by Daniel Wagner. Daniel Wagner is Managing Director of Country Risk Solutions (CRS), a political and economic risk consultancy based in Connecticut (USA). Daniel has more than 20 years of experience managing country risk. He is an authority on political risk insurance (PRI) and analysis and has 15 years of underwriting experience with AIG, the Asian Development Bank (ADB), GE, and the World Bank Group.
Among the many challenges facing risk managers now that the economic convulsions of the past two years appear to have stopped is how to effectively manage cross-border risk, which is more important today than in recent memory for a simple reason: the rules of engagement for conducting international business have changed – the risks associated with cross-border transactions are high, risk aversion is high, but the margin for errors is low.
It is only natural after recovering from global economic trauma that international businesses would think more carefully about assuming and managing cross-border risk, but doing so has become more difficult. One of the things that has changed over the past two years is that the ‘new normal’ includes a paradigm shift: the rule book has changed as a result of a combination of a decade of globalization and a decoupling in growth patterns between the developed and developing worlds, which implies a change in risk profile between the two. The developed world may now in fact be riskier than the developing world; indeed, the Great Recession was born in the USA and Europe.
What has become clear over the past year is that the largest developing countries are galloping ahead of the developed countries, projected to have average growth rates between 6 and 8 percent this year, while North America and Europe will continue to have comparatively anemic growth rates. The temptation among many international companies will be to trade and invest in developing countries as a result, perhaps without fully considering the implications of doing so from a country risk perspective. The need to ensure proper cross-border due diligence was always present, but the manner in which many businesses traded or invested internationally before the crisis did not require the same degree of due diligence that is required today.
To the extent that international companies devote any resources at all to understanding cross-border trade and investment climates (and in my 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 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, they have a true handle on the nature of the risks associated with doing business there. What about gauging legal and regulatory risk, the country’s friendliness toward foreign trade and investment, and other companies’ experience there?
Too often, companies get caught in an ‘investment trap’: they commit 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 impacted their ability to operate, or they selected the wrong joint venture partner. After the investment has been made, it is usually too late to withdraw without incurring large losses and experiencing reputational risk once the story hit the press.
A risk manager may have the right information, but based on a short-term assessment of the risks. The long-term view may be completely different, but in the absence of knowing what questions to ask and having clear lines of communication, the right information may not be taken into consideration.
The simple way to limit the possibility that unforeseen events will occur is to establish clear reporting lines and do your homework – I mean really do your homework – and either hire one or more individuals in your company to focus full time on managing these risks and/or hire an external firm to created a customized risk profile for each and every investment your company plans to make. The expense involved 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.