2013 Promises To Be a Real Challenge for Risk Managers

To some, this may sound alarmist. After all, Euro debt talks have come and gone, and the Middle East seems to be in perennial crisis. However, this time may be different. In the case of Europe, there are few tools left in the toolkit. The European Central Bank (ECB) has thrown just about everything it has at the overall regional debt crisis, and southern Europe seems only to have gotten worse with time. In the case of Greece, we are nearing the end of the road—just how much additional money can be thrown at Greece remains to be seen. In the case of Spain, Italy, and Portugal, there is little desire on the part of any of these governments (or their electorates) to accede to any more austerity measures. In the absence of that, there is very little the ECB or European Parliament can do to turn the tide.

As for the Middle East, it seems clear now that Assad's government cannot last too much longer in Syria, with opposition forces having organized themselves, receiving more funding and heavy arms, and slowly taking control over more territory; 2013 is likely to be the year Mr. Assad's regime falls. This creates more uncertainty and raises the specter that the power vacuum will be filled with Islamic extremists, bent on further destabilizing the region. Opposition rallies have resumed in Egypt, with President Morsi's proclamation of supreme self-power having been met with recurring street demonstrations. Even if he manages to retain office, the only people who will trust him now are members of the Muslim Brotherhood. Jordan may be the next to experience the full power of the Arab Awakening. And, if Israel is to bomb Iran, it certainly seems that 2013 will be the year that it happens.

On top of all that, tension is rising between China and the United States, which are jockeying for influence in Asia, with implications for a variety of countries in the region. Countries throughout the region have already declared their allegiance to one side or the other, with standouts such as Myanmar seemingly up for grabs. Tension has reached postwar highs between Japan, China, and South Korea over ownership of the Senkaku and Takeshima Islands. Economic nationalism is alive and well in natural-resource-rich countries in Asia and beyond.

Cross-Border Risk

Against this backdrop, risk managers would be wise to begin preparing contingency plans for what promises to be a wild ride in the medium term. The first order of business would be to evaluate potential assets, liabilities, and projects that could be exposed to cross-border risk, with the objective of mitigating exposures now. Identifying such exposures will help risk managers quantify the potential impact of a worst-case scenario, while at the same time enabling them to stress test the tools currently available to them against simulations. This is a critical juncture during which potential gaps in coverage can be assessed and insurance and other mechanisms for controlling risks can be updated to reflect the changing landscape.

Uncertainty also creates opportunities, and corporate risk managers and internal stakeholders (such as boards of directors, investment committees, and chief financial officers) should be able to ask the right questions of proposed cross-border investments. Too often, decision makers hesitate to ask difficult questions for fear of the answers that may result, but this is clearly not a prescription for long-term success. We have seen too many instances where the wrong questions were asked, leading to project failure.

While foregoing a planned investment in its totality may seem prudent, based on a high degree of uncertainty, it could also cost your firm long-term competitive advantage and access to new markets and resources. Uncertainty about the future calls for deeper levels of pre-investment due diligence and risk management audits, which should result in plans for action. Moreover, while the costs associated with country risk will certainly weigh on cross-border investments in difficult times, gaining first mover advantage and having limited transnational competition in new markets should be factored into the risk/reward calculus.

As 2013 nears, we leave you with some practical guidance to help maneuver through the turbulent times:

1. Identify cross-border exposures to lives, assets, and liabilities, factoring in the risk/reward tradeoff in your assumptions. Don't rule out worst-case scenarios in your analysis.
2. Analyze the potential impact on your organization should the worst materialize, and start simulations based on that, rather than assuming that the worst cannot happen.
3. Evaluate and stress test risk control measures, reserves, and contingencies, including a comprehensive review of your insurance portfolio before markets "harden."
4. Make special provisions for your "people at risk," given the potential volatility and increase of mass exodus events.
5. Acknowledge what you don't know, and avoid the perils of "group think" by engaging unbiased decision support in the form of external experts, consultants, and risk managers. It pays to be circumspect in these uncertain times.

We would like to believe that all the issues identified in this article will turn out well, but we don't believe they will. From all accounts, 2013 looks to be a particularly challenging year for risk managers. If the past 4 years have taught us anything, it is that anything is indeed possible. Those who will weather the storm well will have done their homework and will have been realistic about what may go wrong.

*Dante Disparte is managing director of partner solutions with Clements Worldwide. Daniel Wagner is chief executive officer of Country Risk Solutions and author of the book Managing Country Risk.