The following is a guest post by Dante Disparte and Daniel Wagner. Disparte is managing director of partner solutions with Clements Worldwide, based in Washington, DC. Wagner is chief executive officer of Country Risk Solutions, director of global strategy with the PRS Group, and author of the new book Managing Country Risk.
Among the many challenges facing risk managers in what has become the new normal is how to effectively manage cross-border risk, which is more important today than in recent memory. Whether we realize it or not, the rules of engagement for conducting international business have changed over the past three years — the risks associated with cross-border transactions are high and risk aversion is high, but the margin for error is low. This means that risk managers’ jobs have become more difficult.
No longer does a simple risk/reward arithmetic serve as the basis for making cross-border investment decisions — or managing the many risks facing existing international investments. Today’s dynamic landscape calls not only for a long-term orientation toward risk — sometimes decades after the investment is made — it also requires a qualitative understanding of short-term options should the worst occur.
It is only natural in this transformed landscape that international businesses would contemplate assuming cross-border risk with a greater degree of caution, but one of the things that has changed is that the new normal includes a paradigm shift. A combination of a decade of globalization, a decoupling in growth patterns between the developed and developing worlds, and the seemingly constant nature of political change implies a new risk profile – whether trading or investing in developed or emerging economies. Let us not forget that since 2008, much of the world’s cross-border risk originated - and continues to emanate from — Europe and North America.
The temptation among many international companies will be to trade and invest in developing countries as a result of the disparity in growth rates without, perhaps, fully considering the implications of doing so from a political risk perspective. The need to do so was always present, but the way many businesses traded or invested internationally before the crisis did not require the same degree of due diligence that is required today. Indeed, the rapidity with which political upheaval dominates the air waves has many risk managers assessing their firm’s readiness for the increasingly unpredictable and fragile markets to which they are exposed.
You’ve heard the story before — it all sounds good on paper. Country X is growing rapidly, it has a democratic government, demand for your product there is high, and the country or buyer appears to have the money to pay for it. But in an era when economic volatility is high, and when change occurs it tends to be dynamic and long-lasting, it is essential to consider what may happen five or 10 years from now — long after your long-term investment has been made, when the government changes and the country can no longer pay its bills. What tools, if any, does your company have to assess and manage such risks? Is protecting the P&L with reactive solutions sufficient any longer, and what mechanisms are in place to consider exposure to staff and contractors, as well as physical assets?
To the extent that international companies devote any resources at all to understanding cross-border trade and investment climates (and, in our experience, most do not), they tend to over-rely on externally generated country risk analyses, which are more often than not produced generically and are not entirely appropriate for specific transactions. This is perhaps the most common mistake risk managers make. They believe that because they may have information about the general political and economic profile of a country, that they have a true handle on the nature of the risks associated with doing business there. All too often, the rapid pace of change is making static country risk indicators an outdated and one-dimensional tool in a risk manager’s weapon arsenal.
Leading practitioners may employ a multi-faceted model and pay particular attention to early warning signs that can be gleamed from their intuition and local and external information sources. Gauging legal and regulatory risk, a country’s friendliness toward foreign trade and investment, and other companies’ experience there are full of common sense, yet less often explored. Too often, companies get caught in an “investment trap,” committing long-term resources to a country only to find that the bill of goods they were sold — or thought they understood — turned out to be something completely different. There are plenty of stories out there about companies whose investments turned into disaster because the regulatory environment changed, a legal issue arose, international sanctions affected their ability to operate, or they selected the wrong joint venture partner. After the investment has been made, it is often too late to pull out without incurring large losses and experiencing reputational risk once the story hits the press.
Another common issue is that the lines of communication between risk management personnel, decision makers and business development are often either bypassed, convoluted or just plain wrong. We have seen instances where:
- Risk management is given only cursory participation in the transaction approval process.
- Sales teams bypass risk management entirely, or ignore risk management’s recommendations, because they fear a transaction will be canceled as a result of unacceptably high levels of risk.
- A CEO delivers a presentation to a board of directors that is false, but he believes it to be true, because the risk manager’s staff said it was.
- A board of directors has no idea what questions they should be asking of corporate decision makers.
- A risk manager may have the right information, but it is based on a short-term assessment of the risks. The long-term view may be completely different. In the absence of knowing what questions to ask and having clear lines of communication, the right information may not be taken into consideration.
It may sound simplistic, but the easiest way to limit the possibility that unforeseen events will occur is to establish clear reporting lines and do your homework — really do your homework — and either hire one or more individuals in your company to focus full time on managing these risks, or hire an external firm to create a customized risk profile for each and every investment your company plans to make. The expense involved often pays for itself many times over when a problem is uncovered and avoided, yet many companies are happy to invest millions of dollars to make cross-border investments without doing their homework. The days when that will get the job done are long gone.