In this post-crisis environment companies have increasingly diversified into new markets. Many are finding themselves operating in unchartered territory, challenging their risk management capacity and forcing them to reassess their risk appetites. This increased exposure to existing external risks, combined with an increasingly global trend of societal and political risk, means effective enterprise risk management (ERM) is now more important than ever to ensuring positive investment outcomes.
A Holistic Approach to Risk
The global risk environment is driven by increasingly interrelated factors. Over recent years, particularly in the emerging markets (EMs), there has been evidence of rising political oppression combined with the disaffection of growing middle classes, government corruption and the inequitable distribution of wealth – all catalysing into key flashpoints around the world.
These issues outlined above act as risk multipliers and increase the chances of societal upheaval, labour unrest and regime instability, in addition to creating an environment ripe for instability, conflict and political violence, legal and regulatory uncertainty, resource nationalism and expropriation. Further impacts extend to a breakdown of societal resilience to combat the impacts of climate change, natural hazards and infectious diseases – risks that are far more prominent in the developing world.
Recognising the increasingly complex country risk environment and the variable impacts these risks have for all business functions throughout an organisation’s global operations, supply chains and investments, a holistic approach to managing enterprise risk is now more essential than ever.
Identify, Monitor, Manage
Continuous monitoring of a company’s country risk exposure is a key component of effective ERM: ensuring that the risk environment is adequately managed across all key business functions, and that the control mechanisms in place to address the impact of these risks continue to be proportional and effective. Risk factors such as regime stability, the regulatory environment, and the level of political violence are among those risks identified as having the highest propensity to change rapidly in a comparatively short period of time. Illustrating this, almost 25% of countries saw a significant increase in risk in Maplecroft’s
‘Conflict and Political Violence Index 2014’
(to be published on 7 May), when compared to just six months earlier.
Furthermore, by analysing the data over a greater time period, it is possible to identify key risk trends, thereby highlighting countries where the operating environment is increasingly challenging, in contrast to those countries which are experiencing a significant improvement in the investment climate.
To ensure a positive outcome when addressing risks such as political violence, it is important to assess the risk on a sub-national level. Key investment destinations such as Colombia (ranked 9th in Maplecroft’s Terrorism Risk Index 2014), Philippines (11th) and India (19th) experience significant sub-national variation in the level of terrorism, ensuring that the risk to operations differs substantially across the country. Utilising sub-national terrorism data, it is possible not only to identify emerging trends and ensure steps are taken to mitigate the risk, but also that the opportunities identified in comparatively lower risk areas may be exploited.
Country risk identification also needs to encapsulate the regional context, to assess the potential implications of changes in neighbouring countries/regions, or of risks which do not remain constrained by borders, such as pandemics and infectious diseases. The terrorist attack on Algeria’s In Amenas gas facility in January 2013, in which 39 foreign workers were killed, illustrates the importance of assessing the risk of a spillover of conflict and instability for neighbouring countries. In that instance, societal forced regime change in Libya influenced the destabilisation of Mali, which in turn acted as a hub for regional instability and contributed to a crisis that led to the hostages being killed in Algeria.
In addition to the regional context, throughout the process of identification and assessment, it is vital to view risks in conjunction with one another, considering their capacity to conflate. For example, a severe power outage – such as that which left 700m people without electricity in India in July 2012 – not only has an immediate impact on production, transportation and water services, but efforts to recover that lost productivity may be accompanied by a considerable increase in health and safety risk through companies introducing significant overtime. By identifying these risks and understanding their impact at every level of the company, effective ERM facilitates an integrated approach to managing these interrelated risks.
The Trajectories of Risk
A key component of effective ERM is the process of horizon scanning for emerging issues. By identifying the root causes of risks, and monitoring trends in these areas, it is possible for companies to both take steps to control risk exposure throughout their organisation and supply chains, and also identify those areas where there is long-term growth potential.
Structural risk indicators, such as the level of civil and political rights in a country, may provide a leading indication of the trajectory of the dynamic risk environment, including the level of security and regime stability. This was demonstrated in Ukraine, where a significant increase in human rights violations under the tenure of former president Viktor Yanukovych combined with exceptionally high levels of corruption to create the conditions for societally-forced regime change and the ensuing crisis.
Treasurers play an invaluable role not only in initial assessment of risk, but also through the process of ongoing monitoring and disseminating information throughout a business. The intelligence derived from assessing the impact of political, economic, legal and regulatory risk on corporate finance can be utilised to further refine actions to address risks. At the same time, this trend analysis can enable companies to identify key areas of opportunity.
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