirements on OPIC’s
                       authority to support U.S. investment. For example, in carrying out its
                       activities, OPIC is to

                   •   administer its entire portfolio (financing, insurance, and reinsurance
                       operations) on a self-sustaining basis and in a manner that ensures that the
                       projects it supports are economically and financially sound;
                   •   refuse support for any investment in countries that are not taking steps to
                       adopt and implement internationally recognized worker rights; and
                   •   decline participation in investments that are likely to significantly reduce
                       U.S. domestic employment levels or pose an unreasonable or major
                       environmental, health, or safety hazard.


                       Improvements in economic and political conditions in many developing
Results in Brief       countries—markets where OPIC services have traditionally been
                       sought—have led to a reduction in investors’ perception of risk and a
                       dramatic increase in private investment in these markets since the late
                       1980s. However, according to most of the 34 firms we surveyed, risky
                       markets still exist where the private sector (investors, bankers, and
                       insurers) stated they are reluctant to invest or operate without public
                       (government or multilateral) guarantees or insurance. For example, four
                       of the firms that we spoke to that invested in Russia or Ukraine said that
                       private insurance was unavailable for their projects and financiers were
                       reluctant to invest without public involvement. In high-risk markets such
                       as these, U.S. investors we spoke with have sought public finance or
                       insurance from OPIC, the U.S. Export-Import Bank (Eximbank), or other
                       public institutions such as Japan’s Ministry of Trade and Industry. In risky
                       markets where OPIC services are not available, such as Vietnam, China, and
                       Mexico, U.S. investors that we surveyed tended to use other public
                       support.2 For example, the two investors in Vietnam used public providers
                       of investment support, and two investors in China used public support
                       while two investors there partnered with the Chinese government. In
                       Mexico, some investors we spoke to used public support; however, two
                       investors self-insured. If foreign export credit agencies provide the
                       support, U.S. suppliers could be excluded.

                       OPIC has historically been self-sustaining by generating revenues from its
                       insurance and finance programs to cover actual losses. OPIC’s risk
                       mitigation strategy includes maintaining reserves ($2.7 billion in reserves

                       2
                        Of the 34 firms that we interviewed, 2 operated in Vietnam, 5 in China, and 5 in Mexico. Some of these
                       firms had operations in more than one country.



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                          held largely in Treasury securities), limiting its exposure in any one
                          country, requiring pre-approval reviews, and establishing underwriting
                          guidelines. Nonetheless, the private sector’s willingness to have greater
                          involvement in some emerging markets has created opportunities for OPIC
                          to further reduce portfolio risks, while continuing to pursue U.S. foreign
                          policy objectives. Possible ways for OPIC to minimize the risks associated
                          with its insurance portfolio include obtaining to a greater extent
                          reinsurance from or coinsuring with other insurance providers, insuring
                          less than 90 percent of the value of each investment, and offering
                          insurance at less than a 20-year term. While OPIC officials agree that
                          reinsurance and coinsurance are good risk mitigation techniques, they
                          cautioned that these strategies should be employed on a case-by-case basis
                          so as to enable OPIC to continue to meet U.S. foreign policy objectives and
                          the needs of its customers.

                          If Congress decides not to reauthorize OPIC, an orderly phaseout of the
                          agency would require specific legislative action. An important issue that
                          would need to be addressed is who would manage the existing portfolio.
                          Also, given that OPIC issues insurance policies with 20 year coverage, and
                          that OPIC had $5.3 billion in insurance contracts with 19-20 years remaining
                          as of September 30, 1996, it could take up to 20 years for OPIC’s existing
                          obligations to expire. OPIC’s past experience, however, shows that most
                          insurance policies are canceled by clients before the end of the 20-year
                          term. Thus, OPIC projects that less than 36 percent of its existing portfolio
                          would remain active after 10 years. The government has the option to sell
                          OPIC’s portfolio to the private sector before its expiration. However, a
                          recent study suggests that immediate disposal of OPIC’s assets could only
                          be accomplished at a discounted price.3 If the risk of the remaining
                          portfolio decreases over time, opportunities for asset disposal may arise.


                          A changing global environment has reduced the perception of risk for the
Global Changes Have       investors we spoke with in emerging markets. Economic growth and
Reduced the Private       liberalization have created investment opportunities in sectors that were
Sector’s Perception of    previously dominated by government-owned companies or were simply off
                          limits to foreign investors. Many countries, for example, have privatized
Risk, Yet Public          their power and telecommunication sectors and enacted laws that permit
Support Still Sought in   foreign ownership, resulting in dramatic increases in foreign investment.
                          More recently, private providers of project finance and political risk
Some Markets              insurance are increasingly available to assist investors. However,

                          3
                           Overseas Private Investment Corporation: Final Report on the Feasibility of Privatization (New York:
                          J.P. Morgan Securities, Inc., Feb. 7, 1996).



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                         according to many of the firms we surveyed, markets still exist where they
                         are unable to obtain private finance or insurance services. As a
                         consequence, they seek public support. Public support includes direct
                         loans, loan guarantees, and political risk insurance from OPIC and the U.S.
                         Eximbank; foreign agencies that provide such services (often called export
                         credit agencies); or multilateral financial institutions, such as the World
                         Bank.


Private Investment in    The privatization of public enterprises, legal and regulatory reforms, and a
Transition Markets Has   more stabilized political and economic environment in developing
Increased Considerably   counties, among other changes, have led to an increase in total private
                         capital flows. As shown in figure 1, private capital flows to finance
                         infrastructure projects and other private investments overseas have
                         increased from $26 billion in 1986 to $246 billion in 1996.4




                         4
                          Total private capital flows are calculated by the World Bank on a net basis (net of repayments) and
                         include portfolio bonds and equity, foreign direct investment, commercial bank loans, and other
                         private flows. Other private flows include credits from manufacturers, exporters, and other suppliers
                         of goods, as well as bank credits covered by a guarantee of an export credit agency.



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Figure 1: Net Private Capital Flows to
Developing Countries, 1986-96
                                         In billions of 1995 dollars
                                         250




                                         200




                                         150




                                         100




                                             50




                                              0
                                                  1986   1987   1988      1989     1990     1991     1992      1993     1994     1995     1996



                                         Source: World Bank.




                                         During the 1990s, private sector finance has increased dramatically,
                                         especially to Asian and Latin American developing countries, despite
                                         setbacks associated with the Mexican peso crisis.5 Private flows going to
                                         infrastructure reflect these overall increases, particularly in commercial
                                         lending devoted to project finance. According to a 1996 International
                                         Finance Corporation report,6 these private infrastructure investments
                                         would not have seemed possible 10 years ago. Today, more and more
                                         countries are introducing competition and private participation in
                                         infrastructure ownership and management.


                                         5
                                          The Mexican peso crisis in 1995 led to a temporary decline in private flows to Latin America.
                                         6
                                          Lessons of Experience: Financing Private Infrastructure (Washington, D.C.: International Finance
                                         Corporation, Sept. 1996), p. 1. The International Finance Corporation is a part of the World Bank group
                                         that promotes investment by the private sector.



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                              The 34 power and telecommunications companies that we surveyed
                              indicated that their investment decisions have been significantly
                              influenced by the recent developments in emerging markets. In general,
                              30 of the companies stated that changes in the legal and regulatory
                              environment in emerging markets have led them to seek investments in
                              countries where they had not invested in the past. At the same time, the
                              U.S. power market matured, and U.S. power companies began seeking
                              investment opportunities in emerging markets.


Availability of Private and   The rise in overseas private investment has been accompanied by
Public Investment Services    increases in investment support by public providers of finance and
Increasing                    insurance as well as increases in private insurance coverage in some
                              markets. Three countries—Japan, the United States, and Germany—are
                              the largest public providers of political risk insurance. (See app. II, which
                              identifies features of the services provided by the major public providers
                              of political risk insurance.) Lloyd’s of London, the American Insurance
                              Group, and Exporters Insurance Corporation—three major private
                              insurers—have recently increased their insurance coverage.

                              Globally, public providers have increased investor coverage. According to
                              the Berne Union,7 new investments insured by its members rose annually
                              between 1991 and 1996, going from $7.1 billion to $15.2 billion. As of the
                              end of 1996, the cumulative amount of investment covered by Berne Union
                              members was $43.4 billion. According to data collected directly from the
                              major public providers of political risk insurance, Japan led all public
                              providers with $13.9 billion in cumulative exposure. OPIC was second with
                              $13.4 billion in exposure, and the German public provider was third with
                              $7.8 billion in exposure. These public insurers have traditionally
                              dominated the public risk insurance market. Although the major public
                              providers generally offer investment services in the same countries, each
                              of the major providers’ business tends to concentrate in different markets.
                              OPIC, for example, concentrates in Latin America, the Japanese in Asia, and
                              the Germans in Asia/Pacific and Central and Eastern Europe. (See app. III
                              for available information on the regional concentration of major public
                              insurance providers.) Investors are also assisted by other Berne Union
                              members, including the Multilateral Investment Guarantee Agency, a
                              multilateral institution affiliated with the World Bank Group, with about
                              $3.9 billion in exposure reported in 1997.



                              7
                               The Berne Union is an international union of credit and investment insurers that represent private and
                              public political risk insurers from 38 countries and locations.



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                           The level of coverage of privately provided political risk insurance has
                           increased considerably over the past 2 years, according to the private
                           insurers we spoke with. Although the volume of coverage provided by
                           private insurers is difficult to determine, a political risk insurance expert
                           estimated that several billion dollars of private political insurance
                           coverage was provided in 1996.8 According to the American Insurance
                           Group, one of the largest private providers of political risk insurance, it
                           increased the length of its coverage from a maximum of 3 years to a cap of
                           7 years in 1996. Additionally, ACE, Inc., a private insurance provider,
                           recently entered into a reinsurance contract with the Multilateral
                           Investment Guarantee Agency, providing up to 15 years of risk coverage
                           on the same terms as that agency. However, according to officials of a
                           large commercial bank and a private political risk insurer, in some risky
                           markets private insurers are only willing to provide insurance when a
                           public sector entity is involved in the project. A private insurer we spoke
                           to said his company had not provided coverage in Russia and most of the
                           other newly independent states of the former Soviet Union.

                           Public and private sources also provide financing in developing countries.
                           Public providers include OPIC; the International Finance Corporation, a
                           multilateral institution affiliated with the World Bank Group; the U.S.
                           Eximbank; and other bilateral credit agencies, such as the Japanese
                           Export-Import bank. Private sector financing to developing countries is
                           available through commercial banks and other private financial
                           institutions. According to the World Bank, this source of financing has
                           increased significantly during the 1990s, with about one-half of these
                           resources directed toward project financing for infrastructure
                           development.


Risk Determines Whether    Investors’, private lenders’, and insurers’ perception of risk frames how
Investors Seek Public or   projects are structured and financed. The risks assumed and the type of
Private Finance and        support sought by investors can differ by project and by sector.9 For
                           example, based on the projects identified in our survey, more
Insurance                  telecommunications projects were completed without public support and
                           with investor self-insurance than were power projects. Power plants are
                           costly and can take 10 years or longer to recoup the investment costs,
                           according to an energy firm official we interviewed, making plant assets

                           8
                            Private insurers generally regard the existence and amount of their insurance as a confidential matter.
                           9
                            Country political and economic conditions, project size, the ability of the investor to remove or
                           dispose of the assets, if necessary, the financial strength of the investors, and many other factors are
                           also considered by project financiers and insurers.



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and income subject to long-term political risks. Telecommunications
projects, on the other hand, may generate enough income to cover
investment costs in just a few years.

Investors we surveyed told us that over the past decade, several Latin
American, East Asian, and East European countries have taken steps to
create environments attractive to investors. Specifically, 22 of the 34 firms
we spoke to were comfortable with assuming investment risks after they
had been successful in a country for a period of time. For example, one
telecommunications company that is developing cellular telephone
operations in Hungary told us that the availability of OPIC political risk
insurance was a critical factor in its initial decision to invest $200 million
when privatization allowed the company to enter the market. After 2 years,
however, the company reassessed the political and economic risks of this
investment and decided to drop its OPIC insurance in favor of
self-insurance.10 A company with 10 projects in Poland told us that it
developed 9 cable projects with private investment after completing 1
successful project in Poland that was financed by OPIC 5 years ago when
private financing was not available. In another example, a power company
that has used OPIC in other high-risk markets has made acquisitions of
privatized public utilities in Argentina and Chile without official support
by obtaining financing from European financial markets and locally
syndicated money. Officials of the International Finance Corporation
confirmed that investors are increasingly likely to cancel International
Finance Corporation loans as lower-priced private financing becomes
more available in lower-risk markets.

Despite these trends, some markets are still considered high risk by
investors, lenders, and private insurance companies. Thus, obtaining
commercial finance and insurance in these markets remains difficult,
according to private firms we surveyed. Several of the power and
telecommunications companies we surveyed concurred with the
assessment that in several regions of the world, including Africa, Russia,
the other newly independent states of the former Soviet Union, and
Central America, the perception of risk remains high. Some companies
told us that they are generally unable to raise the necessary financing for
transactions in high-risk countries without public support. For example,
four firms that we spoke to that invested in Russia or Ukraine said that
private finance was unavailable for their projects. One
telecommunications company with investments in Russia and Ukraine

10
  Some firms still seek public support in Hungary. OPIC officials said that in Hungary they have
recently insured a large telecommunications project and anticipate insuring a power project within the
year.



Page 9                                                   GAO/NSIAD-97-230 Overseas Investment
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                         stated that without OPIC political risk insurance, it would have avoided
                         these high-risk markets.11 A power company with a $150-million equity
                         investment in El Salvador covered by OPIC political risk insurance told us
                         that the availability of OPIC services was a key factor in the company’s
                         decision to invest in the country. According to an official from this
                         company, although it considers Guatemala to have great potential for the
                         industry, private financial institutions and insurance companies still
                         consider Guatemala to be high risk, and the company will not go forward
                         with projects in Guatemala without OPIC or other public support.
                         Additionally, private lenders and insurance companies we spoke with told
                         us that they offer limited, if any, services in higher-risk markets such as
                         the newly independent states of the former Soviet Union. Officials at the
                         major international banks we visited noted that they are reluctant to lend
                         in high-risk markets without some form of political risk insurance and that
                         the private insurance companies often cannot provide the kind of
                         insurance lenders need in these markets.


U.S. Investors Obtain    In countries where OPIC services are not available due to U.S. foreign
Public Support in Some   policy or operational reasons, such as Mexico, China, Pakistan, and
Non-OPIC Markets         Vietnam, we found that most of the U.S. investors we interviewed often
                         seek other forms of public support to facilitate investment.12 As is the case
                         in other emerging markets, investors’ decisions to invest in a project were
                         predicated on their perceived risk. Our survey of U.S. investors showed
                         that when U.S. firms believed they needed public investment support in a
                         non-OPIC country, they sought investment support from the U.S. Eximbank or
                         other foreign export credit agencies or multilateral financial institutions.
                         Although such support facilitates the original investment, subsequent
                         equipment and service procurements are often tied to the countries
                         providing the support. Thus, if foreign export credit agencies provide the
                         support, U.S. suppliers could be excluded.

                         In some non-OPIC markets, such as Mexico, U.S. investors may not always
                         seek public support. According to a telecommunications company official,
                         several risk mitigation factors enabled the company to make a $1-billion
                         investment in Mexico without political risk insurance or other official
                         participation in the project. Mexico’s historical and geographical
                         relationship to the United States, trends in Mexico’s economic

                         11
                          It is difficult to independently discern whether an investment in high-risk markets would have
                         occurred without public support.
                         12
                           OPIC does not operate in a developing country unless it has a bilateral investment agreement.
                         Further, U.S. statutes specify that certain in-country conditions, such as inadequate protection of
                         internationally recognized workers’ rights, preclude OPIC from supporting private investment.



                         Page 10                                                    GAO/NSIAD-97-230 Overseas Investment
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performance, the potential for free trade, and the contractual commitment
of high-level government officials and the Mexican Central Bank, along
with the company’s confidence in its Mexican partner, all helped lower the
company’s perception of risk. In contrast, a $644-million power project in
Mexico is being undertaken by U.S. investors facilitated by a $477-million
U.S. Eximbank loan, $28 million in U.S. Eximbank political risk insurance
during construction, and a $75-million Inter-American Development Bank
loan.

In China, companies have entered into joint ventures with local companies
that are affiliated with provincial governments, which lowers investor
perception of risk. Depending on the size of the project, these companies
were more likely to obtain a portion of their financing from multilateral
institutions or foreign official sources. For example, one power company
with several recent joint ventures in China financed smaller-sized projects
(under $30 million) without public support. However, the same company
is finalizing a $1.6-billion project and is obtaining support from the U.S.
Eximbank and Hermes, Germany’s export credit agency. The opportunities
presented by China’s large market potential may increase investors’
willingness to do business there despite the perceived risk.

In other markets where OPIC is not available, the U.S. firms we surveyed
have used the services of multilateral agencies or export credit agencies.13
One telecommunications company mitigated its risk in Pakistan by
obtaining guarantees and political risk insurance from the International
Finance Corporation and the Multilateral Investment Guarantee Agency.
Because OPIC was not available in Vietnam, a U.S. power firm used the
Asian Development Bank and Coface (the French export credit agency) to
finance a $160-million power plant.

U.S. investors’ use of investment support from sources other than OPIC may
affect the source of procurements. Multilateral institutions generally do
not tie their support to buying equipment from a particular country.
However, some U.S. firms told us that they were unable to use U.S.
suppliers when they obtained support from foreign export credit agencies.
In testimony before Congress, an official of a large U.S. company testified
that her company utilized or planned to use German, Japanese, or French
equipment for projects in China, Pakistan, and Vietnam because the




13
 Some foreign export credit agencies extend support to foreign-owned entities that are domiciled
within their borders.



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                        company obtained investment support from German, Japanese, and
                        French export credit agencies.14


                        Historically, OPIC has been self-sustaining, generating substantial revenues
OPIC’s Revenues         from its finance and insurance programs and its investments that together
Have Exceeded Its       have been sufficient to cover actual losses. As of September, 1996, OPIC
Losses, but Global      had accumulated $2.7 billion in reserves.15 According to a February 1996
                        J.P. Morgan Securities, Inc., report, OPIC’s reserves are more than adequate
Changes May Present     to cover any losses that OPIC might experience, excluding an
Opportunities for       unprecedented disaster.16 OPIC’s risk management strategies, which include
                        maintaining reserves, setting exposure limits, performing pre-approval
OPIC to Further         reviews, and applying underwriting guidelines, help limit U.S. taxpayers’
Reduce Portfolio Risk   exposure to undue risk and prevent project losses. In 1994, OPIC raised the
                        maximum amount of insurance and finance coverage it offers on a given
                        project, a step that increases the government’s exposure to loss but may
                        not negatively affect the quality of OPIC’s portfolio. Notwithstanding OPIC’s
                        track record, the private sector’s willingness to have greater involvement
                        in some developing countries has created opportunities for OPIC to take
                        steps to further reduce the risk associated with its portfolio through
                        greater risk-sharing. Some possible options to explore include obtaining
                        reinsurance from other providers, utilizing coinsurance, and insuring less
                        than 90 percent of the value of each investment. Adoption of any of these
                        options, however, should be carried out with due consideration of U.S.
                        foreign policy objectives.


OPIC Has Generated      Historically, OPIC has generated sufficient revenues from its insurance and
Sufficient Revenue to   finance programs to cover its operating costs and the losses associated
Cover Its Losses        with its portfolio.




                        14
                          Testimony of Linda F. Powers, Senior Vice President of Global Finance at Enron International, before
                        the Subcommittee on International Economic Policy and Trade, House Committee on International
                        Relations, March 18, 1997.
                        15
                          OPIC’s reserves are primarily held in Treasury securities.
                        16
                         Overseas Private Investment Corporation: Final Report on the Feasibility of Privatization (Feb. 7,
                        1996).



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OPIC’s Insurance Program   Since its inception through 1996, OPIC had about $500 million in insurance
                           claims and recovered all but $11 million of this amount from the disposal
                           of assets and recoveries from foreign governments.17 During the same
                           period, OPIC has received over $922 million in premiums from its insurance
                           activities. OPIC’s insurance revenues have exceeded its gross claims
                           payments in all but 3 fiscal years, excluding recoveries that OPIC obtained
                           after the claims were paid and liabilities were incurred but not reported.
                           Also excluded is interest from Treasury securities.


OPIC’s Finance Program     According to J.P. Morgan Securities, Inc., OPIC’s finance program has
                           operated at a small loss or close to breaking even. Although OPIC’s cash
                           revenues from its finance program have exceeded all cash losses from
                           loans or loan guarantees since 1984, when operating costs and loan loss
                           provisions are included, OPIC’s finance program shows a net operating loss
                           for each year since 1993. If income from Treasury securities were
                           allocated for each of these years, the finance program would show a net
                           income.18

                           Under OPIC’s finance program, its direct loans, which by statute are only
                           available to small businesses, have experienced higher rates of
                           delinquencies19 and loan losses than its loan guarantees. Between 1984 and
                           1996, OPIC’s average direct loan loss rate was 4.4 percent; the loss rate was
                           at its highest, at 11.7 percent, in fiscal year 1984. In the same time period,
                           OPIC’s loan guarantee portfolio had an average loan loss rate of
                           0.56 percent for a combined rate (direct loans and loan guarantees) of
                           0.93 percent on average outstandings.

                           OPIC’s finance program has been subject to the Federal Credit Reform Act
                           of 1990, which became effective in fiscal year 1992.20 The act requires that
                           government agencies, including OPIC, estimate and budget for the total




                           17
                             OPIC officials noted that the recoveries may not fully take into account the time value of money.
                           18
                             The allocation of Treasury security interest income is relevant for financial statement purposes. With
                           regard to OPIC’s statement about its interest earnings, only those earnings properly allocable to its
                           credit program are relevant to the discussion of its credit subsidy estimates; under credit reform
                           requirements, interest earned on credit-related reserves is required to be included in estimating the
                           subsidy cost.
                           19
                             Late payments on loans.
                           20
                            The finance program is subject to the Federal Credit Reform Act of 1990 (Public Law 101-508, Nov. 5,
                           1990) for budgetary treatment.



                           Page 13                                                   GAO/NSIAD-97-230 Overseas Investment
                           B-277618




                           long-term costs of their credit programs on a present value basis.21 Based
                           on the required estimation of subsidy costs under credit reform, OPIC’s
                           finance program will cost the government $72 million in fiscal year 1997
                           and total about $135 million between fiscal years 1992 and 1996.22

                           Historically, OPIC’s combined finance and insurance programs have been
                           profitable and self-sustaining, including costs due to credit reform and
                           administration. The J.P. Morgan Securities, Inc., report23 stated that OPIC’s
                           finance program has operated at a small loss or close to breaking even and
                           that much of OPIC’s profitability has come from interest earned on Treasury
                           securities. This interest has accounted for over 60 percent of OPIC’s total
                           revenue over the past 6 years. In fiscal year 1996, OPIC’s net income was
                           $209 million, of which $166 million was interest on Treasury securities.
                           From a governmentwide perspective, interest on Treasury securities held
                           by OPIC represents transfers between two government agencies (that is,
                           OPIC’s income from Treasury securities is a Treasury expense) that cancel
                           each other out. From that perspective, OPIC’s net income from transactions
                           with the private sector, that is, fees and premiums, amounted to about
                           $43 million in fiscal year 1996.


OPIC Has Established a     OPIC’s risk management strategy focuses on limiting OPIC’s maximum
Risk Management Strategy   exposure to loss in any one country or sector. No single country accounts
                           for more than 15 percent of OPIC’s portfolio, effectively protecting OPIC
                           against the adverse consequences of catastrophic events in any one
                           country. The purpose of risk diversification is to spread the risk of one
                           transaction across a number of different transactions, thereby isolating
                           OPIC against the risk of one “catastrophic event.” As shown in figure 2,
                           OPIC’s portfolio is diversified across different regions of the world.




                           21
                            Present value analysis calculates the value today of a future stream of payments/cash flows at the
                           appropriate discount (interest) rate.
                           22
                             Subsidy costs arise when the estimated program disbursements by the government exceed the
                           estimated payments to the government on a present value basis over the term of the credit. Since fiscal
                           year 1992 (except for fiscal year 1995), OPIC has obtained appropriations to cover the costs of its
                           finance program. At the end of each fiscal year that appropriations have been received, OPIC paid
                           dividends to the Treasury equivalent to the finance program costs for the given year. The President’s
                           1996, 1997, and 1998 budget requests asked that Congress grant OPIC the authority to use its insurance
                           program resources to fund its finance program instead of receiving appropriations.
                           23
                            Overseas Private Investment Corporation: Final Report on the Feasibility of Privitization (Feb.7,
                           1996).


                           Page 14                                                   GAO/NSIAD-97-230 Overseas Investment
                                        B-277618




Figure 2: Regional Diversification of
OPIC’s Portfolio of Insurance and
Finance Programs, as of                                                                    Asia & Pacific   20%
September 30, 1996 (insurance and       Central & E. Europe   10%
finance combined)

                                                                                                                     Africa & M. East   11%




                                                                                                                  Newly indep. states   18%
                                          The Americas   41%




                                        Note: Maximum worldwide exposure: $19.8 billion.

                                        Source: OPIC.




                                        Although OPIC seeks to diversify its portfolio, figure 2 shows that the
                                        countries of the Americas account for more than 40 percent of OPIC’s
                                        portfolio. This trend is explained by the fact that U.S. firms choose to use
                                        OPIC support in these markets. In general, OPIC’s portfolio is consistent with
                                        U.S. foreign direct investment in emerging markets. Figure 3 displays
                                        OPIC’s portfolio diversification by investment sector.




                                        Page 15                                             GAO/NSIAD-97-230 Overseas Investment
                                      B-277618




Figure 3: Diversification of OPIC’s
Portfolio of Insurance and Finance
Programs by Sector, as of                                 Telecommunications 11%
September 30, 1996 (insurance and
finance combined)
                                                                                                                    Financial services   20%


                                      Power     29%




                                                                                                                          Other   8%



                                                                                                                 Mining    7%

                                                 Manufacturing     16%                            Oil and Gas    9%

                                      Note: Maximum worldwide exposure: $19.8 billion.

                                      Source: OPIC.




                                      OPIC’s risk management strategy also includes pre-approval review and
                                      underwriting guidelines that take into account some of the same factors
                                      other private and multilateral insurers use in evaluating projects. For
                                      example, a risk analysis is performed as part of OPIC’s insurance approval
                                      process, and a credit analysis is included in the finance approval process.
                                      OPIC officials said they consider the same factors that any commercial
                                      bank or insurance company would concerning the economics of a project
                                      under consideration for financing or insurance.

                                      Additionally, as of September 30, 1996, OPIC had accumulated over
                                      $2.7 billion in reserves as part of its risk management strategy.24 These
                                      reserves were raised from fees or premiums paid by users of OPIC’s
                                      services and from the investment of these funds in Treasury securities.
                                      OPIC’s reserves as a percentage of the total current exposure to claims have
                                      declined somewhat in recent years due to the rapid increase in the size of
                                      OPIC’s portfolio since 1994. The reserves as a percent of OPIC’s total
                                      outstanding exposure have declined from 41 percent in 1992 to 34 percent

                                      24
                                        If OPIC were to draw down its reserves that are comprised of Treasury securities to pay for losses,
                                      the losses would be reflected in budget outlays.



                                      Page 16                                                   GAO/NSIAD-97-230 Overseas Investment
                         B-277618




                         in fiscal year 1995. Despite this decline, J.P. Morgan Securities, Inc.’s, 1996
                         report on OPIC privatization concluded that these reserves are extremely
                         large relative to exposure by private sector standards and compared to
                         OPIC’s historical losses. Further, analysts at J.P. Morgan Securities, Inc., see
                         the reserves as adequate to cover OPIC’s losses in all cases but an
                         unprecedented disaster.


OPIC’s Overall Project   In 1994, OPIC increased per project financing limits from $50 million to
Limits Have Recently     $200 million and insurance coverage from $100 million to $200 million per
Increased                project. Although larger transactions increase the government’s contingent
                         liabilities, large loans are not necessarily more risky than small loans. For
                         example, 13 of the 14 loans currently in technical default or in a
                         non-performing status at the end of fiscal year 1996 were loans made to
                         small businesses and ranged in value from $328,000 to $12.5 million. In
                         addition, OPIC data show that its direct loans have historically experienced
                         more problems than its loan guarantees, which are mostly for high-value
                         loans to large companies. However, for insurance transactions, higher
                         project limits may or may not raise the overall level of risk for the
                         portfolio. On the one hand, OPIC could be subject to larger claims if a
                         foreign government, for example, were to expropriate an insured project.
                         On the other hand, if OPIC’s past experience with claims were to continue,
                         the government’s potential liability may be small. Since 1971, OPIC has
                         recovered over 98 percent of the claims it has paid.

                         We caution that OPIC’s past experience may not reflect future performance
                         because OPIC has new exposure to losses in the newly independent states
                         of the former Soviet Union, where it has had no previous experience.
                         Furthermore, some countries in the region are considered to be very risky
                         by the private insurers and bankers we spoke with.


Possible Options to      The private sector’s willingness to have greater involvement in some
Reduce the Risks         emerging markets has created opportunities for OPIC to further reduce
Associated With OPIC’s   risks in its insurance program. OPIC could share the risk of losses with the
                         private sector, which has shown an interest in emerging markets. For
Insurance Portfolio      example, OPIC could lower the risks associated with its portfolio through
                         reinsurance, coinsurance, and by decreasing project coverage or terms.
                         However, OPIC’s efforts to support U.S. foreign policy objectives, which
                         promote investment in risky markets, present challenges for OPIC when
                         considering ways to reduce the risks associated with its insurance
                         portfolio.



                         Page 17                                     GAO/NSIAD-97-230 Overseas Investment
              B-277618




Reinsurance   Under the reinsurance scenario, OPIC could consider insuring part of its
              high- and medium-risk portfolio with private sector insurance companies
              at premium rates that are mutually acceptable. For example, OPIC could
              enter into a contract with a large private insurer that would pay a specified
              percentage of any claims to OPIC. Care must be taken to ensure that the
              private insurer is not providing support exclusively for the lower-risk
              transactions and that OPIC retains enough of the reinsured premiums to
              cover its administrative costs. According to OPIC officials, OPIC had used
              portfolio re-insurance by the private sector as a mechanism for managing
              risk and stimulating U.S. private sector interest in providing risk insurance
              until the mid-1980s. The Grace Commission concluded that given OPIC’s
              low claims experience, there was no justification for the U.S. government
              to pay reinsurance premiums that exceeded claims payments collected
              from the reinsurers. After the Grace Commission’s study25 of OPIC’s
              reinsurance practices, the Office of Management and Budget directed OPIC
              to stop this practice because it was not cost-effective. OPIC officials told us
              that OPIC is currently in discussions with the Office of Management and
              Budget about the feasibility of once again pursuing portfolio reinsurance.
              As noted earlier, private political risk insurance companies are showing
              greater interest in emerging markets. This trend presents OPIC with
              opportunities to negotiate fee or premium arrangements that it would not
              have been able to negotiate in the past.


Coinsurance   Another risk mitigation strategy that OPIC may use is providing more
              coinsurance. It could coinsure a project with other private or public
              insurers in order to share the associated risks and premiums. In this case,
              the coinsurer would provide insurance that might or might not be identical
              to the type provided by OPIC that would permit both parties to provide a
              higher level and scope of coverage. For example, OPIC could provide
              $100 million of coverage on a $200-million project, while a private entity or
              a number of entities could provide the other $100 million of coverage. An
              insurance industry official has publicly stated that OPIC could leverage its
              resources by inviting the private sector to provide 50 percent of the
              insurance required on a project. However, OPIC officials said that the
              private sector’s reluctance to take long-term risk in risky markets limits its
              opportunity to pursue coinsurance. OPIC has documented only 12 of 1,392
              contracts that it has coinsured with the private sector since 1988.

              25
                The Grace Commission was established in 1982 to identify opportunities for (1) efficiency
              enhancement and cost reduction and (2) greater managerial accountability to provide information on
              governmental expenditures and indebtedness. The Commission recommended that OPIC phase out
              reinsurance on its expropriation and inconvertibility policies and seek reinsurance for its political
              violence policies on a temporary basis.



              Page 18                                                  GAO/NSIAD-97-230 Overseas Investment
                            B-277618




Risk Sharing                A third risk mitigation strategy may be to reduce the coverage and terms
                            of OPIC’s insurance program. OPIC currently offers standard 20-year
                            insurance with 90 percent coverage of the value of the insured assets.26
                            One potential option would be that OPIC could insure less than 90 percent
                            of the value of each investment. OPIC’s rationale for insuring 90 percent,
                            rather than 100 percent, of the value of the assets is to ensure that the
                            investor or project sponsor has an incentive to manage its assets
                            prudently. Another option would be for OPIC to offer less than 20-year
                            coverage. For example, rather than providing its current 20-year standard
                            policy, OPIC could offer a standard 15-year term, as is the practice with
                            other public insurers, and provide 20-year cover only in certain cases.
                            Lastly, OPIC could require that the insured hold OPIC coverage for a
                            minimum of 3 years. These measures would lower the value of assets
                            covered, the length of coverage, and potentially the cost of coverage.

                            Regarding the risk-sharing option, OPIC officials said that reducing the
                            coverage level below 90 percent would have an adverse impact on small
                            businesses and might lead U.S. investors to seek insurance support from
                            foreign or multilateral sources that provide 90-percent coverage. They also
                            noted that it might not be practical to make a project sponsor hold the
                            coverage longer than he or she thinks is necessary or prevent him or her
                            from seeking alternative sources of insurance. However, since a reduction
                            in coverage is likely to come with a reduction in price, U.S. investors might
                            continue to seek OPIC coverage.

                            OPIC officials acknowledged that reinsurance, coinsurance, and greater risk
                            sharing may be sound risk management options, but are not without
                            trade-offs. For example, reinsurance may reduce OPIC’s income from
                            premiums because OPIC would have to pay premiums to the reinsurer.
                            Furthermore, OPIC takes on the credit risks of the reinsurer. The officials
                            also stated that OPIC would need to maintain flexibility as to how and when
                            to utilize these risk mitigation alternatives.


U.S. Foreign Policy         The U.S. foreign policy objective of promoting private investment in
Encourages OPIC to Invest   developing countries encourages OPIC to take risks that the private sector
in More Risky Markets       may not take without public support. OPIC, the State Department, and other
                            U.S. government officials consider OPIC to be a major tool for pursuing U.S.
                            foreign policy goals. One major U.S. foreign policy goal is to assist Russia
                            in its transition toward a free market economy. According to OPIC officials,

                            26
                             When the insured asset is a loan, the term is usually for the life of the loan. Thus, an 8-year loan
                            would be insured for 8 years. Further, lenders are insured for 100 percent of the value of their loans.



                            Page 19                                                    GAO/NSIAD-97-230 Overseas Investment
                       B-277618




                       by entering into OPIC’s bilateral agreement in 1992, Russia began to
                       establish the conditions necessary for attracting private investment.
                       Further, OPIC operates to promote development strategies that are
                       consistent with internationally recognized worker rights. For example,
                       OPIC ceased operations in the Republic of Korea in 1991, due to concerns
                       over worker rights, including the arrest and imprisonment of labor union
                       leaders.

                       OPIC’s involvement in Russia was initially quite cautious, as it offered only
                       coverage for expropriation and political violence. OPIC officials noted that
                       as conditions improved in Russia, OPIC began offering coverage for
                       currency inconvertibility risk. Since 1992, OPIC has accumulated a finance
                       and insurance portfolio in Russia of $880 million and $1.6 billion,
                       respectively. OPIC justifies its involvement in the high-risk markets of the
                       former Soviet Union27—currently 18 percent of its portfolio—by noting its
                       central role in furthering the U.S. foreign policy objective of facilitating
                       private investment in these markets.

                       The private sector has tended to perceive the markets that OPIC operates in
                       as risky, and private investors have often sought support from official
                       sources when investing in these markets. According to OPIC officials, OPIC’s
                       goal is to support deals that would not be made without its support, and
                       OPIC as an agency of the U.S. government has access to risk mitigation
                       tools, including advocacy and intervention to avert claims, that are not
                       available to the private sector. This implies that OPIC would seek
                       transactions that the private sector believes would be too risky without
                       public support. If OPIC is to continue pursuing its mission, its portfolio will
                       always be considered more risky than the portfolios of private sector
                       insurers.


                       OPIC’s authorizing legislation makes no provision for a phaseout process in
If OPIC Is Not         the event the agency is closed. Any legislation shutting down OPIC should
Reauthorized, Any      make clear whether OPIC’s portfolio should be moved to another agency or
Shutdown Legislation   managed by a temporary organization until the portfolio expires. It could
                       take as long as 20 years for OPIC’s portfolio to expire because many of
Should Address         OPIC’s insurance contracts run for 20 years, and OPIC had more than
Future Management      $5 billion in such contracts with 19-20 years remaining as of the end of
                       fiscal year 1996. According to OPIC’s projections, about one-third of the
of OPIC’s Portfolio
                       27
                         The countries that comprise the bulk of the former Soviet Union (also known as the newly
                       independent states) are Armenia, Azerbaijan, Belarus, Georgia, Kazakstan, Kyrgyz Republic, Moldova,
                       Russia, Ukraine, Uzbekistan, Tajikistan, and Turkmenistan.



                       Page 20                                                 GAO/NSIAD-97-230 Overseas Investment
                          B-277618




                          portfolio would remain after 10 years. If the portfolio risk diminishes,
                          Congress’ option to dispose of these assets is more viable.


Legislation Should        If Congress decides not to reauthorize OPIC, any shutdown legislation
Establish Who Would       would need to address whether OPIC would continue to manage the
Manage OPIC’s Portfolio   portfolio during a phaseout period or whether the portfolio should be
                          moved to another agency. If the portfolio is moved to another agency,
                          Congress would need to decide if any OPIC employees would be moved
                          with it to ensure an adequate and knowledgeable work force. According to
                          Office of Management and Budget officials responsible for overseeing OPIC
                          and related agencies, OPIC staff may be best suited to managing the
                          portfolio because they are familiar with the portfolio.28

                          According to OPIC and private sector financial officials, OPIC’s portfolio
                          could suffer losses if it is not properly managed, thereby increasing the
                          cost of closing the agency. For example, a successor entity would need to
                          monitor the construction of power and other projects, as well as political
                          developments in host countries and the portfolio’s financial performance,
                          to help prevent claims and/or defaults. Additionally, such an entity would
                          need to perform OPIC’s administrative and legislatively mandated functions,
                          including fee collection, repayment, environmental oversight, compliance
                          with worker rights, and other monitoring to ensure that clients comply
                          with their contractual agreements. According to OPIC officials, if finance
                          projects encountered payment difficulties, an entity would also be needed
                          to restructure the project and make collections where necessary.

                          If a decision were made to move OPIC’s portfolio to another agency, the
                          U.S. Eximbank would be the closest fit, according to Office of Management
                          and Budget officials who are also responsible for overseeing the U.S.
                          Eximbank. U.S. Eximbank officials also stated that their agency has many of the
                          appropriate skills to do the job.29 The Eximbank officials cautioned, however,
                          that their employees would not be familiar with the various monitoring
                          requirements that OPIC carries out. They noted that OPIC is a foreign policy
                          agency that provides development assistance while the U.S. Eximbank is an
                          export promotion agency whose emphasis is on expanding U.S. exports.

                          28
                            OPIC’s process for providing U.S. firms with financial and insurance services involves (1) an
                          application and approval phase and (2) a period in which approved projects are monitored (see
                          flowcharts in apps. IV and V).
                          29
                           The qualifications for OPIC professionals are similar to those for professionals at the Eximbank.
                          Many employees at both agencies have the same Office of Personnel Management job classifications.
                          These classifications include code 110 (economists), code 905 (general attorneys), code 1101 (general
                          business and industry specialists), and code 1160 (financial analysts).



                          Page 21                                                  GAO/NSIAD-97-230 Overseas Investment
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                            The U.S. Eximbank’s lack of familiarity with OPIC’s monitoring requirements
                            would be less of an issue if OPIC staff were transferred to the U.S. Eximbank.

                            Officials from three other agencies with responsibilities for overseeing
                            loans or insurance obligations, or for encouraging and tracking U.S.
                            investment in key overseas markets, all said that their agencies lack the
                            business skills and resources necessary to manage OPIC’s portfolio. These
                            agencies include the Departments of Commerce, State, and the Treasury.
                            Office of Management and Budget officials concurred that their agency
                            also lacks these skills and resources. In addition, officials from the Agency
                            for International Development, the agency from which OPIC was created,
                            said that their agency would not be well suited to managing OPIC’s portfolio
                            because the agency (1) does not provide political risk insurance,
                            (2) provides mostly grants, and (3) lends primarily to public entities (OPIC
                            lends to the private sector).


Other Issues to Be          Regardless of whether OPIC’s portfolio is turned over to another agency,
Considered If OPIC Is Not   certain Office of Personnel Management rules would affect OPIC employee
Reauthorized                entitlements as he or she is separated from government service.30 These
                            entitlements may include (1) retirement or severance pay,
                            (2) unemployment compensation, (3) the dollar equivalent of unused
                            annual leave, and (4) settlement from any pending equal employment
                            opportunity or other labor-related litigation.31 According to officials of the
                            Office of Personnel Management, if OPIC’s portfolio is moved to another
                            agency, Congress would have to decide if any OPIC employees are to be
                            moved with the portfolio. These officials said that reassignment of OPIC
                            employees to another agency, under current Office of Personnel
                            Management rules, would be temporary, lasting only until OPIC’s portfolio
                            expires or the government disposes of the portfolio.

                            If OPIC’s portfolio is moved to another agency, other issues might be
                            considered for easing the transition. For example, a timetable could be


                            30
                              Previous agency phaseout experience indicates that personnel issues are the most difficult.
                            According to the Federal Deposit Insurance Corporation official responsible for managing the
                            phaseout of the Resolution Trust Corporation, there are lessons that can be learned from the
                            Resolution Trust’s termination. Although these lessons may not require specific legislative action,
                            there are steps that may be taken to mitigate personnel problems in the event of a phaseout. They
                            include (1) setting up a joint task force with representatives from both OPIC and the portfolio
                            monitoring entity so that the OPIC participants feel they have some say in how matters are resolved
                            and (2) establishing a mechanism for employee communications to reduce uncertainty and anxiety.
                            31
                             Severance pay can be up to an employee’s current gross annual salary, depending on the employee’s
                            age and length of government service. Unemployment compensation would begin only if the employee
                            has not yet found a new job once the severance pay is exhausted.



                            Page 22                                                  GAO/NSIAD-97-230 Overseas Investment
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                            established for transferring OPIC functions to the designated agency. In the
                            absence of specific congressional direction, General Services
                            Administration regulations would apply governing the disposal of OPIC’s
                            property including the transfer of office furniture and equipment. In
                            addition, OPIC said it has a commercial real estate lease that runs to
                            June 30, 2007.32


OPIC’s Portfolio May Take   A phaseout of OPIC would require ceasing new business as of a certain
20 Years to Expire          date.33 Also, a phaseout could take as long as 20 years. OPIC’s investment
                            funds run for 10 years; its loans and guarantees, a maximum of 15 years;
                            and its insurance policies, a maximum of 20 years.

                            According to OPIC estimates, which assume a 10-percent annual drop in the
                            declining remainder of the insurance portfolio due to both cancellations
                            and policies ending at term, the agency’s potential exposure of $23 billion
                            for all services would fall by 64 percent, to $8.2 billion, after 10 years.
                            During the same period, OPIC estimates that its current staff of 200 would
                            decrease by more than 70 percent to about 60 people as the portfolio
                            diminishes. We compared OPIC’s assumptions concerning insurance
                            cancellations and contracts ending at term to historical data and found
                            these assumptions to be generally consistent with these data.34 According
                            to OPIC, just under 10 percent of the original exposure would remain in the
                            20th year, with less than 8 percent of the staff needed to monitor it. The
                            decline in OPIC’s portfolio is shown graphically in figure 4. The insurance
                            portion of the portfolio is by far the largest, currently at just under
                            $16 billion. This portion is about 3 times the value of the finance portion
                            and almost 8 times that of the investment fund portion. In the 20th year,
                            just the insurance portion would be left, having dropped by 86 percent to
                            just over $2 billion (see fig. 4).



                            32
                             According to OPIC officials, if OPIC terminates this lease without finding a suitable sublessee, it
                            would be liable for the payment of 1 year’s rent (about $4 million) as liquidated damages.
                            33
                              OPIC issues a “commitment letter” when it approves a project. As of the end of fiscal year 1996,
                            OPIC’s insurance commitment letters covered $3.4 billion, 25 percent of its total insurance portfolio;
                            its finance commitments stood at $1.6 billion, or 38 percent of its total finance portfolio (excluding
                            investment funds). Any legislation phasing out the agency should recognize the existence of the
                            commitment letters. According to OPIC officials, legislation that does not give effect to these
                            commitments would result in a U.S. government liability.
                            34
                             Our analysis compared OPIC’s assumed 10-percent rate of decline to past experience regarding
                            OPIC’s insurance cancellation rates. We also subjected OPIC’s calculations to a 15-percent annual
                            decline and compared this to the previous results to determine the sensitivity of OPIC’s assumption.
                            Using OPIC’s 10-percent assumption, 35 percent of the insurance portfolio would remain after
                            10 years, versus 20 percent if the 15-percent assumption is used.



                            Page 23                                                    GAO/NSIAD-97-230 Overseas Investment
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Figure 4: Projected Phaseout of OPIC’s Portfolio

Dollars in millions
18,000

16,000

14,000

12,000

10,000

 8,000

 6,000

 4,000

 2,000

    0
         97   98   99   0   1   2    3   4        5    6    7     8     9    10    11    12    13    14    15    16    17    17
                                                        Fiscal years

                                              insurance finance funds




Disposal of Portfolio                        Although the government may wish to divest OPIC’s portfolio before its
Assets Could Be Revisited                    expiration by selling it to the private sector, such a decision would need to
in the Future                                account for the relative riskiness of OPIC’s portfolio and any discounts such
                                             a disposal would necessitate. According to a recent study, a privatization
                                             of OPIC’s current assets could only be accomplished at a discount.35 As
                                             OPIC’s portfolio matures during a phaseout, external factors may affect the
                                             riskiness of the portfolio, either negatively or positively, and thus any
                                             potential privatization discount.

                                             If existing economic and political trends continue in the markets where
                                             OPIC currently operates, OPIC’s portfolio may become less risky. With each
                                             year that passes, the length of the government’s obligation decreases and
                                             the insured as well as the government becomes more familiar with the
                                             risks and issues inherent in a given transaction. As stated earlier, OPIC’s
                                             clients tend to cancel their insurance coverage after a few years as they

                                             35
                                              Overseas Private Investment Corporation: Final Report on the Feasibility of Privitization
                                             (Feb. 7, 1996).



                                             Page 24                                                  GAO/NSIAD-97-230 Overseas Investment
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                  feel more comfortable with the political risks. On the other hand, OPIC’s
                  portfolio may experience greater risk. In general, long-term transactions
                  are riskier than similarly situated short-term loans, guarantees, or
                  insurance transactions. Also, according to OPIC officials, cancellations are
                  more likely to occur in the lower-risk segment of OPIC’s portfolio, thus
                  making the portfolio riskier in the future than it is today. Either
                  situation—less risk in the portfolio or greater risk—may occur.

                  Regardless of the risk characteristics of the portfolio over time, OPIC’s
                  portfolio will decrease. As the portfolio decreases, the amount of the
                  discount will decrease for a given risk in the portfolio. If the quality of the
                  portfolio improves as a result of improvements in OPIC markets, then the
                  rate of discount will likely be much lower or even disappear. If, on the
                  other hand, the portfolio becomes more risky over time, the rate of
                  discount is likely to increase. Since the condition of this portfolio a decade
                  or more from now is unclear, the government has the option of revisiting
                  its choice to sell the portfolio if the risk is reduced.


                  OPIC provided written comments on a draft of this report. OPIC generally
Agency Comments   agreed with the information and analyses in the report. In commenting on
                  the draft, OPIC provided additional information to further clarify its view of
                  (1) the role of the private sector, (2) risk mitigation opportunities, and
                  (3) phaseout issues. OPIC also orally provided technical corrections and
                  updated information that were incorporated throughout the report where
                  appropriate. OPIC’s comments are reprinted in appendix VI, along with our
                  evaluation of them.


                  To identify trends in private sector investment in developing markets and
Scope and         the public sector’s role in these markets, we focused on various
Methodology       characteristics. Specifically, we obtained and analyzed World Bank data
                  on the extent and types of private capital flows going to finance
                  infrastructure and the trend of these flows over time. To identify the
                  recent developments in the volume and types of investment support
                  provided by the public and private sectors for investments overseas, we
                  obtained and compared information from (1) five large private providers
                  of political risk insurance; and (2) the largest public providers of
                  investment support representing France, Germany, Japan, Canada, Italy,
                  the United Kingdom, and the United States. (see app. II) and the
                  Multilateral Investment Guarantee Agency. We also discussed with the
                  Berne Union information on the nature of political risk insurance and the



                  Page 25                                     GAO/NSIAD-97-230 Overseas Investment
B-277618




role and capability of the public and private sectors. We obtained total
insurance exposure data directly from the Group of Seven (G-7)36
insurance providers. Regarding financing, we obtained information from
major financial institutions that provide financing to U.S. investors,
including the Chase Manhattan Bank and Citibank, and the International
Finance Corporation. We also discussed the international finance
environment with Standard & Poor’s Ratings Services and Moody’s
Investors Service, two large financial rating agencies. An important
component of our analysis of private sector investment was the
identification of the kinds of investment services U.S. investors have
utilized in various developing countries or economies in transition as well
as countries in which OPIC is not open for business (for example, China
and Mexico). To obtain this information, we surveyed a judgmental sample
of 34 U.S. investors that had made major investments within the last
5 years in the power and telecommunications sectors.37 We selected the
power and telecommunications sectors because they (1) are listed as the
major sectors of growth in emerging markets38 and (2) represented two of
the four largest sectors supported by OPIC.39 Since these sectors have
considerably different resource requirements and risks, their inclusion
allowed us to make several important distinctions regarding the
investment environments in which they operate.

To survey firms in the power and telecommunications sectors operating
overseas, we (1) reviewed relevant literature including the Directory of
American Firms Operating in Foreign Countries and U.S. Security and
Exchange Commission data, (2) contacted appropriate Department of
Commerce officials, (3) reviewed OPIC’s annual reports that list overseas
investors, and (4) asked the firms contacted to identify their major
competitors. We attempted to contact the 54 firms identified and
successfully interviewed 34. We asked each firm to identify the projects it
was involved in over the past 5 years, how these projects were structured,


36
  Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
37
  We characterize our sample as judgmental due to the difficulties associated with identifying the
universe of firms with overseas investments in these sectors. As a result, we did not randomly select
the firms chosen.
38
  According to International Finance Corporation data, the power and telecommunication sectors
represented about 67 percent of all private investment in developing countries between 1990 and 1995.
39
  The financial services and manufacturing sectors are larger than the telecommunications sector. We
did not include the financial sector in our sample because it is an intermediary activity that combines
investments in various sectors, including power and telecommunications. We did not include the
manufacturing sector because, although this sector has received a considerable amount of OPIC
support in the past, only a small amount of OPIC’s business in the last 5 years has been in this sector.




Page 26                                                    GAO/NSIAD-97-230 Overseas Investment
B-277618




their views on the nature of the risks involved, and how it mitigated the
risks.40

To determine OPIC’s risk management strategy and the steps that OPIC may
take, if it is reauthorized, to further reduce portfolio risks while pursuing
its objectives, we obtained and reviewed documents on OPIC’s risk
assessment policies and financial reports that detailed the condition of
OPIC’s portfolio. We also gathered and reviewed information on the risk
assessment policies of two World Bank institutions (the Multilateral
Investment Guarantee Agency and the International Finance Corporation),
organizations that have programs comparable to OPIC’s insurance and
finance programs. To support our analysis of these policies, we
interviewed OPIC, Treasury, and State Department officials. Furthermore,
we interviewed officers of private banks, investment institutions, and
political risk insurance companies about steps that OPIC could pursue in
reducing the risks associated with its portfolio.

To determine the issues that would need to be addressed and the time it
would take to phase out OPIC if it is not reauthorized, we reviewed laws
and regulations and discussed applicable policies and practices with
officials from the Office of Personnel Management, the General Services
Administration, and the Office of Management and Budget. In addition, we
reviewed our past work on the closure of the Resolution Trust
Corporation and interviewed the Federal Deposit Insurance Corporation
official responsible for managing the phaseout of the Resolution Trust
Corporation. To determine how long it would take for OPIC’s obligations to
expire, we obtained documents from OPIC on (1) its current financing and
insurance obligations, (2) its insurance policy cancellation rates, and
(3) its projections on the duration of its existing portfolio and the
resources it would require to manage the portfolio. To assess the
reasonableness of these projections, we reestimated OPIC’s analysis using a
higher projected phaseout rate. With regard to which agency might be best
suited to manage OPIC’s existing portfolio until the obligations expire, we
interviewed officials from the Agency for International Development, the
Commerce Department, the U.S. Eximbank, the National Economic Council,
the Office of Management and Budget, OPIC, the State Department, and the
Treasury Department. We also obtained Office of Personnel Management
documents showing job classifications at OPIC and two other agencies—the
Agency for International Development and the U.S. Eximbank.


40
 Our analysis did not consider the implications closing OPIC would have on the private sector. Such
an analysis would be highly speculative; and as we discuss in the report, there are many public and
private sector alternatives to OPIC available to private investors.



Page 27                                                 GAO/NSIAD-97-230 Overseas Investment
B-277618




We conducted our review from January 1997 to July 1997 in accordance
with generally accepted government auditing standards.


We are sending copies of this report to appropriate congressional
committees and the President and Chief Executive Officer of the Overseas
Private Investment Corporation. We will also make copies available to
other interested parties upon request.

This review was done under the direction of JayEtta Z. Hecker, Associate
Director. If you or your staff have any questions concerning this report,
please contact Ms. Hecker at (202) 512-8984. Major contributors to this
report are listed in appendix VII.

Sincerely yours,




Benjamin F. Nelson
Director, International Relations
  and Trade Issues




Page 28                                  GAO/NSIAD-97-230 Overseas Investment
Page 29   GAO/NSIAD-97-230 Overseas Investment
Contents



Letter                                                              1


Appendix I                                                         32

Firms Contacted
During the Review
Appendix II                                                        34

Main Features of the
Group of Seven
Investment Insurance
Programs
Appendix III                                                       35

Regional Investment
Insurance Exposure
of the Major Group of
Seven Providers
Appendix IV                                                        36

OPIC Insurance
Process
Appendix V                                                         37

OPIC Finance Process
Appendix VI                                                        38

Comments From
OPIC
Appendix VII                                                       47

Major Contributors to
This Report



                        Page 30   GAO/NSIAD-97-230 Overseas Investment
          Contents




Figures   Figure 1: Net Private Capital Flows to Developing Countries,                6
            1986-96
          Figure 2: Regional Diversification of OPIC’s Portfolio of                  15
            Insurance and Finance Programs, as of September 30, 1996
          Figure 3: Diversification of OPIC’s Portfolio of Insurance and             16
            Finance Programs by Sector, as of September 30, 1996
          Figure 4: Projected Phaseout of OPIC’s Portfolio                           24




          Abbreviations

          Eximbank    U.S. Export-Import Bank
          OPIC        Overseas Private Investment Corporation


          Page 31                                   GAO/NSIAD-97-230 Overseas Investment
Appendix I

Firms Contacted During the Review



Firms Surveyed

Power Companies      AES Corporation
                     Coastal Power Energy
                     CalEnergy Company, Inc.
                     CMS Energy Corporation
                     Constellation Power, Inc.
                     Dominion Resources, Inc.
                     Duke Energy International, Inc.
                     Enron International
                     GE Capital Corporation
                     GPU International, Inc.
                     Houston Industries Energy, Inc.
                     Edison Mission Energy
                     Ogden Energy Group, Inc.
                     TECO Power Services Corporation
                     El Paso Energy International
                     The Wing Group Ltd. Co.


Telecommunications   Adelphia Communications International
Companies            African Communications Group, Inc.
                     Ameritech Corporation
                     Andrew Corporation
                     BellSouth Corporation
                     Comcast Corporation
                     Chase Enterprises
                     D & E Communications, Inc.
                     GTE Service Corporation
                     Hungarian Telephone & Cable Corporation
                     Lucent Technologies, Inc.
                     MCT of Russia, L.P.
                     Millicom International Cellular, S.A.
                     Motorola, Inc.
                     Radiomovil Digital Americas, Inc.
                     Telecel International, Inc.
                     SBC Communications Inc.
                     US WEST International Holdings, Inc.




                     Page 32                               GAO/NSIAD-97-230 Overseas Investment
                           Appendix I
                           Firms Contacted During the Review




Other Public and Private   American International Group, Inc.
Entities Contacted         AT&T
                           Bechtel Corporation, Inc.
                           Berne Union
                           The Chase Manhattan Bank, N.A.
                           Citibank, N.A.
                           Citicorp International Trade and Indemnity
                           Citicorp North America, Inc.
                           Exporters Services
                           FCIA Management Company, Inc.
                           International Finance Corporation
                           MCI Communications
                           J.P. Morgan Securities, Inc.
                           Lloyd and Thompson Insurance Co.
                           Multilateral Investment Guarantee Agency
                           Moody’s Investors Service
                           NYNEX
                           Sedgewick Reinsurance Brokers Ltd.
                           Standard & Poor’s Ratings Services
                           Taylor-DeJongh, Inc.
                           Unistrat Corporation of America




                           Page 33                                 GAO/NSIAD-97-230 Overseas Investment
Appendix II

Main Features of the Group of Seven
Investment Insurance Programs


                                                            Eligible                                Maximum duration risks
G-7 Country Investment   Eligible investors                 enterprises             Coverage limits covered
France/COFACE            Legal entities registered in       No restrictions.        No limit.           15 years.
                         France.                                                                        Expropriation, war,
                                                                                                        inconvertibility, breach
                                                                                                        of government commitments.
Germany/C&L              Domestic German entities.          No restrictions.        No limit.           15 years.a
                                                                                                        Expropriation, war,
                                                                                                        inconvertibility, breach of
                                                                                                        government contracts.
Japan/EID/MITI           Persons and entities existing      No restrictions.        $500 million per 15 years.b
                         in Japan.                                                  project.         Expropriation, war,
                                                                                                     inconvertibility, bankruptcy
                                                                                                     after 2 years of operation.
Canada/EDC               Persons or business beneficial No restrictions.            No limit.           15 years.
                         to Canada.                                                                     Expropriation, war,
                                                                                                        inconvertibility.
Italy/SACE               Persons or entities domiciled      Developing              No limit.           15 years.
                         in Italy.                          countries only.                             Expropriation, war,
                                                                                                        inconvertibility, natural
                                                                                                        catastrophe.
U.K./ECGD                Persons and entities carrying      No restrictions.        No limit.           15 years extendable to 20.
                         on business in United                                                          Expropriation, war,
                         Kingdom.                                                                       inconvertibility,
                                                                                                        breach of contract by host
                                                                                                        government.
U.S./OPIC                U.S. citizens and entities and Developing                  $200 million        20 years.
                         foreign entities 95% owned by countries only.c             per project.        Expropriation, war,
                         U.S. interests.                                                                inconvertibility, breach of
                                                                                                        contract by host government.
                                      a
                                      Twenty years if a project involves long construction period.
                                      b
                                       Longer periods for projects with long construction periods; commercial risk for 10 years with
                                      longer periods possible.
                                      c
                                       Bilateral agreement required; host government attitude toward human rights, worker rights
                                      considered; environmental impact considered.

                                      Source: Overseas Private Investment Corporation (OPIC) Insurance Department.




                                      Page 34                                                   GAO/NSIAD-97-230 Overseas Investment
Appendix III

Regional Investment Insurance Exposure of
the Major Group of Seven Providers


U.S. dollars in millions
Major insurance providers   Asia/ Pacific                 Europea                 Africab       The Americasc       Reported total
Japan                        Unavailable               Unavailable           Unavailable            Unavailable           $13,943
MITI/EID
U.S.                             $ 2,740                    $3,517                $ 1,554                $ 6,622          $13,386e
OPICd
Germany                                2,751                  3,826                   650                     608           7,835
C&L
France                                 1,050                    730                 1,590f                    100           3,470
COFACE
Canada                                    50                    250                    40                     910           1,250
EDC
U.K.                                    380                     110                    48                       2             540
ECGD
Italy                                      2           Unavailable           Unavailable                       39              41
SACE
Total                                   N/A                     N/A                   N/A                     N/A         $40,465
                                   Note: All data are as of 1996; exchange rates as of December 31, 1996.
                                   a
                                       Europe includes the former Soviet Union, Eastern Europe, and Turkey.
                                   b
                                       Africa includes the Middle East.
                                   c
                                       The Americas includes Central America, South America, and the Caribbean.
                                   d
                                       OPIC data as of September 30, 1996.
                                   e
                                    The sum of the geographic regions exceeds the reported total by $1,048,133 due to a
                                   client-specific stop loss adjustment that limits OPIC’s liability.
                                   f
                                   French data for Africa include Middle East and Turkey.

                                   Source: Group of Seven Insurance Providers.




                                   Page 35                                                   GAO/NSIAD-97-230 Overseas Investment
Appendix IV

OPIC Insurance Process



               Application process

                 Preliminary review of application




              Approval process

                Determine effects of project on U.S.
                economy and obtain clearances pertaining
                to environmental impact, worker and
                human rights issues
                Present to investment committee
                Present to board of directors
                Policy review committee
                Perform risk analysis
                Negotiate contract
                Execute contract or commitment letter




              Monitoring process

                Annual reporting by clients
                Perform periodic monitoring for compliance
                with effects on U.S. economy, environmental
                impact, worker and human rights issues
                Advocacy efforts to head off claims
                Recovery of claims
                Retire expired contracts




              Page 36                                         GAO/NSIAD-97-230 Overseas Investment
Appendix V

OPIC Finance Process



                Application and credit assessment
                process


                  Formal screening meeting
                  Conduct reference and credit checks
                  Perform credit analysis on project and
                  sponsors
                  Conduct site visits
                  Determine effects of project on U.S.
                  economy and obtain clearances
                  pertaining to environmental impact,
                  worker and human rights issues




                Approval process


                  Present credit due diligence report
                  Assign pre disbursement loan rating
                  Meet with finance-credit committee
                  Present to investment committee meeting
                  Present to board
                  Prepare commitment letter/term sheet
                  Negotiate loan documents with borrower and
                  prepare loan agreement




                Monitoring process

                  Monitor construction of projects (with
                  each disbursement)
                  Conduct annual loan review
                  Conduct independent, periodic credit
                  review
                  Revise/amend agreements as needed
                  Perform periodic monitoring for
                  compliance with effects on U.S.
                  economy, environmental impact, worker
                  and human rights issues
                  Close out loan




              Page 37                                          GAO/NSIAD-97-230 Overseas Investment
Appendix VI

Comments From OPIC


Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.




See comment 1.


Now on p. 12

Now on p. 14




Now on p. 12.
Now on p. 17.




Now on p. 9.




                             Page 38   GAO/NSIAD-97-230 Overseas Investment
                 Appendix VI
                 Comments From OPIC




Now on p. 20.




Now on p. 14.


Now on p. 10.




See comment 2.




                 Page 39              GAO/NSIAD-97-230 Overseas Investment
Appendix VI
Comments From OPIC




Page 40              GAO/NSIAD-97-230 Overseas Investment
                 Appendix VI
                 Comments From OPIC




See comment 3.




See comment 4.




See comment 5.




                 Page 41              GAO/NSIAD-97-230 Overseas Investment
                Appendix VI
                Comments From OPIC




See comment 6




                Page 42              GAO/NSIAD-97-230 Overseas Investment
                 Appendix VI
                 Comments From OPIC




See comment 7.




See comment 8.




                 Page 43              GAO/NSIAD-97-230 Overseas Investment
                  Appendix VI
                  Comments From OPIC




See comment 9.


See comment 10.




                  Page 44              GAO/NSIAD-97-230 Overseas Investment
               Appendix VI
               Comments From OPIC




               The following are GAO’s comments on OPIC’s letter dated August 6, 1997.


               1. The points that OPIC highlights are there own interpretation of our
GAO Comments   analyses. Several points discussed by OPIC, such as the health of their
               reserves, filling a commercial void and the impact of its activities on U.S.
               employment, are not our specific conclusions. Rather, the report provides
               factual information and our analysis of the trends in private sector
               investment, the public sector’s role in emerging markets, OPIC’s portfolio
               and risk management strategy, and issues to be addressed if OPIC were not
               reauthorized.

               2. Information in the report on OPIC’s risk management strategy is not
               restricted to a discussion of how OPIC limits exposure in any one country
               or sector. The report also includes a discussion of OPIC’s pre-approval
               review process and underwriting guidelines. Appendixes IV and V contain
               information on the application, approval, and monitoring processes for the
               insurance and finance programs.

               3. Although the report notes that the larger finance projects tend to be less
               risky than smaller projects, we do not agree that the same is necessarily
               true for OPIC’s insurance projects. Financing involves commercial risks
               that well-capitalized and experienced private participants have greater
               influence in mitigating. However, political risk insurance only covers
               actions taken by governments—actions that are less within the control of
               the private sector.

               4. The report discusses only the recent growth in privately provided
               political risk insurance. The extent to which the private market capacity
               for political risk insurance would be affected by changes in demand for
               property/casualty coverage is not certain.

               5. We recognize that OPIC has in some cases pursued the risk mitigation
               options discussed in the report. However, we believe that the private
               sector’s current high level of interest in investing in emerging markets has
               created opportunities for OPIC to further reduce portfolio risk through
               greater use of the options presented.

               6. The report provides OPIC data that show 18 (now 12) cases since 1988 in
               which OPIC coinsured with the private sector. Although there may be other
               cases in which the private sector provided insurance to investors also
               insured by OPIC, this information is more anecdotal and these instances



               Page 45                                    GAO/NSIAD-97-230 Overseas Investment
Appendix VI
Comments From OPIC




would not represent cases in which OPIC formally sought to coinsure with
the private sector.

7. We revised the report to reflect that any loss that was covered by a
drawdown in reserves (that are comprised of Treasury securities) would
become a budgetary outlay. However, we do not agree that such an outlay
should then be compared to the offsetting collections that OPIC receives. If
it were necessary for OPIC to redeem Treasury securities, then it would
need more cash to cover losses than it would be taking in.

8. The report states that under the Federal Credit Reform Act of 1990,
agencies are to estimate and budget for long-term costs of their credit
programs on a present value basis. Subsidy costs arise when the estimated
program disbursements by the government exceed the estimated
payments to the government on a present value basis. The subsidy cost
data in our report are based on OPIC’s reported estimates. In order to show
lower subsidy costs, the costs must be reestimated, with key factors such
as the credit risk of the borrowing country showing improvement. OPIC
identified $72 million in subsidy costs for fiscal year 1997 programs.

With regard to OPIC’s statement about its interest earnings, only those
earnings properly allocable to its credit program are relevant to the
discussion of its credit subsidy estimates. Under credit reform
requirements, interest earned on credit-related reserves is required to be
included in estimating the subsidy cost.

9. We modified the report to include this information.

10. We modified the report to include this information.




Page 46                                    GAO/NSIAD-97-230 Overseas Investment
Appendix VII

Major Contributors to This Report


                        Jaime Dominguez
National Security and   Kay Halpern
International Affairs   John Hutton
Division, Washington,   Patricia Martin
                        Tom Melito
D.C.                    Rona Mendelsohn
                        Eluma Obibuaku


                        Ernie E. Jackson
Office of the General
Counsel, Washington,
D.C.
                        Tom Zingale
Los Angeles Field
Office




(711244)                Page 47            GAO/NSIAD-97-230 Overseas Investment
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