The ability to effectively manage cross-border risk used to be considered either something an international business may not need or could not afford, but the risk management landscape has experienced a transformation over the past 20 years. Traders, investors and lenders no longer have the luxury of assuming everything will work out, or maintain the mistaken belief that the horror stories that have happened to other organizations will not happen to them.
Conventional wisdom used to dictate that because everyone else is investing in a given country, it must be the right place to invest, the idea being that strength lay in numbers, and, surely, not everyone could be wrong. Yet, the ‘herd’ mentality and chasing the ‘hot dollar’ has gotten many companies into a lot of trouble. While global investors know that Putin’s Russia is fraught with risks, and while Brazil’s economy has failed to perform even close to its potential (or expectations), they continue to invest, in the belief that eventually, things will get better. We know that is often not the case. Mr. Putin isn’t going anywhere any time soon, and Brazil’s economy is in a dire state.
While most risk managers would probably say that they do not have any particular expertise in assessing and monitoring political risk, the truth is that they do so every day in an international business, whether they realize it or not. And since most businesses (apart from banks and natural resource companies) tend not to have political risk specialists on their staff, it is incumbent on risk managers to become political risk managers.
This may appear as a daunting task – and it is. Political risk management is an art, not a science, and the average risk manager will have had no formal training in the subject. Managing political risk is all about creating a mosaic of risk factors that form a unique risk profile for each transaction, whether it involves investing, lending or trading.
Political risk management is not merely about considering obvious variables -- such as the health of a country’s economy and its political stability -- but in addition to that, such things as the regulatory environment, developmental issues, environmental concerns, and socio-cultural considerations. Each transaction has a unique risk profile. To be effective as a country risk manager, the ability to identify what truly distinguishes one transaction from another, and their implied short and long-term risks, is critical to making the decision to invest, and stay invested. Doing so requires ongoing monitoring, which can be rather time consuming.
Throughout my career in cross-border risk management, I have constantly been surprised by the number of companies – including some of the largest and best known names in business -- that have no formal methodology or staff for assessing and monitoring cross-border risk. Their belief is that they are either so large, so well known, or have such a long operating history in a country that all they may need to do when a problem arises is send the CEO in country to ‘solve’ the problem. That is an obviously flawed approach and very often has the opposite effect.
It is therefore incumbent upon every company doing business abroad to implement a meaningful approach to cross-border risk management. Smaller companies may have no choice but to rely on third party-produced reports. The problem with doing so is that these reports are often out of date as soon as they are published, and in general do not make recommendations about whether or how to proceed with a transaction. That said, having at least made an attempt to understand an investment or trade climate is better than no effort at all.
By the same token, some companies become deluded into believing that because they may have a person or ‘system’ in place to monitor political risk, that they are bullet proof. Too often, gaps and inconsistencies in the risk management process, the nature of the internal reporting system, or the manner in which senior management delivers information to the board, can itself can be a significant problem.
It is recommended that organizations with significant international exposures devote the monetary and personnel resources necessary to adequately address cross-border risk, which will only become a more important component of the risk management landscape with time. Every international risk manager is by definition now a political risk manager. Ultimately, each risk manager must take it upon him/herself to become better educated on this subject, and to educate senior management about the importance of meaningful political risk management.
*Daniel Wagner is Managing Director of Risk Solutions at Risk Cooperative. He is the author of the book “Managing Country Risk”.