Managing Country Risk

Managing Country Risk

1. Chapter 1: Country risk in perspective

   • Political change in MENA has had a profound impact on many countries in the region and beyond, pummeling some of the most established governments in the world.
     • Unintended consequences of this change has been to prompt some country risk analysts to reevaluate how they analyze risk.
       • Some risk management lessons a country risk analyst may learn were learned within the MENA situation:
         • Even though political change may be expected in any country, the ability to anticipate when and how such change may occur presents a daunting task.
           • Therefore it is important to be aware of the that social, political, and economic disenfranchisement can reach a boiling point in an instant, given the right circumstances.
         • Although an analyst may expect that political change is likely to erupt from a largercountry in a given region, the fact that a country is larger and more important may prevent it from embracing political change.
         • What may appear to be fundamental change is not really change at all, or change for the worse. In reality, not much changed in 2011 in either Tunisia or Egypt.
         • In today’s linked-in, globalized world, political change that may have been limited in regional impact has great potential to explode in scope.
       • Also, some important insights and facts could be relevant in order to manage country risk:
         • It appears that countries with significant terrorist acts tend to have democratic forms of government. Terrorism does not appear to occur with great frequency in countries with authoritarian or communist forms of government,
         • According to a PSU Author: terrorist incidents do not produce any statistically significant effect on the likelihood that a country will be chosen as an investment destination or on the amount of FDI it receives.
           • However, a study done on the impact of terrorism and FDI in Spain said that acts of terrorism had a significant and persistent negative impact on net FDI.
             • It was concluded that smaller countries that face a persistent threat of terrorism may incur economic costs in the form of reduced investment and economic growth.
         • Perceptions of terrorism risk have a great deal of influence on some investment decisions, Some factors that influence decision makers are:
           • Economic health of the investment destination
           • Difficulty associated with doing business in a given country
           • Existence of rule of law and good corporate governance
           • Existence of corporate and government connections
           • Level of public discord
           • Media attention
           • Cost of production
       • Some common errors within Risk Managers and the different departments of a company are:
         • Risk management is given only cursory participation in the transaction approval process.
         • Sales teams bypass risk management entirely or ignore risk management’s recommendation 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 ask- ing of corporate decision makers.
         • The simple way to limit the possibility that unforeseen adverse events will be to focus full time on managing these risks and/or hire an external firm to create a customized risk profile for the investments
     • The Arab Spring was a series of anti-government protests, uprisings, and armed rebellions that spread across much of the Arab world in the early 2010s. It began in response to oppressive regimes and a low standard of living, starting with protests in Tunisia.
       • The agents of change actually achieved very little., even though they had many governments removed. The majority of their original aspirations were not met. And the overall situation of these countries did not improve.
         • This created greater levels of frustration and sets the stage for ongoing uncertainty and instability for all FDI.

2. Chapter 2: Foundation of country risk management

   • Reasons why Extractive industries are more vulnerable to adverse action on the part of host governments:
     • They tend to be large and high profile
     • They employ thousands of people and have significant economic impact on local communities.
       • By building relationships with local leaders outside government, such project sponsors have gained trust, and provided a way through which concerns can be negotiated and addressed before they can erupt into violence.
     • They are strategically important to host countries.
     • They are subject to a wide range of legal regimes and laws, which frequently change
     • They involve the production of waste products, which makes them more highly scrutinized for environmental compliance than other forms of investment
   • Elements of an Effective Risk Management Process
     • Effective oversight by a board of directors
     • Adequate risk management policies and procedures
     • An accurate system for reporting country exposures
     • An effective process for analyzing country risk
     • A country risk rating system
     • Established country exposure limits
     • Regular monitoring of country conditions
     • Periodic stress testing of foreign exposures
     • Adequate internal controls and an audit function
   • Distinctions of what measure what country risk is.
     • Transactional risk
       • The country, sovereign, political, economic, financial, technical, environmental, developmental, and sociocultural risk that an organization assumes in every international trans- action in which it engages.
     • Political risk
       • Concerns those political and social developments that can have an impact upon the value or repatriation of foreign investment or on the repayment of cross-border lending
     • Sovereign risk
       • Is the risk that a foreign central bank will alter its foreign-exchange regulations
     • Instability risks
       • Arise from political power struggles.
         • These conflicts could be between members of a government fighting over succession or mass riots in response to deteriorating social conditions
     • Government risks
       • Those risks that arise from the actions of a governmental authority, whether that author- ity is used legally or not.
     • country-specific political risks
       • Are not directed at a firm, but rather are countrywide and may affect firm performance.
         • Include a government’s decision to forbid currency transfers or the outbreak of a civil war within the host country.
           • The only sure way to avoid country-level political risks is to stop operating in the country in question
     • firm-specific politi- cal risks
       • Are directed at a particular company and are, discriminatory.
         • Refers to the risk that a government will nullify its contract with a given firm or that a terrorist group will target the firm’s physical operations
           • The risk can be reduced by incorporating strong arbitration language into a contract

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