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 2 years is that
the "new normal" includes a paradigm shift. Just as the rule book
changed after the collapse of the Soviet Union, it has changed again
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.
There was plenty of debate when the financial crisis began about
whether industrialized and emerging countries would move in tandem
downward. Indeed, they did, by and large, but 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 may have growth rates of 1 to 3 percent. You could argue,
rightly, that this is really little different than the reality prior
to the crisis. The difference is, 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.
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 many financial professionals have little more than
a quarterly orientation to the future, have you considered what
may happen 5 or 10 years from now, after your long-term investment
has been made, 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?
Assessing the Risk
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
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 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 hit the
Another common issue is that the lines of communication between
risk management personnel, risk management and decision makers,
or between decisions makers is either bypassed, convoluted, or just
plain wrong. I 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.
Conclusion: Do Your Homework
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.